Date: 30 April, 2014 , Published in UWL journal
Table
of Content
Abstract
The continual cases of expropriation of
minority shareholders by the dominant shareholders suggest that expropriation
is becoming the norms among listed firms and organisations. This dissertation reviewed
different organisation structures and corporate governance mechanisms. It also explored
the effect of the board of director’s affiliation with the dominant
shareholders on fund misappropriation and expropriation in listed firms.
Additionally, it analysed the roles of board of directors in firms and
evaluated the impact that ineffectiveness of the board of directors have on the
alleviation of expropriation in listed firms. Furthermore, it elicited
different ways by which protection of investors can be enhanced in an
organisation. In conclusion the dissertation suggested that strong legal
frameworks for guiding corporate governance systems and managing firms through
certain ownership and control structures could alleviate expropriation and
enhances the effectiveness of board of directors.
Keywords:
Expropriation; Corporate Governance;
Investor Protections; Board of Directors; Board effectiveness; Governance Mechanisms.
Acknowledgement:
My great regards to all members of my
family for being so supportive and understanding during this research study. My
sincere regards also goes to my supervisor, Mrs Corinna Coors for providing me
with assistance and guidance during the research.
Corporate governance is mechanism by which companies are controlled and
directed.[1] It is a concept which revolves around jurisprudence, corporate law and
viewing of modern day business in different structures apart from the latent
form.[2] Shareholders are investors who
own a corporation; and efficiency of corporate governance is determined on how
well shareholder’s rights and wealth are protected.
The significance of effective corporate governance has been highlighted
by many cases of corporate scandals which engulfed the business world in the
past few years. Corporate scandals as exemplified by reports of mismanagements
at Enron, WorldCom, Wal-Mart, Dynergy, Schlecker,
Lehman brothers, Northern Rock, Tyco and HealthSouth, all illustrate that when
board of directors fail to do their job appropriately, serious damages can be
done to the company and investors can be financially hurt. This indicates that effectiveness of board
of directors is the main tool which sustains a company and business
organization.
However,
due to global economic recession and financial crisis; as well as the emergence
of numerous corporate scandals in the past few years, the roles which the board
of directors need to take to ensure the effectiveness of their duties are
changing dramatically. Nowadays, board of directors are not only responsible
for complex oversight accountability of the company or organisation they
represent, but they are also responsible for personal risks and liability.[3]
Protection
of investors is now one of the priorities of the board of directors because, in
many countries, controlling shareholders are extensively expropriating minority
shareholders and creditors. Outside
investors such as finance firms are continually exposed to financial risks due
to fraudulent activities of controlling shareholders and managers - the
insiders. To protect investors effectively, board of directors often operate
through certain governance system or mechanism.[4] Typical examples of such governance
mechanisms include: manager focus approach - where a manager dominates the
board; proactive board approach - where a manager and the board are on the same
page and speak with one single voice; geographic representation approach -
which focuses on the investors which the board member represents; community
representation - where a board member represents a community rather than an
organisation[5]. All these governance mechanisms
are supposed to safeguard the minority shareholders in one way or the other, as
it is widely believed that success of equity markets is highly dependent on how
strong the protections given to investors and shareholders are.[6]
In other
words, since corporation fundamentally belongs to shareholders, the efficiency
of the above governance system would depend on how the shareholder’s wealth and
rights are guided and protected. However, irrespective of the governance model
utilized by the board of directors, evident suggests that expropriation
activities are still peculiar within most organisation and companies[7]. This is because expropriation takes many forms, most of which are
difficult for the board of directors to effectively address.
In some
instances, expropriation activities occur due to stealing of profits by the
insiders. In this situation, corporate insiders consume more private benefits
than necessary; which leaves little or no dividends available for the
shareholders[8]. Again, the selling of output, assets or additional securities in a
company or organisation, under the control of an insider, at price below the
market value also constitute to expropriation activity[9]. Furthermore, overpaying of executives, installing unqualified family
members in managerial position and diversion of corporate opportunities from
the firm may also be classified as expropriation activities.[10]
Against
these backgrounds, it can be argued that expropriation is synonymous with
agency problem as highlighted by Jensen and Meckling (1976) where consumption
of profits by insiders was adjudged to be a classic example of expropriation
activity because it does not benefit the outsiders.[11] This signifies that any situation where an insider uses a firm's profit
to benefit themselves instead of the outsider investors, represent a fraudulent
activity and that the board of directors in such a firm or organisation is
ineffective.
Evidently,
extensive expropriation activities have the potential to disrupt and undermine
a financial system; hence it is important that expropriation activities
effectively monitored or controlled. This represents the notion on which
investor protection and effective corporate governance system is based. Such
control and monitoring is only possible if certain legal frameworks are
followed. The legal approach to corporate governance is a mechanism which
protects outsider investors such as shareholders through legally backed and
legally enforceable principles and guidelines.[12]
To address
expropriation activity legally, it is important to understand the context where
the expropriation activity took place as well as the scope of the expropriation
provisions – or the measures that constitute expropriations.[13] This is because different range of expropriation law and regulatory
measures are applicable to different expropriation cases. A typical scope for expropriation
activities, is corporation with disperse ownership structure where conflicts
between agents (a firm's controlling manager) and shareholders who own the firm
(the principals) are facilitated.[14] This scope often results in expropriation activities which can only be
controlled if the board of directors adopt a specific governance system backed
by certain legal frameworks.[15] Another scope or context responsible for expropriation activities is
publicly listed company, where interests of minority shareholders and corporate
performance suffer, as the dominant shareholders often prioritise their own
interest.[16]
Such
prioritisation of interest is also contextually defined as direct and indirect
expropriations. For instance, in situations where ‘trading for individual
gains’ is the main ambition of the corporate insiders, such action is
considered as direct expropriation; whereas in situations where corporate
insiders implement policies that are capable of holding a firm back, such as
appointing an unqualified member of family as member of management team, their
actions would be considered as indirect expropriation[17]. Research shows that appointment
of unqualified members of family as members of the board of directors to
facilitate expropriation of profits is common in business organisations
fashioned on the platform of pyramid business group system. And such actions
are perceived as indirect expropriation.
Other
contexts responsible for expropriation are government or the states’ measures
which are synonymous with direct and indirect expropriation activities of the
dominant shareholders.[18] For instance, diverse types of government actions such as requisition of
land, forced sales, exorbitant or arbitrary taxation, deprivation of profits
and implementation of measures which have severe consequences on the management
or control of business enterprises can be adjudged to represent indirect
expropriation.[19] And government and state measures
such as naturalisation of strategic industries or expropriation for public
infrastructures, such as confiscation of properties for roads or parks can be
considered as direct expropriation.[20]
Relative
to government or states’ expropriation activities, the legal framework which
guides expropriation and payment of compensation to those people affected is
the United Nation Resolution 1803, which requires States and international
organisations to strictly and conscientiously respect the sovereignty of people
and Nations regarding their natural resources[21]. The resolution also states that the States have the right to
expropriate properties in the interest of national policies or national
securities.[22] And that shareholder, investors or anybody affected by such actions are
liable to reasonable compensations. Such compensations however vary from States
to States. Thus, in situations like these, it will be very difficult to review
the effectiveness of the board of directors as they have no control over
States’ activities. The best they could do is to ensure that the investors,
shareholders or those people affected by the States’ expropriation activities
are adequately compensated.
Other
measures through which board of directors are assessed include how they
alleviate conflicts of interests in a firms or organisation constructed on the
structure of dispersed small share owners and powerful controlling managers.[23] This system is very popular in America.
However, in Asia, Europe and the rest of the world, effectiveness of board of
directors are often assessed by how they alleviate expropriating powers of
dominant shareholders.[24] This
is because, in Europe, Asia and most part of the world, typical firms are
listed on the stock exchange and dominant shareholders often control majority
of the votes and hence activities that go on within the firms.
In Europe and the UK in particular, effectiveness of the board of
directors depends on how they handle severe shortcomings of pyramid ownership
systems which gives dominant shareholders powers to control the firm without
owning a large fraction of the cash flow.[25] It has been argued that such pyramid
ownership structure is facilitated by the lapse in UK company law. Arguments
and debates surrounding this issue centred on the fact that the UK governance
system is rooted in the concept of profit maximisation rather than profit
optimisation.[26] And any initiative to reverse the system is not often encouraged.
On the
other hand, it has also been put forward that corporate governance in the UK is
revolves around the duties of board of directors towards shareholders and the
community in general.[27] The UK company law uses a tripartite corporate governance
system which comprises of directors, shareholders and auditors. Under this
tripartite system, the directors’ responsibilities include leadership of a firm
and maximisation of a company’s profit, while the shareholders are required to
ensure that their directors maximize profits on their behalf. And the auditor’s roles are to ensure that they
guide against financial irregularities[28]. Based on these roles, it can be argued that tripartite
system operates on the principle of check and balance in other to prevent abuse
of powers by the directors within the corporation they work for. But critics of
this system of governance in the UK argued that tripartite system of governance
does not adequately address running of company or organisation per se. They
claimed that the system is good for satisfying legitimate expectations of all
the shareholders, board of directors and other investors; but governance is
more than these. They assert that tripartite system is good management system
but not a good governance system.[29] And this is because it can still lead to expropriation by dominant
shareholders. Typical examples of expropriation by dominant shareholders are:
Profit Appropriation; Tunnelling of Assets and Improper Dilution.
