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What if all shareholders don't want the same thing? Implications for directors

Dr Jack Jacoby
Managing Director - Jacoby Consulting Group

Business has undergone many changes in style and practice during the 20th century, much of which has been stimulated by promises of increased effectiveness and efficiency. The focus of such changes has traditionally been on directors and management, because they have been perceived as the controllers of corporate destinies. When most business was small and operated with the daily involvement of its owners, this was an appropriate perspective as the distinction between owners and managers was minimal.

However, the face and structure of industry has changed, as has the average corporation that has grown in size and complexity. The relationship between owner and manager has therefore also changed. For all intents and purposes, and notwithstanding employee share structures, owners, particularly owners of large corporations, are rarely the same individuals and entities that make the daily management decisions which impact on the performance and destiny of organisations.

This evolution has led to fundamental differences in perspective as to the role and relationship that the corporation plays regarding its shareholders. The 'property' view sees the corporation as a vehicle intended to advance the purposes of its owners. The 'social entity' view sees the corporation as an institution, an 'entity separate from its owners, one that pursues its own lawful economic interests and objectives separate from and, at times, even contrary to those of shareholders'.

In discussing corporate philosophy with the leaders of business, the writer concludes that there is little doubt that the dominant view of mainstream business today is that of the Social Entity proponents - that the corporation exists to pursue its own interests rather than those of its owners. This is despite well-publicised rhetoric to the contrary.

Research conducted into shareholder objectives and their relationship to corporate steerage examined assumptions that underpin modern business practices that have profound effects on shareholder satisfaction and on the way enterprises should conduct business.

The core assumptions examined in the research were that all shareholders hold the same objectives, and that managers and directors act in the best interests of shareholders.

Refutation of these assumptions should have profound implications on contemporary business practices, corporate regulation, corporate governance, director responsibility and shareholder expectations. Some of the issues that could legitimately be raised in the event of successful refutation would include:

How can directors and management reconcile differing shareholder objectives within the context of their own corporation's objectives and outcomes?

How can directors satisfy their obligation to all shareholders when they use a small segment of shareholders as a proxy for all shareholder objectives?

To what extent are commonly used industry-wide performance ratios inappropriate as a means for assessing corporate and CEO performance?

To the extent that industry-wide performance ratios are inappropriate, then what are more appropriate measures for assessing corporate and CEO performance?

To what extent do executive remuneration structures based on management incentives threatens the enhancement of shareholder wealth that such incentives are meant to engender?

To what extent is a corporation's mission and strategies inappropriately directed and influenced by the natural subjectivities and foibles of its directors and managers and to what extent do they detract from shareholder optimisation?

What methods are available to align a corporation's mission with its shareholders' objectives?

The research examined the on-market performance of the top-20 shareholders in five banks over a ten-year period. The banking industry was chosen because it has traditionally been regarded as a reasonably homogeneous industry. If shareholder differences could be identified in a homogeneous industry - then how much greater would be the implications of such a finding in heterogeneous industries?

What's wrong with the status quo?

There are basically four reasons why the existing relationship between owners and directors/managers is flawed and leads to the under-optimisation of corporate outcomes in terms of satisfying shareholders.

Firstly, corporations have exhibited an inability to resolve the classic dilemma of the incongruence between what is good for the organisation versus what is good for shareholders. When management chooses to adopt TQM, for example, it usually does so at considerable cost. If owners have specific short-term optimal dividend objectives, then the investment in TQM, as legitimate as it may be to the longer-term benefit of the organisation, is clearly to the short-term disadvantage of the owners. What is the correct path? Satisfy the owners at the expense of the longer-term health of the corporation, or satisfy the organisation's needs at the expense of owner objectives? How much harder is it to solve this dilemma, based on a "Property" view of the corporation, when you don't actually know, in pragmatic terms, what those shareholders want?

Secondly, the attitudes, perspectives and subjectivities (among other influences) of directors and management shape corporate destinies. Instead, based on a "Property" view of the corporation, they should be shaped by viable and commercially logical strategies that lead to the delivery of acceptable and pre-established owner-driven outcomes.

On one hand, boards and management argue that shareholders have generic objectives, are not fully informed, have conflicting interests and suffer from a range of other attributes, all of which contribute to their "inappropriateness" in determining the destiny of the organisation in which they hold ownership. This philosophy holds that the board and management are better placed to determine the destiny of the organisation and determine the outcomes that the corporation will deliver. Shareholders who don't like the way the company is run (so the "Social Entity" philosophy goes) can quit the registry and take up ownership elsewhere.

