The role of investor's protection has become very important in corporate governance in recent years. It has now become a custom that controlling shareholders and managers are taking the possession of the rights of investors and creditors. In most cases investors face a lot of risks that return on their investments will never materialize because of the rights of controlling shareholders or the executive level managers.
Expropriation from insiders (managers and controlling shareholders) of the firms is taking a variety of forms; La porta (2000) describes expropriation that takes place in companies, stealing the profits, by selling outputs, assets or the additional securities by the insiders of the firms to another firm they own at a lesser price. This process of selling outputs and assets to other firms is legal but some managers do it without the consent of the investors. Expropriation can be related to all the problems under which the insiders use the profits of the firms to benefit themselves rather than returning the profits on the investments by the investors from the outside the firm
The fundamental changes in the concept of corporate governance initially began with "Cadbury Report" which ultimately can alter the auditor-client relationship Percy, J. P. (1995). Percy, J. P. further describes that the most significant achievement of this report was the requirement that an audit committee of independent directors should be appointed. Corporate Governance is playing a significant role in the protection of weak and widely dispersed shareholders against self-interested directors and managers.
1.2: Research motivation
The reason I picked this topic is I see myself as a potential investor in the future and would like to research whether my rights as a minority shareholder/investor are well protected as that of the controlling shareholders.
1.3: Research purpose
This research investigates how corporate governance has played its role in the protection of investors. The research will look at what potential investors think about the role played by corporate governance, it will also look at what motivates investors to invest in a particular company and not the other, This report will try to help in building a strong relationship between investors and firms and hence encourage long term investment in U.K
1.4: Aims and objectives
The research aims to analyse the role corporate governance has played in the protection of investors; the purpose is to explore investors' opinion and perception of the topic. In order to meet my aims I will need to meet the following objectives.
To research existing literature on corporate governance and its role in investor protection
To research how investors are protected from expropriation
To analyse the relationship between investors and firms after fraud and accounting scandals
To investigate differences in legal protection of investors and how it has affected long-term investments
To conclude with ways to enhance the level of confidence between investors and firms to gain more fiancés.
1.5: Dissertation outline
1.5.1: Introduction
This chapter will provide a basic introduction of the research issue, background information, the purpose of the research and the aims and objectives of the study.
1.5.2: Literature review
This chapter reviews and analyses previous research done on the topic, which helps to develop a methodology necessary for carrying out data analysis
1.5.3: Research methodology
This chapter will explain how the primary data will be collected; explain the sample size and the source of the questions used for the questionnaire.
1.5.4: Data analysis
This chapter will be analysing the findings collected from the online survey, the questions set on the questionnaire are derived from literature review
1.5.5: Conclusion & Recommendations
This chapter will provide an overview of the findings and recommendations for future research. Any limitations will also be mentioned in this chapter
Chapter 2: Literature review
2.1: Introduction
This chapter contains a review of the secondary material from different authors; I will be identifying, evaluating and assessing the published information on my research topic. By doing this, it will allow me to develop an understanding of previous research relevant to my study also understand how previous research has developed. I will try to establish the state findings in my research data. Wilson (2010)
The key authors are La porta et al (1999) and Djankov et al (2008) as they have done a lot of research on corporate governance and investor protection. I have used their studies to build a list of relevant articles to help create a comprehensive literature review on the chosen topic.
There is an extensive research done on corporate governance, although being a wide topic it lacks an official definition, Its meaning has gradually developed through the years, Tricker (1984, p.7) asserts that, 'if management is about running the company, corporate governance is about ensuring the company is run properly'. Cadbury report (1992) defines corporate governance as the system of controls, financial and otherwise, which ensure that a firm is directed in the right way towards the right direction. However, Keasey and Wright (1993) distinguished corporate governance, which concerns the structures and processes associated with production, decision-making, control and other activities within an organisation, from accountability, which was specified as a sub-set of corporate governance which involves the monitoring, evaluation and control of organisational agents to ensure that they behave in the interests of shareholders and other stakeholders. La Porta et al (2000) defines it as a mechanism through which the outside investors protect themselves against expropriation by the managers and controlling shareholders. To a large extent it is sort of phenomena with which investors from outside the firm can protect themselves from expropriation of the managers and the shareholders from inside the firm Klapper E.T, (2004). As time went by corporate governance became more about protection of investors and from this I can assert that corporate governance deals with every aspect of the business and therefore a major and crucial part of a company. Walker (2009 p.19) adds on that the role of corporate governance is to protect and advance the interests of shareholders through setting the strategic direction of a company by appointing and monitoring capable management to achieve this.
