Study Session 12: Corporate Finance (1)
Study Session 11: Corporate Finance (2)

Describe mechanisms to manage stakeholder relationships and mitigate associated risks

Even though corporate frameworks differ across companies and across countries, some tools for stakeholders management are common.

General meetings

General meetings (also known as general assemblies) are meetings of shareholders in which they can use their voting rights. Companies are often obligated to call annual general meetings after the end of each financial year to present (and approve) annual audited financial statements, appoint directors, appoint auditors, vote on remuneration of directors/management. Shareholders can also call meetings called extraordinary general meetings to discuss any other significant business, such as any changes in the company’s bylaws, mergers and acquisitions, etc. 

While the ordinary business requires only an ordinary majority (50%), special business may require supermajority (2/3rd or 3/4th). Supermajority may benefit the minority shareholders. Shareholders can often participate in the meetings by appointing another person, called proxy, to act on their behalf. Such a voting is called proxy voting and the majority of voting takes place using proxy. Some jurisdictions allow cumulative voting (as opposed to straight voting, in which there is one vote per share), in which a shareholder can cast all his votes to a single candidate. This increases the chance of minority shareholders having representation on the board of directors.

Board of director mechanisms

Shareholders elect a board of directors which appoints, oversees management on their behalf, provides strategic direction to the company, and supervises a company’s audit, control and risk functions.

Audit function

An audit function represents systems, controls, and policies designed to examine a company’s operations and financial records. Internal audit is an independent function which reports to the board or audit committee. External auditors are recommended by the audit committee for appointment by the company or the board. The board of directors is generally required to review annual financial statements and the auditor’s report and confirm their accuracy before they may be presented to the shareholders. Management is also required to attest to the existence of adequate controls.

Reporting and transparency

In order to reduce information asymmetry and enable shareholders to assess performance of directors and management, make informed decisions regarding valuation, and vote on key corporate matters, corporate laws and regulations allow them access to a range of financial and non-financial information (audited financial statements, ownership structure, related parties, etc.) through annual reports, proxy statements, company’s website, investor relations department, etc.

Policies on related party transactions

Directors and management are often required to disclose their interest in any related party transaction which are then voted on by the board or shareholders.

Remuneration policies

In order to best align the interests of managers with shareholders, management is often paid variable remuneration in the form of profit sharing, stocks, stock options, but this may lead to short-termism. To avoid it, it is important to base remuneration on long-term performance and attach a vesting period condition with any stock remuneration. Some regulators require companies to include a claw back provision, which enables them to recover any remuneration previously paid if certain events such as financial restatement, misconduct, breach, etc. occurs. 

Say on pay

Say on pay policies enable shareholders to voice their concern on executive remuneration. In some jurisdictions, such as Canada, shareholders may or may not vote on executive compensation and they are non-binding, while in others, such as the US, such a vote is mandatory but non-binding. But there are jurisdictions in which say on pay is both mandatory and binding, such as the Netherlands. However, there is criticism on say on pay policies because some people believe shareholders are not involved in strategy formulation. However, these can reduce one of the most significant agency problems.

Contractual agreements with creditors

Creditors rights are governed by law and bond indenture, the legal document which forms the basis of the loan and often contain covenants, actions that a company must or may not take. Creditors often require period information to make sure covenants are met. Issuers often appoint a trustee which takes care of verification that covenants are met. In event of liquidation, credit committees are constituted which represent bondholders in bankruptcy proceedings.

Employee laws and contracts

Employee rights are secured through labor laws which defines employee and employer’s rights and responsibilities. Many countries also allow employees to form unions which negotiate with management on behalf of employees. Some countries allow employee’s representatives to sit on the board of directors. At an individual level, relationships are guided by employee contracts with additional facilitation from human resource policies, code of ethics and business conduct. In order to increase employee retention, many companies offer employee stock ownership plans, etc.

Contractual relationships with customers and suppliers

Contracts specify the products/services, their prices, payment terms, rights and responsibilities. They also specify recourse available when one party defaults.

Laws and regulations

Government and regulatory authorize promulgate laws and regulations and monitor compliance with them. Regulations in case of products/services which are more likely to endanger the public are more rigorous. Many regulatory authorities require publicly traded companies to compile and present corporate governance reports.