Shareholder Value Reconsidered · Shareholder value reconsidered ... • ‘The effect of General Principle 9 is that you are ... prices, taxation changes (Jorgensen)

CBR Summit: Innovation and Governance 29-30 March 2006

Shareholder Value Reconsidered

Simon Deakin and Ajit Singh

Centre for Business ResearchUniversity of Cambridge


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?


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]


‘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 others; 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)


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 of its suppliers and customers; rather, it corresponds to their general, common interest, which is that of ensuring the survival and prosperity of the company’ (Viénotreport, 1995)


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


‘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)


‘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 out to shareholders in ever larger scoops and force other stakeholders to pay the price’(Marjorie Kelly, Harvard Business Review, 2001)


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

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Internal Bankfinance

Bonds New equity Tradecredit

Capitaltransfers

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Germany Japan UK US

Source: Singh, 2003:49


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


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).


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 only; 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


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; other consistent gainers were advisers


Figure 1

The Importance of Regulatory Factors in Determining Takeover Outcomes

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Takeover Code andSAS Rules

Fiduciary duties ofdirectors

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Figure 2The Mean Perceived Effect of Mergers on Different Groups

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Shareholders Employees Managers Directors Suppliers Customers Banks Bondholders Competitors Advisors

Bidders Targets


Takeover Premiums in Selected Takeover Bids 1993-96

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Kingfish

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arty

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SELGEC - V

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Dobson Park

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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’


Stakeholders• ‘Employees? They never came into it. I spoke to

one [target] director once, on a picket line outside 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 owner 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)


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


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 outperformed the market by 40% (26 November 1999); Marconi in need to rescue from banks, CEO and FD resigned (September 2001)


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 of 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%.


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)


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)


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)


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)


TABLE 1: How concentrated is family control?

39.353.346.232.29.41.68Thailand

1720.118.414.541.17Taiwan

48.329.926.619.56.41.26Singapore

46.755.152.542.817.12.68Philippines

76.228.324.817.37.41.97Malaysia

12.938.436.829.711.42.07Korea

2.12.82.41.80.51.04Japan

21.561.757.740.716.64.09Indonesia

84.234.432.226.26.52.36Hong Kong

familiesfamiliesfamiliesfamiliesfamiliesof firms per family

Top 15Top 15Top 10Top 5Top 1Average NumberCountry

1996that families control (1996)

% of GDP% of total value of listed companies


Characteristics of Asian corporate governance

• There are advantages to concentrated ownership, 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)


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 of the state and institutions of civil society including trade unions as a source of countervailing power


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 of history’ but is a fad which, having taken hold in the US and UK, could endure for some time in those systems, or tip over once its disadvantages are clearly seen to outweigh its advantages

Documents

Shareholder Value Reconsidered · Shareholder value reconsidered ... • ‘The effect of General Principle 9 is that you are ... prices, taxation changes (Jorgensen)