"Corporate Governance Ownership and Management Control"
Corporate governance and management control in cooperatives Pellervo Confederation of Finnish Cooperatives November 2000 Contents Foreword 3 1 Background to the debate on corporate governance 5 What is corporate governance? 5 Dispersed ownership necessitates corporate governance mechanisms 6 Efficient capital markets have increased external control 6 The difference between European and American systems 7 Stakeholder versus shareholder value approach 8 Ownership policies also concern cooperatives 9 2 Corporate governance mechanisms 11 1. External corporate governance and its meaning in cooperatives 11 Capital markets 11 The nature of ownership 13 Ownership stuctures and cooperative strategies 14 2. Internal governance 14 Composition of the boards 14 Should board members occupy many positions? 16 Board members from outside the membership 17 Who should be chairperson? 17 Efficient board practice 18 3 The governance of cooperative groups 20 Federal organisations 20 The governance of hybrid organisations 21 4 Cooperative incentive schemes 23 The remuneration of managers 23 The remuneration of non-executive directors 24 Conclusion 25 Appendix 1.Recommendations on good corporate governance practice Appendix 2.The differences between manager-based and owner-based cultures Appendix 3. Ownership and governance stuctures of the major Finnish cooperatives 2 Foreword In recent years corporate governance has developed rapidly throughout Europe and particularly in Finland.The control of listed company managements has pro- gressively taken place via the capital markets and away from the banks and other financial institutions.At the same time, a mana ger-based culture has become an owner-based one. A Finnish consultant,Dr. Jyrki Veranen wrote in 1966 that:"The problem of a 'traditional' mana ger-based culture is that the return on capital invested in the company by the owners is often unnecessarily low and so the rise in the compa- ny's value and its ability to pay dividends is also low." The demands of owners on management have become more vocal and clearer once the goal of producing added value has been set. The important question,however, is how to organise a company's operating framework and governance so that management works in the best interests of the owners. What is the mechanism by which owners in the widest meaning can effectively supervise the activities of a company and also obtain the largest pos - sible benefit? This is core element in corporate governance. The proliferation of share ownership and the de velopment of the capital mar- kets have led to the ef fective supervision of management by the capital markets. The decisions of major corporations are assessed daily by the owners,as well as by the hundreds if not thousands of analysts and investors. Ownership in a cooperative is different from that in a listed company because cooperative shares are not normally freely transferable and so there is no market for them. In practice, the benefit and added value produced by a cooperative accrues to the owners, that is the members of the society, via the business relations between them and the cooperative. Many cooperatives have grown into major enterprises. The major cooperatives - whether incorporated as joint stock companies or not - are exposed to compari - son with listed companies. They compete for the best managers and their infor- mation is compared to their competitors.Today's major cooperatives demand from their directors, as well as from their owners, at least as good professional skills as listed companies.The role of cooperative member-owners and their responsibility for the success of the enterprise is in actual fact greater than in publicly quoted companies as the market continuously monitors the company and distributes infor- mation via the media. The management of cooperatives, both professional and lay, has certainly improved during the last decade. Likewise transparency has increased.The require- ments, however, are growing continuously and cooperatives are subject to the same pressures for greater efficiency and change in corporate governance as other enterprises. For this reason, it is important for cooperatives to consider cor- porate governance within the framework of their cooperative origins. It is useful to think about building up an effective system of internal control simply because even the largest cooperatives lack the kind of control that comes from the stock market. The general discussion concerning joint stock companies will provide many sug- gestions, but the cooperatives themselves must find solutions suitable to their form of enterprise, field of operation and operating environment.This discussion should 3 concern itself with good governance practice, that is how internal con- trol is organised, as well as such broader issues as how to run coopera- tives so that their resources produce the best possible benefits to their members. In spring 1999, the Board of Directors of the Pellervo Confederation of Finnish Cooperatives decided to organise a Working Group to consider these topics. The members of the working group were top managers and non-executive directors from cooperatives.The working group was chaired by Mr Samuli Skurnik, CEO of the Pellervo Confederation of Finnish Cooperatives and the secretary was Dr Raija Volk, Research Director of the Pellervo Economic Research Institute. The report is based on discussions held within the group and presen- tation given by outside experts.The report aims at stimulating discus- sion of this vital subject within the cooperative movement rather than offering readymade models. The European Commission D.G. Agriculture generously con- tributed to wards the cost of translating the report into English.The translation was made by Michael Wynne-Ellis.This paper has been pro- vided also for the Corporate Governance seminar organised by the General Committee of Agricultural Cooperatives in the EU (COGECA) in Brussels in November, 2000 4 What is corporate governance? through which the company objectives are set, Basically, corporate governance concerns all the and means of attaining those objectives and moni - steps taken by the owners of a company to toring performance. ensure that it produces for them the best possible Put simply, therefore, corporate governance benefit. One detailed definition of the concept is concerns all the institutional structures that help that used by the OECD, which is available on their to maximise efficiency, ie, legislation, company website. organisations, agreements, etc.A division is often The corporate governance structure specifies made between internal and external control,as,for the distribution of