MANAGING THE CONFLICT BETWEEN SHAREHOLDERS AND DIRECTORS

The conflict between shareholders and directors is a major issue when it comes to Corporate Governance.  The major role of the directors is to increase the value of the company for the benefit of the shareholders. This requires that any policies or decisions made by the directors must always be done with the aim of increasing the value of the company. The company is owned by the shareholders….the ownership of the company lies with them. However the control of the company lies with the directors. The possibility of conflict comes up due to conflicting interests between those who own the company and those who control it.

 

Areas of conflict

There are many areas in which the conflict arises. A director with little or no ownership in the company may not feel motivated to take the best decisions for the company. Sometimes a high risk needs to be taken or a huge sacrifice done for the benefit of the company. A director with no ownership will not feel motivated to undertake such risk.

 

One of the interests of a director may be to increase control for himself, even if this means that the company value will go down in the long run. Some of the ways that directors would seek to increase control is pass resolutions extending their term notwithstanding the fact that their performance is below par.

 

Another area of conflict is the possible need for directors to appear in good light before the shareholders. Some of the ways this may happen is by misrepresenting performance by doctoring audit reports and financial statements to make the company appear as if it has been making a profit whereas this may not necessarily be the case.

 

Directors control vital information of the company…they have the expertise and skill to run the company while the shareholders are seldom skilled. How company information is managed may be a source of conflict.

 

There are other areas of more direct conflicts between shareholders and directors…for example when contracting with third parties, directors may award contracts to parties affiliated with them and who are not necessarily the best placed.

 

Directors may also award themselves high packages like remunerations and allowances to the detriment of the company.

 

Shareholders may conflict with directors when they impose strict and stringent rules on dsirectors in regards to performance and benefits like remuneration and others.

 

Managing the conflicts

This article is geared more for smaller unlisted companies that have a corporate structure separating shareholders and directors. Larger companies especially listed companies have sound corporate governance policies that manage the conflict adequately. Besides for listed companies, the regulator has regulations on corporate governance that must be adhered to. On the flip side is the typical Kenyan company. The shareholders in the typical Kenyan company are the same ones who form the board of directors. This is therefore for smaller companies whose ownership and control functions are separated.

 

One of the ways of managing this conflict is to come up with performance contracts based on expected return. The performance contract should be realistic and should contain penalties for non performance for example salary cuts.

 

Another way of managing this conflict is by drawing up sound engagement contracts for the directors. The contract should contain the scope of duties and responsibilities and also set out the expectation of the shareholders ‘clearly. The policies of the company should be highlighted to avoid ambiguity. It must be made clear that the directors owe a fiduciary duty to the shareholders and where this duty is breached then some penalties apply. It should also be made clear that the director must disclose all pertinent information regarding conflict of interest. There should be penalty clauses in the engagement contract if the director fails to meet his obligations.

 

Another way of managing the conflict is by ensuring that the board of directors includes a shareholder with skills and expertise in the affairs of the company. This shareholder will serve as the shareholders “watchdog” and will safeguard the shareholders’ interests.

 

The best way of managing the conflict is by employing motivation mechanisms for the directors.  One way would be by awarding the directors who perform…maybe by salary increment, extension of terms and other perks.

A method of employing motivation tools for directors’ that has worked is by giving deserving directors some ownership in the company. A director who has a stake in the company will ensure that every decision made is in the company’s best interests.

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