Profit
Appropriation refers to transaction of services or goods at lower than the
expected market prices, selection of wrong companies as vendors, outright theft
or fraud, and disproportionate allocation of shared revenues and cost to
affiliates.[30] Tunnelling of assets refers to: any
activity that contributes to transferring of assets at non-market prices, acquisitions
and investments that destroy the value of a firm’s share on the market and
expropriation of corporate opportunities by related companies.[31] Improper dilution occurs when certain activities taken by the dominant
shareholders or board of directors are reflected by the underperformance of a
firm’s share. Such activities can range from allocating issuance to a sub-set
of investors at a discount, compensating executives by issuing shares at a
steep discount or paying for unlisted entitles through shares at inflated
valuation.[32]
Irrespective
of the forms it takes, expropriation activities is prevalent among the board of
directors and dominant shareholders worldwide. This implies that getting
corporate governance and investor protection right is vital to curbing
expropriation activities. However, there is no general consensus over what
constitute good corporate governance system or effective investor protection
mechanism and how these can be evaluated as measures that guide against
expropriation activities.[33]And it is on this platform that this research is based.
To explore
these notions by the researcher, this research will be designed to address the
three following research questions:
- How do ownership structure and directors' affiliation
with dominant shareholders
influence fund misappropriation and negatively impact on listed
company?
- How can
board effectiveness alleviate expropriation?
- How can investors be protected against financial losses?
Claessens
et al (2002)[34] and La Porta et al (1999)[35] explain that dominant shareholders often go into contracts with company
directly or indirectly fundamentally to facilitate their chances of
expropriation. They claim that although such businesses may be legitimate, but
extraction of pecuniary benefits is mostly the reasons for embarking in such
activities by the dominant shareholders, especially if they have different
levels of cash-flow rights in such companies[36].
Johnson et
al (2000)[37] similarly asserts that listed companies are often subjected to financial
stresses through expropriation by dominant shareholders. He claims that
tunnelling represent the most commonly taken route by the dominant shareholders
to defraud a company or an organisation. Any activities, which differentiate
against minority shareholders or mergers between affiliated companies, can be
classified as tunnelling. Such activities include: outright theft; dilutive
share issues; any value-destroying investments and acquisition to aid
affiliated companies. To investigate the costs of expropriation activities to
companies and organisations various tools or mechanisms are often employed.
Internal governance mechanism is the tool use to check the dominant
shareholders’ expropriation activities as well as other governance problems, in
situations where the legal protection for investors is very weak. This tool is
also useful in emerging markets takeover market for corporate control and where
external merger rarely occurs.
Related-party
transactions remain the most recurring theme highlighted during recent
corporate scandals. Related-transactions have the potential to cause conflicts
of interest because it is often difficult for an investor, such as a dominant
shareholder, to have similar interests in two companies without compromising
one for the other. This shows that related-party transactions can compromise
the responsibilities of management’s agency. It could also have a detrimental
effect on effectiveness of board of directors’ roles in an organisation and
further enhances the chances of expropriation by the dominant shareholders.[38]
2.1.1 Impact of dominant shareholder’s
portfolio considera- tions
relative to expropriation
Investigations
into the ability of dominant shareholders' entire portfolio to enable or
compromise their ability to carry out expropriation activities from a
particular company have been minimal. This is because if such investigations
lead to exposure of expropriation, severe penalties are likely to be issued out
to the culprits. However, an advantage of carrying out such research outweighs
the disadvantage as the findings of such research could potentially highlight
the factors that influence the dominant shareholders' expropriation activities.
For instance, research by David et al (2006) indicates that the size of
investment in the company and the importance of such investment are the two
dominant factors that encourage expropriation activities in companies. While an
investment’s size is a reflection of the dominant shareholder's equity stake in
a firm,[39] the significance of an
investment is however depicted by the ratio of the market value of that
particular investment to the overall value of the equity stakes that belong to
the majority shareholders in listed companies, domestically.
2.1.2 How expropriation is facilitated through weak investor protection.
Another
reason for expropriation activities by dominant shareholders is typified by
research study of Karolyi, and Stulz (2001)[40], where it was concluded that controlling shareholders have better chance
to carry out expropriation activities on minority shareholders in countries
where investor protections is not firmly prioritised or in countries which have
weak rules relative to expropriation of the minority shareholders by the
majority shareholders as exemplified by Nenova (2002).[41] Less investor protection is also linked to bad governance mechanism as
it has been argued that establishing a good governance mechanism can lead to
excellent investor protection scheme, which will consequently be reflected in an
organisation' performance and market valuation. This infers that in other to protect
investors from expropriations, country - level laws relative to expropriation
must be strong and firms must be well governed.[42]
2.2 Impact of Ownership Structures and director's affiliation
with dominant shareholders on expropriation activities. How Agency
Problems in the Controlling Shareholder Systems with Bad-Law Facilitates
Expropriation Activities in Organisations?
Unlike the
United States and the United Kingdom, where separation of ownership and
management – the dispersed shareholder system - is prevalent among firms and
organisations[43], controlling shareholder system is the norms across Europe and Asia[44]. Controlling family and government shareholder system are two types of
controlling shareholder system which are equally capable of facilitating
expropriation activities by dominant shareholders. While the government of a
country controls corporation in government shareholder system, the control of
corporations are literally under the control of
a controlling family in controlling family shareholder system.
For
instance, although there are many family based corporations in China, many
corporations in China are under the control of Chinese government[45]. But on the other hand, in countries like
Korea, India, and Brazil, economies are widely dominated by corporate groups
belonging to family shareholders. Evident amounts that both systems can lead to
expropriation activities and destabilise a firm financially. In fact, it has
been argued that controlling shareholders system is systematically worse in
protecting outside investors than the dispersed shareholder systems[46].
Unfair
self-dealing has been identified as the most common factor that leads to
expropriation in controlling shareholder systems. Unfair self-dealing is typified by the case of
Sinclair Oil Corp .Vs. Levien,[47] where controlling shareholders - by the virtue of their domination of
the corporation - were adjudged to have committed expropriation activity by
causing the corporation to act in such a way that they received something from
the corporation to the disadvantage of the minority shareholders of the
corporation. This case also led to clarification of the standard of review
concerning business transactions. The judgement, in the case, indicates that
business judgement is not valid in situations where a business transaction at
issue is perceived as being made solely because controlling shareholders have
financial interest in the transaction[48]. Hence, it can be reasoned that ownership structures that encourage
unfair self-dealing has the potential to enhance expropriation activities by
controlling shareholders.
Besides
unfair self-dealing, the controlling shareholders system ownership structures
also encourage expropriation through facilitation of tunnelling.[49] For instance, it has been found that dominant shareholders often use
sophisticated form of expropriation such as changing and manipulating terms and
conditions of internal transactions. Such manipulations occurs through making
favourable transfer pricing from one company – where dominant shareholders have
control – to another company – where the same dominant shareholders have
control. In these cases, minority
shareholders are always the one who suffers eventually.
Minority
shareholders also suffer from expropriation in organisations where low level of
ownership structures is being used.[50] Exercising of controlling power by maintaining majority of voting power
by the virtue of stock pyramiding, intra-shareholdings and dual class equity
structure are typical ways through which dominant shareholders expropriate in
firms where they have low level of ownership.[51] A typical example of
intra-shareholding expropriation activity was exemplified by the case of Mr.
Kun-Hee Lee and Others Vs State of UP (2006), where it was held that Mr. Kun –
Hee Lee, the controlling shareholder of Samsung Group, has committed an act of
expropriation by having control over more than 70 subsidiaries of the Samsung
Group despite having only 0.69 percent of economic control in Samsung Group.[52] It was adjudged that Mr. Kun-Hee Lee had used
complicated intra-shareholding system to manipulate the magical voting leverage
scheme[53]. In this type of situation, it
can be argued that ownership structure and director's affiliation with dominant
shareholders indirectly led to expropriation activities by the dominant
shareholders.
