[PPT] - Shareholder Value Reconsidered Simon Deakin and Ajit Singh Centre PowerPoint Presentation

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CBR Summit: Innovation and Governance 29-30 March 2006

Shareholder Value Reconsidered

Simon Deakin and Ajit Singh

Centre for Business Research University of Cambridge

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CBR Summit: Innovation and Governance 29-30 March 2006

Shareholder value reconsidered

Defining ‘shareholder value’ and its relationship

to company law

The pivotal role of the market for corporate

control: evidence on UK takeovers

The perverse effects of stock market volatility in

the US

Developing countries: the ‘crony capitalism’

hypothesis

Is the shareholder value norm a source of

efficiency, or just a fad?

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CBR Summit: Innovation and Governance 29-30 March 2006

The end of history for corporate governance?

‘A principal reason for convergence [in corporate

law] is a widespread normative consensus that corporate managers should act exclusively in the economic interests of shareholders… Since the dominant corporate ideology of shareholder primacy is unlikely to be undone, its success represents the “end of history” for corporate law’ (Henry Hansmann and Reinier Kraakman, January 2000) [emphases added]

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CBR Summit: Innovation and Governance 29-30 March 2006

‘Enlightened shareholder value’

‘[a]n obligation on directors to achieve the success of the

company for the benefit of the shareholders by taking proper account of all the relevant considerations for that purpose’ including ‘a proper balanced view of the short and long term, the need to sustain effective ongoing relationships with employees, customers, suppliers and

thers; and the need to maintain the company’s

reputation and to consider the impact of its operations on the community and the environment’ (UK Company Law Review Steering Group, 2000)

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CBR Summit: Innovation and Governance 29-30 March 2006

The company’s interest ‘in itself’

‘In Anglo-Saxon countries the emphasis is for the most

part on placed on the objective of maximising share value, whilst on the European continent and France in particular the emphasis is placed more on the human assets and resources of the company… Human resources can be defined as the overriding interest of the corporate body itself, in other words the company considered as an autonomous economic agent, pursuing its own aims as distinct from those of its shareholders, its employees, it creditors including the tax authorities, and

f its suppliers and customers; rather, it corresponds to

their general, common interest, which is that of ensuring the survival and prosperity of the company’ (Viénot report, 1995)

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CBR Summit: Innovation and Governance 29-30 March 2006

Origins of shareholder value

The takeover revolution
The City Code on Takeovers and Mergers:

constraining the target board

Shareholder value metrics
Share option schemes
New managerial class
Rise of the institutional shareholder

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CBR Summit: Innovation and Governance 29-30 March 2006

‘Creative destruction’

‘[i]t was impatient, value-focused

shareholders who did America a great favour by forcing capital out of its traditional companies, and thereby making it available to fund the venture capitalists and the Ciscos and Microsofts that are now in a position to propel our economy very rapidly forward’ (Larry Summers, 2001)

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CBR Summit: Innovation and Governance 29-30 March 2006

‘The unproductive shareholder’

‘stock-market investors have become,

collectively, an extraordinarily unproductive force in business. Indeed, for the last two decades, their contribution to corporations has been literally negative… it’s wrong to shovel money

ut to shareholders in ever larger scoops and

force other stakeholders to pay the price’ (Marjorie Kelly, Harvard Business Review, 2001)

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CBR Summit: Innovation and Governance 29-30 March 2006

Net Sources of Finance for Germany, Japan, the UK and US 1970-89 (percentages)

20

20 40 60 80 100 Internal Bank finance Bonds New equity Trade credit Capital transfers Other Germany Japan UK US

Source: Singh, 2003:49

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CBR Summit: Innovation and Governance 29-30 March 2006

The regulatory framework for takeover bids

Company law: directors owe duty to act in good faith in

the interests of the company

Takeover Code: soft law which imposes a bid timetable

and principle of ‘equal treatment’ of target shareholders; major reason for dispersed share ownership in UK

Specific duties are owed by directors to target

shareholders

In the UK, restrictions on poison pills make all listed

companies open to the possibility of a hostile bid

In the US, poison pills are generally permitted, but may

have to be redeemed by the board in the event of an ‘auction’ between competing bidders

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CBR Summit: Innovation and Governance 29-30 March 2006

The Thirteenth Directive

‘actual and potential takeover bids are an important

means to discipline the management of listed companies with dispersed ownership, who after all are the agents of

shareholders. If management is performing poorly or

unable to take advantage of wider opportunities the share price will generally under-perform in relation to the company’s potential and a rival company and its management will be able to propose an offer based on their assertion of their greater competence. Such discipline of management and reallocation of resources is in the long term in the best interests of all stakeholders and society at large. These views also form the basis for the Directive’ (EU High Level Group).

