"The Role of Shareholder’s in Corporate Governance Morality 1Corporate Governanceby Student?s NameCode + Course NameProfessor?s NameInstitution of LearningCity, StateDate The Role of Shareholder’s in Corporate Governance Morality 2IntroductionThe claim thats “We rely on shareholders to impose morality in the global marketplace”is valid since the ultimate benefits of corporations rests on the owners. With weak interventionsand internal control of the operations of firms including the existence of information asymmetrybetween the agent- principle arrangements, leads to an adverse effect where agency problemcreeps in. Companies? executives and managers amass much wealth and benefits when theincentives to do so exist. This paper seeks to identify the validity of the claim and the solutionsproposed as alternative corporate governance strategies and their possible positive and negativeimplications to the corporations and society.”Validity of the claimThe concept of corporate governance concerns the management of relationships betweendifferent corporate shareholders (Malek 2004, p. 46). The concept is all about the management ofthe principle- agent relationship that aims at maximising the shareholders? long term interest(Goodpaster1991, p.53-73). With slack and undefined directions of the company, the interests ofthe share-holder and the agents (management team) may conflict leading to an agency problem.Activities like tax evasion, interest rates rigging,illegal consumer products inflation and“horsemeat sales in place of beef?? are some of the institutional abuses that arise when measuresto regulate the companies/ corporations activities are feeble or non- existent or when there is an incentive ofdivergence of interest between the principle and the agents (Schwalbach et. al,1997, p. 3) .The cost of illegitimate and unethical corporate dealings whose liability rest entirely onthe shareholders could be very high if intervention is not taken into consideration (Waygood The Role of Shareholder’s in Corporate Governance Morality 32006.). Companies like Enron and Worldcom in US are just but examples of companies that losttheir glory and the shareholders long- term interest buried. Shareholders have therefore been considered accountable over the action and activities oftheir companies since they are the ultimate owners (Schwalbach et. al 1997, p. 3). Erturk et. Al(2006) points out the assumptions that the shareholders and the owners of a company who bearrisks have a function to monitor the agents. The study further points out that ownership rightsenforcement does create shareholders? value as claimants of residuals. They should thereforemonitor the managers? actions that aim at value creation to minimise wastages and facilitategrowth. Although the general assumption is that the shareholders are held accountable upon anymisalignment of the corporations? objectives, study shows that there exists a limitation to suchreality on the basis of the law.According to Mitchell( 2009, p. 171 ), the law excepts theshareholders and creditors from the corporations duties and the productive entities based on thedoctrine of limited liability- a situation that has risen ethical concerns. To strengthen the isolationof the shareholders from the blame of moral depravity in the market place, Freeman et. al (2004,p. 364- 369) suggest that managers and executives should inculcate values necessary for doingbusiness. These will define the clarity of the strategies used to achieve corporate performanceand the kind of relationships to create with the stakeholders to deliver their objectives.Over the years, the incentive to align the management interests and effort with theshareholders interests has seen to an increase of management compensation. A study done byErturk et al (2006) on the comparison of workers and executive pay in UK and USA found outthat the pay-ratio between the executive and the workers rose from 50 to 109 from 1980 to 1990 The Role of Shareholder’s in Corporate Governance Morality 4and 109 to 525 from 1990 to 2000 in USA. In UK the ratio rose from 9 to 54 from 1978/79 to2002/03.For far too long, the shareholders have been relied to “impose morality in the globalmarketplace”, although it comes with a cost the appointment of non- executive directors to helpin scrutinising of companies dealing on behalf of the share- holders. Having the non- executivedirector share the same legal responsibility with the executive directors places them allaccountable to the shareholders.Rotational retirement and democratic elections too have beenused to regulate the activities of the directors. The directors are task with the responsibility ofmanaging performance, compliance, control and behaviour within an organization.Theshareholders therefore are responsible for the companies? compliance with all regulatorymeasures and standards. Therefore the general claim that it?s the responsibility of theshareholders to define and ensure companies? morality within the marketplace is not in questionsince the shareholders are expected to monitor the firm managers activities in shareholder?svalue creation at all cost.Failure to commit to the mandate and the responsibilities expected of the shareholder, acompany risks not only non- compliance cost implication imposed by the government,accounting or legal abodes but also its survival. A company like Andersen was sentenced forobstruction of justice acting through its employees and received a fine of $500,000 (Ireland et. al1999); levels I type of cost valued at about four billion dollars was not such weightier toAndersen since its financial portfolio was intact and mature to sustain it. The survival ofAndersen was guaranteed still even after the incidence.To maintain the lawyers? services and agents including expensive auditors Andersen hadto manage the level 2 costs. These cost that Andersen incurred were much greater than the level The Role of Shareholder’s in Corporate Governance Morality 51 cost. These costs ran in multiple millions of dollars that although the costs were high, Andersenwas able to manage it based on its financial base. Level 3 costs which were considered most detrimental to the organisation were not onlymuch high but were linked to its survival status. A loss of reputation, employees, defection ofcustomers, and cynicism of the government and tight regulation of the government were muchdevastating to the company than any other moments before. Investors, customers, and employeesholding expectation of performance of the