The rate
at which ownership structures based on voting leverage mechanism such as stock
pyramiding, dual class equity structure and intra-shareholdings are being
widely used in the world to facilitate expropriation is increasing. Companies,
where voting leverage mechanisms have been adjudged to be the cause of
expropriation include Anglo-American Group in South Africa, Agnelli Group in
Italy and Hees-Edper Group in Canada[54]. In particular, the use of pyramiding
scheme is peculiar to Chinese listed companies. For instance, in China, a
municipal government was found to own 100% stake in a Holding Company, who own
another listed company (Kelon Electronics).[55]
2.2.1 Interactions between large shareholders:
La Porta
et al (1999); and Faccio and Lang (2002)[56] explain that listed companies typically have one or few large
shareholders. In their research into expropriation activities by dominant
shareholders, they found out that at least two dominant shareholders had
minimum of 10 percent of the votes in 39 percent of European firms and 16
percent of the European firms had minimum of three dominant shareholders. Analyses
of interactions between these shareholders have been found to facilitate
expropriation. Hence, monitoring of such interactions is often a necessity. In
most cases, large shareholders bear the financial burden of the monitoring
costs as benefits of monitoring often outweigh its costs. [57]For instance, in situation where the sale of large blocks of equity could
lead to a substantial drop in stock price, dominant shareholders' activities
have to be closely monitored even if this requires the use of voice monitoring
equipment’s.
2.2.2 The Effect of Family Control Ownership
Structure on Expropriation by Dominant shareholders.
It has
been argued that ownership structures that revolves around family controlled
organisations leaves rooms for expropriation activities by dominant
shareholders as such ownership structures are mainly typified by poor
shareholder protection mechanism. [58] This ‘Crony capitalism’ type of ownership structure is very popular in
Asia where between families predominantly owned up to 58% of the aggregate
value of listed equities.[59] The case involving Berle and Means Corporation highlights the prevalent
of expropriation activities among family controlled ownership structured
organisations. However, researches by La Porta, Lopez-de-Silanes, and Shleifer [60] and Claessens, Djankov and Lang[61], reveal that family-controlled firms, which are mostly managed by family
members, rather appear to be keeping a tighter leash on managers as a measure
of guiding against expropriation. But Shleifer and Vishny [62] maintained that , in large corporations where family control ownership
structures are being used, fundamental agency problems predominantly revolves
around controlling shareholders having nearly full control over the managers as
exemplified by family control ownership structures which mostly lead to
expropriation. Again, this clearly indicates that ownership structures can
hugely influence expropriation activities in organisations and firms.
2.2.3 Influence of Concentrated Ownership
Structure and Voting Rights on expropriation.
The
influence of voting rights or premiums on expropriation activities is more
common in corporations or countries where concentrated ownership structure is
the norm. This is because the trading of shares with superior voting rights at
a premium value that is too small can amount to expropriation. Zingales (1995)[63] also point out that in situations, where control is contested; premium
often rises sharply because dominant shareholders receive private benefits at
the expense of minority shareholders. In Sweden, the average voting premium is
6.5%.[64] In Israel the average voting premium is 45.5% [65] and in Switzerland, the average voting premium is 20%. [66] While these figures are relatively normal, the average voting premium in
Italy, according to Milan Stock Exchange is 82%.[67] This figure indicates that the average voting premium in Italy is very
high. This value shows that the
prevalence of expropriation by the managers or controlling shareholders in
Italy is very high because they have voting power in addition to management
power. Hence, they are more likely to acquire profits through expropriation at
the expense of the non-voting shareholders (Zingales, 1994). One of the reasons
for these in Italy is due to the fact that Italian legal system is ineffective
relative to prevention of expropriation by controlling shareholders.[68]
In the
pasts, the laws that guide against the interests of minority shareholders in
continental Europe is very weak. However, recent legislative changes in some
expropriation laws in some European countries have been aimed at correcting and
alleviating expropriation by controlling shareholders. Such legislative moves
have been centered on preventing dominant shareholders from voting their shares
until approved by other shareholders. Other legislative moves designed to
protect the interests of minority shareholders are based on prevention of
dominant shareholders from acquiring remaining shares in a firm at a specified
price. For instance, recent legislations to prevent expropriation by dominant
shareholders in Italy, Belgium, Denmark and France require that, before more
than 30% of the equity of a firm is acquired,
a tender offer at the same price must be submitted to all investors with
voting shares. [69]
2.3 The Roles of board of directors and
their effectiveness in alleviating expropriation
“In the
current market driven economy, the board of directors has a pivotal role in the
management of a company, as it is the centre of all management powers and
authority. It provides leadership and strategic guidance, objective judgment,
independent of management to the company and exercises control over the
company. It is not involved in the day to day management and administration of
the company which is the responsibility of the management. However, it controls
the company and its management by laying down the code of conduct, overseeing
the process and disclosure and communications, ensuring that there is
appropriate system for financial control. The board consists of eminent people
drawn from various professions and business backgrounds and exercises all the
powers of a company, except those reserved for the shareholders to whom they
are responsible. The Executive Directors are involved in the day to day
management of the company; the non-executive directors bring external and wider
perspective and independence in the decision making.” [70]
The
principle of corporate governance brings about a need for supervision over the
activity of the management and bring about a sense of accountability so that
the interest of the owners are safeguarded and that the management should
observe and follow ethical standards in its dealings and should keep informed
all the interested parties thereby bringing about transparency in the
functioning of the company. Independent Directors plays a vital role in
ensuring Corporate Governance in a company. It is said that if the board of
directors consists of right mixture of executive and non-executive directors
and among the non-executive directors, it comprises of independent directors
who could discuss without any bias matters pertaining to company affairs, good
governance would automatically follow. The rationale behind having independent
directors is that it would increase the quality of board supervision and reduce
the possibility of damaging conflict of interest[71]
Directors
are representatives of shareholders in an organisation but their motives are
not always in alignment with that of the shareholders. Ideally, the functions
of the board of directors are meant to revolve around protection of the
shareholders' interests and guiding against expropriation activities within an
organisation. However, corporate scandals in the recent years have indicated
that this have not been the case. For instance, corporate Scandals at Enron and
WorldCom led to conviction of some members of board of directors in these
organisations for directly or indirectly facilitating expropriating activities
in one way or the other. While the board of directors at Enron had to pay $168
million to investor plaintiffs, the board of directors at WorldCom had to pay
$36 million to investors. [72]
Cases like these, have led to
increased interest in the roles and functions of board of directors within
organisational set up. In fact,
how the board of directors protect the interests of all shareholders have been
a subject of considerable scrutiny and debates in both media and scholarly
researches. Researches based on organisational power dynamics[73] and agency relationships [74] all pointed to the fact that corporate boards are tools of top
management. On the other hand, other researches see boards of directors as the
people responsible for shaping direction of companies strategically.[75] Furthermore, Fama and Jensen
(1983) explain that board of directors are the apex of organisational decision
control because delegation of internal control responsibilities often flow from
shareholders to the board of directors.
A
prominent area of board of directors’ responsibilities is centred on the
incidence and costs of their responsibilities. In countries, where investors
have poor legal protection, shareholders often use the board as a mean to
strengthen their grip on the company in other to gain unfair financial
advantage.[76] Effectiveness of the board of directors can be influenced by social
embedded-ness framework. For instance, embedded ties can create unique values
and facilitate or motivate exchange partnership which could lead to sharing of certain
mutual values – through transfer of private resources and self-enforcing
governance.[77]
The
effectiveness of the board of directors is also influenced by weak legal
protection for shareholders in emerging economies. This is because; dominant
shareholders are often tempted to use every means at their disposal to tighten
their grips on companies they work for.[78] Weak legal protections for protection of non-dominant shareholders
indicate that dominant shareholders could dictate who they want on the board of
director without any challenges from the minority shareholders. In most cases
they appoint people with whom they have ties in the past, to board of
directors. In situations whereby a member of board of directors is appointed by
dominant shareholders, it can be argued that effectiveness of such member of
board of directors cannot be guaranteed as the particular member of the board
of director will mostly have to satisfy the wishes of the dominant shareholders;
even it involves facilitation of their expropriation activities.
Foreign
retail investors have been found to have positive impact on the performance of
firms, especially those in the stock markets. Foreign retail investors are
foreign retail shareholders who trade in small stake shares in many companies.[79] Because they are basically profit
- driven investors, they usually do not have close ties with the firm they hold
equity stake in (Aguilera and Jackson, 2003). As a result of this, they
generally do not have close relationship with the dominant shareholders.
However their frequent trading, often culminate in increase in the stock liquidity
- which mostly results in reduction to the cost of capital and information
asymmetry.[80] In situations whereby an organisation have significant numbers of
foreign retail investors, members of board of directors will have less
influence on the activities of the shareholders. Hence, members of board of
directors will be effective in their roles within an organisation and this will
lead to regulation of expropriation.
Another
way by which effectiveness of board of directors can be facilitated is by adopting
the notion of fewer independent non-executive member of board of directors.
Muth and Donaldson[81] report that, where there are fewer independent non-executive directors
and where the roles of chairman and CEO are combined, there is better financial
outturn for shareholders as expropriation activities in such organisations are
not common. This counters a generally accepted fundamental principle of good
governance that the roles of chairman and chief executive should be separate.
