Section 4: stakeholder management. Stakeholder management
involves identifying prioritizing and understanding
the interests of stakeholder groups and on that
basis managing the company's relationships with
these groups. This is taken straight from the curriculum
and you need to remember this definition of stakeholder
management. Now managing the company's relationships
with the different stakeholder groups will require
a legal infrastructure, a contractual infrastructure,
an organizational infrastructure and a governmental
infrastructure. So understand these in a few words
now legal infrastructure refers to the laws and
regulations that must be followed and the recourse
that a company has if the laws are violated. The contractual
infrastructure is what a company has most control
over and this has to do with the contracts and agreements
that a company will make with its creditors, suppliers,
customers, employees and so on. The organizational
infrastructure deals with the internal systems
and procedures that a company adopts and the governmental
infrastructure has to do with the regulations that
a company needs to follow and this is linked with
the legal infrastructure. Mechanisms of stakeholder
management: There are no standard set of mechanisms
across different companies, but what you see here
is a list of mechanisms that are quite common and
these are the mechanisms that you need to be aware
of. Specifically you need to know a few lines about
each of these items and how these items address
some major risks. Lets start with general meetings.
Now, these are general meetings of shareholders
and in almost all countries there is a law that requires
these general meetings. Broadly speaking, there
are two kinds of general meetings: an annual general
meeting and an extraordinary general meeting.
As the name implies an annual general meeting happens
every year typically a few weeks after the end of
a fiscal year. Now the most important activity in
the annual general meeting is to elect the board
of directors. As I've explained earlier shareholders
own the company, they elect the board of directors
who are then responsible for overseeing the management
of the company. Now, there is a risk that the board
of directors gets aligned with the managers and looks
after their best interest rather than the best interest
of the shareholders. Through the annual general
meeting and the election that takes place here
the shareholders have control over who represents
them on the board. Now, there might be other items that
are also voted on in the AGM. But the main item is the
election of the board of directors. The extraordinary
general meeting can happen anytime during the year.
This meeting can be called by the company or the shareholders.
And if there is some significant item that needs
to be voted on such as a change in the bylaws or perhaps
a vote related to whether the company should be
taken over or not that will happen in the extraordinary
general meeting. In the general meetings, there
are some resolutions that simply require an ordinary
majority and the election of the board of directors
typically requires an ordinary majority. There
might be other resolutions that require a supermajority
a supermajority would mean that for a resolution
to pass either we need 2/3 or 75% of the votes.
In the context of voting you need to understand the
term proxy voting. This is a process that enables
shareholders who are unable to attend a meeting to
authorize another individual to vote on their behalf.
You should also understand the distinction between
cumulative voting and straight voting and I'll
explain this through a very simple example. Lets
say that we have two seats and we are voting for a director
over here and here. Lets say for seat 1, the vote is
between A and B and for seat 2 the vote is between
C and D. Now we have a minority shareholder with a
thousand shares, under straight voting the shareholder
would be able to vote his thousand shares over here
and then vote again his thousand shares over here. Under
cumulative voting what the minority shareholder
can do is combine these two so have 2,000 votes and
vote all of them for C let's say that this minority
shareholder really likes this candidate and does
not really have an opinion on A or B. So cumulative
voting gives minority shareholders a little more
strength. The point I made earlier about supermajority
voting requirements where we need either 2/3 of
the votes or 75% of the votes to pass a given resolution
is also intended to help minority shareholders.
With a supermajority vote it becomes harder for
majority shareholders to influence corporate
decisions at the expense of minority shareholders.
