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Participation of Shareholders in Corporate

Governance

RESEARCH · APRIL 2015

DOI: 10.13140/RG.2.1.4049.3601

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1 AUTHOR:

Nelson Maseko
ICSA in Zimbabwe
14 PUBLICATIONS 5 CITATIONS

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Retrieved on: 23 October 2015
 DBA Working Papers, March 2015

Participation of Shareholders in Corporate Governance

by Nelson Maseko – Doctorate of Business Administration, SMC University, Zurich,

Switzerland
e-mail: nelson.maseko@student.swissmc.ch

Shareholders have rights under both common and corporate law to participate in key

corporate governance decisions, including the right to nominate, appoint and remove

directors and external auditors, and the right to approve major corporate decisions. According

to Waring (2006), other basic shareholder rights include the right to secure methods of

ownership registration, right to convey or transfer shares, the right to obtain relevant and

material information on the company, the right to participate and vote in general shareholder

meetings (in person or by proxy) and the right to share in the profits of the company. Also,

shareholders have the right to receive information, including about the firm’s financial

performance and to ask executives questions at general meetings.

Good corporate governance practices entail active participation of shareholders in the direct

and indirect control of the company through the board of directors and an arrangement of

effective checks and balances among shareholders, the board and management (Crowther &

Jatana, 2004). However, the major corporate governance problems with participation of

shareholders in the governance process emanates from the agency problem of information

asymmetry. The shareholders are therefore disenfranchised. The corporate governance issues

related to shareholders discussed in this paper are (1) the power of controlling shareholders,

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(2) excessive executive remuneration, (3) related party transactions, (4) expropriation of

minority shareholder rights, and (5) institutional investors.

Schlimm et al (2010) posited that the presence of a controlling shareholder can dramatically

change best corporate governance practices. Controlling shareholders have the opportunity to

engage in abusive behaviour, a situation which is exacerbated in jurisdictions where

transparency is poor and where a weak rule of law fails to give minority investors proper

judicial recourse (Ararat & Dallas, 2011). The interference by controlling shareholders with

fiduciary duties and business judgment of their nominee directors (“shadow directors”) in

favour of their own interests violates the interests of all the other shareholders. For good

corporate governance, all parties affiliated with the controlling shareholder must be identified

and disclosed, including those with any direct or indirect ownership interest in the firm

(Ararat, 2013).

Sometimes controlling shareholders use pyramid ownership, shareholder agreements and dual

classes of shares to exercise control without owning a large fraction of the cash flow rights

(Enriques & Vlopin, 2007). A study by Chen et al (2011) concluded that it is difficult to deal

with controlling shareholders because most good governance practices are mainly designed to

resolve conflicts between shareholders and management but not conflicts between controlling

shareholders and minority shareholders. Boards are typically not independent to controlling

shareholders.

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By contributing capital to a company, shareholders benefit from a distribution of the

company’s profits through dividends or through surplus assets (in case of ordinary

shareholders) if a company is wound up (Waring, 2006). The European Commission (EC,

2014) has reported insufficient link between executives’ pay and performance, insufficient

alignment of directors’ incentives with long-term interests of the company, inappropriate

information on remuneration and insufficient shareholder oversight on remuneration. The

EC’s report documented that in more than 50% of EU member states, shareholders do not

have tools to express their opinion on directors’ remuneration, with the result of repeated

cases of mismatch between directors’ pay and companies’ performance. In the end,

shareholders lose out by receiving no dividends as directors pocket all the profits from the

company through excessive pay. A study by Jiraporn and Ning (2006) have however found

that firms pay higher dividends when shareholder rights are more suppressed, in line with the

substitution theory which contends that firms with weak shareholder rights need to establish a

reputation for not exploiting shareholders and thus pay dividends more generously than firms

with better shareholder rights protection.