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CBR Summit: Innovation and Governance 29-30 March 2006

Examining takeover bids

Inconclusiveness of econometric studies suggests role

for more focused research (reported in Deakin and Slinger, 1997; Deakin, Hobbs, Nash and Slinger, 2003)

Non-random sample of 15 bids mounted in period 1993-

96 chosen to reflect main bid types (hostile; agreed; UK

nly; international; cash only; shares only; shares and

cash)

Interviews with directors, bankers, lawyers,institutional

investors, union representatives, aimed at understanding perceptions of bid process

Sample re-examined 5 years on to see how the merged

firm was perceived to have performed

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CBR Summit: Innovation and Governance 29-30 March 2006

How market actors view takeover regulation

Takeover Code and directors’ fiduciary duties ranked

highest among factors affecting bid outcomes

Regulatory factors more likely to affect outcome in

hostile as opposed to agreed bids

Employees’ interests less likely to be given priority in

hostile bids than in agreed bids

Target employees were expected to suffer losses from

bids; target shareholders were the most likely to gain;

ther consistent gainers were advisers

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CBR Summit: Innovation and Governance 29-30 March 2006

Figure 1

The Importance of Regulatory Factors in Determining Takeover Outcomes

10 20 30 40 50 60 70 80 90 100 Takeover Code and SAS Rules Fiduciary duties of directors Companies Acts

bligations

Tax Possibility of reference to MMC Takeover law s of another country EC merger law % of respondents citing factors as important

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CBR Summit: Innovation and Governance 29-30 March 2006

Figure 2 The Mean Perceived Effect of Mergers on Different Groups

1
0.8
0.6
0.4
0.2

0.2 0.4 0.6 0.8 1 Shareholders Employees Managers Directors Suppliers Customers Banks Bondholders Competitors Advisors Bidders Targets

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CBR Summit: Innovation and Governance 29-30 March 2006

Takeover Premiums in Selected Takeover Bids 1993-96

20 40 60 80 100 120 140 K i n g f i s h e r

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t e Takeover Prem ium (% )

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CBR Summit: Innovation and Governance 29-30 March 2006

Directors’ duties

‘The effect of General Principle 9 is that you are

given permission to temper your pursuit of your shareholders’ interests with your employees’

interests. It is used as an argument but never

really has an influence on the outcome.’

‘I have yet to come across a bid in which the

creditors’ and employees’ interests have been thought about in front of shareholders: it’s on the list, but of no practical importance: first is share price, and second are service contracts for directors’

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CBR Summit: Innovation and Governance 29-30 March 2006

Stakeholders

‘Employees? They never came into it. I spoke to
ne [target] director once, on a picket line
utside an EGM. He shook my hand and

thanked me for all I was doing for the

shareholders. I told him I was doing it for the
employees. In general, as long as the new
wner tells us that they intend to carry on as

before, the directors feel that they’ve done their

job. In reality, employees’ interests (and

differences in company practices) are not

considered. [Target] directors never came to

see us at all.’ (trade union official)

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CBR Summit: Innovation and Governance 29-30 March 2006

The aftermath

Merger is almost invariably followed by asset disposals
For most bids, investor opinion five years on is sceptical

about whether shareholder value has been created

Granada-Forte takeover: ‘the returns for Granada have

barely matched the group’s cost of capital and… its shareholders might have been better off if the deal has never been done’ Financial Times, 29 May 2001

‘Glaxo-Wellcome is destroying shareholder value at the

moment’ Financial Times, 1 August 1997

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CBR Summit: Innovation and Governance 29-30 March 2006

The aftermath

Even bids seen as successful initially

encounter investor scepticism before long: Lloyds/TSB; Scottish Power

BAe/VSEL/GEC: Marconi delivering on

high growth for shareholders, having

utperformed the market by 40% (26

November 1999); Marconi in need to rescue from banks, CEO and FD resigned (September 2001)

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CBR Summit: Innovation and Governance 29-30 March 2006

Did shareholder value promote ICT in the USA in the 1990s?