The contrary view held by many, perhaps most shareholders, regulators, and certain key associations, maintains that the organisation exists to deliver shareholder satisfaction. As such, the organisation is the servant of the owners and all that the organisation does, must in one way or another enable those shareholder objectives to be fulfilled or enhanced.

Examples abound of management which has taken an organisation down a particular path for a range of seemingly admirable reasons only to find that its owners either flee the registry or whose best interests are seriously damaged.

The problem with boards and management who are beholden to no one except themselves is that they have no reference point against which decisions and strategies can be assessed and determined. An organisation whose principal accountability is to itself is not compelled to maximise owner benefit or even to avoid owner harm if it believes that such a course "is not in the best interests of the corporation" or is in some other way defensible.

Corporations that act in other than the best interests of owners (including those who only give lip service to the concept of shareholder satisfaction) create decreased probability of satisfaction, and imply higher risk to their owners. Investors denied access and input feel vulnerable to the character and machinations of management. They will tend toward other forms of investment where probability of outcome is stronger, and where the investor is offered greater accountability from the chosen investment vehicle and less susceptibility to the foibles of individuals.

Corporations must ultimately be accountable to their owners and the outcomes delivered by those organisations must be unashamedly aimed toward satisfying and/or enhancing owner objectives - whatever they may be. It is only through the establishment and enforcement of an external accountability on a corporation that owners can start to feel some comfort (but no guarantee) that their organisation is striving to achieve that which its owners intend or want.

Thirdly. Whether we are prepared to admit it or not, many boards abrogate the responsibility for steering the organisation to management. During interviews with some corporate icons of some of our largest corporations, I was stunned to be told that the board does not review strategies and visions for the organisation because "that is the responsibility of management". And yet managers, as we all know, are coloured or biased by human individuality and subjectivity. If the board, whose job it is (among other things) to ensure shareholder "optimisation", then how much harder is optimisation to achieve when the strategies for their delivery are abrogated to those who may subjectively determine what is to be optimised, how it is to be achieved and when it is to be achieved.

Fourthly. CEO and corporate performance is most frequently measured against the performance of peer CEOs and corporations. On a regular basis, one sees in the general or specialist media the corporate performance ranking for a range of industries.

The principle seems to be that the organisation, and therefore the CEO, with the "best" ratio or set of ratios are deemed to win the prize. A prize incidentally, that can be worth considerable investment funds while a low ranking can spell financial disaster for those at the bottom of the list. The problem with this is simple. If a company has the best, say ROI, of its peer group, then (assuming this was the only criterion), it is deemed to be the best company. But what if the ROI was achieved through high gearing and/or high risk, and what if the corporation's shareholders were risk averse? Is the CEO still the best?

Understanding why companies must recognise that "value" is whatever shareholders consider of "value".

My work at the governance end of scores of corporations, together with much detailed work within the depths of those organisations leads me to observe that much (but nowhere near all) of what corporations do, is often a product of unjustified or invalidated subjective assessments by management.

As an example are the range of definitions for the concept of "Value". Is "Value" for the corporation the same as "Value" for the shareholder? What does RONA, EVA or some other measure do to drive corporate performance and to deliver shareholder satisfaction? If, as has been said to me by Chairmen of leading organisations that "all shareholders want the same thing", then surely the same measure of "Value" would be applicable to all - and this is demonstrably not the case. The research shows that different shareholders want differing outcomes in the same way that different organisations create different outcomes.

If different measures of "Value" create different outcomes, as they do, then the process used to establish what is "Value" is as important as the outcomes it is meant to deliver.

Matching one with the other is a skill required of both corporations and shareholders. And the easiest way to do this is to define "Shareholder Value" as "the delivery of the outcome which shareholders want". The challenge then is to determine exactly what that is.

Recognising the diversity of shareholder objectives

One aspect of the research tested the thesis that shareholders do not have common objectives and that the same shareholder has different objectives for different investment targets. The following charts illustrate some of the findings.


