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Introduction to WH Smith PLC. WH Smith PLC is a UK company recognised as a newspaper, periodical and book retailer currently standing as an Ultimate Owner. Historically owned, WH Smith was established in 1792 as an Ltd, originally family owned and passed down until the last family member owned all ordinary shares and considered the major shareholder. WH Smith emerged as a PLC where its shares were sold to the public. Eventually, the Smith family's control faded resulting in the last family member leaving the board in 1996. (WH Smith PLC, 2010)
1b.) Classical Objective
WH Smith is a corporate business encountered in fulfilling market share and current earnings (profit) all in which revolve around the 'interests' of its owners (shareholders). Shareholders control the corporations' direction and policies (electing Board of Directors), who in turn select top management whom serve as corporate officers and manage the operations of the firm in the best interest of shareholders. (Damodaran, 2006) Corporate financial theory determines stock price maximisation as the classical objective in decision making. (Damodaran, 2006: p. 11) Once shares are traded and markets are viewed as efficient, the narrowed objective is to maximise shareholder wealth for which translates through the maximisation of share price. Share prices are accessible and observable for judging the performance of a PLC and constantly reflecting company performance. If stock price maximisation is to be a dominant objective, assumptions are made that managers are in fact responsive to the owners of the firm. (Damodaran, 2006)
WH Smith shareholders
In the UK shareholders typically have ultimate firm control through hiring and firing the board of directors. (Hillier et al, 2010) WH Smith has a diverse shareholder base consisting of no individual/institution controlling the corporation. (Mallin, 2010) The company measures as an 'independent company' ranked as A+ whereby no shareholder exceeds 25% of total ownership. WH Smith gains independence as 75.1% of its shareholders are known making it impossible for unknown shareholders to own 25.1%+. (Fame, 2011) To examine the ownership and control WH Smith pursues, this assignment will focus on the known 95 shareholders identified on Fame whom together hold over 75.1% of shares. This assignment will predominately examine the top 10 of the 95 shareholders. (See table 1)
Not only do the top 10 shareholders hold fairly high stakes in the company; the top 6 in particular own a total of 52.9%. This indicates more than half of ownership and control is held by the selected majority. The majority are defined as, a group of shareholders who collectively control more than 50% of a corporation's outstanding shares. (Besley et al, 2008) The majority top 10 is also illustrated on pie chart (1) where it shows the ownership range from 10.51% to 4.99%. Critically, ownership dispersion can result in powerless shareholders as no individual among them has any appreciable voting power or control. (Leech, 2002) If ownership is too dispersed amongst a high number of small shareholders, a downgrade in corporate governance is evident as little incentive is invested in examining the board's actions. Large shareholders are likely to have more power to monitor management activity thus strengthening corporate governance. (Kostyuk et al, N. D) Since WH Smith's top 10 shareholders are large associates with concentrated power, the company has strong corporate governance since larger stakes encourage better monitoring to ensure shareholder interests are served.
WH Smith represents a variety of foreign shareholders in which may also affect monitoring corporate governance. Fame demonstrates WH Smith is involved with over 10 different countries for which can create problems. (European Central bank, 2008) Foreign companies must comply with the differing regulations 'on accounting standards, disclosure and transparency and inevitably, with the norms of that countries corporate governance.' (Economist, 2001) However, the chosen 10 only consist of shareholders from GB, US and FR. (Fame, 2011) Fortunately GB holds a dominant representation amongst the top 10 thus monitoring is less of an issue.
Top 10 WH Smith Shareholders (Table 1)
Standard Life PLC
Affiliated Managers Group
Artemis Strategic Asset Management Limited
Lloyds Banking Group PLC
Total shareholder rate above 50%:
JP Morgan Chase & Co
AXA Financial SA
Jupiter Fund Management PLC
Employee Share Scheme Trustees
Total shareholder rate:
A: Insurance Company
F: Financial Company
E: Mutual & Pension Fund/Nominee/Trust/Trustee
Pie Chart (1) showing the level of ownership amongst Top 10 Shareholders at WH Smith
Pie Chart (2) showing the level of ownership in relation to type of Shareholding Company
Conflicts of interest and Agency Costs
3a.) Conflicts of interest between Shareholders (Majority Vs Minority)
WH Smith is considered a large organisation consisting of various shareholders (individual and institutional) each likely to possess a diverse range of ownership interest. (Damodaran, 2006) Institutional shareholders hold a dominate position amongst the majority as they hold higher stakes in the company thus overpowering the considered minority in decision-making. (Mallin, 2010) Since the majority own 50%+ of equity stake, many companies are controlled by few large top shareholders (WH Smith top 6 shareholders) that generate a powerful voting block where the majority cast votes and control the appointment of directors. (Leech, 2002)
Consequently, WH Smith had experienced a critical period during 2004-2005, where management performance was criticised. A specific conflict emerged due to irrational incentive payments proposed by the remuneration committee. 'One in three WH Smith shareholders' rebelled against the boardrooms pay policies by 'either opposing or abstaining from a vote to approve its remuneration report.' (Independent, 2004) Since some shareholders disproved the pay plan, others supported it resulting in a conflict of interest between shareholder views towards fair compensated operations. 'Around 100 million shareholders backed the group's pay plan, but 34 million voted against it and a further 17 million abstained.' (Independent, 2004) With the risk of insufficient voting from all shareholders, WH Smith was exploited to weak corporate governance.