Board of director mechanisms as we've said before
shareholders elect the board of directors who are
responsible for overseeing the managers of the
company. Now this is an extremely important function and
it will be discussed in a lot of detail in the next
section. The audit function: to understand the importance
of this audit function let's consider the risks
that shareholders face. shareholders are clearly removed from the day-to-day management
of the company. So there is a risk that managers are
misusing the resources of the company which ultimately
belonged to the shareholders. There is a risk that
manages a presenting financial statements that
do not adequately reflect the economic reality
of the company. That is the risk of fraud. So, how
do we deal with all these risks? These risks are mitigated
through the audit function. The audit function represents
the systems, controls and policies and procedures
in place to examine the company's operations and
financial records. Reporting and transparency
It should be fairly obvious by now that there is a substantial amount of information
asymmetry between shareholders and managers. Clearly
managers just know a lot more about what's happening
with the company relative to what shareholders
know now this is addressed through reporting. regulations
require that managers disclose a substantial amount
of Financial and non-financial information. This connects with
the governmental infrastructure that we've talked
about before. So what is the benefit of the reporting
and transparency? The reporting requirements reduce
the extent of the information asymmetry between
shareholders and managers, it allows shareholders
to assess the performance of the company managers
and directors. It allows shareholders to make informed
decisions in valuing the company and deciding whether
or not to invest in the company. It also allows shareholders
to vote on key corporate matters. The next
point has to do with policies on related-party transactions.
We've talked about this briefly before but I will
again set the context. Lets say that we have the board
of directors and there is one person on this board
of directors who has a substantial interest in a
third party company and this third party is a customer
of the company. So what is the risk? The risk is that
person A uses his influence to have the company
sell products and services to the third party at
a huge discount. Now obviously this is good for the
third party and since person A has ownership of this
company person A will benefit, but the company does
not benefit because the company is giving an unreasonable
discount to this third-party. So how is this dealt
with? There need to be policies and procedures to limit
such a situation and generally the policy is that
if anybody on the board or even if senior managers
at a company have third-party interests then those
third party interests need to be disclosed and if
there is any transaction that is taking place with
the third party then the board needs to vote on it
and obviously the person whose interested is
involved should not be part of the voting process. Remuneration
policies also called compensation policies. The
issue here is that senior managers at a company
might be paying themselves too much which obviously
hurts the shareholders. The idea behind compensation
policies is that the compensation structure should
align the interest of shareholders with managers.
If managers are being rewarded for either the sales
or earnings in a given quarter then the risk is that
they will have a very short term perspective. Also
if managers are being rewarded based on stock price
or stock options, then they might also be tempted
to just bump up sales in the current period. So compensation
policies should be designed to discourage a short-term
perspective. Consequently companies are increasingly
designing incentive plans that discourage a short-term
perspective or that discourage excessive risk-taking
by managers. In some cases regulators are requiring
companies to base compensation on long-term
performance measures. And in fact, some regulators
are also requiring companies to adopt clawback
provisions. These provisions allow a company to
recover previously paid compensation, if certain
events such as financial restatements or misconduct
are identified. Say on pay allows shareholders to vote
on executive compensation. In some countries such
as the United States say on pay is mandatory, but non-binding.
This means that the board is required to enable shareholders
to vote on compensation plans or packages, but the
board does not have to abide by the result of the vote.
There is a debate about the benefits of say on pay
some people argue that shareholders do not have
enough information about the company operations
and strategy in order to have a fair view on what executive
compensation should be. The other side of the argument
is that there is a risk that executives might pay
themselves too much and shareholders need to have
a say in terms of how much executives are paid. Contractual
agreements with creditors now this item and the
next couple of items fall under contractual infrastructure.
This is fairly straightforward. This is saying that
creditors are supplying money to the company. So
there needs to be some agreement between the creditors
and the company that agreement is called the indenture
which is a legal contract. This contract will have
several covenants and we'll study these covenants
in detail when we do fixed income. Often the lending
of the money that is given to the company is secured
through collateral. And again, that is something
that we discussed in fixed-income. Employee laws
and contracts are also fairly straightforward
these laws and contracts clearly define the roles
and responsibilities of employees. And then also
the roles and responsibilities of the company. The
employee laws and contracts can also encompass
codes of ethics and business conduct. Eontractual
agreements with customers. So these agreements
that clearly outline what the company is providing
to the customer and what the company can expect from
the customer similarly contractual agreements
with suppliers indicate the roles and responsibilities
of the company and the suppliers. Laws and regulations
connect with the government infrastructure and
legal infrastructure that we talked about earlier.
Companies need to follow the laws and regulations
established by the government and regulatory authorities.
Generally the intent behind these laws and regulations
is to protect the rights of specific groups such
as customers or to protect the environment and so
on. For certain industries such as banks, food manufacturers,
healthcare companies and airline companies the
laws and regulations can be quite strict.