Assignment 6 Business Ethics

SMC University

Zurich

Course : Ethics, Corporate Governance and Company Social Responsibility

Assignment : 6

Date : 24 May 2011

Student : Kulwant Kumar SHARMA

Professor : Dr. Jeffrey Henderson, Ph.D.

Assignment # 6, May 24, 2011, Doctorate of ManagementMr. Kulwant Kumar Sharma

Most of the companies in emerging countries are family-owned and not listed in stock markets. Does this circumstance make a difference with regard to principles of corporate governance? How could family-

owned companies attract capital through minority shareholders? What are the proper principles of corporate governance for these companies?

Topic 6 Assignment: Ethics, Corporate Governance & Company Social Responsibility

Introduction

Discussions on corporate governance (CG) have covered mostly those companies which have

dispersed holdings and are public listed. Non-listed companies (NLC) have not been in focus for

CG and best practices’ debates. The OECD paper on ‘CG of Non-listed companies in emerging

markets’ is an useful document for these markets.

NLCs are mostly closely held companies whose shares do not trade freely in stock markets. This

could be due to the small number of shareholdings or restrictions limiting their transferability

(Hansmann/Kraakman, 2004). Prasad (2007) quoted industrialist Rahul Bajaj, that in India; more

than 75 per cent of large listed Indian companies are family-owned. Family shareholding in these

companies is significant (30 per cent upwards). The balance is largely public sector units or

subsidiaries of multinational companies. Companies where the management has little or no stake

in the company constitute less than 5 per cent of the large, listed companies. He further states

that over 85% of businesses in the European Union and USA are family-run. In Italy the figure is

as high as 99%. 40% of the US S&P 500 companies are family-run firms. The study of Prasad

shows that there are conflict situations between family interests and minority shareholders

interests. These vary from pricing of preferential issues, dividend decisions, conflict between

family owners and depositors, lack of adequate exposure for one family, enrichment of one

branch of family in management control at the expense of others and family succession deciding

management succession.

Many of these large companies are by choice unlisted but have financial stakeholders (equity

and/or creditors) besides their controllers. This includes companies, partially or completely,

under founder/family control, with professional management although the founder/family may

continue to play an important governance/shareholder role. The creation of a minority

shareholder class is a fairly predictable event in the life cycle of a family company. Succession


through multiple generations results in more inactive shareholders and dilution of ownership

(Visscher 2005). In another study by Chourov, using a sample of Canadian family firms, they

found that when there is divergence between voting rights and cash flow rights, owner CEOs

receive higher compensation than non-owners. The higher the divergence between voting rights

and cash flow rights, the higher the excess compensation. Further analysis shows that only

poorly governed firms are affected by the expropriation problem (Chouroy L 2010).

Financial Disclosure - An Economic Analysis

The analysis provided in OECD report indicates that introducing a requirement of large private

corporations to disclose publicly their financial statements is unlikely to achieve an appropriate

balance between the costs and benefits. Requiring large private corporations to disclose publicly

their accounts is likely to impose definitive and significant costs, while the benefits of the

proposal are unclear. The costs could be from the adverse consequences for personal privacy,

lack of commercial confidentiality, loss of personal property rights and increased direct costs.

The benefits of disclosing more information are likely to accrue to the disclosing company. The

NLCs may be family owned business where the main conflict of interest in family firms becomes

the expropriation, often legal, of minority shareholders and creditors by the controlling

shareholder rather than the common conflict of interests between professional managers and

shareholders. This expropriation may take a wide variety of forms, some of which are legal in

some locations but illegal in others. (Johnson, La Porta, Lopez-De-Silanes, & Shleifer, 2000).

Ownership and Financing Structures

The OECD paper compares Listed Companies (LCs) and NLCs in Europe, in terms of ownership

structure and financial ratios. From a performance viewpoint, while NLCs may face different CG

problems than LCs, they resolve these equally well since performance differences are small

between matched firms. Thus, one conclusion could be that the presence of block-holders in

NLCs offers advantages in monitoring and control, and generates organisational benefits in terms

of decision speed and unity of command. Moreover, NLCs may benefit from avoiding the cost of

complying with reporting and other requirements that are imposed on listed firms, thus saving

them resources, and potentially allowing them to focus on longer-term investment strategies. The

OECD research given in the paper compares NLCs with larger LCs.


The Indian corporate sector has seen substantial and significant changes in the last ten years of

liberalisation and globalization, specially in financial structures and CG. The CG is still based on

Companies Act of 1956, which are under revision since 2004. CG remains a weak area with the

issues of ownership and control, management integrity, accountability and transparency,

succession and split still haunting majority of the Indian companies. Their number comprises of

both public and private companies (other than listed companies), including the family - founded

and managed business. These issues continue to impact the growth of the economy and the

vitality of the business sector (Batra Sumant, OECD Paper 2006).

Family ties can be seen as providing bonds of trust that can substitute those that are supposed to

be provided by the legal system. This has lead some authors (see, for example, Panunzi, Burkart,

& Shleifer, 2002) to propose that family firms are more common in countries with weak

protection of minority investors precisely because family ownership is a substitute for the legal

protection of minority investors. But this is based on either of two implicit assumptions: (a) that

agency problems do not exist when the agent and the principal are members of the same family,

or (b) the family has internal mechanisms to deal with such problems whenever they exist (Pablo

2007).