Conflicts of interest may arise amongst shareholder companies. Insurance companies and banks often vote with management due to potential business interlinks they wish to pursue. Nonetheless, mutual and pension funds contrast with management as internal benefits are less evident. (Eakins, 1993) Academics argue shareholders tend to 'follow the Wall Street rule and either vote with managers or sell their stock when policy disagreements occur.' (Eakins, 1993) In relation to WH Smith, pie chart (2) illustrates 54% of the top 10 shareholders are insurance and financial companies (including banks) indicating a large % vote alongside managers, whereas mutual and pension funds make up 20%. Such distinctive shareholder interest can generate conflicts of interests throughout board voting.
Further potential conflicts are between pension funds themselves. 'Public funds' primary goal is to avoid poor performance, while private funds try to achieve superior performance - a fine but very important distinction.' (Monks et al, 2008: p 149) Since mutual and pension funds hold the least percentage (20%) in the top 10, the risk of this differing interest is unlikely, particularly since most pension funds are not present in the top 6 of the majority holding 50%+. Therefore their level of ownership and control is minor.
3b.) Conflict of interest between shareholders and Managers
Although shareholders are ultimate owners of the company, the day-to-day operations of the business are delegated to the board of directors and managers thus creating an agency relationship. (Hiller et al, 2010) Collectively, shareholders are regarded as outsiders and no 'one' shareholder has the power to influence or control the firm. In effect, the 'principle' hires 'agents' to control and base decision making around shareholder interests. Focussed on maximising stock price and shareholder wealth, corporate finance exposes itself to risks where the possibility of conflicts of interest between shareholders and managers arises for which may obstruct the firms' classical objective. Managers' interests are known to revolve around job security and firm growth for which allows greater control, corporate power and higher salaries. (Band, 1992) Conversely, shareholders aim to maximise profits through share prices, for which in turn maximises their wealth. (Damodaran, 2006) The separation in ownership control can create problems known as 'Agency costs.' (Mallin, 2010) Firms incur agency costs to reduce conflict of interest between principle and agent. (Baker et al, 2005)
Theoretically, shareholders are assumed to have the power to discipline and replace individuals in management level who do not achieve shareholder interests. (Damodaran, 2006) This is known as a 'proxy fight' (Hillier et al, 2010). In relation to WH Smith, such power is exercised through their 'Annual General Meeting' (AGM) whereby shareholders assess, evaluate and monitor management performance. A further mechanism is through the board of directors whose duties are to ensure managers serve shareholder interests and achieve the corporations' classic objective. In return the board is kept informed of the views and concerns of major shareholders for any decisions made on election/re-election. (WH Smith, 2010)
WH Smith presented a rapid decrease in share prices during 2004 to late 2005 straining shareholder wealth and reduced the value of the firm. It can be assumed the various conflict of interests proposed in this assignment were provoked throughout this period. Coincidently, a change of management was also reported whereby former board member Richard Handover (whom was Chief Executive Officer since 1997) was appointed to take over Martin Taylor's position as Chairman as the latter retired due to ill-health. Assumingly, this replacement enforced a positive impact on share price as figures on graph (1) show an increase from 290.03 to 366.00 for which inconsistently improved until late 2008. In relation to the classical objective on share price maximisation, the best-case scenario of a conflict free corporation is when managers of a firm put aside personal interests and instead maximise shareholder interest. (Damodaran, 2006) Since shareholders consign their interests to managers, they expect positive results. Theoretically, this commitment may occur due to the intimidated nature shareholders uphold since they have control to replace management if unimpressed. (Damodaran, 2006) For example, in 2003, the previous Chief Executive Officer (CEO) of WH Smith was sacked within the weeks after a disappointing Christmas performance (BBC News, 2004) to fulfil shareholder interest. Statements clarified that there has been 'strong shareholder criticism of executive performance.' (BBC News, 2004) Astonishingly, the newly appointed Handover was referred for re-election as statements verified 'Mr Handover... has come under fire for disappointing trading' as votes were adamant for an earlier leave. (Telegraph, 2004) Since the Chairman ensures the interests of shareholders are actively met, one can assume the fluctuated share price performance may be due to a disappointing effort in serving shareholder interest.