Correlation between % Equity held by top 20 shareholders and Dividend

Equity / Dividend chart


Correlation between % Equity held by top 20 shareholders and Debt/Equity

Equity / Debt Equity chart


Correlation between % Equity held by top 20 shareholders and Market Capitalisation

Equity / Market Capitalisation chart


Correlation between % Equity held by top 20 shareholders and % Dividend Yield

Equity / Dividend Yield chart


Correlation between % Equity held by top 20 shareholders and Net Tangible Assets per Share

Equity / Assets chart


Correlation between % Equity held by top 20 shareholders and Earnngs per Share

Equity / EPS chart


Correlation between % registry churn and % Debt/Equity

Registry Churn / Debt Equity chart


Correlation between % registry churn and Market Capitalisaton

Registry Churn / Market Capitalisation chart


Correlation between % registry churn and Dividend Share

Registry Churn / Divdend chart


Correlation between % registry churn and Net Tangible Assets per Share

Registry Churn / Assets chart


Correlation between % registry churn and and % held by top 20 shareholders

Registry Churn /Percentage held chart


A common response to these findings is "I can explain why these differences between the banks occur." These explanations of why differences occur only reinforce that the differences exist.

It was clear from these findings that shareholders have different objectives and perception of "value" and that the same shareholders have different "value" expectations from their differing investments.

Conclusions and Implications for directors

The results of the research, the review of literature and of current practices indicates a range of conclusions regarding the corporation, its relationship to shareholders and the way it manages itself in determining its activities, outcomes and accountabilities.

Contemporary and guru theory

Classical and contemporary management and organisational theory generally takes an introverted view of the corporation, with the principal emphasis being on the maximisation of corporate outcomes. Although many management and corporate theories, remedies or techniques have positive outcomes, none provides a perspective that will enhance shareholder benefit in all circumstances or contexts. Little discussion revolves around the concept of optimisation of outcomes within a context of competing objectives versus the maximisation of an outcome, often at the cost of all else.

The bulk of contemporary business and academic thought revolves around the 'independence' of the corporation from the shareholder, particularly the role of management and directors to deliver outcomes that they consider appropriate. Similarly, managers appear to have the imprimatur of directors to mould and shape a corporation's destiny based on management's view of the world, the corporation's industry and the general environment and context. On occasion, these views are incorrect or biased and impact shareholder benefit and satisfaction.

The conclusion one draws from this is that classic and contemporary views of the relationship between shareholders and the corporation do not enhance, and in many cases they hinder, the ability of shareholders to secure satisfaction from their association with the corporation.

The model proposed in the research study (but not discussed here) enables the corporation to be focused on shareholder satisfaction and ensures that all activities, initiatives, projects and investments undertaken by the corporation are determined on the basis of their contribution to such satisfaction.

Director and management subjectivity

Although recent writers have acknowledged the biases of managers (and by extension directors), few if any ask the hard questions that come from their conclusions. The natural and human biases of managers and directors affect their decisions and therefore their behaviour both as individuals and as corporate members.

The model proposed in the research study helps the corporation minimise the negative effects of the natural subjectivity of managers and directors by providing a quantified and measurable set of deliverables against which all activities, initiatives, projects and investments undertaken by the corporation are determined. This helps insulate the corporation from the natural foibles, machinations and subjective decisions of management and directors. Although the model will not eliminate altogether such natural behaviour, it will ensure that its impacts will be minimised and largely restricted to lower level and less harmful decisions.

Modern management practice and performance measurement

Contemporary management practices clearly support the contention that it is management, and not the board, which develops and formulates high-level strategy and direction. It is further clear that the performance measures against which the CEO and the corporation's performance are assessed are determined in part by management and directors, and in part by industry performance measures, neither of which ensures the satisfaction of shareholder objectives.

The prevalent contemporary view appears to be that managers and directors formulate those outcomes that shareholders will benefit from by determining what is in the shareholders' best interest. In that context, managers and directors are 'boss'. Directors and management as "servants of shareholders" is not a prevalent view nor is it practised on a wide scale in listed companies despite its recognition at the intellectual level.

The model proposed in the research study provides the corporation with a method by which its mission is determined by quantified criteria based on clear shareholder objectives. This removes entirely the prevalent practice where management and corporations are assessed against inappropriate, management or board-determined criteria.

Shareholder objectives vary

Current management thinking largely adopts a view that sees shareholder benefit as a generic outcome with which most shareholders will be content. Although there is recognition at the intellectual level that shareholder objectives vary, no attempt is made by corporations to dimension such differences and reconcile the corporation's efforts against those differing shareholder objectives.

The research undertaken examined the on-market behaviour of shareholders across five banks to discover whether shareholders have generic and common objectives or have different objectives despite a high degree of ownership overlap between the five banks studied. The research thesis maintained that these issues, coupled with the subjective nature of decision-making, raise serious questions about management and board ability, and motivation to satisfy owners.