2.2: Background of corporate governance
The United Kingdom (U.K) has some of the highest standards of corporate governance in the world, making U.K market attractive to new investments this could explain why there are fewer accounting scandals.
U.K's corporate governance operates on a principle of "comply and explain" which covers issues like board composition and effectiveness, role of committees, risk management, remuneration and relations with shareholders.
In U.K Investors have the power to appoint and remove directors if they are not satisfied but they are also encouraged to sign up to the stewardship code which sets standards for monitoring and engaging with companies they have invested in. Davies and Aston (2011)
The recommendations in the Cadbury Report have been added at regular intervals since 1992. In 1995 a separate report set out recommendations on the remuneration of directors, and in 1998 the two reports were brought together in a single code (known initially as the Combined Code and now as the UK Corporate Governance Code). In 1999 separate guidance was issued to directors on how to develop risk management and internal control systems, which has subsequently been updated. In 2003 the Code was updated to incorporate recommendations from reports on the role of non-executive directors and the role of the audit committee. At this time the UK Government decided that the Financial Reporting Council (FRC), the independent regulator responsible for corporate governance and reporting, was to take responsibility for publishing and maintaining the code.
2.3: Background of ownership and control
There seems to be an issue of which countries are responsible for pioneering separation of ownership and control, Reports by Alfred Chandler claims that "personal capitalism" was to be blamed for UK firms to remain laggard as American and German firms benefitted by creating managerial hierarchies this is in the 19th and 20th century(Alfred D chandler 1990) cited by (Cheffins 2010 p.222) However, Leslie Hannah in a 2007 article claims that Britain and France in the early 20th century exhibited the largest degree of separation of ownership, this is supported by evidence on share ownership in "very large" industrial and commercial companies 1931 and 1951. (Leslie Hannah 2007) cited by (Cheffins 2010 p.225). However, Leslie Hannah explains that there are several reasons for the results found, for example U.K's domestic equity may have been exaggerated as most British companies had overseas direct investments which were included in their domestic capitalisation.
Frank Mayer and Rossi report from a sample of 40 companies incorporated around 1900 and 1910 the directors collectively owned 53% of the shares. The evidence however is inappropriate to draw strong conclusions because the sample was between 13- 40 companies which were listed on the London Stock Exchange as of 1914. (Cheffins 2010 p.221-225)
Berle and Means (1932) has looked at separation of ownership and control as a hallmark of U.S firms, this has come into question with the development of corporate governance. Monks and Minow (2011 p.102) suggest the separation of ownership and control impact the company as managers have different agendas from the owners, this can be addressed by law that is not just based on contracts but on honour integrity, trust and ethics.
2.4: The failure of Investors' Protection
The failure of Investors' Protection has led to the collapse of successful companies such as Enron and Polly Peck. The scandal affected creditors and investors and its surprising that none of the audit members discovered the years of fraud involved in the company (Solomon, 2010) In the U.K it led to consider the robustness and effectiveness of existing corporate governance, Sir Robert Smith, published a report on Audit Committees, the combined code guidance giving the audit committees responsibilities of overseeing the work of internal and external audits and reviewing the scope and results of audits. In America the reaction to the 2001 scandals was the Sarbanes-Oxley Act 2002 it is a legal requirement to comply with the Act. (Davies and Aston 2011)
Authors are looking at the sharing of the control in the firm as a way to curb expropriation, La Porta et al (1999) If investors rights are poorly protected, then the value of control goes up as the managers and the controlling shareholders have an opportunity to expropriate, so the question is "will control in such environment be concentrated in the hands of an entrepreneur or dispersed among many investors?" Zingales (1995), La Porta et al. (2000), and Bebchuk (1999) argue that if investors disperse control between many investors, they give up the "private benefits" when it comes to takeover. In Bebchuk's (1999) model, diffuse control structures are unstable when investors can concentrate control without fully paying for it. An entrepreneur or his family may need to retain control of the firm because the family's reputation is needed to raise external funds when the legal protection of outside investors is poor. For all these reasons, firms in countries with poor investor protection may need concentrated control. Haidar (2009) suggest that countries with poor legal investor protection concentration is higher to prevent being cheated, while in where expropriation is curbed, equity investment is higher and ownership concentration is lower. "Is the ownership concentration in U.K dispersed or concentrated?"
2.5: Agency theory
A lack of concentrated control has increased the agency problem where by the interest of the managers and shareholders are not aligned. Agency problem was introduced through introduction of stock market to the public and the investors not wanting to play a role in the running of the business therefore, creating an opportunity for the managers to expropriate finances Healy and Palepu (2001).