Furthermore, directors do not necessarily spend productive time on their fiduciary duties; mainly due to other commitments served in different corporate boards. (Damodaran, 2006) For example, Handover was also Chairman of the Remuneration committee at Royal Mail PLC group. (Bloomberg, 2011) Moreover, studies found that many directors hold small equity stakes in their corporations. Therefore, many find it difficult to empathise with the dilemma of shareholders when share prices decrease. (Damodaran, 2006) 'Managements ownership of shares is predicted to positively affect firm value' (Band, 1992) as it's assumed they will be motivated to increase share value. Unfortunately, WH Smith fails to follow this since its current Chairman Robert Walker holds only 0.02% of ownership whereas CEO Kate Swann holds even less. In fact, some argue, although the CEO was given 141,000 shares once joined, 'she had not spent any of her own cash on buying shares. So she has no faith in the company?' (Independent, 2004)
Additionally, WH Smith sales were reported as 'unacceptable' during its critical period as the company revealed exceptional operational costs for which strained the firms' profit. Swann clarified the company's cost base was to be 'materially reduced.' (BBC News, 2004). Corporate theorists suggest the board of directors are the 'insider' body that represent the authentic owners and who should ensure all operations within the business are carried out in the best interests of shareholders. As such, shareholders do not appreciate excessive corporate expenditure (Hillier, 2010) especially if resulting in share price reduction. WH Smith managers acted towards their own desires by strengthening management levels and improving store image (BBC News, 2004) resulting in decisions that made managers better off at the expense of shareholders presenting a direct from of agency cost. (Damodaran, 2006)
Although graph (1) entails a fluctuated performance it also illustrates an improved increase through its variations since share prices increased from 366.00 in 2005 to 448.20 in early 2009. In 2004 the CEO was typically appointed through the standard procedure of the UK's corporate governance whereby the majority casted votes and appealed Swann as WH Smith's next potential. Being CEO for 8 years, Kate Swann 'has won plenty of fans amongst shareholders' (This is money, 2010). The CEO is the most senior manager and in ultimate control of the day-to-day business operations. Since this position plays a crucial role, Swann is evidently targeting shareholder interests whilst reducing conflict between shareholder and management.
3c.) Minimising conflict of interest
Since potential conflicts can arise, shareholders often issue incentives to encourage management to act on their best interest. One way to minimise conflict of interest is through managerial compensation (Hillier, 2010) in particular, cash bonuses. In 2010 the company increased both executive cash bonuses under the 'Annual bonus plan.' The CEO is given the chance to earn an additional 200% of the basic salary and the Financial Director 130%. (WH Smith, 2010) This shows a balanced incentive for managers to principally keep shareholder interest in mind. In turn, an effective remuneration committee (non-executives) are able to conquer payment packages (base and bonus) to align performance level better with the interests of shareholders. As a result, managerial compensation will remain efficient in the long run, motivating managers to maintain positive performance in order to maximise total salary whilst minimising conflict of interest.
To assess the extent pay incentives work in aligning management performance with shareholder interest, an accurate analysis is measured through the Total Shareholder Return (TSR) rather than dividends per share and capital gain since TSR measures shareholder wealth. Since WH Smith consists of only 2 executives, I looked at CEO and Finance Director Base and total (Base + Bonus) remuneration % change against the company's TSR.
TSR % = (Stock price end of period - Stock price start of period) + Dividends per share Stock price start of period
WHSmith PLC TSR
Graph (2) illustrates a correlation between share price and TSR indicating that as share price drops, shareholder wealth is also at risk. For example, as WH Smiths share price decreased during early 2005/06, this reflected in TSR. The fluctuations presented on graph (1) also correlate with the variations in TSR thus supporting the concept that managerial decisions can have an effect on shareholder wealth.
