THE FAILURE OF SHAREHOLDER VALUE GOVERNANCE IN CORPORATE GOVERNANCE (Research Paper Sample)

THE FAILURE OF SHAREHOLDER VALUE GOVERNANCE IN CORPORATE GOVERNANCE NAME Date Introduction Shareholder value governance is management and governance that incorporates or imposes the fundamental belief that the maximisation of value for the shareholder in an enterprise main objective. The idea is also pegged on the fact that when the wealth and value of the corporation at large are protected, shareholder value is maximized. This system of governance focuses on the market value and capitalisation of the company. Also, it adds that the stock prices, dividends, and wealth of the shareholders should be the primary drivers in the management of a corporation. The weakness with this approach, in the area of corporate governance, is that it fails to capture very many key elements in the management of corporations, such as risky investments, which can inflate the share value of the corporation. Thus, even though the market value may be good, the underlying management of the corporation may be in a catastrophic situation. The paper will analyse the market for corporate control, takeovers, the use of non-executive directors and the use of incentive-based pay as key concepts within the framework of shareholder value governance. The angle taken by the paper will analyse whether the adoption and use of the above strategies in governance have yielded success in corporate governance. The thesis of this paper is captured by the excerpt “The disciplining forces which are fundamental to the shareholder value governance at large public corporations, including the market for corporate control, the hostile takeover, non-executive directors and incentive-based pay, have proven largely ineffective”. In this analysis, key references will be made to corporate failures such as Enron to indicate the role of shareholder value governance in corporate failures. The market for Corporate Control and Takeover The key assumption under the market for corporate control is that there is a high positive correlation between the market prices of shares of the company and the corporation's managerial efficiency. If the resources of the corporation are not used in a manner which enhances the value for the shareholder, the market price of the share of the corporation will be reduced as compared to when the management is maximising the resources. Hence, the share is not only associated with the value of the company but also goes to the root of current management practices and expectations about the future performance of the company. Therefore, this allows for the transfer of control through contention for proxy and mergers. It also allows for different managerial terms to contend for the control rights over a corporation and its resources. These findings and assumptions imply that if a corporation has bad management, there is an expected low corporate efficiency, and this leads to low stock prices, which makes a company easily attracted to a takeover party that could manage the targeted corporation better or more efficiently. As Manne illustrates, “… the potential return from the successful takeover and revitalisation of a poorly run company can be enormous”. In his empirical study, Amel-Zadeh Amir and Yuan Zhang reveal that for large shareholders, the liquid stock market can facilitate exercising corporate control in several ways. First, the same would ensure that large shareholders can emerge and correct managerial failures. Secondly, the same would enable them to dispose of their shares before any expected stock fall and remove themselves from the management of the company. If the market is more liquid, then there would be more monitoring, since it would allow the investors to cover the costs of monitoring through informed share trading. Even though the dissatisfied shareholders will suffer from some considerable losses, massive capital losses will be prevented by a working market for corporate control. Shleifer & Vishny have argued that the emergence of a bidder for the stock market, which is now underperforming, who thinks they could manage the resources of the corporation effectively, would rectify the mismanagement of the corporation. However, this theory has its limitations; many times it fails to ensure effective governance by the management and directors. Firstly, the market for corporate control has to be set in motion. It is a precursor that some shareholders of the company must be dissatisfied. In many corporate scandals, this is not usually the case. The concept also places focus on short-term performance rather than long-term suitability of shareholder value by looking at superficial indicators like the market value. Take, for instance, the case of the Volkswagen emission scandal; the company had good financial performance, and therefore no serious shareholder would seek to interfere with the management. However, long-term shareholder value was at risk as the management was involved in practices which were hidden from the shareholders. This just explains one of the weaknesses of the shareholder-based governance models. Also, the model is faulty in ensuring proper governance as it only focuses on the interest of shareholders’ maximum value at the expense of other stakeholders, like employees and customers. This can be attributed directly to the collapse of Enron and Lehman Brothers. For other industries like the banking sector, which has a modified and strong agency, including taxpayers, depositors, and regulators. Thus, emphasising the market value of the share may be misguided as the management may be involved in high-risk practices hidden from the market. Also, the market for corporate control can come in too little too late. Such a reaction means that a new bidder will come to try to salvage a ship already sunk. This means that the market for corporate control only comes in when the management has completely failed. Indeed, this is not a healthy way of preventing corporate failure or installing effective governance structures. The approach assumes that the shareholders have correct information about the internal management of the corporation, but this is not the case. Thus, it is hard for the shareholders to act if the information is not complete. The implications are that in a takeover bid, the value of only a few shareholders is considered. It is the large shareholders who are capable of having financial power to access information and acquire a majority stake for a takeover. They are the ones who could control the management. There is no guarantee for shareholder value governance since they could also have the same motives as the managers who are removed. The shareholders could also appoint a less effective management to replace the former, making the cycle continue. Market control and the consequent reliance on hostile takeover are insufficient in creating effective governance or sustaining long-term shareholder value. One of the key concerns of a market for corporate control is the issue of huge transactions. During takeovers, the companies involved in large takeovers are usually involved in large financial transactions. These create high costs, defeating the very argument of value creation. Secondly, the management always seeks to guard information, and hence, the potential purchasers may not get proper management information to effect change. Besides, the take-over is not always guaranteed as the information which may be received by the potential bidders may be suppressed by the management. Thirdly, the danger of reliance on the share price, as in the case of the market for corporate control, is that it is usually of no avail, as it rarely reflects the market’s expectation of the company’s profit. The last danger of reliance on this concept is that the purchaser itself may also be controlled by the managers seeking to maximise scale and not value, hence impeding long-term, effective, and sustainable governance. On the issue of the takeover, it is argued that it occurs because the management lacks the ability and operational efficiency, hence low market value. These concepts and conditions have been criticised more often. There are many random elements which determine the value of a company; many of these are not related to the management. Secondly, it is very hard for the market to get proper information due to the lack of symmetry of information between the market and the managers. It thus becomes a challenge for the market to correctly evaluate the conduct of the managers using this concept, reducing the dependence between the share price and the management's conduct. This means that, indeed, takeovers play a small role in ensuring proper governance. Some of the common reasons why takeovers occur include economies of scale and the pursuit of synergy, the building of enterprise empires, and the accumulation of market strength. This shows the inadequacy of the market for corporate control and takeovers. The reliance on the market for corporate control has also been revealed to lead to short-sightedness on the part of the management. The theory fails to resolve the problem of principal-agent. At the same time, the use of mergers and acquisitions implies the manifestation of agency action. The consequence is that it does not resolve, but rather amplifies differences and contradictions between the shareholders and the management. Thus, instead of creating value and ensuring governance that is shareholder-oriented, it destroys value. According to the words of Sommers market for corporate control is more often a ‘competitive, violent and avaricious world’. The market for corporate control fails to deal with corporate governance risks in corporations fully. The CEOs and the managers can effectively hide all their misdeeds and ensure that the market is fed with information which makes value and stock market price rise. The best-case example is the Volkswagen emission scandal. Bad corporate control will, in ...