Davies and Aston (2011) raises concern for the need for corporate governance to indicate whether directors are maximising shareholder returns and keeping business risk at a reasonable level, Jensen and Meckling (1976) suggest a use of law and sophisticated contracts which provide strong incentives to help reduce the agency cost; however there are opportunities to create new ones for example, by issuing additional more senior claims, by paying out the cash received from investors as a dividend, or by taking on high risk capital projects Smith and Warner (1979), Boatright (1999) further explains that agency problem leads to short-termism projects rather than long-term shareholder wealth maximisation, he also adds that Britain industry is in nature a short-termism industry due to flawed remuneration structures and excessive risk taking on the current crisis in the world bank sector. However, Eisenhardt (1989) David Band (1992) agree with Jensen and Meckling (1976) in the use of out-come based contracts such as management share ownership schemes is effective as it reduces the self-interest behaviour, and hence the top management and the shareholders goals merge.
2.6: Relationship between investor and firms
Financial reporting council (FRC) says the key relationship is between the company and its shareholders and not company and security regulators. It also encourages shareholders to get involved with corporate governance matters. Monks (1994) cited by Jill Solomon (2010 p.124) agrees by emphasizing the need for institutional investors to practice 'relationship investing' with their investee companies.
The accounting scandals and financial crisis have altered the relationship between investors and firms. Allen (2002) in the post Enron era, investor relationship vaults at the top of corporate governance agenda, he further stresses that "communication skills of investor relations will be more important than ever. The most important issue to investors is trust, Lev Baruch (2012) states that regaining investors trust and support should be at the top of managers' agenda, The managers should make a substantial shift in their conception of investors needs based on honesty, relevant information sharing and smart communication with investors.
2.7: Investors' Protection
Investor protection is characterised as the extent of laws that protect investors' rights and the strengths of the legal institutions that facilitate law enforcement. Defond and Hung (2003). The level of investor protection can be measured by the level of disclosure and legal protection in a company.
2.7.1: Disclosure
Disclosure is the act of making new or secret information known (oxford dictionary). Accounting Standard Board (ASB) has set out requirements on disclosure in order to support more transparency. Stigliz and Weiss (1981) greater information flows can mitigate the principal-agent problem, Kanodia and lee (1998) suggests that company disclosure facilitates external discipline, preventing expropriation of investors' wealth by the managers. Healy and Palepu (2001) disclosure helps investor monitor firms operations closely and this simplifies evaluation of how managers use the resources in the best interests of the shareholders. Durnev and kim (2005) suggest that expanded disclosures improves corporate governance structures, thereby enhancing firm value. Wheatley (2011) carried out a survey in Hong Kong and he finds that disclosure based on the belief that sufficient information enables sensible decisions and conduct regulation, which imposes suitability requirements and addresses conflicts of interest. 59% of investors do not read the prospectus and 64% would not read fact sheets or product brochures about information that has been disclosed to them, even though, 78% of investors believe that investor protection is to provide investors with information before making an investment. The reason why investors do not read the information might be due to the extensive information presented and it is not clear for investors and creditors what the figures on the financial statements mean. Financial reporting council in U.K has launched a road map for a disclosure framework improving the quality of disclosure and their value to users.
2.7.2: Legal protection of investors
The formation of new laws and regulations in the financial reporting system has helped to build investor confidence. Price et al (2011) states that some managers would hide their true statements in order to attract investors this calls for strong legal action. Sarbanes Oxley ACT 2002 in United states of America (U.S.A) is a mandatory law that all firms must comply to, on the other hand in U.K firms use the corporate governance code of practice which states that firms' operate under a principle of 'comply or explain' rule, that they can choose to comply and if not they have to explain why they did not.
La porta (1997,1998), states that, countries with stronger legal investor protection allocate resources more efficiently, as strong legal investor protection limits the ease with which a bidder once in control can divert corporate resources as private benefits.
Wangler (2000) Burkart et al (2011) suggests that countries with strong legal protection increase investment more in growing industries and decrease investment in decreasing industries. Djankov et al (2008) links having strong legal protection with disclosure suggesting that having strong legal protection implies high disclosure of transactions and ease of providing managerial misconduct Bris & cabolis (2008) mentions that strong legal protection does extend coverage to firms operating abroad, as the subsidiaries may be subject to corporate laws of the host country only if a subsidiary is fully owned then its subject to corporate laws of the home country.