It also counters an important provision of the new combined code that 50% of
the board of a FTSE 350 company should comprise independent non-executive
directors[82]. The Conference Board Commission on Public Trust and Private Enterprise
(Conference Board 2003)[83] also recommend that independent NEDs should make up at least 50% of a
board. The New York Stock Exchange now requires this. However, given that this
system could enhance effectiveness of the members of board of directors and
regulate expropriation, it is fair to say that it should be adopted by most
organisations.
2.3.1 How Board
Effectiveness is Evaluated.
The global
financial crisis has necessitated the need for effective board evaluation on a
regular basis. Various legislative and policy changes have been designed to
suggest that monitor and regulate management procedure and well the board of
directors are performing in their duties. Some of these policies also
emphasised that boards of directors are expected to monitor their own
performances as well as that of the management team. For instance, OECD (2009)
maintains that an effective structural tool for evaluating the effectiveness of
board of directors in performing their duties should be a process of board
evaluation, carried out with the backing of independent experts regularly.[84] Furthermore, according to ASX (2007), an organisation should be
transparent in the process for evaluation of the performance of the board of
directors - by disclosing the mode of evaluating the board of directors'
performance to its committees and individual directors.[85] Supportively, it was recommended by a recent Walker Review of Corporate
Governance in the UK banking industry that transparency in the procedure for
evaluating the effectiveness of the board of director's duties represents one
of the best ways to address expropriation by dominant shareholders.
Board
evaluation is now perceived as a vital tool for ensuring effectiveness of
corporate governance system; however, if conducted poorly it can also have
negative consequences on an organisation.[86] The critics of the board evaluation
concepts have argued that it could lead to a tick-a-box approach by investors.[87] It has also been contended that some of the frameworks used by corporate
governance researches are mostly prescriptive, where board of directors’
activities are examined and re-examined continually to ascertain whether they
comply with extensive regulations and guidelines; and that it does not really
reflect the performances of board of directors.
Hence, it
can be argued that in other to examine the effectiveness of board of directors,
emphasis must be placed on the roles of the board of directors as a measure of
what they are supposed to be doing in an organisation. Again, emphasis must
equally be placed on how the procedures for determining whether these roles are
being adequately performed or not. Additionally, the ways in which this
evaluation procedure is communicated to all interested parties in an
organisation must also be prioritised. Sonnenfeld (2002) maintains the roles of
board of directors that should be evaluated by monitoring tools are: monitoring
of management; provision of advice and provision of linkages to external
resources; and setting of overall corporate strategy.[88] This shows that to monitor the effectiveness of the board of directors,
these aforementioned roles of the board of directors will have to be continually
monitored to ascertain how well the directors are performing relative to
realisation of these goals.
This is
also reinforced by ASCI (2009) which highlights that board of directors need to
have clearly established goals, objectives and strategies for achieving them in
appropriate ways that are transparent to the management.[89] Another procedure through performance of board of directors can be
established or their effectiveness measured is through establishing of
performance indicators with the management in other to facilitate monitoring of
real results against them. Garratt (2003) similarly asserts that effectiveness
of board of directors’ roles in an organisation centres on how they perform
their duties of care, legitimacy of their actions, how they uphold governance
values, trusts, loyalty and critical review; as well as having an independent
thought.[90] Critical review of the board of director’s
roles can be presumed to be an indication of evaluation of how their
performances measure up to the standard expected of them. Such critical reviews
could reveal whether they have been efficient or not and whether they encourage
expropriation within an organisation or not.
One of the
criticisms of the evaluation of the effectiveness of board of director's roles
is that more management staffs of organisations are now spending more time on
monitoring rather than spending time on strategy to move the organisation
forward. This has been found to be as a result of introduction of policies,
legislations and corporate reforms designed to address expropriation and
facilitate effectiveness of the board of directors.[91] Sonnenfeld (2001)[92] however argues that regulation, policies and legislation surrounding
effectiveness of the board of director's roles are not the determining factors
for shaping or regulating the roles of the board of directors in organisations,
but the way that people work together on boards is what enhances effectiveness
of board of directors.
Sonnenfeld
(2001)'s notion was equally echoed by Daily and Dalton (2003) who claim that
integrity is the chief determinant for board effectiveness.[93] They emphasised that collection of individual character that comprise a
board dictate the performance of the board; and that structural adjustments
cannot override individual flaws in characters of the members of board of
directors. [94] This infers that irrespective of the legislation, regulation and
policies put in place to guide against expropriation and ineffectiveness of
board of directors, such measures can only be successful if the members of
board of directors do not have inherent bad characters and attitudes such as
greediness and selfishness.
Another
measure to ensure effectiveness of the board of directors is by increasing the
number of independent board members. Bhagat and Black (2001) assert that
increasing the number of independent boards members significantly can result in
less expropriation activities and improve the effectiveness of the board of
directors, as organisations with low profitability who responds by increasing
the number of independent board members always perform better.[95] However, MacAvoy and Millstein (1997) maintain that effectiveness of
board of directors is mainly influenced by the governance system adopted by an
organisation. [96] A study involving 128 public companies, where their economic values were
assessed against board's independence and professionalism, indicates that over
a period of ten years, the board of directors in firms that are effectively
governed, performed effectively; and vice versa.[97]
As far as
the investors are concerned, evaluation of the effectiveness of the board of
directors give the investors opportunity to gain knowledge and acquire
information regarding how the company is doing on the market and what to expect
from the company in the nearest future. For instance, an evaluation of the
board of director’s effectiveness in 2007 by Price Waterhouse Coopers led to
understanding of greater maturity regarding operation and disclosures by the
investors of Price Water Coopers. Some of the information made available to the
investors as a result of evaluation of the effectiveness of the company's board
of director's duties include: increase use of external facilitators;
information about certification of the board's effectiveness; information about
committees and directors; as well as provision of insights into future action
plan.[98]
Another
factor that influences effectiveness of the board of directors' roles is
failure to properly supervise risk management and incentive systems. For
instance, an OECD report suggests that, accounting standards, credit rating
agencies and disclosure regimes can all contribute to ineffectiveness of the
board of directors' roles in an organisation, if left unaddressed.[99] The report highlighted that major flaws in risk management systems in
organisation such as financial institutions constitute as ineffectiveness of
the board of directors. For example the OECD report shows that some board of
directors encouraged high level risk taking in financial market, and this often
lead to financial crisis in organisations where those board of directors
function.[100] Since one of the vital roles of the board of director is reviewing and
guiding risk, it is fair to say that failure to do this by the board of
directors represents ineffectiveness in their duties. Thus for board
effectiveness to alleviate expropriation, it will have to supervise risk
management and incentive systems effectively.
This was
corroborated by research findings of Egan
Partners and Korn Ferry (2009)[101], which reveals that both risk and remuneration committees in an
organisation need to work in partnership with board of directors to ensure that
there is no loop-hole through which risk takings and remuneration can land a
firm in financial woe or lead to expropriation activities. Supportively, the
Walker review (2009) suggests that non-executive members of the board of
directors should be designated to challenging and testing proposals on
strategies put forward by the executive; and that regular board evaluation
should be conducted and better disclosure of such evaluation should be made
available to investors.[102] Through challenging and testing of proposals by the non-executive
members of board of directors, any risks that can lead to expropriation or
ineffectiveness of the board of directors can be detected at early stages and
rectified accordingly.
2.4 Protection of Investors against financial losses
Through
such legal rules and regulations, investors and dominant shareholders are able
to recognise risks of expropriation activities easily; and these often allow
them to take precautionary measures or report to appropriate bodies. Again,
such legal rules and regulations empower the investors and shareholders to
penalise firms that are in the wrong. This is because; organisations and
entrepreneurs are required by legal frameworks to be binded through contracts
to shareholders and investors – as a measure of guiding against expropriation.[103] This infers that investors can be protected against financial losses
through contracts with an organisation; as such contracts are mostly designed
to reflect legal rules protecting shareholders and investors in different
countries.
La Porta
et al. (1998) asserts that those legal rules and
frameworks can be divided into shareholder and creditor rights rules or indices
in different countries; and that different judicial systems are used by
different countries to enforce such legal rules. This indicates that
effectiveness of investor protection mechanisms in different countries could
vary based on the effectiveness of the legal systems of the countries where
such legal rules are being enforced.[104] Most of the law and regulations guiding against expropriation and
protection of investors’ interests in organisations are based on commercial
legal systems adopted by different countries. In England and most of the
British colonies such as U.S, Australia, New Zealand and Canada, English common
law is being used to protect investors from financial losses. [105] The English common law is also applicable to some French, Dutch and
Spanish speaking countries.
2.4.1 Investor protection based on
ownership and control of firms
Research
finding suggests that there is a link between ownership structure of an
organisation and how investors are protected against financial losses.[106] Evident suggest that when investor
protection is poor, entrepreneur are most likely to keep their firms or
organisation. This is mostly typified by concentration control structure in
organisations; or where a firm is run by few people. However, in situations whereby investors
protection mechanism is very strong, entrepreneur are not likely to hold on to
their firms as they will find it difficult to engage in expropriation
activities.[107] This is also exemplified in business
organisation whereby entrepreneur disperses control between many investors.
