By Paul Lee
Until recently, Volkswagen (VW) was a widely respected company. As we all know, in September this abruptly changed when it was found guilty of manipulating data from emissions tests. How could such a reputable company get it so wrong?
The ownership structure of VW is notable because major stakes are held by the founding families and by the German state of Lower Saxony. VW’s board often proudly told minority investors that this insulated the company from the negative influences of the financial markets. Unlike other public companies, they claimed, VW could plan and build for the long-term and not simply focus on short-term profitability and returns.
The scandal certainly undermines that argument. The corporate accountability demanded by shareholders can in fact encourage companies and their managers to act in a long-term, sustainable fashion that creates value for shareholders and other stakeholders. But shareholders need to carry out their duties as responsible stewards.
There has been recent debate on whether shareholders can be said truly to ‘own’ a company. Economist John Kay cites 11 criteria that define ownership. Comparing the principle of owning an object (an umbrella) to the concept of an equity investor holding a company share, Kay suggests that the latter satisfies only two of his 11 criteria of ownership.
However, to argue that a shareholder only owns its share certificate is a misapprehension. It is like suggesting that the freeholder of a property who has granted a long lease of that building no longer owns it but owns only the title deeds. Just as with the shareholder, the freeholder has no right in normal circumstances to go into the property and make use of it – that right has been given, on a temporary basis, to others.
Having said that, the freeholder has a right to income from the property as agreed, and owns the residual (in the jargon, reversionary) interest in the property. Furthermore, the freeholder typically has a right to require good maintenance of the property, that it is insured, and to receive sufficient information such that it can be confident this is being done. In extreme circumstances the freeholder usually has the right to reassert control of the property so that its residual value is not damaged.
That sounds very much like the ownership rights of shareholders. We have granted management temporary control and oversight of the assets of a company. We must leave management free to make the most of those assets in normal circumstances. Regular income and reporting are enough to give us confidence that they are doing the best job possible to maintain and enhance the value of those assets. We challenge them in order to remind them that this is what we expect. In rare circumstances, we intervene because that is the best way to maintain the value of the assets. Our clients have the right to expect no less of us. It is good ownership of these assets, to leave them in the hands of competent management up to the point that we as owners have lost confidence in management.
None of this means that companies should only have the interests of their shareholders in mind. Businesses only succeed in the long term by providing value to all their stakeholders.
This was the spirit behind the 2006 Companies Act. Directors must promote the success of the company in the interests of its members (shareholders), but they must also “have regard” to other stakeholders – employees, customers, suppliers, local communities and the environment as a whole. The Act encouraged a shift away from the view of the firm as a shareholder value-maximising entity to one that acts in the best interests of all stakeholders. In this sense, it aimed towards the stakeholder model of corporate governance that is more usually attributed to continental European and Japanese firms.
Ultimately, there is no single perfect system of corporate governance. Each country and company’s system is a function of its history, laws, customs and social environment. There are some absolutes though. Well-governed companies everywhere create an environment that encourages accountable, transparent and inclusive decision-making. Shareholders play a key role in ensuring that companies act fairly and responsibly for the benefit of all stakeholders. And shareholders, as good owners, cannot abdicate their responsibility to hold management to account for delivering long-term business success.
Paul Lee is head of corporate governance at Aberdeen Asset Management