The differences in legal protection is based on the jurisdiction protecting the investors, this could come from different sources as mentioned previously, rights of investors depend on the legal rules of the jurisdiction where securities are issued. The laws and quality of enforcement are important determinants of what rights shareholders have and how well these rights are protected. La Porta et al (1998) concludes that the differences in legal investor protection is due to their origin, countries using French civil law, German civil law, Scandinavian civil law have weaker investor protection compared to countries observing the common law (or English law).
The law can regulate a transaction involving conflicts of interest by empowering minority shareholders to seek remedy through courts; a good example is Hedley Byrne & Co ltd v Heller & Partners ltd [1] the appellants and advertising company became concerned about the financial stability of a client E ltd, They asked their own bank to make enquiries of the respondents E ltd.'s bankers. The respondents gave their opinion without responsibility that E ltd was considered good for its ordinary business engagements this was later found to be untrue, and the appellants suffered a loss, the house of lords held that a duty of care was owed in such circumstances by the suppliers of information.
2.8: Conclusion
According to the literature review, authors have favoured the following ways to minimise expropriation, the use of contracts between managers/controlling shareholders and investors, another way is having a more concentrated control, stronger legal protection this gives the investors a platform to sue in court and therefore give them a chance to receive their money back, legal protection and concentrated control seems to be favoured in countries with poor legal investor protection. Disclosure is at the fore front when it comes to building trust after the financial crisis and accounting scandals that have occurred in the past years.
2.9: Summary of key authors
La porta et al (1999) this article looks at the differences in legal protection across countries. The possible origins of these laws and the effectiveness of their enforcement, it looks at how this is linked to how well investors are protected by law from expropriation by managers and controlling shareholders of the firms. This article associates stronger investor protection with good corporate governance by looking at the financial markets, dispersed ownership of shares and efficient allocation of capital across firms. By using investor protection as a starting point appears to be a more fruitful way to describe corporate governance regimes across countries.
Djankov et al (2008) this article presents a new measure of legal protection of minority shareholders against expropriation from corporate insiders ( controlling shareholders and managers) the article focuses on disclosure, approval and litigation that govern specific self- dealing transaction by using the anti-self-dealing index. Fig.1 illustrates the methodology adapted by Djankov by setting a scenario where companies that work for 9 Lex Mundi firms in different countries, fill out questionnaires according to the 3 index extent of disclosure, extent of director liability and ease of shareholders suits.
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Fig.1 methodology used by Djankov (2008)
Chapter 3: Methodology
3.1: Introduction
Methodology is an approach to the process of the research, encompassing a body of methods, while a method is a technique for collecting and analysing data. Collis and Hussey (2003 p.73). This chapter will include the rationale behind my chosen of strategy of collecting and analysing data.
3.2: Research Design
The research design will be conducted in two ways, first of all, initial and background information will be taken from previous studies mostly journals. After that in order to fulfil the aims and objectives I will carry out a survey using on-line questionnaires to collect primary data. The questionnaires will be sent to two different audiences, these are (students/ accounting students social networks) and (accountants/investors forums) who will have experience in the area this way it will be possible to compare the results.
When using questionnaire each person is asked to respond to the same set of questions in a predetermined order. De Vaus, (1969) cited by Saunders et al (2000 p.278). The reason for this choice of method is the characteristic required from the respondents is diverse, and so their availability is not guaranteed and for this reason I have decided to use an online based questionnaire. Saunders et al (2000 p.281)
The results will be analysed in order to draw a constructive conclusion. Questionnaire is a popular tool for collecting primary data as it incorporates different questioning techniques and helps to gain a wide range of data. The technique I have chosen to use is mainly closed questioning as it makes it easy to interpret the results. Wilson (2010 p.154)
3.2.1: Advantages of questionnaires
With the appropriate set of questions, questionnaires allow the researcher to obtain effective and accurate data. They are cost effective and a reliable means of gathering feedback that can be both qualitative and quantitative. McClelland (1994 p.22) states that a survey questionnaire can provide accurate and relevant data through thoughtful design, testing and detailed administration.
3.2.2: Disadvantages of questionnaires
Questionnaires can be termed as impersonal due to the way questions are set; for example, it is not possible to clarify some of the questions if the respondent does not understand therefore, creating inaccurate data or the respondent failing to answer the question. Wilson (2010 p.155)
The researcher's inability to explain the questions clearly this could lead to respondents giving inaccurate information and therefore creating a false set of results.
Poorly designed questionnaires could create "tick box syndrome" where the respondents assumes a pattern of the answers and so does not read the questions, to overcome this problem the researcher is advised to include a "reverse question" which forces the respondent to pay attention to the question although, this sometimes fails. McClelland (1994 p.22)
3.3. Sampling method
The sampling frame will include graduates of accounting, professionals in the accounting department and normal citizens in order to avoid inaccurate or biased results. The reason I chose accountants instead of investors is difficulty in finding a large sample of investors willing to take the survey questionnaire prepared.