Because investor protection will be relatively strong, this will alleviate
investor’s losses financially or limits the extent to which expropriation could
be exercised.
Bennedsen
and Wolfenzon [108] further explain that weak investor
protection mechanism will always lead to dissipating control powers among
majority shareholders. And because, in such situations, it will be relatively
difficult for decisions to be made without disagreement among the controlling
shareholders, expropriation activities may not be facilitated. Again, lack of
single controlling shareholders signifies that for any major corporate actions
to be taken, agreements of several large investors will be required. In most
cases, these large investors hold reasonable cash flow rights which can be used
to influence expropriation positively or negatively. From this standpoint, it
can be argued that dissipation control mechanism in organisation has the
potential to reduce inefficient expropriation. It thus represents optimal
method for maximisation of wealth. Hence, it is fair to say that investors can
be protected against financial losses if an organisation adopts dissipation
control mechanism.
Another
means of ensuring that investors are protected from financial losses is when
entrepreneur try to retain control of firm by selling shares with minor voting
rights to outsiders, while holding on to shares with major voting rights.
Pyramidal ownership – where a holding company sells shares in one of its
controlled subsidiaries – can also be used to protect against investor’s
financial losses. Through pyramidal ownership structures, cross-shareholdings
among firms is facilitated; and this fundamentally make it difficult for an
outsider to gain control of a firm or carry out expropriation activities that could
lead to financial losses by investors.[109]
Furthermore,
Jensen and Meckling [110] suggest that cash flow ownership
structure by an entrepreneur have the ability to reduce opportunities for
expropriation and henceforth reduces financial losses of the investors.
Similarly, La Porta et al.(1999b)[111] claim that in companies with cash flow ownership structures, expropriation
of the investors by the dominant shareholders is limited.
2.4.2 Investor’s Protection through
regulation of Financial Markets
Regulation
of financial market in a country has the potential to facilitate investor
protection against financial losses because the credibility of organisation in
such countries is normally high; and this makes it more attractive for
entrepreneurs to provide securities for investors. Evidently, when investors
are guaranteed effective protection from expropriation, they are more likely to
pay more securities, however the gains that the investors eventually get
normally outweighs the securities that they paid. The fact that the investors
are fundamentally protected indicates that the effectiveness of the board of
directors in organisations that adopt this system is high. It can also be
argued that countries that adopt this system will be held high among its
contemporaries. La Porta et al.
(1997)[112] reveals that
in countries where shareholders are protected, valuable stock markets of such
countries are normally of high values, and they normally have large numbers of
Initial Public Offering rate (IPO). Additionally, La Porta et al. (1997)
further explain that such countries normally have larger number of listed
securities per capita; and that they also have credible credit markets. This
infers that by simply protecting financial market in a country, investors in
general can be protected against financial losses indirectly.
Again
corporate valuation and insider ownership cash flow have been found to impact
on the investor protection in organisations. [113] For instance, research by Gorton and Schmid (2000)[114] reveals that higher valuation of corporate assets is dependent on higher
ownership by large shareholders in such corporation. Again, research study Claessens
et al. (1999b)[115] infer that greater insider cash flow ownership can be attributed to
higher valuation of corporate assets. The same research study by Claessens et
al. (1999b) also indicate that higher
insider control of voting rights can be attributed to lower valuation of corporate assets. Furthermore, La Porta et al.(1999b)[116] show that companies in countries with excellent shareholder protection system
are more valuable than companies in countries with poor shareholder protection
system. Again, La Porta et al. (1999b) show that that higher insider cash flow
ownership structure is slightly linked with higher corporate valuation, and
that this is rife in countries where shareholder protection mechanism is poor.
All these lines of evidences suggest that, insider cash flow ownership have the
ability to limit expropriation activities, increase the value of a firm and
protect investors from financial losses. Thus it can be inferred that to
protect investors from financial losses in an organisation, the management of
the organisation should encourage insider cash flow ownership structure, as
this will not only protect the investors from financial losses, it will also
raise the value of the company.
However,
it is important to point out that insider cash flow ownership’s influence on
investor’s protection against financial losses is more prevalent in countries
with poor investor protection law and mechanism. For instance, Johnson et al.
(2000a)[117] associate investor protection and
financial losses to countries with poor protection, where insiders have been
found to often threat outsider investors with regards when they are financing
an organisation externally; but often result to expropriation activities when business transactions decline or deteriorate.
Such financial losses were exemplified by the research findings of
Johnson et al. (2000a), which was based on examination of decline of stock
markets and fall of currencies in 25 countries from Asia between1997-1998. The
findings of the research suggest that, variables, such as investor protection
and the strength of the legal framework have the potential to dictate the extent to which expropriation
and financial losses impact on the affected firms.
Investors
can also be protected against financial losses by making sure that appropriate
governance system that focus on legal protection of investors is adopted in
organisations. For instance, Bank-focused corporate governance system such as
those used in Japan and Germany can be adopted because of their efficiency in
protecting investors from financial losses. Typical example of such corporate
governance system in Bank revolves around bank providing financial support to
firms they are in contract with. This type of mechanism is known as
market-based governance – where finance comes from multiple number of
investors; and where take over normally play a key role in governance. Edwards
and Fischer (1994)[118] and Hellwig (1999),[119] maintain that market-based governance
system stipulates that financial information must be provided by the issuer of
the finances; and that shareholders must be made aware of any financial
responsibilities that they are liable to. Additionally market-based governance
system is strongly backed by various legal frameworks. These infer that shareholders’ rights can be
effectively upheld by market-based governance system. [120] Hence, it can be argued that adoption of market-based governance system
in an organisation has the potential to protect investors against financial
losses to a large extent.
chapter 3: Methodology
This chapter describes the methodology used in this research study and
the rationale for using it. It explores the research design, the data
collection procedure, and how the data
Literature
Action Research approach was used to address the research topic, explored the
research questions, and analysed other issues relative to the research.
Literature Action research is an exploratory research method that is commonly
used when research issues emerge from evidence.[121] This indicates that Literature Action Research do not have the potential
to influence the direction of an investigation or influence the researcher in
one way or the other. This represents
the reason why the researcher decided to use this research method. Other research
approaches such as case study research approach require the researcher to have
a broad knowledge about a research from reviewing various literatures, right
from the beginning of a research; and thus have the potential to influence the
direction of an investigator during the course of a research.[122]
Again,
Literature Action Research has certain characteristics which make it ideal for
the researcher’s research study. Firstly, it is a scaled down version of
quasi-experimental studies and it is highly quantitative in nature. The fact
that it is highly quantitative in nature implies that it facilitates
exploration of large quantity of data.
This also indicates that it is very statistical in nature.[123] Hence, it is more suitable to research which investigates social issues
where large volume of information needs to be explored and analysed. Evidently,
expropriation of minority shareholders by the majority shareholders could be
attributed to many factors. And to adequately explore those factors, large
volume of information will have to be scrutinised to arrive at reasonable
conclusion. Since Literature Action Research facilitates statistical analysis
of data, it can be presumed that it represents an ideal approach to use for the
research.
There are
different approaches to literature review, but this research study adopted
narrative literature review. Narrative literature review refers to selective
review of literature that broadly encapsulates a particular research.[124] Narrative literature review does not specifically follow a rigidly
defined method to draw out articles or literature relating to a particular
research topic; what it rather does is that it provides an overview of
literature relating to a particular topic through integration and evaluation of
themes.[125] This thus facilitate the
researcher efforts in using thematic analysis to analyse data collected,
compare the themes and draw out conclusion (s) relative to research issues. The major strength of the
narrative literature review and the rationale for selecting this research
method out of all the other literature Action Research methods is that it
focuses on conceptual relationships between key variables, which make drawing
of theoretical and methodological insights into a research issue possible.[126]
As explained in chapter one, this research study aimed to address:
how ownership structure and directors'
affiliation with dominant shareholders influence fund misappropriation and
negatively impact on listed company; how board effectiveness can alleviate
expropriation; and how investors can be protected against financial losses.
The
researcher decided to explore only peer reviewed literature, journals and
articles because they are more credible and reliable, as they have been
scrutinised by experts in their respective fields before they were published.[127]
3.3 Search Strategy.
After removal of duplicates and incomplete articles, journals and
literature, the total number of literature left were 35 (8 from UWL e-resource,
15 from EbscoHost and 12 from Hein Online).
The remaining 25 literature were then accessed by using quality
assessment procedure. Quality assessment is a process that is use to assess the
quality of studies, particularly if they could lead to contradictory evidences.[128]
This table shows that any literature and articles that discusses how
ownership structure of an organisation and director’s affiliation with dominant
shareholders influence misappropriation and negatively impacted on listed
company; or explores how board effectiveness can alleviate expropriation
activities in organisations; or expatiates on how investors can be protected
from financial losses or expropriation were equally rated. Again, the table indicates
that large sample size article/journals were rated above low sample size
articles and literature. This is because large sample size has been found to
contribute to validity of literature review, whereas low sample sizes are the
norms for qualitative researches.[129]
Cont……
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|
|
|
|
|
|
Table 3.3 the grading of the articles/journals.
