The controlling shareholder


INM Teaching Note

Synopsis of the Case - brief description of the case and the context in which it is set

The presence of a controlling shareholder can dramatically change best corporate governance practices. How extensive these changes need to be depends on the character of the controlling shareholder and the ability of an independent board (a board independent not only of the corporation but also of the controlling shareholder) to effectively handle its relationship with this very special shareholder. Institutional investors will identify red flags that may indicate controlling shareholder opportunism and then try to persuade the board to improve its corporate governance practices. Minimally, making these red flags known to other shareholders and stakeholders will help put pressure on the board to correct bad practices and change the ways of the inappropriately opportunistic controlling shareholder, protecting value for all shareholders and other stakeholders.

Abuse of power by Anthony O'Reilly - Questions

Independent lead director:

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Was there an official or unofficial independent lead director who has the authority and stature to take Anthony O'Reilly quietly aside and objectively express concern about the controlling shareholder's strategic plans and operational decisions—and will the controlling shareholder listen? Is there one there now for Gavin O'Reilly and Denis O'Brien?

Executive Compensation:

If the controlling shareholder has an employment contract with the company, it is important that the board negotiate the contract through an independent committee with advice from outside counsel and compensation consultants directly engaged by the committee.

Limits of Authority:

If the controlling shareholder is the CEO, what are his “limits of authority” when it comes to board involvement? A review of committee charters will reveal what issues need to be reviewed independently, e.g. , hiring and termination of senior officers, director nominations, major investments, strategic decisions, etc. A review of committee reports will reveal the board's ability to retain independent counsel and other professional advisors.

The Independence of the Board & the Value of an Independent Board

Denis O'Brien up to this point was publicly branded a dissident shareholder by INM and was a man who publicly stated a vendetta against the then Group CEO of INM -Tony O'Reilly. Denis O'Brien had over a six year period taken actions as a shareholder that negatively impacted on the value of INM shares while simultaneously making himself a majority shareholder. Denis O'Brien made personal attacks on the then Group CEO as to his decision making abilities for running companies not related to INM. To allow Denis O'Brien to nominate three directors for the board of INM was a major decision for INM as it means there are now two warring factions on the board of INM. Both of whom are represented by majority shareholders of near equal values. It means that the board of INM really and truly cannot be considered independent.

A recent article by Professors Lucian Bebchuk and Assaf Hamdani has brought to the fore the idea that good corporate governance practices at a publicly held firm 1 will not necessarily be good practices at a publicly traded firm in which there is a controlling shareholder. 2 This is because board independence, 3 a key concept in structuringappropriate corporate governance practices, has a different meaning when a controlling shareholder is present. Corporate board members of a controlled company, even if meeting all of the currently mandated independence requirements and truly independent of the corporation's management, 4 may not be independent of the controlling shareholder. 5 If so, then these directors may be severely lacking in the ability to exercise “independence of mind,” the ultimate purpose of board independence. 6 Therefore, where a controllingshareholder is present, board independence must mean independence from the controllingshareholder as well as the corporation. 7

Board independence is also critical to corporate governance because it allows a board to properly fulfil its duties under the law. Corporate law requires the firm 8 to be led by a board of directors, not the controlling shareholder.

Identifying whether or not a board is truly independent is just the first step in evaluating the quality of corporate governance at a controlled corporation. After all, a controlling shareholder 14 still has the power to dominate an independent board through his direct voting power and by threats of removal. 15 Therefore, a proper evaluation requires knowledge of those corporate governance practices that a controlled company uses to monitor and manage the decision-making influence of the controlling shareholder. Furthermore, to make sure these practices are optimal, a subjective analysis of just how the controlling shareholder interacts with the board is required. In addition, the focus of such a subjective analysis must go primarily to an evaluation of the character of the controlling shareholder and his/her motivations regarding the welfare of the company.

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The personality of the controlling shareholder will also play a role in determining the most optimal corporate governance practices (Bebchuk and Hamandi's)

The questions this raises for corporate governance at IMN such as:

Will the board of INM always make decisions in the best interest of the company or will they have motivation to make decisions to spite the representatives of the antagonist (DOB) and vice versa.  

Will the representatives of Denis O'Brien and representatives of Anthony O'Reilly provide checks and balances for each other that create a better decision making board than what was previously the case where there was only one majority shareholder on the board: the Group CEO Antony O'Reilly?

Anthony O'Reilly was a majority shareholder and Group CEO of INM when the decision was made allow Denis O'Brien representatives on the board of INM. If INM had an independent board at the time would they of made the same decision?  Or to put it another way: was this decision made because of the personal pressure Anthony O'Reilly was put under by Denis O'Brien?