business form the basis of stakeholder?s costs .Thesecost implicative activities were at the discretion of the companies? managers that least informedthe shareholders (Thomas 2004, p.56-66).Solutions to relying on shareholders to impose marketplace moralityDifferent solutions have been suggested to solve the problem of relying on shareholders?imposition of marketplace morality. This rises from the reality that the executive have anincentive to drive a company beyond its optimal level which increases their power of control ofthe resources (cited by Jensen 1986, p.1). Even with the legal requirement of executives taken asecond option participation in the purchase of shares, there exists insider dealings instigated bythe managers when such incentives arise. Clarke (2009, p.4) points out that chief executives whoare the agents if chairing the boards can prevent the challenge of their position and too aggregateto their own substantial increase in the companies? wealth share through inflation of salary andgrowing stock. The executives do take maximum advantage of the shareholder- agentinformation asymmetry if it does exist on the management team to maximize their long-termenterprise values (Schwalbach et. al 1997, p. 3)The need for immediate changes arose with the challenges that were too way out of hand.Clarke (2009, p.8) identifies these challenges that include; uncontrollable rise in executives? The Role of Shareholder’s in Corporate Governance Morality 6compensation; unethical and functionally damaging disparity of executive- worker rewards; therising agency problem with executives taking proportionately large shares of corporationsearnings; and the immodest bench- marking of executives compensation gradually building.One of the adopted solution to these agency and societal challenges is the enactment ofthe Sarbanes-Oxley Act of 2002 (SOX) which came after the collapse of Enron and Worldcom inUS- as Perino, (2002, p 212) terms it; „the Enron legislative aftermath. This came as a state?sreaction to safeguard the citizens who own stocks directly or indirectly through retirement fundsand pensions (Coates 2007, p. 91- 116). The Act came to address the reallocation of risks to theperpetrators and further isolating the shareholders from liabilities. To eliminate the auditors?agency problem, the duty to appoint the external auditor?s (agents) services is the principals(shareholders) auditing the corporate management and executives (Gavious 2007, p. 451- 467).The Act recognises the independence of the auditors and mitigates management interference.The Act does increase the risk of the directors hence reducing the supply of them whileincreasing outside directors demand (Linck et. al 2009, p.3287-3328).The concerns of theimplementation though of the SOX are divergent since companies that face agency problem havethe company insiders lobby against the implementation while investors lobby for the fullimplementation (Linck et. al 2009, p.3287-3328). Advantages and Disadvantages of the SolutionSome of the advantages of the adoption of SOX as identified include; the act helps todecrease the incentive of fraud collusion between the management and the auditors (Gavious2007, p. 451- 467). With the provision of the audit- firm rotation unlike the audit- partners?rotation, and the time-window expedition between audit and the non-audit services, the Act seeks The Role of Shareholder’s in Corporate Governance Morality 7to address the joint- agency challenge. With this in mind SOX will help in the improvement ofthe financial statements within companies (Li. et. al 2008, p.111-134).Additional advantages identified by include: the standardization of processes amongcompanies of the same characteristics; effective exploitation of convergence opportunities;strengthening internal weak links that may include human resource management, wagesregulation and taxation processes (Wagner 2006, p.133.)Some of the identified disadvantages are that; The legislation imposes significant cost onfirms (Leuz 2007, P. 146-165). These cost include the increase in the pay of the directors andexecutives (Fried 2011, p.722-751.), increased internal control mechanisms (Zhang 2007 , p.74- 115) and increase cost of equity (Ashbaugh 2009, p.1). As observed by Carney (2006p.141),that cost of .these regulations do exceed the benefits n some companies. There also exist concerns on the discrimination of the application of the Act. The act isframed to apply to the listed level 2 and 3 but not 1 and 4 (Litvak 2007, p.195-228). Thisdiscriminates a universal control of companies? alignment to the market integrity and limit this tofew companies that have a high purchase value and agency risks. As points out by Wang (2010,p.885-920), CFOs within companies with high internal control receive high wages ascompensation which results to a increased cost of control under SOX. ConclusionCorporate governance, a concept focusing on the management of the relationshipsbetween different corporation shareholder has been moulded by a myriad of challenges amongwhich agency problem is paramount. The divergence of interest between the principals andagency has attracted incentives to engage in illegal corporate practices at the managements?discretion.These practices range from consumer product quality deprivation, environmental The Role of Shareholder’s in Corporate Governance Morality 8unfriendly practices, tax evasion, and insider trading that deprive democratic marketparticipation. Among some of the solutions advocated and adopted include re-allocation of risksto the perpetrators mostly the agents. Legislation like SOX Act in US came as a result ofcorporations? indulgencies in unethical dealings.The emergence of SOX in US brought to rise to missed reaction- the principals as pro- adoption and implementation of the bill while agents interests been greatly affected. The mainareas within the Act include: the external auditors independence and rotational contracting;executives? risk- bound high compensation and shareholders isolation to corporate liabilitiesinstigated by managers.Although the benefits of the adoption of SOX are tangible, realistic and corporate- redemptive, there have been cases of negative implications of SOX. Discrimination of theapplication of the Act to companies and increased cost through advanced internal control andexecutives? wages are among the challenges associated with the adoption of SOX. This amongother solutions have been identified and adopted to mitigate the problem of agency. "