Harvard Business Review
|
|||
3.4. Validity
Validity of a research refers to the ability of the
research to effectively reflect the specific concept that the research
aim to address.[130] To enhance the validity of this research study, the researcher made sure
that all the data collected were not contaminated by inconsistent coding.
Inconsistent coding could create errors and invalidate the findings of a
research. Again, one of the reasons for sticking with peer reviewed journals
and literature by the researcher, was also to increase the validity of the
research. Peer reviewed journals, articles and literatures are more reliable
than ordinary literature, journals or articles. All the information and data
deduced from the search engines were also personally clarified by the
researcher before being processed. The researcher confirmed the contents of
most of the articles, journals and books through the University of West London
e-direct internet resources access for electronics journals. This was also
aimed at preventing error or incorrect information from affecting the validity
of the research findings. Another measure taken to increase the validity of the
research findings of this research was that the researcher ensured that all the
data collected before analysis and interpretation were security protected so
that they could not be tampered by an external element.
Chapter 4 : Results
and Findings
This chapter deals
with analysis of the results of the literature from the search engines. It explores the common themes from the
literature and provides thorough discussions on the themes fall under the
research domain; and the extent to which the themes adequately answer the
research questions.
4.1 Reviewing Selected Articles
The selected articles
and journals were categorised based on the three major themes dictated by the
research questions i.e. discussions about how investors can be protected from
financial losses; effectiveness of board of directors in addressing
expropriation and how director’s relationship with dominant shareholders impact
on the prevalence of expropriation in organisations and firms
4.2 Unit of Analysis.
Unit of Analysis
refers to the major entity which is being analysed in a research study[131].
Some of the factors which could be used as unit of analysis in a research study
include individuals, groups, books, journals, articles etc.[132] The Unit
of analysis for this dissertation were the journals and articles that
demonstrated the above themes.
Table 4.1 below represent the Sources, Author’s names, year of publication and
titles of the literature which explore the above themes.
Table 4.1 Unit of Analysis.
Article N0
|
Title
|
Source
|
Author
|
Year
|
1
|
Theories of Corporate Governance: The
Philosophical Foundations of Corporate Governance
|
Book
|
Clarke, Thomas.
|
2004
|
2
|
The Role of the Board of Directors
|
Book
|
Boland, M. and Hofstrand, D
|
2009
|
3
|
Corporate Governance in Asia
|
Book
|
Roche, J.
|
2005
|
4
|
Capital Structure and Corporate Financing
decisions: Theory, Evidence and Practice.
|
Book
|
Baker, H.K and Martin, G.S
|
2011
|
5
|
Corporate Governance in Asia: A Survey
|
International
Review of Finance
|
Claessens, S., and Fan, J.P.H.
|
2002
|
6
|
Law and Practice of Investment Treaties
|
Book
|
Newcombe, A. and Paadell, Lluis
|
2009
|
7
|
Theory of the Firm: Managerial Behaviour,
Agency Costs, and Ownership Structure
|
Journal
of Financial Economics
|
Jensen, M and Meckling, W. 1976
|
1976
|
8
|
Investor protection and corporate governance
|
Journal
of Financial Economics
|
La Porta, R. et al
|
2000
|
9
|
The Corporate Governance of the 21st
Century
|
Book
|
Mullerat, R
|
2011
|
10
|
Corporate governance, investor protection, and
performance in emerging markets
|
Journal
of Financial Economics
|
Leora F. et el
|
2004
|
11
|
Why are foreign firms listed in the US worth
more’?
|
National
Bureau
Of
Economic Research
|
Doidge, C.,
Karolyi, G.A and Stulz, R.M.
|
2011
|
12
|
The value of corporate voting rights and
control: A cross-country analysis
|
Journal
of Financial Economics
|
Nenova, T.
|
2003
|
13
|
Corporate Ownership Around the World
|
Journal
of Finance
|
La Porta R., Florencio Lopez-de-Silanes and
Andrei Shleifer
|
1999
|
14
|
Relational Theory of Japanese Corporate
Governance: Contract, Culture, and the Rule of Law
|
Harvard
International Law Journal
|
Curtis J. Milhaupt
|
1996
|
15
|
The Separation of Ownership and Control in
East Asian Corporations
|
Social
Science, Research Network (SSRN
|
Claessens, S., Djank, S and Lang, L.
|
2000
|
16
|
The Value of the Voting Right: A Study of the
Milan Stock Exchange Experience
|
The
Review of Financial Studies
|
Zingales, L.
|
1994
|
17
|
Who shall succeed? How CEO/Board references
and power affect the choice of new CEO
|
Academy
of management journal
|
Zajac, E.J and Westphal, J.D
|
1996
|
18
|
Eclipse of the Public Corporation
|
Harvard
Business Review
|
Michael C. Jensen
|
1989
|
19
|
Strategic leadership: top executives and their
effects on organizations
|
Book
|
Finkelstein, S and Hambrick, D.
|
1996
|
20
|
Managerial Value Diversion and Shareholder
Wealth
|
The
Journal of Law, Economics, and Organization
|
Bebchuck, L.A
|
1999
|
21
|
Investor relations, liquidity and stock prices
|
The
Journal of Law, Economics, and Organization
|
Brennan, M and Tamarowski, C.
|
2000
|
22
|
Corporate Governance: An International Review:
Stewardship Theory and Board Structure, a contingency approach
|
Wiley:
Online
|
Muth, M. and Donaldson, L.
|
1998
|
23
|
Corporate Governance and the Financial Crisis:
Key Findings and Main Messages
|
OECD
Journal
|
OECD
|
2009
|
24
|
Whispering Sweet Nothings”: The Limitations of
Informal Conformance in UK Corporate Governance
|
Journal
of Corporate Law Studies
|
Moore, M
|
2009
|
25
|
What makes great boards great
|
Harvard
Business Review
|
Sonnenfeld, J.A
|
2002
|
As explained above, a review of these aforementioned journals and
literature resulted in three main themes that reflected the research questions. The review was carried out
by exploring the abstracts of each article and
journals or the introduction part of the books to get all
the necessary the
knowledge about their contents. The Table 4.2 below displays the themes and the
articles/journals/books that explored them.
Table 4.2: Cross referencing of the
themes with articles/journals/books.
Themes
|
Cross referencing of themes with
Articles/Journals/Books.
|
Influence
of ownership structures and director’s affiliation with dominant shareholders
on expropriation.
|
1,2,3,4,5,7,8,9,10,12,13,
14,15,16,17,18,19,20,22,23.
|
Board
effectiveness and alleviation of expropriation.
|
2,3,4,5,17,20,24, 25.
|
Protection
of Investors from Financial losses due to expropriation.
|
6,8,10,11,12,16,21,25.
|
A review of the abstracts of the returns
indicates that 20 of
the journals and literature relate to influence of ownership structures and
director’s affiliation with dominant shareholders on expropriation. Eight of the journals and books were also directly
related to effectiveness of board of directors on alleviation of expropriation.
Again, eight of the reviewed literature were directly related to protection of
investors from financial losses as a result of expropriation by the dominant
shareholders and ineffectiveness of the board of directors.
4.3 Discussions
4.3.1
How Ownership structures and directors’
affiliation with dominant shareholders influence fund misappropriation and
negatively impact on listed companies:
As explained above, ownership structures and
business relationship between members of board of directors and the
shareholders have the potential to influence the prevalence of fund
misappropriation or expropriation activities in firms and organisations. While
some ownership structures deeply facilitate expropriation, some ownership
structures have the potential to guide against expropriation and protect the
interests of minority shareholders. Ownership structures and corporate
governance have been found to be closely linked by most of the literature
reviewed within the context of this dissertation. Corporate ownership
structures have been found to vary systematically in manners consistent with
value maximisation.
And some of the variables which dictate how
ownership structures influence fund misappropriation in listed companies
include: corporate voting rights of the shareholders and members of board of
directors; diffuse and concentrated ownership structures of the listed
companies; cash-flow rights level of the dominant shareholders; the strength
and effectiveness of the internal governance mechanism; effectiveness and
strength of legal protection for the investors; dominant shareholders portfolio
consideration; dispersed and diffused shareholders systems; the prevalence of
unfair self – dealing in listed companies etc.
Most of these variables were highlighted by the
articles, journals and books reviewed within the context of this dissertation.