Managerial compensation is frequently connected to financial performance. Thus it is interesting to see if pay incentives propose an influence on managerial performance. Monitoring what management does is a major practice in reducing conflict. Graphs (3-6) illustrate the % change in base and total salary in relation to TSR amongst both executives. However, pay adjustments will not be made until after the previous year's performance is known. Thus for an accurate representation for the related correlation between salary and TSR I decided to also show an adjustment for both executives base and total remuneration by TSR year n+1. (See graph 4 and 6) Therefore, a decent correlation between TSR and executives is noticeable. In particular, the total remuneration illustrates a clearer correlation and this shall be explained in more detail below. (See graph 5 and 6 for year n+1)
In 2007/08 graph (6) shows a fall in TSR along with the CEO's total remuneration. This indicates that as shareholder wealth decreases, CEO is punished since her bonus decreased. In fact, in 2008 her total salary was reduced from £1,453,000 to £1,421,000. (WH Smith PLC, 2010) As TSR increased again in 2008/09, CEO total salary dropped even further. One can assume the inconsistent fluctuations over time may have provoked shareholders to decrease CEO compensation since a stable increase is not maintained. On the other hand, in 2008/09, graph (6) illustrates a rapid fall in total Finance Director's pay. Explaining this drop, in 2008 Alan Stewart was replaced by Robert Moorhead whom is the current Finance director of WH Smith. One can assume that Moorhead's level of experience may not have been as advance resulting in total salary reduction until earned. Nonetheless, as TSR rose in 2009, the Financial Directors' total remuneration also showed a positive correlation.
Graph (7) illustrates a sincere overall correlation of both executives combined to demonstrate the relationship of base and total when compared against TSR year n+1 presenting an accurate correlation. Despite the fall in managerial performance during 2005/06, WH smith has successfully improved the quality of its remuneration as both, total and base indicate a positive alignment with TSR. As TSR decreased in 2007/08 both Base and Total remuneration fell in 2008/09. Once TSR picked up again in 2008/09, Base and Total also increased the year after in 2009/10. Not only does this indicate that managerial compensation positively reflects financial performance, it also signifies that WH Smith has managed to align managerial performance along with shareholder interests thus minimising agency problem. However, in 2005 the company experienced turbulence in its remuneration scheme since a slight agency cost is demonstrated particularly for total remuneration. As mentioned, a large number of shareholders criticised the company's pay plan during 2004/05. One can assume the majority whom voted for better remuneration were successful since the agency cost used, resulted in a better performance in the remuneration committee for the following years.
The remuneration committee are principally responsible over managerial salary. They have shareholder interest at heart and have conquered an effective strategy in controlling managerial performance as they are able to punish if interests are not met and reward when owners are satisfied with management targets. Nonetheless, if the remuneration committee are not using pay effectively to attain positive performance, shareholders have the power and control to dismiss the committee and elect members whom target shareholder interest. Overall, managers who are successful in pursuing shareholder interests will be in greater demand within the labour market and thus receive higher salaries.
Balance of power
In conclusion, the balance of power at WH Smith lies with shareholders since they uphold the major control of hiring and firing board members whom fail to fulfil their interests. The remuneration committee are a suitable example in serving shareholder interest as managerial compensation is determined accurately on the basis of performance. However, the various conflicts of interest proposed indicate that shareholders lack the 'full' control specified in theory. In practice, managers exerted control over shareholders as they incurred exceptional direct agency costs. This left shareholders at the expense of managers indicating an agency problem. Overall, WH Smith practices the UK Combined Code of corporate finance as managerial positions are segregated ensuring no individual has excessive power over shareholders. Today's corporate governance consists of smaller boards as WH Smith shows with 2 executives and 5 non-executives. A study on corporate governance found the average board has a 'five to one ratio of independents to non-independents.' (Hembrock, 2010) Since WH Smith have a small ratio of executives compared to non-executives the risk of management empowering is unlikely.
Theoretically, financial markets are regarded as efficient as managers are assumed to convey information honestly and truthfully. In turn, financial markets judge the 'true value' of the corporation, in this case through share price. Not only does WH Smith present general company information available on sources such as FTSE, Fame, annual reports and other financial databases to measure performance, its visibility slightly increased during its critical period when the company's corporate governance performance was announced through online newspaper articles (media) in 2004/05. To some extent WH Smith constitutes efficiently as its available 'bad' news correlates with the affairs taken place during that period. However, 'an organisation that responds quickly to a bad situation... Can culminate very quickly into a bad storm of press.' (Ipranet, 2010) There is no guarantee that free available information constitutes to an efficient financial market since managers are able to control the information by delaying the release of bad news. Although WH Smiths severe fall was in 2004, its first signs of share price reduction happened in 2001. The available information presenting 3 years of critical performance was only just announced in 2004/05 when share prices increased. If bad news was constantly announced during 2001-2005 the company's reputation would be severely damaged whilst jeopardising its financial implications in the long-term. Although WH Smith was reluctant to bad press in the past, today the company has managed to redeem itself and reduce its level of visibility in which encourages better performance by managers in the long-run. (Damodaran, 2006)
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