What is the Role of Shareholders in Corporate Governance

Agency theory, described by Jensen and Meckling, is the concept surrounding the agency relationship where one party, the agent, works following the guidance of another party, the principal. In corporate governance theory, shareholders are identified as the principal, with boards of directors acting as their agents and supposedly acting in their best interests. Due to this relationship, shareholders can exercise their rights. However, difficulties arise when there are diverse shareholder bases with differing views.

Furthermore, in the separation of ownership and control, as identified by Berle and Means, was conceptualised on the account of firm ownership and control becoming separated during development of market and industrialisation. Due to recent high-profile scandals and corporate collapses, there has been a recent push for shareholders to act as owners of the firm and hold more influence in firm decisions. Therefore, putting more shareholder pressure on firms.

Shareholders have significant ability for participation in a firm's internal corporate governance. They survey management, are present at and participate in their firm's AGM, as well as vote on important business decisions. Shareholders employing pressure to boards to fulfil the requirements of Corporate Governance Code would, in theory have a positive impact on the firm, as is promotes good governance practices.

However, attendance to AGMs is worryingly low much like many other countries, with as low as 0.1% of shareholders in attendance. Indeed, when a firm is in public financial trouble meeting participation only increases to 1%, on average. Thus, votes made during these meetings towards any firm decisions, such as corporate governance decisions, are concentrated by those in attendance (often institutional investors) of the meetings and not representative of a firm's total shareholders.

Through pressurising managers, shareholders can invoke agents to take part in fraudulent activity. Shi et al. found that this was caused by excessive pressures from institutional investors inciting fears around takeovers. They further discern that an excess of pressure applied from external corporate governance mechanisms could adversely influence the motivation and autonomy of managers. The authors further stipulate that the systems employed to manage and oversee agents, such as auditing fees and both time and monetary cost of annual corporate reports, are highly expensive to enforce and can have a highly negative effect on agents. Thus, too much pressure and control given to investors, can aggravate principal-agent problems.

Shareholders can sometime lack some aspects of business knowledge, such as not comprehending the link between increasing risk with increasing rates of return. Thus, pressuring managers to make exceptionally high-risk decisions. There are agency costs known as 'principal costs', which occur when shareholders have firm incompetence. For example, when investors are myopic and focus too much on short term investments.

Stewardship theory is a normative alternate to agency theory. The theory is the idea that managers will behave faithfully over the assets in their control, due to a distinct link between satisfaction and firm success (Donaldson and Davis, 1989). It relies strongly on the principal (investor) steward (manager)'s trust in each other.

The notion of stewardship has recently come to the forefront with the development of the 2010 FRC Stewardship Code. Shareholder stewardship is the concept that institutional investors are requested, morally and legally, to maintain an active role in firm corporate governance practice (Talbot, 2010). This is a change to previous theories where directors were deemed to be stewards of corporate governance, as opposed to their shareholders.

However, this concept has its flaws. In 1992, the Cadbury Committee report discussed the importance of institutional investors in particular in corporate governance recommendation implementation in firms, as they are considered to have the greatest influence due to their size. Institutional investors tend to be comprised of mainly insurance firms and pension funds. Tilba and McNulty discuss how institutional investors, by their nature of being pension funds and insurance firms have a wide variance of interests and diverging opinions. Therefore, these investors generally give primary emphasis to share performance and therefore give little consideration towards the investing firm's corporate governance. In contrast, Rock states that institutional investors are wanting to push for good corporate governance practice, but only when it is evident that by doing this, it would maximise firm value, and therefore shareholder value.

Furthermore, it is important to note whether the shareholders pressurising the firms for good corporate governance, in terms of their motivations. Either shareholders have shares in a select number of firms, in which case they would likely want good governance in the firm to ensure long-term sustainable success (therefore having a positive impact on the firm), or shareholders have a large, diverse portfolio and therefore would likely push for short-term value maximisation.

To conclude, shareholder pressure can yield good results and have good impacts on firms. It ensures that companies keep their principal-agent relationship and fulfil their requirement to maximise shareholder, and therefore, firm value. However, in exerting pressure on managers, there are significant results which have negative effects on firms. Shareholders can pressure managers to make decisions which they deem in their own best interests, but often there is a lack of accurate business knowledge so there is a risk of forcing the wrong decisions. Furthermore, due to a lack of attendance to AGMs and a lack of shareholder activism, institutional investors have a large say in how they want firms to be run. As institutional investors are primarily monetarily focussed, it can lead to short-termism in a firm and does not prioritise sustainable success.