National Variation in Financing Patterns

As regards to the differences between LCs and NLCs, the research of OECD states that these are

not significant in terms of their implications for financing patterns. Widely held firms should

disclose, though it is difficult to define widely from closely held due to national differences.

Degree of protection for minority shareholders remains a political decision, as as been elaborated

in the paper. Differences are seen as in the United States assesses some listed firms with very

infrequent trading similar to NLCs. As far as the policy on financing NLCs goes, access to

external finance may not be different from that of LCs. In CG field, major issue of concern

remains minority shareholders and their stake in the governance of NLCs. The OECD paper

suggests that the best way to ensure effective access to external finance and low costs of capital,

as well as CH, is to decrease the risks posed to creditors and providers of external equity by

enacting investor protection laws and enforcing them. This will include easy collateral registries,

information availability on borrowers and a reasonable disclosure on ownership.


Policy framework has to work on two objectives – employing the capital assets in an effective

and efficient manner and consumers or investors must have a choice to diversify. Mutual Fund

industry provides one such avenue to diversify retail investments and lower the costs. The

corporate performance from 2003 to 2010 shows glaring shortcomings in the CG all over the

world. Banking and financial sectors were specifically criticized in various reports. It has shown

situations where corporate governance might fail in its task to facilitate the achievement of both

these fundamental goals (OECD paper quoting Buchanan and Yang, 2005). Transparency and

accountability are keystones to achieving good CG and OECD principles can be applied to all

NLCs.

The Role of the Law in Developing Efficient CG

CG has become an important topic for both research and business practice in emerging and

transition markets. NLCs will continue to play a significant role in a wide variety of economies

special studies are needed to bring in CG in them. OECD research brings forward company laws

to improve the performances of NLCs and encourage them to be more transparent. There is a

consensus that the most pressing matter involves the abuse of minority interests by controlling

shareholders. Company law is the most important source of CG techniques in the context of

NLCs. Precise valuation methods, minority protection and fiduciary duties can be part of the

company laws to regulate and encourage NLCs towards CG. There has been a debate on public

disclosure and its effectiveness in informing the stakeholders about the company’s financial

health as many issues are not highlighted. This can be supplemented with a right of inspection of

company ledger, books and other records. Enforcement is another approach to protect investors

in non-listed companies. Company rules need to be flexible as one legal framework suitable for

non-listed companies across the board would be difficult to achieve. There can be some optional

guidelines to supplement the existing legal frameworks.

In spite of the issues of concerns bright out in the OECD paper, empirical evidence shows that at

least some large, multinational NLCs do protect the rights of their minority shareholders,

whether the law requires them to do so or not. This is even if the minority shareholders are not

related to the core of the family. Pablo in his study explained that it is necessary to understand

mechanisms NLCs use to align the incentives of all stakeholders (Pablo 2007).


Conclusion

The debate on CG has mostly focused on listed companies particularly in countries with

developed capital markets and companies with dispersed shareholdings. A leading CG issue

concerns the appropriate design of a legal, institutional and regulatory framework that helps to

align the interests of shareholders and managers of NLCs. Policy makers worldwide have looked

to devise an effective framework that supplies proper incentives for the board and management

to act in the interest of the company and its shareholders; and furnish investors with sufficient

monitoring information. One of the primary risks shareholders face, is that they will end up in a

situation where the controlling shareholder may use his or her position to deprive the non-

controlling shareholder of influence over major decisions. Many jurisdictions have legislation

that can prevent abuse of non-controlling shareholders in both circumstances, and typically these

measures apply to both non-listed companies and public companies.


References:

1. Chourou, L. (2010), Compensation of owner managers in Canadian family-owned businesses: expropriation of

minority shareholders. Canadian Journal of Administrative Sciences / Revue Canadienne des Sciences de

l'Administration, 27: 95–106. doi: 10.1002/cjas.145

2. Johnson, R., La Porta, R., Lopez-De-Silanes, F., & Shleifer, A. (2000). Tunneling. The American Economic

Review, 90 (2), 22.

3. OECD Corporate Governance for Non-Listed Companies. OECD 2006.

4. Pablo MARTIN DE HOLAN (2007); Protected by the family? How closely-held family firms protect minority

shareholders. Instituto de Empresa and INCAE, Madrid, Spain.

5. Panunzi, F., Burkart, M., & Shleifer, A. (2002). Family Firms.Unpublished manuscript, Boston, Mass.

6. Prasad S.A.Murali (2007), The Functioning of the Audit Committee in Family-owned Companies.

7. Batra Sumant, India: An Overview of Corporate Governance of Non-Listed Compaines; OECD Paper 2006

(Chapter 10).

8. Visscher de Francois (2005), Minority shareholders: Handle with care; Published in Family Businesses: The

Guide to Family Companies; http://www.familybusinessmagazine.com/


Assignment 6 Business Ethics

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