The reviewed journals/literature
1,2,3,4,5,7,8,9,10,12,13,14,15,16,17,18,19,20,22, and 23 expatiate on
different factors peculiar to ownership structures and director’s affiliation
with dominant shareholders, which could result in fund misappropriation and
negatively impact on listed companies. For instance, journal
1 explained different organisational structures
and corporate governance mechanisms which are often adopted by listed companies;
while journals 2 and 5 explained different roles of board of
directors such as fiduciary, monitoring and control functions, establishment of
policy based governance system etc. The
governance system was identified as the main factor which influences the
relationships between the board of directors and the dominant shareholders. One
of the vital roles of the board of directors was identified as prevention of
expropriation activities by the dominant shareholders.
Again, journals 3 and 4 respectively highlighted that organisation structures, where dealings are transparent; and where
emphasises are placed on capital structures which can maximise the value of a
firm to the shareholders, are capable of alleviating fund misappropriation.
Journal 7 also revealed that fund
misappropriation is common in organisation structures which are based on
joint-stock ownership because directors, in such organisations and firms, do not have personal interest in preventing
fund misappropriation. Journals 8,9,10 also explained different
corporate governance systems and cited ownerships concentration, which permit
access to firm's external finances as one of the key ownership structures which
facilitate expropriation and fund misappropriation in listed companies.
Furthermore,
journals 12, 13 and 14 respectively cited organisation structures based on
control block of votes, pyramids governance systems and ‘styling of a
corporation in contract form’ as typical examples of organisational structures
that can lead to fund misappropriation and expropriation. Additionally, journal
15 revealed that in countries such as East Asian countries, where voting rights
often exceed cash-flow right through cross-holding and pyramid structures, the
opportunity for fund misappropriation and expropriation is often limited.
Similarly, journal 16 explained that ownership structure and concentration of
the voting rights in Italy make rationalisation for private benefit possible.
Emphasises
was also laid on the directors' affiliation with dominant shareholders as one
of the determinants for fund misappropriation and expropriation by journal 17,
where it was highlighted that top managers often appoint board of directors
which can favour their interests in firms and organisations. Journal 18 on the
other hand maintained that any firm that operate on publicly held corporation
governance guidelines will always experience conflicts over cash flows as a
result of fund misappropriation. Journal 19 further explained different
strategies used by the top executives to control organisations and drew on the
affiliation of board of directors with dominant shareholders as one of the reason
for expropriation activities. Supportively, journal 20 stated that dominant
shareholders used every means - such as manipulating board of directors for
expropriation purposes - to tighten their grips on companies they work for.
Organisation structures that adopt the notion of plenty independent
non-executive member of board of directors was also cited by journal 22 as one
of the determinants for fund misappropriation and expropriation.
All
these lines of evidences, as explained by the above journals/literature, show
that organisational structure plays a dominant role in how life expropriation
or misappropriation of fund is in an organisation or firm is. Again, the
relationship or affiliation of the board of directors with dominant
shareholders plays a significant role in misappropriation of funds or
expropriation.
4.3.2
Board effectiveness and alleviation of expropriation:
As
previously mentioned, one of the vital roles of the board of directors is to
guide against fund misappropriation or expropriation activities within the
firms they work for. Evidently, doing this effectively is often difficult
because lots of factors often count against the board of directors. Critical
among those factors are the personal behaviour of the members of the board of
directors such as fraudulent activities and greediness. Again, the wayS in
which organisations and firms they work for are structured can make it
difficult for them to perform their duties effectively. It has been
demonstrated within the context of this dissertation that while some
organisation structures facilitate expropriation, some are specifically
designed to guide against expropriation and fund misappropriation. Furthermore, the legal frameworks guiding
firms and organisations have been argued to have effect on how board of
directors perform their duties relative to prevention of expropriation. For
instance, in countries where legal tool guiding against expropriation is very
weak, effectiveness of board of directors have been found to be poor; whereas
in countries with strong legal tool, their effectiveness in preventing
expropriation is often excellent.
Journals/literature 2, 3, 4, 5, 17, 20,
24 and 25 all explored
effectiveness of the board of directors in alleviating expropriation activities
in one way or the other. For instance, literature 2 and 3 explained various
philosophical foundations of corporate governance and emphasised on the
importance of board of directors in carrying out their roles effectively within
listed firms in other to guide against expropriation of the minority
shareholders by the dominant shareholders. Journal 4 also highlighted various
roles performed by the board of directors in ensuring that expropriation
activities are kept to the minimum in firms and organisations. Such roles include
taking vital corporate financial decisions in other to guide against agency
problems in organisations and firms. In situations where agency problems
culminate in insider using an organisation's profits for personal benefits, it
can be reasoned that effectiveness of board of directors in such instances can
be called into question.
Journal
5 also revealed that effectiveness of board of directors in dealing with
expropriation in firms can be measured by how well they prevent dominant
shareholders from prioritising their own interest in publicly listed company.
This is because interests of minority shareholders and corporate performance
always suffer at the hand of the dominant shareholders. Journal 17 further
infers that CEO-board relationships have the potential to influence the
effectiveness of board of directors in performing their duty relative to
alleviation of expropriation. The journal explained that effectiveness of board
of directors is often compromised through favouring of certain directors by
dominant shareholders in other to facilitate expropriation and fund
misappropriations. Again, Journal 20 revealed that ineffectiveness of the board
of directors always allows the dominant shareholders to employ every means at
their disposal to manipulate firms – thus resulting in expropriation. Journal
24 similarly inferred that ineffectiveness of the board of directors in
performing their duties of guiding against expropriation often stems from their
inclination to produce perfunctory corporate governance statements. The journal
explained that such inclinations are due to compliance on code for corporate
governance as a measure of controlling financial market. Journal 25 further
explained that for board of directors to be effective in addressing expropriation,
the members of the board of directors of a firm need to be: involved in equity,
attending regular meetings with other management teams in the firm; be skilful
and experienced or matured relative to their functions within the firms they
work for.
4.3.3
Protection of investors against financial losses:
It
is apparent from most of the literature reviewed in this dissertation that
protection of investors from financial losses should be prioritised by the
board of directors because most dominant shareholders are greedy, and they are
always looking for ways to take advantage of the minority shareholders. Some of
the measures that have been highlighted include making sure that a firm follows
organisational structures designed to guide against financial losses, ensuring
that board of directors are effective in performing their roles, and
implementation a fit-for-purpose legal frameworks designed to prevent financial
losses by firms. These measures were echoed by some of the journals and
literature that were quality assessed and analysed in this dissertation.
Journals and literatures 6,8,10,11,12,16,21 and 25 all explored how investors
could be protected from financial losses.
While
journal 6 explores different situational factors that could result in
deprivation of profits, journal 8 explained that adoption of certain legal
norms in firms can alleviate the prevalence of financial losses in such firms.
Journal 10 also revealed that the degree of investor protection is closely
linked to corporate governance and firm’s performances in a stronger legal
environment and vice versa. The journal indicates that in comparison with US
firms, where strong legal frameworks are in place to guide corporate
governance, the level of protection against financial losses available to
investors is very high. However, in country such as China, the reverse is the
case, as China’s legal framework that guides corporate governance is very weak.
This was also corroborated by Journal 11, which emphasised that foreign firms
listed in the US are worth more than those listed in other countries. This was
attributed to the fact that controlling shareholders in the US firms cannot
carry out expropriation activities because investors in US firms are better
protected legally.
Journal
12 and 16 on the other hand cited control voting rights and voting shares of
the shareholders as the factors which can be manipulated to prevent financial
losses by the investors. According to the journals, shareholders with enormous
voting rights or voting share can easily instigate financial losses in firms
and organisations. Hence, implementation of governance systems which restricts
the voting rights and voting share power of the shareholders can lead to
prevention of financial losses.
Again journal 21 revealed that activities of
Investor Relations are vital to protection of investors from financial losses
in listed companies. The journal shows that effective corporate Investor
Relations often lead to high rise in the number of the analyst who follows a
firm; and this often result in high liquidity value of the firm’s share, higher
stock prices, reduction in trading costs and protection of investors from
financial losses.
4.4.
Strengths and Limitations:
The
major strength of this Literature Action Research study lies in the fact that
it used peer reviewed literature. Hence, all the information reviewed within
this dissertation can be considered as credible. The limitations of this
dissertation is that its unit of analysis (only 25 reviewed literature) were
limited, which means that the generalisation of the research findings is not
advisable.
chapter-5: Conclusion &
recomendation
5.1.
CONCLUSION
This
research has described the prevalence of expropriation and financial losses to
listed firms as a result of the ineffectiveness of the board of directors;
adoption of different non fit-for purpose governance mechanisms; and weak legal
protections for investors or weak legal frameworks for guiding firms’
governance systems. The research associated good corporate governance and
investor protections from financial losses with strong and efficient legal
frameworks. Empirically, such legal frameworks also dictate how valuable firms
in certain countries are. The research highlighted that different strengths of
these legal frameworks in different countries is responsible for differences in
the rates at which expropriation
activities are carried out in different firms listed in different
countries.
