CORPORATE GOVERNANCE 2: Corporate Governance and the Stakeholder
Corporate governance defines - the framework of laws, rules, procedures and regulations of the way people interact and relate with each other. It defines - the way the providers of capital (shareholders), the governing body (board of directors), managers and other parties comprising an organisation interact in the process of making decisions for the company which have an impact on disposition and activities of the company. Corporate governance clearly defines the respective roles and responsibility of each party in the organisation and the extent of their influence in helping an organisation achieve its goals and objectives. Corporate governance is one of the core factor defining characteristics of governing process of an organisation. In a simple definition, corporate governance is “the relationship among various participants in determining the direction and performance of a corporation”. (Oman and Blume 2005, p. 3)
Shareholders are primarily responsible for financing the operations of an organisation. In normal circumstances, controllers of the company are usually appointed by the shareholders. Owners of the firm are the one who hire managers who in turn control the operations of the organisation. This is a common feature of many organisations. (Stijn 2003, p.34)
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In deed shareholders need the right to hold directors to account. In most markets the right to appoint, remove and propose members to the board are valued as an essential part of the corporate governance tool kit. In light of this statement, this paper will look closely to the practice of corporate governance in UK and Italy in order to critically validate the statement. Let us look closely at the practice of corporate governance in the two countries. I have chosen Italy because the Italian system is characterised by the peculiar relationship that exists between. senior managers, majority shareholders and minority shareholders. As compared to the UK, which is a system based on notions and practices of individualism, short-termism and competition (Bhasa, 2004)
In the UK the financial market model that is dominant is characterised by a dispersed ownership and control structures which are coupled with availability of institutional investors. With time individual ownerships in corporation has fallen drastically. (Mendez, 2002) This could have a far reaching effect on the strength of the shareholders to control the board of directors since an institution may find it difficult to make a decision easily like an individual person. Individuals can make decisions more easily than institutions since the decision making mechanism is somehow not consultative. At the same time institutional ownership of a corporation may create a fair trading ground since they are bound to have some influence. When individuals are shareholders, there are those who will tend to have more influence than others depending on their economic background or their career background. Institutions usually extend some respect for one another and are likely to exert their influence based on the shareholding percentage. As usual in any corporation, institution with major shareholding may be given more voting rights than those with less percentage of ownership. (Mendez 2002, p.32)
In European countries there is a bank oriented model which is characterised by some degree of ownership concentration which translates to a higher degree of control by some shareholders, sometimes referred to as block holders. This clearly shows that this model is bank oriented instead of being oriented to financial markets simply due to the function financial institutions play like bank and insurance companies in providing capital for the corporate organisation. Contrary to many models in the world, this one in most European countries is insider dominated rather than outside dominated since the funding financial organisations are very much involved in running the organisation having a representation on the board. In some other models you will find that the financial institution funding the organisation will just provide funds in form of loan but will not demand to have a representation in the board. As expected being the one providing funding means that the financial organisation will have an influence on the decision made in the organisation. This sometimes leaves other shareholders with little say in the running of the organisation. But in a normal practice the financial organisation should just provide funds for the organisation and leave it to operate on its own.
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You will find that in this model financial institution will appoint their person to the board. Contrary to other models where other shareholders may have a say on who represents them on the board, the financial institutions here may not need to consult with others since the institution is seen to occupy a central role in the organisation. This model has a weakness arising from the ownership landscape due to strong block holders and weak dispersed owners. In most organisations the dispersed owners group holds the majority of the capital in the organisation. Most of the time there are at mercy of block holders who most of the time appoints managers and strategies for the operations of the organisation in pursuing their selfish interests. This model discriminates against the influence of majority shareholders. (Ronals 2004, P. 70)
However there is a different model in the UK in which there is dispersed and fragmented ownership. This results from the role played by the financial market in the organisation. Contrary to the other model in European countries, this UK model produces a weak ownership and control link. Weakening of this link means that one party between the owners and control or between the shareholders and the board will have more power over the other. In most instances it is the board that ends up with more power over the shareholders because they are more involved in running the company than the shareholder. In some instance it becomes difficult for the shareholders to have a control of organisation. This kind of ownership structure in which ownership has a more weak control of the company is called Anglo-Saxon system. (Mark 2004, p. 65)
Here is it evident that when voting power of the shareholders is concentrated and the ownership is not, there are temptations to have private benefits for the managers or for block holders. But in most instances this depends on the devices that have been put in place that separate ownership from control. In the whole of Europe, the UK then comes with a model that is different from others. (Arye 2005, p. 4)
In the EU there are various structures of the board that have been put in place. There are some differences in the way the boards are constituted in the various countries. There are those countries using the two-tier system, others use quasi-tier while other like Italy and the UK use unitary board as the only system. In these countries there are variations related to the role of non-executive Chairman of the board and that of executive committee. However unlike in the UK, in Italy there is a board of auditors that is separate from the board. In the UK non-executive chairman is supposed to ensure that there is smooth function of the board. The chairman sets the agenda, presides over the board of meetings, guides selection of new directors, informs the directors, and serves many other functions. (Calvin 2006, p. 65)
These results show that in Italy, the corporate governance structures are oriented to the financial institutions. It lacks fiduciary duties and there are separations between ownership and control which is guaranteed by a mix of state ownership. This system of corporate governance does not fit in either category of bank-based or stock exchange based system. It can be considered as a recent emerging system which distinct between insiders dominated and outsider dominated system. The governance structure of Italy is such that firms depend more on bank finances, financial markets, ownership and control which are concentrated. Firms have adopted the use of great mechanism which separate ownership and control. This sets out conflicts between minority and majority shareholders. Also in the system, boards play a minor role which is limited and the market for corporate control is not active. In such an environment hostile take-over are rare and unlikely. It is evident that in Italy the state has a lot of control of the corporations.
However this is changing in Italy as the process of privatisation has taken root. Financial institutions are increasing their role and they have started lending more to these corporations. Italy has enacted a financial act which is protecting the rights of small shareholder against exploitation by major shareholders averting a possible conflict between the two. (Barca 2006, p. 45)
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Hence the Italian system of shareholding cleary gives us a good example of corporate governance through the influence of the shareholders. In Italy it is recorded that the domestic non-financial sectors owns more than 87.3% of all shares. It is in the same light that these majority domestic shareholders have a right in the appointment of the board of directors. This may explain the reason why coalitions of control in Italy are perpetuated for a long time. It has also been evidenced the minority shareholding in Italy has used all levels of the pyramid in order to ensure funding without necessarily giving up the control of the organisation. (Visintin1999, p. 87)
The above explanation sets out the important role that is played by shareholders in ensuring that they are given a hand in deciding who sits in the board. We have seen Italy as an emerging example of outside oriented corporate governance where the shareholders are coming up to exert more controls in the running of the institutions. Shareholders as the owners of the corporations have several rights which enable them to govern the corporations. This can be directly or it can be through an elected representative to the board. The right to vote in deciding on matters concerning the organisation is perhaps one of the most important powers that are given to the shareholder. This right to vote should be guarded by all means since shareholders must decide for their investment. Voting right is the shareholders democracy.
Hence in the UK shareholder may have less power in influencing how the board of directors runs the corporation unlike in Italy. The board of directors in the UK seems to wield more power over the shareholders. Contrary to this in Italy, there seems to be a dispersed control which shareholders increasing their say in the markets.
After making this comparison it is clear that the shareholder should have the right to decided who represents them in the board of directors. Being the owners of the company, shareholders must be given their democratic right. It is time the UK adopted a similar model as it is being developed in Italy which is giving shareholder more control over the board.
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