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The Actuary The magazine of the Institute & Faculty of Actuaries

Corporate governance

An eminent philosopher arguing with impeccable
logic, Dr Elaine Sternberg lifts the world of gov-
ernance out of the murk produced by an
unholy alliance of vested interests that puts the baptists and bootleggers of the US prohibition era in the shade.

What’s the point?
First, she homes in on the sole purpose of corporate governance, namely the accountability of company directors to their shareholders. Stakeholders are another issue (whatever relevance other stakeholders have is not limited to corporate businesses, being a subset of corporate bodies). The distinctive characteristic of a corporate body is the separation of ownership from control, and in the Anglo-American system the directors’ powers (often legally embedded) and responsibilities constitute the main reason for non-executives, who must be independent from management and unswervingly serve the interests of shareholders. The major guide for these interests is the constitutional purpose as established in the memorandum and articles or similar documents. Ethical conduct is obeisance to this (and ‘common decency’ and ‘redistributive justice’ as distinct from the law).

Hostile takeovers
While many takeovers may be unethical, a hostile takeover is certainly not unethical by itself; often any hostility comes from the management and not the shareholders. Now heavily circumscribed if not quite neutered by state law and regulation, hostile takeovers are an essential method of getting rid of incompetent even corrupt management. Management is in the main short-termist, and emphatically not shareholders who sell because present value calculations point that way, says Sternberg. Many other management privileges such as share options (which she calls ‘loser-friendly’), low payouts, and high gearing are blessed and propped up by government.
Takeovers are a derivative of the AGM, enabling wholesale changes of directors and direction. Here too the state has seriously weakened the power of shareholders. State rules and regulations have made the flow of information and the costs of acting on it at the AGM prohibitively expensive and often illegal. For example government, not private enterprise, is responsible for the inability of shareholders to nominate new directors. Indeed these are the causes of serious ‘democratic deficits’ not the ‘tyranny of the majority’ which is a fundamental feature of any democratic process and is most tyrannical and most abused by government.

It’s a scandal
Sternberg is equally critical of establishment views concerning insider dealing and other scandals. Insider-dealing laws result in less information from management, not more yet critical investors need to have more information, without the risk of becoming an insider or forced to make a bid.
The law of unintended consequences and moral hazard is everywhere. The chief wrongs in recent scandals were already illegal, with the worst ones in the most heavily regulated industries, which often enjoy regulatory capture (ie have moulded the regulations themselves). Enron was granted special accounting privileges and auditors are not detectives but directors are, or should be, a point that is also made in Unshackling Accountants by David Myddleton.

While Sternberg believes that board seats for small shareholders are a silly idea, she is not an unreconstructed fan of institutional investors. They too are agents, often badly aligned to their own ultimate owners or beneficiaries. They too, however, can be managed in free markets rather than by government dictatorship.
How, then, would such markets clean up bad corporate governance? Sternberg’s call for a competitive ‘market for corporate control’ widens ‘control’ from takeover activity to underlying supervision on behalf of shareholders, which companies, advisers, and the market generally would compete to supply. Current fashions like hygiene and activism don’t work and ignore the issues of costs and free-riders. She is particularly severe on stakeholder theory and dismisses the German and Japanese systems as negligent not only of shareholder rights but also of property rights in general. Competition could occur in framing objectives and in voting on specific topics, such as debt, takeover, poison pills, asset sales, director selection and remuneration, and information disclosure. It could also occur in AGMs, EGMs, Internet meetings, nominee and proxy rights, and separate trading in voting rights.

Corporate objectives
In particular the corporate objective itself is often overlooked indeed the authorities frown on it as restrictive (on management of course!). As Sternberg says, ‘companies could significantly differentiate themselves in the competition for funds by identifying their corporate objectives more precisely’. I’m sure she would support Richard Epstein’s solution for the insider-trading ‘problem’, quoted in another IEA publication (Regulation without the state, Readings 52, p39): ‘ for a company to legitimise insider trading all it needs is a provision in its charter saying “if you want to deal in the shares of this company, please understand that every employee and every director is entitled to trade on inside information to their heart’s content. If you do not want to trade with us you are free to buy shares in our competitor which does not allow that option”.’
This is a thought-provoking book displaying immense breadth and vision.