The
research also emphasised on the fraudulent and greedy behaviours by members of
the board of directors; as well their affiliation and relationships with
dominant shareholders, as some of the factors that can negatively impact on
financial losses and expropriation of the minority shareholders by the dominant
shareholders. Additionally, the research cited different ownership structures
and voting rights as the vital factors that shape the direction which
expropriation in different organisations and firms often take. Disperse and
concentrated ownership structures; cash flow ownership structures, pyramid
system ownership structures, market based ownership structures are some of the
ownership structures explored by the research. And relative to voting rights,
the research provided evidences that indicated that dominant shareholders with
voting rights have the power to engage in expropriation activities. Based on these lines of facts and evidences
revealed by this research study, it can be argued that the following
recommendations should be followed if expropriation and fund misappropriation
are to be effectively alleviated; and if protection of investors is to be
prioritised.
5.2. Recommendation
Minority
shareholder’s rights should be continually assessed by the board of directors
in other to safeguard them and other investors from potential financial losses.
Again, as it has been argued within the context of this dissertation that there
is a gap between corporate governance regulatory frameworks among different
countries, it is fair to say that government and policy makers in countries
with poor or weak regulatory frameworks should work towards adoption of the
legal framework that seems to be effective in alleviating expropriation of
minority shareholders by majority shareholders.
Again,
given that different organisational structures and ownership systems influence
expropriation differently, it is fair to say that adoption of systems and
structures that work represents the most reasonable way to prevent
expropriation and financial losses by the investors. Some of the ownership
systems or organisation structures which could be followed include market based
governance system because it is very effective in upholding shareholder’s
rights, as it operates on financing of a firm from multiple numbers of
investors. Again, disperse ownership system have been found to restrict the
power of dominant shareholders relative to expropriation and fund
misappropriation. Hence firms should endeavour to adopt this system. Since,
various shortcomings of pyramid ownership system have been highlighted in this
research, it is fair to say that, this system in addition to any governance
system that give major voting rights to dominant shareholders should be
refrained from. This is because they all facilitate expropriation of minority
shareholders by dominant shareholders.
Furthermore
as lots of expropriation activities have been linked to affiliation of members
of board of directors with dominant shareholders, it can be reasoned that
minority shareholders should be proportionally represented on the board of
directors if expropriation by dominant shareholders is to be addressed or
alleviated. Also, in running a firm, a mechanism must be put in place to ensure
that any dealings of the board of directors are transparent to the minority
shareholders. Also any decisions made in board meetings should be disclosed to
the minority shareholders.
Additionally,
effective monitoring tools and strategies must be in place to review all
transactions and monitor trading activities within firms if expropriation is to
be alleviated. Shareholder’s approval must also be sought relative to some
transactions above certain levels. This will allow rogue transactions and
activities from being spotted before damages are done.
Independent
Auditors should also be employed to look into the affairs and transaction
activities by firms on a regular basis in other to highlight related party
transactions and protect the interests of the minority shareholders. Such
independent auditors should also be rotated on a regular basis so that they do
not get accustomed to shareholders and become corrupt. Because of the complex
ownership structures through which most of the listed companies operate, it is
difficult to vouch for effectiveness of these aforementioned recommendations in
addressing expropriation and prevention of financial losses. However, it is
fair to say that implementation of most of these recommendations within an
organisation will go a long way in alleviation of expropriation of the minority
shareholders by the majority shareholders.
Total
words count: 14800 (excluding bibliography)
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[1]
Karl Hofstetter, One Size Does Not Fit All:
Corporate Governance for “Controlled Companies,” 31
N.C.J
. INT'LL.
& COM. REG. 597 (2006).
[2] Clarke,
Thomas (ed.) "Theories of Corporate Governance: The Philosophical
Foundations of Corporate
Governance,"(Routledge, London and New
York, 2004)
[3] In the current climate, where asset values
have diminished and directors’ decisions are increasingly
under the
microscope, it is in a director's personal interests to be fully aware of what
planning should
be implemented
within their company generally (regardless of how well it may be doing), and
the
necessary steps
to take in advance of or upon a company becoming insolvent, in order to avoid
any
future
criticism.
[4] Securities legislation in most jurisdictions
has stringent rules in place to prevent insiders from taking
advantage of their privileged position for
pecuniary gain through insider trading. Offenses are
punishable by disgorgement of profits and
fines, as well as incarceration for severe offenses.
[5] Boland, M. and Hofstrand, D. The Role of the
Board of Directors (Iowa State University Press, Iowa
2009)
[6] La Porta, R.; Lopez-de-Silanes, F.;
Shleifer, A., 1998, “Law and Finance”, Journal of Political Economy,
106(6)
1113-1155
[7] Liebscher, K., Christil, J., Mooslechner,
P., and Ritzberger-Grunwald, D. Financial Development,
Integration
and Stability. (Elgar Publishing Limited, Cheltenham 2006)18
[8] Liebscher, K., Christil, J., Mooslechner,
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Integration
and Stability. (Elgar Publishing Limited, Cheltenham, 2006)20.
[9] Roche, J. Corporate Governance in Asia.
(Routledge , London 2005)40
[10] There are many controversies regarding
executive salaries within companies. Over the years different
people have
proposed different theories to solve the problem. How much should they earn?
Upon what
variables
should the salary be based on?
[11] Baker, H.K and Martin, G.S. Capital Structure
and Corporate Financing decisions: Theory, Evidence and
Practice.
(John Wiley and Sons Limited, London,2011) 96
[12] Schill, S.W. International Investment Law
and Comparative Public Law (Oxford University Press
Oxford,
2010)110
[13] Schill, S.W. International Investment Law and
Comparative Public Law (Oxford University Press
Oxford,
2010)110
[14] where no single investor owns enough to
control the company
[15] Maximise profits for the shareholder as well
company
[16]
Claessens, S., and Fan, J.P.H. 2002. Corporate governance in Asia: A
survey. International
Review of Finance, 3(2): 71-103
[17] Schill, S.W. International Investment Law
and Comparative Public Law (Oxford University Press
Oxford, 2010)110
[18] Dominant-shareholder and controlling-shareholder are used
interchangeably in this research
[19] Newcombe, A. and Paadell, Lluis. Law and
Practice of Investment Treaties. (Kluwer Law International
Publishers,
The Netherlands 2009)327
[20] Newcombe,
A. and Paadell, Lluis. Law and Practice of Investment Treaties. (Kluwer Law
International
Publishers, The Netherlands 2009)324.
[21] Dixon,
M. Textbook on International Law. (Oxford University Press, Oxford 2013) p.276
[22] Dixon,
M. Textbook on International Law. (Oxford University Press, Oxford 2013) p.276
[23] Jensen,
M and Meckling, W. 1976. Theory of the Firm: Managerial Behaviour, Agency
Costs,
and Ownership Structure. Journal of Financial Economics, 3(1): 305-360.
[24] La
Porta, R. et el. 2000. Investor protection and
corporate governance. Journal of
Financial Economics,
58(1–2): 3– 27.
Netherlands
2006) p.93.
[26] In the context of technical analysis, it is
the process of adjusting one's trading system in an attempt to
make it more effective.
[27] Corporate social responsibility
[28] Mullerat R., Corporate Social Responsibility:
The Corporate Governance of the 21st Century. (Kluwer
Law
International, The Netherland
2011)
[29] Ward R D. , 21st Century Corporate Board, (John Wiley &
Sons, Inc, Canada 1996)
[30] Leora F. et el, Corporate governance,
investor protection, and performance in emerging markets: Journal of
Corporate Finance, Volume 10, Issue 5,
November 2004, Pages 703–728,
[31] Supra
notes 30
[32] Supra notes 30
[33]
Supra notes 29
[34] Claessens, S., and Fan, J.P.H. 2002.
Corporate governance in Asia: A survey. International
Review of
Finance, 3(2): 71-103
[35]
La Porta R., Florencio Lopez-de-Silanes
& Andrei Shleifer, Corporate Ownership Around the World,
54 J. FIN. 471 (1999).
[36]
If an owner or controlling shareholder
owns a company through the pyramidal structure or cross
shareholdings, it is possible that the voting
rights of the owner (or controlling shareholders) are greater
than the cash flow rights of the same owner.
[37]
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Asian financial crisis,
Journal of Financial Economics
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[38] Jensen, M and Meckling, W. 1976. Theory of the Firm:
Managerial Behaviour, Agency Costs, and
Ownership Structure. Journal of Financial
Economics, 3(1): 305-360.
[39] The percentage of a business owned by the
holder of some number of shares of stock in that company.
Shareholders of a significant equity
stake in a company may exercise some level of control, influence,
or participation in the activities of
the company. Acquisition of a sufficiently large equity stake in a
company can also enable a company or
individual to initiate a merger, buyout, or other transfer of
ownership.
[40] Doidge, Karolyi, and Stulz , 2001: ‘Why are
foreign firms listed in the US worth more’? National Bureau
of
Economic Research. Cambridge. Working Paper 8538 http://www.nber.org/papers/w8538
[41] Nenova T, The value of corporate voting
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Financial
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[42] Leora F. et el, Corporate governance,
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