Given the bitter rivalry that was shared between the present board members of INM would it be in the best interests of the company to create an independent board of directors free from the influence of majority shareholders?

Issues in relation to Majority Shareholders and Agency Theory

Before retirement Anthony O'Reilly was the Group CEO of INM with a stake of over 28%, with leverage over more than 29.5% with family and other connected parties. Because of this situation the board of INM could not be considered “independent” in the parlance of Corporate Governance Best Practice. Anthony O'Reilly's large share in the business and his competitive personality would suggest that he was a majority shareholder who reduced “agency costs” for INM by seeking wealth maximisation for the company. However if you consider some of the benefits Anthony O'Reilly enjoyed as a result of his position there may be a suggestion of personal indulgence on his part. For example Denis O'Brien believed that Anthony O'Reilly used his power in INM to ensure that O'Brien was given negative news coverage in regard to the awarding of a telecoms licence and the subsequent Moriarty Tribunal that followed. Another example in this vein is while he is a person in a unique position to communicate with the Group CEO, Anthony's appointment of his son Gavin as Chief Operating Officer could be construed as nepotism by critics.

In a publicly held company where there are a large and diverse number of shareholders, a classic agency problem is created because of the separation of ownership and control—will the managers work for the shareholders or advance their own interests? 18 Inserting the presence of a controlling shareholder into the mix may help reduce these agency costs, if he uses his clout to monitor the activities of management, 19 either by becoming the Chief Executive Officer (CEO), actively participating as a board member or having one more of his agents representing his interests on the board.

However, the presence of a controlling shareholder can also create agency problems between the controlling and noncontrolling shareholders 20 and other stakeholders as a controlling shareholder can also create agency problems between the controlling and noncontrolling shareholders 20 and other stakeholders in the firm. This problem arises if the controlling shareholder tries to use his authority to transfer corporate resources to himself for personal consumption or gain in which the non- controlling shareholders do not proportionally benefit, 21 and/or results in harm to the corporation.

There are two types of private benefits of control: pecuniary and non-pecuniary. 22 Pecuniary benefits include “tunneling transactions,” corporate perks and theft. 23 Non-pecuniary benefits include “forms of psychic and other benefits that, without more, involve no transfer of real

company resources and do not disproportionately dilute the value of the company's stock to a diversified investor.” 24 For example, nonpecuniary benefits may derive from having control of a major national newspaper through which the controlling shareholder may have the opportunity to influence national opinion. 25 Or, one can receive the non-pecuniary benefits of placing family members in executive positions whether or not they are qualified.

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While the ability of a controlling shareholder to take advantage of non-pecuniary benefits

may seem less pernicious, the result can be just as financially harmful to non-controlling shareholders and other stakeholders since the controlling shareholder who takes advantage of either type of benefit, pecuniary or non- pecuniary, may be effectively “maximizing the controlling shareholder's utility,” but not necessarily “maximizing the value of the corporation.”

Questions that arise in regard to the agency problem and INM's majority stakeholder situation are:

· Did Anthony O'Reilly abuse his position as Group CEO for his own benefit?

· Was it in the best interests of INM to appoint Gavin O'Reilly as COO?

· Is there a conflict of interest in being involved in high profile public tenders and also in control of the most prolific media group in Ireland?

· Is the case that Denis O'Brien's majority shareholding is creating new problems for INM?

The Impact of a Controlling Shareholder on Corporate Governance Practices

Denis O'Brien may have had some credible reasons for criticising INM's Corporate Governance in terms of “Best Practice”.

There are numerous corporate governance practices that are presumed to be optimal in a publicly traded corporation; these include having an independent majority of the board, majority voting, annual election of directors, allowing the board to meet in executive session without the presence of executive management and requiring shareholder approval to amend bylaws. In addition, corporate governance is normally enhanced when there is an absence of the following: a poison pill, charter provisions that allow directors to be removed only for cause and super majority voting requirements for shareholders.

What we normally consider best practices are not so when a controlling shareholder is present. The presence of a controlling shareholder moves the focus of agency costs from executive management to the controlling shareholder. We are now most worried about controlling the possible bad behavior of the controlling shareholder, not the executive management team.