Sampling method chosen convenient sampling opposed to a probability sampling method as it is convenient and inexpensive whereas probability sampling are time consuming` Berenson et al (2012 p.280). I am considering the limited amount of time I have to carry out this research but also because the sample is size is small enough to use the non- probability sample.
The research sample size required is n=30 for the first respondents and n=30 for the second respondents, the reason for this is statistically a sample size of 30 should give me a normal distribution of the population and 15 will have a fairly normal distribution of the population although the statistical inferences developed does not apply to a non-probability sampling method. Berenson et al (2012 p.291) although this is an online survey to be able to receive this number of response will help with the data analysis.
3.4: Other research methods
3.4.1: Interviews: A method of collecting data where selected participants are asked questions to find out what they do, think or feel. It can be done face to face or by using telephones or video conferencing methods. The interview can be structured, semi-structured or unstructured depending on the researchers' required results. Under a positivist paradigm interviews are structured that is planned in advance. Collis and Hussey (2003 p.144) the reason interview did not work for me although it would have been able to obtain the results required, is they are time consuming and difficult to carry out when you have a large sample size. For example setting a meeting with an important manager might require rescheduling due to their busy schedules.
3.4.2: Observation: A method of collecting data used in a laboratory or a natural environment to observe and record people's actions and behaviour. The most common type of observation in business research is non-participation observation where the researcher observes and takes notes without being involved, the other type of research is participant observation where the researcher is fully involved with the participants or the phenomena being researched.
The reason I didn't choose this type of method is it can be difficult to record people's reaction as sometimes people's opinions change due to "demand characteristics" and this may affect the answers given, an example of this is someone changing their opinion to fit with the majority. Collis and Hussey (2003 p.155)
3.4.3: Focus groups: selected participants discuss their reactions and feelings about a product service or concept. The problem with this is they offer opinions of a small group of people. In order to overcome this, it is suggested to carry out different groups of different backgrounds and compare the results. Also the same problem of demand characteristics maybe experienced on this method. Collis and Hussey (2003 p.156)
3.5: Pilot study
Wilson (2010 p.153) emphasises on the importance of carrying out a pilot study in order to increase the level of reliability and validity prior to the main survey. On my pilot study I sent out a few questionnaires to accounting students and one professional accountant, the youngest being 19 years old and oldest was 50years old. The reason for this I wanted to test if the questionnaire can be answered by people of different ages and backgrounds, the first response from the 19 year old was I needed to define some of the key words as they were not familiar with the meaning.
The other problem was as I was not familiar with online survey before, I made an error and selected ranking instead of rating which then changed the results and therefore would have created a problem when recording the data, if it wasn't for the pilot test I would not have realised this mistake.
Pilot test helped to rectify how some of the questions were set for instance, at first Q.3 read as, "Please rate the following according to you perception of importance" The question is not complete and it leaves the respondent with a question mark, and so I rectified it to read as, "please rate the following according to your perception of importance when it comes to choosing what business to invest in"
3.6: Problems encountered and solutions
With an online based survey, respondents choose when and how they wish to fill the questionnaires, so there is the typical non-response error as I only received almost half of the surveys I initially sent from each set of respondents, this were the only surveys that were error free and fully completed with no mistakes.
The other problem was coverage error; there is only a limited amount of time and money to be able to access the required audience for my research study.
The solution was to work with the responses I received as I have already explained 15 respondents is a fair sample size although the results will not be as accurate and will not portray what the population of investors or potential investors might think.
3.7: Data analysis
In the literature review the methods used was hypothesis testing and Index method, although this method has been criticised by a number of scholars for its mistakes in its coding and the conceptual ambiguity in the definitions of some of its contents. Djankov et al (2008)
My research is going to analyse the results using a descriptive method as the aim is to research some of the suggestions derived from the literature review.
Chapter 4: Research findings and Data analysis
4.1 Introduction
Question
Location in the literature review
Topic of literature review
3
2.2 -2.7
Collective literature review
4,5 &12
2.7.1
Disclosure
6
2.4
The failure if investor protection
7,10 & 14
2.7.2
Legal protection of investors
8 & 9
2.2
Background of corporate governance
11& 15
2.6
Relationship between investors and firms
16
2.3
Background of ownership and control
This chapter will be analysing the findings collected from the online survey. Below is a table showing the questions and the chapters from the literature review the questions have been set from.
