Business Economics And Managerial Decision Making.pdf

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

and sizes, but have the following common characteristics:

Owners.

Managers.

Objectives.

Apoolofresources(labour,physicalcapital,¢nancialcapitalandlearnedskillsand

competences) to be allocated roles by managers.

Administrative or organizational structures through which production is

organized.

Performance assessment by owners, managers and other stakeholders.

Whatever its size, a ¢rm is owned by someone or some group of individuals or organiza-

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

performance of the ¢rm is at the centre of many of the issues dealt with in this book.

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

who may share in the appointment and supervision of managers and in the determina-

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

owned by national and local government.

The notion that privately owned enterprises should be run in the interests of share-

holders is not a characteristic of companies in all advanced economies. Yoshimori

(1995) proposed that shareholder companies can be classi¢ed as follows:

Monistic ^ where the company serves a single interest group, normally share-

holders. These types of companies are commonly found in the UK and the USA.

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

are commonly found in France and Germany.

Pluralistic ^ where the company serves the interests of stakeholders in the company

and not just shareholders. Employee and supplier interests may be paramount.

Such companies are found in Japan.

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

greater emphasis on pro¢tability.

PATTERNS OF SHAREHOLDING

The pattern of share ownership varies between countries and with time. In the UK and

the USA, ownership is more widely dispersed than in continental Europe and Japan

where it is more concentrated.

UK share ownership

Table 1.1 presents data on share ownership in the UK from 1963 to 2001.

Table 1.1 Shareholding in the UK

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

Of which:

Pension funds

6.4

16.8

30.6

27.8

22.1

16.1

Insurance companies

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

Source Compiled by author using data from:

CSO (1993) Share register survey 1993, Economic Trends, No 480, London, HMSO

CSO (1995) Share Ownership, London, HMSO

CSO (1999) Share ownership, Economic Trends, No 543, London, HMSO

National Statistics (2002) Share Ownership 2001, http://www.statistics.gov.uk

6 PART I g CORPORATE GOVERNANCE AND BUSINESS OBJECTIVES

Table 1.2 Structure of share ownership in Europe 2000

Type of investor

France

Germany

Italy

Spain

(%)

Individuals

Private ¢nancial enterprises

Private non-¢nancial organizations

Public sector

Foreign investors

Unidenti¢ed

Total

100

Source Compiled by author using data from FESE (2002) Share Ownership Structure in Europe 2002, Brussels,

http://www.fese.be

The key features are:

The largest group of domestic owners of company shares are ¢nancial institutions.

Financial institutions’ share of ownership increased between 1963 and 1997, but

fell to 50% in 2001.

Individual ownership of shares has been in long-term decline and fell to 14.8% in

2001.

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

¢nancial institutions.

Shareholding in Europe

Comparative data for the ownership of shares in France, Germany, Italy, Spain and the

UK for the year 2000 are presented in Table 1.2. It shows that in each country the

structures are di¡erent in broad terms compared with the UK:

Holdings by ¢nancial institutions are lower.

Holdings by non-¢nancial companies are more important, particularly in Germany.

Individual ownership is more important in Italy and Spain, but less so in France.

Foreign owners are more important in France and Spain, but less signi¢cant in

Germany and Italy.

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

outvoted if the other shareholders formed a united front. If the majority of shareholders

do not form a united front or do not vote, then an active shareholder with a holding of

substantially less than 50% could control the company.

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, that do not emerge from the crude data.

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,

would be expected to exhibit a higher degree of control for any given level of sharehold-

ing than would external shareholders.

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, less than a 5% holding was necessary for control.

Control of a company is therefore a function of the following factors:

Thesizeofthelargestholding.

The size and distribution of the remaining shares.

The willingness of other shareholders to form a voting block.

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