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Further notes for Lecture 1

Stakeholders in corporate governance

1. Stakeholders are people, groups or organisations that can affect or
be affected by the actions or policies of an organisation. Each
stakeholder group has different expectations about what it wants, and
therefore different claims upon the organisation.

2. Stakeholders can be classified by their proximity to the organisation.


Stakeholder group Members
3. Mendelow classifies stakeholders on a matrix [below] whose axes are
power held and likelihood of showing an interest in the organisations
activities. These factors will help define the type of relationship the
organisation should seek with its stakeholders, and how it should view
their concerns.



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4. Clearly, an organisation must keep its main stakeholder groups happy
whether active or passive.



5. Passive stakeholders may still be interested and powerful. If corporate
governance arrangements are to develop still further, there may be a
need for powerful, passive stakeholders (eg institutional investors)
to take a more active role.

6. Practice
Required
Who are the main stakeholder groups in a commercial company, and
how should they be considered with respect to the role and scope of
corporate governance?

Answer:
Corporate governance reports worldwide have concentrated significantly
on the roles, interests and claims of the internal and external
stakeholders involved.

(a) Directors: The powers of directors to run the company are set out in
the companys constitution or articles. Under corporate governance best
practice there is a distinction between the roles of executive directors,
who are involved full-time in managing the company, and the non-
executive directors, who primarily focus on monitoring. However under
company law in most jurisdictions the legal duties of directors apply to
both executive and non-executive directors.

(b) Employees play a vital role in an organisation in the implementation
of strategy; they need to comply with the corporate governance systems
in place and adopt appropriate culture. Their commitment to the job may
be considerable involving changes when taking the job (moving house),
dependency if in the job for a long time (not just financial but in utilising

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skills that may not be portable elsewhere) and fulfilment as a human
being (developing a career, entering relationships).

(c) Suppliers. Major suppliers will often be key stakeholders, particularly
in businesses where material costs and quality are significant. Supplier
co-operation is also important if organisations are trying to improve their
management of assets by keeping inventory levels to a minimum; they
will need to rely on suppliers for reliability of delivery. If the relationship
with suppliers deteriorates because of a poor payment record, suppliers
can limit or withdraw credit and charge higher rates of interest. They can
also reduce their level of service, or even switch to supplying competitors.

(d) Customers have increasingly high expectations of the goods and
services they buy, both from the private and public sectors. These include
not just low costs, but value for money, quality and service support. In
theory, if consumers are not happy with their purchases, they will take
their business elsewhere next time. With increasingly competitive
markets, consumers are able to exercise increasing levels of power over
companies as individuals.

(e) External auditors. The external audit is one of the most important
corporate governance procedures; it enables investors to have much
greater confidence in the information that their agents, the
directors/managers are supplying. However, the main focus of the
external audit is on giving assurance that the accounts give a true and
fair view. Because of the significance of the external audit, the external
auditors must be independent.

(f) Regulators. A key interest of regulators in corporate governance is
maintaining shareholders - stakeholder confidence in the information with
which they are being provided.


Problems with stakeholder theory

7. A principle of company law in most jurisdictions remains the fiduciary
and legal obligations that managers have to maximise shareholder
wealth. Therefore, if managers are to fulfill responsibilities to a wider
stakeholder base, it must not jeopardise long term profitability.


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8. Some commentators have tried to reconcile stakeholder and agency
theory by arguing that managers are stakeholders, responsible as
agents to all other stakeholders. Although stakeholders have
divergent interests that may be difficult to reconcile, this does not
absolve management from at least trying to reconcile their interests.

9. There are two motivations for considering stakeholders. An
instrumental view justifies considering stakeholders because of the
economic benefits to the company. A normative view is based on the
idea that the company has moral obligations towards stakeholders


Major issues in corporate governance

10. The scope of corporate governance is vast and we shall expand on
the following key issues during this course of study.

11. Major issues pertaining to corporate governance, that could arise in
any exam question, are illustrated below.



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Comments on ethical responsibility:

12. Carol has identified four stances (positions) of ethical responsibility.

1) Economic Responsibility
Economic responsibility focuses on shareholders wealth maximization.
Treatment to other stakeholders83 depends on effect on shareholders wealth.

2) Legal Responsibility
Legal responsibility focuses on compliance with laws and regulations.
Compliance with corporate governance76 codes such as Sarbanes Oxley act in
US is subject to legal responsibility in rule-based jurisdictions.

3) Ethical Responsibility
Ethical responsibility focuses on commitment with ethical and voluntary codes.
It involves fulfilment of social expectations which not covered by law. Ethics is
the behaviour required by the society.

4) Philanthropic Responsibility
Philanthropic responsibility focuses on commitment beyond social
expectations. It involves commitment with those aspects of ethics, which laws
and voluntary codes failed to address.

Impact of ethics on strategy formulation
13. Ethics has gained increasing importance in modern business
environment. Investors are increasingly following the approach of
ethical investment where they only invest in companies that undertake
ethical behaviour.

14. It is important to understand that if ethics is applicable to corporate
behaviour at all, it must therefore be a fundamental aspect of mission,
since everything the organisation does flows from that. Objectives are
derived from mission and strategies are set from objectives.

15. Therefore, managers responsible for strategic decision making cannot
avoid responsibility for their organisation's ethical standing. They
should consciously apply ethical rules to all of their decisions in order
to filter out potentially undesirable developments, for example poor
ethical behaviour leads to damage in reputation


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Other comments:

16. Honesty / probity not simply telling the truth but also not being
guilty of issuing misleading statements or presenting information
in a confusing or distorted way

17. Accountability emphasis of the directors accountability to
shareholders, but opens the door for discussion about the extent
of their accountability to other stakeholders

18. Independence strong emphasis on the appointment of
independent nonexecutive directors who are free from
conflicts of interest and are thus able to monitor effectively the
entitys and executive directors activities, ideally working
closely with the external auditors

19. Responsibility a system of responsibility should exist whereby
entity directors acknowledge their responsibilities to the
stakeholders, and will take whatever corrective action is
necessary in order to keep the entity focused

20. Decision taking / judgement the skill with which management
make decisions which will improve the wealth / prosperity of the
organization

21. Reputation built by directors, often as a result of their ability to
comply with other cg concepts

22. Integrity straightforward dealing, honesty, and balance For
financial statements to have the characteristic of integrity, this
depends upon the integrity of those people who prepare them
Integrity involves a person who demonstrates high moral
character, is principled, professional, honest and trustworthy

23. Fairness taking into account the interests, rights and views of
everyone who has a legitimate interest in the entity

24. Transparency / openness involves full disclosure of material
matters which could influence the decisions of stakeholders This

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means not simply openness in the reporting of information
required by IFRS in the financial statements It also involves other
information such as cash and management forecasts,
environmental reports and sustainability reports

25. Innovation the requirement that entities should continue in
their efforts to be innovative. If not, and they stagnate, their
long-term future is under major threat

26. Scepticism the need for entities always to be sceptical in their
estimation of the probability that good times lie around the next
corner. The need therefore to adopt an attitude of prudence
and caution