This change in focus means the following in regard to best practices:

  • Board member independence now has to be evaluated in terms of the controlling shareholder as well the corporation.
  • The annual election of directors and the absence of charter provisions which allow directors to be removed only for cause smoothes the way for a controlling shareholder to force the termination of disobedient directors and puts pressure on individual board members to obey the controlling shareholder or be ousted. Instead, it would better to have staggered boards in combination with charter amendments protecting directors from dismissal prior to the expiration of their term except for cause. 40
  • The company should require the Chairman of the Board to be independent of both the controlling shareholder and CEO.
  • It should not allow the controlling shareholder to be on the board nominating committee.
  • It should not allow family members of the controlling shareholder to serve on the executive management team
  • A number of presumed best practices become inconsequential such as majority voting, meeting in executive session (controlling shareholder on board, but not part of executive management), shareholder approval of bylaws, shareholder nomination of directors and the absence of a poison pill.
  • Supermajority voting requirement for shareholders becomes a necessity in order to give some voice to minority shareholders.

Such practices not only help keep the controlling shareholder from engaging in opportunistic behavior, but also supports the board's role as an independent decision-making body within the corporation.


Understanding the Controlling Shareholder

Anthony O'Reilly is a man with a competitive nature, a man who knows how to win. The question is did he use INM to further his own interests in other business situations or use INM to sway public mood to align with his interests. The Independent Newspaper is the widest read daily in Ireland with a circulation in excess of 500,000. It is the case that Anthony O'Reilly published biased content on the front page of The Independent that debatably swayed public opinion in favour of Fianna Fail and the Progressive Democrats in the 1997 general election. This many attribute to action to stem from a dispute between Sir Anthony and the former Taoiseach John Bruton over one of his business interests.

Anthony O'Reilly and Denis O'Brien both competed for the Esat mobile telecom licence and O'Brien won. The Independent's subsequent coverage of the Moriarty Tribunal then can objectively be viewed as history repeating with O'Reilly using his influence at INM to paint a negative picture of O'Breien's role in that contest. Even if this is not the case

O'Reilly has left himself open to accusations for acting unethically in reagard to news coverage in the past - i.e. by putting opinionated stories on the front page of the largest newspaper in Ireland at a critical time in an general election.

Denis O'Brien is an extremely successful business man who knows how to get things done. However he has a public vendetta against the O'Reilly family and their affiliated board members and has acted in a way that hurt the interests of other shareholders in the past and perhaps will do so again in the future to further his own ambitions.

In the worst case scenario, where the controlling shareholder uses every opportunity to abuse his position and steal value or opportunities from the corporation, impose his whim and will on the corporation, and steamroll his directors into submission and timid compliance,

implementing the above list of best practices and more must be considered a necessity.

The practical reality is that most controlling shareholders, who can be assumed to be driven

and powerful people, fall somewhere in between these two extremes[..]. 43 If so, the board will be working with a strong-willed person, who has a sense of ownership, high level of identification with the company and is driven to succeed no matter what. Such a controlling shareholder will want to convince the board that his ideas are best for the company rather than just telling them what to do. 44 He will realize that “buy in” will ease implementation whereas ordering compliance breeds resentment. This dynamic will force the controlling shareholder to think through his ideas, prevent major snap decisions, and open the opportunity for generating more and better options. 45 In other words, the directors will more than likely have an opportunity to provide counsel, influence the controlling shareholder's thinking and move forward in real alignment.

Moreover, although it is true that the controlling shareholder has ultimate control over who sits on the board, nominating his own candidates from the floor if necessary, it cannot be assumed that every controlling shareholder will only want to surround themselves with sycophants. For example, the controlling shareholder may have the desire to assemble a high caliber board because it both benefits him and “his” company and (on a less complementary issue) because star power on the board strokes his ego. 46 In addition, many powerful people are smart enough to surround themselves with people whom they believe are smarter than they. As a result, the controlling shareholder may try the best he can to retain his independent directors and view the threat of resignation by a key independent director as a cause for grave concern. Finally, resignations “en masse” may be a credible threat to the controlling shareholder as it could do damage to his net worth by sending

a negative signal to the stock market, while also tarnishing his image as a leader. 47

It is also important to keep in mind that the passion, drive and ingenuity of a controlling shareholder may be the secret to superior company performance, accruing to the benefit of all shareholders and other stakeholders. Therefore, the benefits derived from the presence of a “benevolent dictator” may mean that the corporation is better off by seriously considering whether to implement all of the best practices described above. At the same time, the controlling shareholder (especially coming from full ownership) may never lose his attitude of “l'entreprise c'est moi,” i.e. , never accepting that he is no longer the “owner” of the corporation, and as a result, not adequately respecting the interests of other stakeholders, especially other shareholders.


Have Anthony O'Reilly's high profile business dealings outside of INM made INM a target for thwarted rivals who have been angered by news coverage?

Can Denis O'Brien ever be trusted to represent the interests of other shareholders given his track record with the company?