US share prices were not efficient in the fundamental

valuation sense during the 1990s, and technology stocks, in particular, were subject to mispricing and volatility

The NASDAQ index stood at 1052 in 1991, but doubled

to reach 2193 in 1998 and reached its all time high of 5060 in 2000; it then fell to 1336 in 2004 and is still at less than half its peak value

Between 1990 and 2000 the share of stock market value
f technology companies rose from 7% to 35% but in the

same period their employment share rose from 6% to 9% and their share of sales from 6%-10%.

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CBR Summit: Innovation and Governance 29-30 March 2006

Negative effects of share price volatility

Between 1997 and 2001 Nortel acquired 19

companies at a price of over $33billion, mostly using Nortel stock; the company’s share price subsequently fell by 95% and the acquisitions had to be written off.

‘Nortel destroyed those companies and in so

doing destroyed not only the corporate value that the acquired companies – on their own – could have generated but also the social value those companies represented in the form of jobs and products and services (Michael Jensen, 2003)

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CBR Summit: Innovation and Governance 29-30 March 2006

Other explanations of US ICT growth in 1990s

Increased capital input, increased investment in

IT, but also an accelerated fall in semi-conductor prices, taxation changes (Jorgensen)

The ‘developmental state’: ‘US dominance in

computers, microelectronics, software and data communications is impossible to explain without recognising the role of government in making both seminal investments that developed new knowledge and infrastructure developments that diffused the knowledge’ (Lazonick)

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CBR Summit: Innovation and Governance 29-30 March 2006

Inter-country evidence on ICT and the stock market

The Information Society Index measures ICT

infrastructure and development and degrees of informational and social freedom

Multivariate regression analysis shows that the

ISI is positively correlated to the number of scientists and engineers in a given country (at the 5% level) and to GDP per capita (at the 10% level); however, stock market variables are not significantly correlated to the ISI, and in some cases, such as the number of listed companies, there is a negative relationship (Singh, Glen, Zammitt, De Hoyos, Singh and Weiss, 2005)

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CBR Summit: Innovation and Governance 29-30 March 2006

Did crony capitalism cause the Asian financial crisis?

The IMF defines crony capitalism as the

concentration of control of a large proportion of a society's assets by a few families, which is indeed the case in many Asian economies (see Table 1)

However, whether a country suffered an

economic crisis is not linked with the degree of control concentration; there is no robust empirical association between crony capitalism and financial crisis, let alone a causal one (Singh and Zammitt, 2006)

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CBR Summit: Innovation and Governance 29-30 March 2006

TABLE 1: How concentrated is family control? 39.3 53.3 46.2 32.2 9.4 1.68 Thailand 17 20.1 18.4 14.5 4 1.17 Taiwan 48.3 29.9 26.6 19.5 6.4 1.26 Singapore 46.7 55.1 52.5 42.8 17.1 2.68 Philippines 76.2 28.3 24.8 17.3 7.4 1.97 Malaysia 12.9 38.4 36.8 29.7 11.4 2.07 Korea 2.1 2.8 2.4 1.8 0.5 1.04 Japan 21.5 61.7 57.7 40.7 16.6 4.09 Indonesia 84.2 34.4 32.2 26.2 6.5 2.36 Hong Kong families families families families families

f firms per family

Top 15 Top 15 Top 10 Top 5 Top 1 Average Number Country 1996 that families control (1996) % of GDP % of total value of listed companies

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CBR Summit: Innovation and Governance 29-30 March 2006

Characteristics of Asian corporate governance

There are advantages to concentrated
wnership, in particular the ability of managers

to take a long-term view of investment decisions

Stable employment relations enhance

cooperation, particularly over technological change

Data on the persistence of profits in firms

suggests that the intensity of inter-firm competition is, if anything, greater in developing countries than in developed ones (Glen, Lee and Singh, 2003)

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CBR Summit: Innovation and Governance 29-30 March 2006

Ownership concentration in a wider perspective

High concentrations of control are not simply an

Asian phenomenon or necessarily wholly negative in terms of overall social and economic welfare (Singh and Zammitt, 2006)

Sweden, with a very large proportion of the

country's industrial assets controlled by the Wallenberg family, has not suffered the posited misallocation of resources through corrupt relationships, in part because of the active role

f the state and institutions of civil society

including trade unions as a source of countervailing power

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CBR Summit: Innovation and Governance 29-30 March 2006

Conclusions

Criticisms of the short-term focus of US and UK

corporate governance remain valid

Firms in developing markets would be well

advised to ignore stock market valuations and concentrate on profitability and building market share

Shareholder value does not represent the ‘end
f history’ but is a fad which, having taken hold