The mishandling of related party transactions (RPTs) is one of the pitfalls in corporate

governance where shareholder rights, especially minority shareholders’, are violated. RPTs

can have negative impact on the value of the company since they can transfer value from the

company and its minority shareholders to those who control the company (directors,

controlling shareholders and companies affiliated with these) (EC, 2014). The presence of

large scale business groups maximises the potential for such practices. For instance, in

Zimbabwe, 50% of the market capitalisation on the Zimbabwe Stock Exchange is controlled

by three counters: Delta Corporation, Econet Wireless and Innscor Africa Limited. Good

corporate governance practices can avert the potential of related party transaction

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disenfranchising minority shareholders. Any RPT should be exercised in the interests of the

firm and controlling shareholders should pose no competition directly or indirectly with the

firm (Ararat, 2013). All significant related party transactions must be approved by

shareholders. However, shareholders sometimes do not have access to information ahead of

the planned RPTs and do not have tools to oppose abusive RPTs (EC, 2014). Independent

directors must meet separately as a group without executives and must have access to

appropriate level of information to be able to discharge their responsibilities of representing

minority shareholders in RPTs (ABI, 2013).

Independent directors can both support and challenge the decision-making process of the

board and, ultimately, represent minority shareholders’ interests in RPTs. Non-executive

directors are therefore believed to be independent representatives of shareholders on the

board. Ararat and Dallas (2011) have however argued that the influence of independent

directors is hard to demonstrate. The inescapable problem is the uneven balance of power as

controlling shareholders will be receptive to shareholder proposals only if these proposals are

demonstrably in their own interests.

Companies should ensure equitable shareholder rights through one-share-one-vote.

Differentiated voting or dividend rights result in a number of unintended consequences and

affect the interests of minority shareholders adversely, rather than stimulate longer-term

ownership (ABI, 2013). According to Ararat (2013), tag-along rights/mandatory offer

provisions can be put place to allow shareholders to participate in corporate actions along the

same terms as controlling shareholders. Supermajority requirements (75%) for key

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resolutions such as key strategic or corporate actions that affect minority shareholders should

be put in place.

Research has documented the role of institutional investors in safeguarding the rights of

shareholders in corporate governance (Waring, 2006). Because of their economic muscle,

institutional investors can influence good corporate governance practices. They can

encourage regular, systematic contact at senior executive level for the purpose of an exchange

of views and information on strategy, performance, board composition and processes and

quality of management (ABI, 2013). Shlimm et al (2010) posited that institutional investors

will identify “red flags” that may indicate, for instance, controlling shareholder opportunism

and then try to persuade the board to improve its corporate governance practices. Making

these “red flags” known to other shareholders and stakeholders will help put pressure on the

board to correct bad practices and change the ways of the inappropriately opportunistic

controlling shareholders, thus protecting value for all shareholders and other stakeholders. Of

late, institutional investors are redirecting their investment strategies away from a focus on

short-term returns in such a way as to favour stakeholder inclusive practices. Armour et al

(2003) have decried this change as a shift in the role of institutional shareholders in corporate

governance, especially from an Anglo-American perspective.

The “free-rider” problem is one of the challenges in shareholder activism (Waring, 2006;

Widman, 1998, p.106). Shareholders usually benefit from the engagement efforts of a few

who bear the costs.

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From the discussion above, it is difficult to contend seriously that shareholders have a

meaningful role in corporate governance under the existing frameworks and regulations.

Their participation is by representation and is rather theoretical. Management still wields

excessive power, with controlling shareholders exploiting their own. Major decisions such as

setting executive compensation have remained under the control of the stewards because of

information asymmetry, much to the detriment of the owners. Policy makers and regulators

are still faced with a daunting task since research has shown that none of the existing

corporate governance mechanisms for curbing these abuses are effective.

Acknowledgement

I wish to thank Dr Albert Widman of SMC University for the mentorship and guidance he
provided in the course of writing this essay.

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References

Ararat, M. (2013).Corporate Governance and Shareholders Rights in Emerging Markets.

Presentation at the International Corporate Governance Network, 11 November,
Istanbul, Turkey.

Ararat, M. and Dallas, G. (2011). Corporate Governance in Emerging Markets: Why It

Matters to Investors-and What They Can Do About It. Global Corporate Governance
Forum, 22 (Private Sector Opinion).

Armour, J., Deakin, S. and Konzelmann, S.J. (2003).Shareholder Primacy and the Trajectory
of UK Corporate Governance. Working Paper 266 of the ESRC Centre for Business
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Association of British Insurers (2013).Improving Corporate Governance and Shareholder

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Chen, V.Z., Li, J. and Shapiro, D.M. (2011). Are OECD-prescribed “good corporate
governance practices” really good in an Emerging Economy? Asian-Pacific Journal
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Crowther, D.And Jatana (2004). Agency Theory: A Case of Failure in Corporate Governance.

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