Business Economics and Managerial Decision Making

501 Pages·2004·4.941 MB·English

by  Trefor Jones

BUSINESS
ECONOMICS AND
MANAGERIAL
DECISION MAKING
Trefor Jones
Manchester School of Management
UMIST
4 PART I g CORPORATE GOVERNANCE AND BUSINESS OBJECTIVES
INTRODUCTION
Firms are major economic institutions in market economies. They come in all shapes
andsizes,buthavethefollowingcommoncharacteristics:
g Owners.
g Managers.
g Objectives.
g Apoolofresources(labour,physicalcapital,¢nancialcapitalandlearnedskillsand
competences)tobeallocatedrolesbymanagers.
g Administrativeororganizationalstructuresthroughwhichproductionis
organized.
g Performanceassessmentbyowners,managersandotherstakeholders.
Whateveritssize,a¢rmisownedbysomeoneorsomegroupofindividualsororganiza-
tions.
These are termed shareholders and they are able to determine the objectives and
activities of the ¢rm. They also appoint the senior managers who will make day-to-day
decisions. The owners bear the risks associated with operating the ¢rm and have the
right to receive the residual income or pro¢ts. Where ownership rights are dispersed,
control of the ¢rm may not lie with the shareholders but with senior managers. This
divorce between ownership and control and its implication for the operation and
performanceofthe¢rmisatthecentreofmanyoftheissuesdealtwithinthisbook.
OWNERSHIP STRUCTURES
The dominant model of the ¢rm in Western economies is the limited liability company
owned by shareholders, but the form varies signi¢cantly between countries. In some
countries the control rights of the owners are limited by powers given to stakeholders
whomayshareintheappointmentandsupervisionofmanagersandinthedetermina-
tion of the enterprise’s objectives. In Germany, for example, large companies recognize
the role of workers and other groups by giving them half the positions on the
supervisory board that oversees the management board (Douma 1997). There are also
¢rms owned by members and operated as co-operative or mutual enterprises and some
ownedbynationalandlocalgovernment.
Thenotionthatprivatelyownedenterprisesshouldberunintheinterestsofshare-
holders is not a characteristic of companies in all advanced economies. Yoshimori
(1995)proposedthatshareholdercompaniescanbeclassi¢edasfollows:
g Monistic ^ where the company serves a single interest group, normally share-
holders.ThesetypesofcompaniesarecommonlyfoundintheUKandtheUSA.
g Dualistic ^ where the company serves two interest groups. Shareholders are the
CHAPTER 1 g OWNERSHIP CONTROL AND CORPORATE GOVERNANCE 5
primary group but employees’ interests are also served. These types of companies
arecommonlyfoundinFranceandGermany.
g Pluralistic^wherethecompanyservestheinterestsofstakeholdersinthecompany
and not just shareholders. Employee and supplier interests may be paramount.
SuchcompaniesarefoundinJapan.
Since Yoshimori’s study some commentators have argued that there has been some
degree of convergence between European and Anglo-American forms of corporate
organizations because of greater international competition between enterprises.
Likewise, commercial and economic forces in Japan have put signi¢cant pressure on
companies to reduce the emphasis on the long-term employment of sta¡ and place
greateremphasisonpro¢tability.
PATTERNS OF SHAREHOLDING
Thepattern of shareownership varies betweencountries andwithtime. In theUK and
the USA, ownership is more widely dispersed than in continental Europe and Japan
whereitismoreconcentrated.
UKshareownership
Table1.1presentsdataonshareownershipintheUKfrom1963to2001.
Table1.1 ShareholdingintheUK
Owners 1963 1975 1989 1994 1997 2001
(%) (%) (%) (%) (%) (%)
Individuals 54.0 37.5 20.6 20.3 16.5 14.8
Institutions 30.3 48.0 58.5 60.2 56.3 50.0
Ofwhich:
Pensionfunds 6.4 16.8 30.6 27.8 22.1 16.1
Insurancecompanies 10.0 15.9 18.6 21.9 23.6 20.0
Companies 5.1 3.0 3.8 1.1 1.2 1.0
Overseas 7.0 5.6 12.8 16.3 24.0 31.9
Others 3.6 5.9 4.3 3.1 2.0 2.3
Total 100.0 100.0 100.0 100.0 100.0 100.0
Source Compiledbyauthorusingdatafrom:
CSO(1993)Shareregistersurvey1993,EconomicTrends,No480,London,HMSO
CSO(1995)ShareOwnership,London,HMSO
CSO(1999)Shareownership,EconomicTrends,No543,London,HMSO
NationalStatistics(2002)ShareOwnership2001,http://www.statistics.gov.uk
6 PART I g CORPORATE GOVERNANCE AND BUSINESS OBJECTIVES
Table1.2 StructureofshareownershipinEurope2000
Typeofinvestor France Germany Italy Spain UK
(%) (%) (%) (%) (%)
Individuals 8 16 25 30 16
Private¢nancialenterprises 29 18 20 14 48
Privatenon-¢nancialorganizations 21 40 25 20 3
Publicsector 6 6 15 0 0
Foreigninvestors 36 20 15 36 32
Unidenti¢ed 1
Total 100 100 100 100 100
Source CompiledbyauthorusingdatafromFESE(2002)ShareOwnershipStructureinEurope2002,Brussels,
http://www.fese.be
Thekeyfeaturesare:
g The largest group of domestic owners of company shares are ¢nancial institutions.