The research thesis presented a case for a new relationship between management and owners that enables the corporation's efforts to ensure more effectively the optimisation of shareholder objectives - whatever they may be. From a managerial perspective, the proposed model ensured those management decisions, and corporate outcomes, are aligned with owner objectives by involving the board's directors at critical ratification milestones in an organisation's planning process. From a board perspective, the proposed model established the need for, and method to, quantify owner objectives. Such quantified objectives are then interpreted by the board using their knowledge of the organisation, the industry and the context, to ensure that corporate goals and objectives are such that they optimise owner objectives.

The relationship model proposed establishes the primacy of owner objectives as the definer of corporate outcomes. Boards and management are entrusted with the responsibility of navigating the corporation through a course that delivers those outcomes - not the outcomes that management has determined through its own subjectivity. Owner objectives and corporate mission are thus one and the same, save for the interpretive role of the board who must adjudicate optimal outcomes when confronted with a desired range of quantified outcomes from a diversified shareholder population.

The quantified outcomes derived directly from owners are used to drive and assess all that is undertaken by the corporation. Initiatives, program and investments are assessed against this benchmark in order to ensure that all corporate activity, one way or another contributes to the attainment of the deliverables. Optimisation of funds and resources is therefore easier, as that activity which has the greatest impact on the desired deliverables is adopted over those initiatives with lesser outcomes.

The model also establishes a clear decision-making hierarchy within corporations. It asserts that owner objectives determine corporate objectives and deliverables - which determine the markets from which those deliverables must be secured - which define the product and service options used in those markets to extract the deliverables - which define the methods and channels used to bring the product and services to the market - which define the resources (human, technological and knowledge) needed to achieve these outcomes - which define and structure the organisation needed to operationalise these decisions. These decisions mould the financial and other outcomes of the corporation. These outcomes must deliver the outcomes sought by owners.

The implications of this research call into question some of the fundamental models used by management and boards. They also force corporations to question the way that they manage the interdependencies between elements of their organisation and the decision processes used by it. Adoption of the model instigates a rigorous assessment of all strategies, techniques and tools used by corporations against quantified shareholder-based outcomes. The potential for radical realignment of focus, rationalisation of non-value adding (to shareholders) activities and substantial cost and investment savings is profound.

Probably the most innovative and potentially most powerful implication of the proposed model, is its impact on Corporate Governance. Adoption of the model implies the identification of quantified owner objectives. These metrics and the ability of corporations and their CEOs to deliver them, provide the baseline against which corporations can be assessed by shareholders, managers, analysts, regulators and investors.

The conclusion that one draws from the study is that shareholder objectives differ and that corporations must, in order to establish relevant and focused strategies, be aware of the objectives of their own shareholders in order to establish congruence between them and the corporation's objectives.

Shareholder objectives in different investments vary

Management and boards appear to assume that shareholders share consistent objectives across their individual shareholding portfolios. All shareholders in the banking sector, for example, are assumed by some banking chairmen, CEOs and senior managers to have the same objectives.

The conclusions from this research contradict these apparently widely held views. Shareholders can have different objectives for each of their investments even when those investments are in the same industry. These differing objectives will cause shareholders to behave differently to the same stimulus across their portfolio. As corporations set their strategies to deliver certain outcomes, it is imperative for them to identify the extent, degree and diversity of shareholder objectives in order to ensure the adoption of suitable and targeted strategies, practices and policies.

The recommendations that emerge from this research can be summarised as follows:

  • Corporations should no longer assume that the shareholders that constitute their share registries necessarily have common objectives and aspirations.

  • Corporations should survey their shareholders in order to establish their quantified objectives.

  • Corporations should adopt a corporate/strategic planning process that adopts shareholder objectives as the corporate mission and reason for existence, and use these metrics to assess the viability, suitability and applicability of all initiatives, projects and opportunities undertaken by the corporation.

  • Corporations should recognise the humanity of management and their resultant subjectivity. Adoption of the proposed planning model helps minimise the effects of the dysfunctional and deleterious effects of such subjectivity.

  • Corporations who survey all their shareholders and thus develop a detailed Investor Profile, should use the Investor Profile to attract new shareholders who share common attributes and objectives, and to explain to existing shareholders, analysts and brokers the core objectives that drive the organisation. The Investor Profile should be published and included in the corporation's annual report.

  • Corporations, their directors, shareholders, analysts and other interested entities should assess the performance of corporations, CEOs and managers against their ability to deliver the shareholder-based corporate objectives, rather than against generic industry or competitor-based metrics and ratios.

The failure to acknowledge the continuing evolution of the relationship between owners and their corporations is both naive and arrogant. Such naivety and arrogance will impinge on an organisation's ability to adapt to the changing needs of its owner constituency.

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