g Financial institutions’ share of ownership increased between 1963 and 1997, but
fellto50%in2001.
g Individual ownership of shares has been in long-term decline and fell to 14.8% in
2001.
g Overseas ownership of UK companies has increased and stood at 31.9% in 2001.
This trend re£ects the growing internationalisation of the asset portfolios held by
¢nancialinstitutions.
ShareholdinginEurope
ComparativedatafortheownershipofsharesinFrance,Germany,Italy,Spainandthe
UK for the year 2000 are presented in Table 1.2. It shows that in each country the
structuresaredi¡erentinbroadtermscomparedwiththeUK:
g Holdingsby¢nancialinstitutionsarelower.
g Holdingsbynon-¢nancialcompaniesaremoreimportant,particularlyinGermany.
g IndividualownershipismoreimportantinItalyandSpain,butlesssoinFrance.
g Foreign owners are more important in France and Spain, but less signi¢cant in
GermanyandItaly.
CLASSIFYING FIRMS AS OWNER OR MANAGEMENT CONTROLLED
The pattern of share ownership at company level varies widely. In the UK, quoted
companies ownership is generally described as being widely dispersed among large
numbers of shareholders. The largest shareholder often owns 5% or less of the stock
CHAPTER 1 g OWNERSHIP CONTROL AND CORPORATE GOVERNANCE 7
and a signi¢cant proportion is owned by non-bank ¢nancial institutions. The board of
directors typically own a tiny proportion of the shares, often much less than 0.5%.
Thus, managers rather than owners control many medium and large-sized companies
and set the ¢rm’s objectives. In France and Germany shareholding tends to be more
concentrated with greater blocks of shares held by companies and banks. According to
Denis and McConnell (2003) concentrated ownership structures are more likely to be
found in most countries in contrast to the dispersed ownership patterns that are
typicalonlyoftheUKandtheUSA.
How then can companies be classi¢ed as owner or managerially controlled? If a
single shareholder holds more than 50% of the stock, assuming one vote per share,
then they can outvote the remaining shareholders and control the company. If the
largest shareholder owns slightly less than 50% of the equity then they can be
outvotediftheothershareholdersformedaunitedfront.Ifthemajorityofshareholders
do not form a united front or do not vote, then an active shareholder with a holding of
substantiallylessthan50%couldcontrolthecompany.
Berle and Means (1932), who ¢rst identi¢ed the divorce between ownership and
control, argued that a stake of more than 20% would be su⁄cient for that shareholder
to control a company but less than 20% would be insu⁄cient and the company would
be management-controlled. Radice (1971) used a largest shareholding of 15% to
classify a ¢rm as owner-controlled; and a largest shareholder owning less than 5% to
classify a ¢rm as managerially controlled. Nyman and Silberston (1978) severely
criticized the ‘‘cut-o¡’’ or threshold method of assessing control and argued that the
distribution and ownership of holdings should be examined more closely. They
emphasized that there was a need to recognize coalitions of interests, particularly of
families,thatdonotemergefromthecrudedata.
Cubbin and Leech (1983) also criticized the simple cut-o¡ points for classifying
¢rms. They argued that control was a continuous variable that measures the
discretion with which the controlling group is able to pursue its own objectives
without being outvoted by other shareholders. Management controllers, they argued,
wouldbeexpectedtoexhibitahigherdegreeofcontrolforanygivenlevelofsharehold-
ingthanwouldexternalshareholders.
They then developed a probabilistic voting model in which the degree of control is
de¢ned as the probability of the controlling shareholder(s) securing majority support
in a contested vote. Control is de¢ned as an arbitrary 95% chance of winning a vote.
This ability depends on the dispersion of shareholdings, the proportion of shareholders
voting and the probability of voting shareholders supporting the controlling group.
The likelihood of the controlling group winning increases as the proportion voting
falls and the more widely held are the shares. Applying their analysis to a sample of
85 companies, they concluded that with a 10% shareholder turnout, in 73 companies
less than a 10% holding was necessary for control and in 37 companies with a 5%
turnout,lessthana5%holdingwasnecessaryforcontrol.
Controlofacompanyisthereforeafunctionofthefollowingfactors:
g Thesizeofthelargestholding.
g Thesizeanddistributionoftheremainingshares.
g Thewillingnessofothershareholderstoformavotingblock.
8 PART I g CORPORATE GOVERNANCE AND BUSINESS OBJECTIVES
g thewillingnessofothershareholderstobeactiveandtovoteagainstthecontrolling
group.
Case Study 1.1 Manchester United – owner or
managerially controlled?
Manchester United epitomizestheconflicts betweencommercialization andthe influence
ofsupporters.Theclub’soriginslieintheformationofafootballteambytheworkersofthe
Yorkshire and Lancashire Railway Company. It joined the Football League in 1892 in its
fourth year of existence. The club finished bottom in their first two seasons and became
founder members of the second division. However, since returning to the first division in
1906 and winning the title in 1909, they have played only 10 seasons in a lower division.
Until the early 1960s, no shareholder had overall control of the club. In 1958, Louis
Edwards, a Manchester businessman was elected to the board at the behest of the then
manager Matt Busby. This was at the end of the most successful period in the club’s
history having been League champions in 1952, 1956 and 1957. In 1962 he was elected
chairmanowningonly17ofthe4,132issuedshares.By1964,hehadacquiredamajority
and controlling interest in the club. In 1981 his son Martin became chief executive of the
club.In1989,MartintriedtosellhiscompleteinterestintheclubtoMichaelKnightonfor
£20m,butthedealfellthrough.In1991theclubwasfloatedonthestockexchange.This
led to the most successful period in the club’s playing history. It won the first Premier
Leaguetitlein1993,fivemoreinthenextsevenyearsandtheEuropeanCupin1999–the
latter a featthey hadpreviouslyachieved in 1968.
The changing nature of football and the dangers of flotation were highlighted by the
£635m takeover bid made for the club in 1998 by BSkyB. The satellite television station,
40% owned by Rupert Murdoch’s media empire News International, shows live
Premiership football on subscription channels. Payments from television companies are a
significant source of income for the club. The bid was not motivated by the failure of the
club’s management, but by the strategy of BSkyB. It was agreed to by the board of
directors, but was vetoed by the government after a reference to the Monopolies and
Mergers Commission. The bidder was forced to reduce its stake in the company to
below 10%. This left BSkyB owning 9.99% of the share capital and still being the largest
shareholder inthe company.
Sinceflotation,MartinEdwardshasgraduallyreducedhisstakeintheclubto14%in
1998 and to 0.7% in 2002. The club’s shares are now more widely dispersed with some
20,000smallshareholdersowning3.5%andthedirectorsaround3%.Thelargestholdings
in September 2002were:
%
BSkyB 9.99
Cubic Expression 8.65
Mountbarrow Investment 6.54
LandsdownePartners 3.11
E.M.Watkins 2.31
C.M. Edwards 0.70
Other directors 0.10
In September and early October 2003 there was significant trading, giving the following
estimated structure:
CHAPTER 1 g OWNERSHIP CONTROL AND CORPORATE GOVERNANCE 9
%
CubicExpression Ltd 23.2 (J.P. McManusandJohn Magnier,Irish
businessmen)
MalcolmGlazer 8.9 (TampaBayBuccaneers, USAowner)
Mountbarrow Investment 6.5 (HarryDobson, Canadian-based
Scottish businessman)
UBS 5.9 (Financialinstitution)
TalpaCapital 4.1 (Johnde Moi,Dutchtelevision tycoon)
LandsdownePartners 3.7 (Financialinstitution)
Legaland General 3.3 (Financialinstitution)
E.M.Watkins 2.3 (United director)
Amvesscap 1.8 (Financialinstitution)
Dermot Desmond 1.6 (Glasgow Celtic,dominant shareholder)
Shareholders United 1.0 (Activist group)
Otherinvestment companies 16.8
Ordinary United fans 15.0
Others 5.9
To determine whether the club is owner or managerially controlled, we would need to
consider the size of the largest stake, the distribution and size of other holdings including
thedirectors’holdings,themotivationforholdingthesharesandthepropensitytovote.The
club was owner-controlled when Martin Edwards was chief executive and the largest
shareholder. There appeared to be a period when the company was managerially
controlled when the board of directors controlled a small proportion of the shares and
the largest shareholders were said to be investors rather than active owners. However,
thatpositionappearstohavechangedwiththeemergenceofdominantshareholderswho
maywish tocontrolthecompany.
SYSTEMS OF CORPORATE CONTROL
The di¡erences between countries in shareholder ownership patterns in£uence the
nature of their corporate governance systems. According to Franks and Meyer (1992),
there are fundamental di¡erences between the corporate control systems of the UK
and the USA and France, Germany and Japan. The former they describe as outsider
systems and the latter as insider systems. The characteristics that distinguish the
systemsarelistedinTable1.3.
Insidersystems
Insider systems are characterized by relatively few quoted companies, concentrated
ownership, dominance of corporate and/or institutional shareholders and reciprocal
shareholding. Shares are infrequently traded, but when they are they often involve
large blocks. Takeover activity is largely absent, and where mergers take place they
are largely done by agreement. However, Vodafone did acquire Mannesmann
10 PART I g CORPORATE GOVERNANCE AND BUSINESS OBJECTIVES
Table1.3 Characteristicsofinsiderandoutsidersystems
Characteristics UKandUSA EuropeandJapan
Listedcompanies Many Few
Tradingownership Frequent;liquidcapitalmarket Infrequent;illiquidcapitalmarket
Inter-companyholdings Few Many
Shares Widelyheld Largeholdings
Dispersedindividuals Concentratedcompanies
Financialinstitutions
Concentrationof Low High
ownership
Source Author
following a hostile bid. These characteristics, it is argued, lead to more active owner
participation. Owners and other stakeholders are represented on the boards of
companies, and there is active investor participation in controlling the company; this
minimizes externalin£uencesinthecontrolofthecompany.Ownership lieswithinthe
corporate sector rather than with a multiplicity of individual shareholders. Directors
are representatives of other companies and interest groups, while a two-tier board
structure allows a wider group of stakeholders to o¡er the company a broader
spectrum of advice tending to reinforce longer term goals and stability for the
company. Information about the ¢rm’s problems and performance is available more
readily to corporate or institutional shareholders than to individual shareholders; this
enables them be better informed about the ¢rm’s performance because they have
insideinformation.
Germany
Germany is an example of an insider system. It has according to Franks and Meyer
(2001) around 800 quoted companies compared with nearly 3,000 in the UK.
Ownership is much more concentrated with 85% of the largest quoted companies
having a single shareholder owning more than 25% of the voting shares. Large
ownership stakes tend to rest in the hands of families or companies with inter-
connected holdings. Where shares are more widely dispersed then the in£uence of
banks is stronger: for example, the largest shareholder in BMW is the Quandt family
which owns 46% of the voting equity. Stefan Quandt is one of four deputy chairmen,
and his sister Susanne is a member of the supervisory board. Head of the family is
Joanna Quandt, who is the majority owner of Altana, a pharmaceutical manufacturer;
thismakesthem thecontrollersoftwo of Germany’stop 30companies(FinancialTimes
16 August 2002). The supervisory board appoints the management board. When the
company’s acquisition of British Leyland was deemed unsuccessful the chairman of
the management board and two other directors were quickly dismissed in early 1999
byinsideraction.
CHAPTER 1 g OWNERSHIP CONTROL AND CORPORATE GOVERNANCE 11
Outsidersystems
Outsider systems are characterized by dispersed share ownership, with the dominant
owners being nonbank ¢nancial institutions and private individuals. Owners and
other stakeholders are not represented on the boards of companies. Shareholders are
seen as passive investors who only rarely question the way in which a company is
being operated. Shares are easily sold and tend to be held for investment purposes, as
part of a diversi¢ed portfolio, rather than for control purposes; this discourages active
participation in company a¡airs since shares are easily traded. Thus, dissatisfaction
with the performance of a company leads the shareholder to sell shares, rather than
initiatemovestochangethemanagementorevencompanypolicies.
Dispersed ownership is assumed to mean managerial control; this is particularly
true when ¢nancial institutions hold numerous small stakes. While such institutional
investors may have information advantages, they do not use this to in£uence
management directly but to maintain the value of their investment portfolios on
behalf of clients. The monitoring of managers is said to be superior in insider systems,
with deteriorating performance more quickly acted on. In the outsider system,
changing management and policies is a slower process and may involve the takeover
ofthefailingbusinessbyotherenterprises.
CONSTRAINTS ON MANAGERIAL DISCRETION
The degree of discretion that senior executive managers have in setting objectives is
limited by both external and internal constraints. External constraints arise from the
active market in company shares while internal constraints arise from the role of non-
executive board members and stakeholders, trying to align the managers’ and the
owners’interestsbytherulesshapingcorporategovernance.
Externalconstraints
Thereare¢ve sourcesof externalconstraintonmanagerial behaviour inany systemof
corporatecontrol.Thosewhopotentiallyholdthispowerare:
g Holders of large blocks of shares who use or threaten to use their voting power to
changemanagementortheirpoliciesiftheybecomedissatis¢ed.
g Acquirers of blocks of shares sold by existing shareholders unhappy with the
performanceofmanagement.
g Bidders in the takeover process who promise to buy all the voting shares of the
enterprise.
g Debtors/Investors,particularlyintimesof¢nancialdistress,whoacttoprotecttheir
interestsinthecompany.
g Externalregulatorsandauditors.