rights and responsibilities example, between legislative and capital market among different participants in the corporation, control.The organisation of corporate governance such as, the board, managers, shareholders and is more widely concerned with ownership struc- other stakeholders, and spells out the rules and tures as a company's success is affected by the procedures for making decisions on corporate type of ownership structure and owners it has. affairs.By doing this,it also provides the structure Owners' channels of influence 5 are constantly on the lookout for new opportuni- Dispersed ownership necessitates ties.Simultaneously, the importance of stock mar - corporate governance mechanisms ket information in corporate governance has Corporate governance has been a major economic increased. Owners are more active and increasing- and managerial question ever since ownership ly "vote with their feet" by selling when dissatis- and management in a company were separated. fied with share developments. Strengthening mar - The theoretical and juridical roots of the debate ket control has forced management to pay stretch back to the 1930s. increasing attention to the development of share - The continuous growth in company size has holder value. One outcome of rising investor created a need to find newer sources of financing, activity has been that companies devote more such as the stock exchange,which has further dis- time to investor relations. Companies are also persed ownership.Cooperatives,too,have a wide increasingly returning money to their owners in group of owners and limited liability, but here the the form of dividends and share redemptions for motivation of membership comes from the ser- two reasons: firstly, they operate more efficiently if vices produced rather than a return on capital no "loose" money is available; and secondly, own- invested. ers are more efficient at reinvesting assets than Dispersed ownership and the growth in com- companies. pany size pose a challenge to corporate decision- Emphasising shareholder value is generally con- making, because they suppose the separation of sidered to be a typically American phenomenon. ownership and control. Separation is a strength However, one of the experts called by the Working because it allows a division of responsibilities Group, Professor Bengt Holmström (MIT) has based on specialisation: the owners entrust deci- shown that the concept of shareholder value is sions concerning the company's production to a also quite novel in the United States.Its origins lie professional and skilled management.On the other in the takeover boom of the 1980s,but it was not hand, separation is a weakness because manage- until the mid-1990s with resistance to the tradi- ment can use its decision-making authority con- tionally, high-handed behaviour of American cor- trary to the interests of the owners. For instance, porate managers that shareholder value was management may be tempted to overinvest or emphasised. Takeovers were in the 1980s a sig - overemphasise growth or market shares. It could nificant mechanism for the control of manage - also pursue private objectives that are contrary to ment.They resulted in the downsizing of multi-sec- the owners' interests.In corporate governance, the tor conglomerates. At the same time discussion aim is to give management sufficient latitude to focussed on issues as minority shareholder protec- use its expertise whilst ensuring it recognises its tion.Therefore, existing legislation in the United responsibility to the owners. States has made takeovers very difficult and increasing shareholder value is supported through management incentive systems like stock options. Efficient capital markets have The emphasis on shareholder value is largely a increased external control question of those market mechanisms by which Company control occurs via numerous channels owners try to ensure that management works to both from within and from outside like the capital their advantage. In other words,that they receive and commodity markets. Internal governance is the best possible return on their investment in the the essential part of owner control. During the case of a joint stock company or the most effi- 1990s, external control via the capital markets ciently produced services in the case of a cooper- became increasingly stronger due to deregulation ative.The strengthening of external,capital market and the revolution in information technology.This control is reflected in company objectives.In a list- has led to the rapid globalisation of financial ed company, increasing share value has become a markets, accelerated in turn by the growing role primary objective. of institutional investors like pension and invest- We can summarise the owners' channels of ment funds.According to one estimate,the world's influence through the capital markets as follows: pension funds amount to something in the region of USD 11 000 billion. 6 With the proliferation in shareholding,investors Owners´ channels of influence the capital markets • Daily stock exchange evaluation of company’s and management’s achievements -> facilitates control • Stock exchange helps to guide operations -> facilitates decision making -> analysts and investors function as management’s ”sparring partners” • Investment bank studies of listed companies elicit ideas and can help in decision making and evaluation • Stock exchange exerts a positive influence on management to operate in the interests of the owners -> share undervaluation weakens compensation and increases take-over threat Mika Ihamuotila,Mandatum Asset Management The difference between European and corporate governance has been in the field of American systems external control. European systems are typically bank-based and owner-concentrated, whereas The pressure for uniformity in corporate gover - American ones rely on the stock market and dis- nance systems caused by globalisation has given persed ownership.The differences are due to leg- rise to a lively dialogue throughout Europe. The islation (banks in America are forbidden to have greatest difference between existing systems of significant holdings in companies), the nature of Different financing systems, different corporate governance mechanisms Bank-based Market-based Japan Germany Finland UK USA Ownership structure Concentrated Dispersed Much cross-shareholding Largest owners of Banks Institutional investors industrial companies Investment funds Share structure Vote-carrying ordinary shares One-share-one-vote Minority protection Poor High Take-overs Never Normal phenomenon Board of Directors Insiders Outsiders Controlling Guiding Meaningless Very important Operative management Insignificant Considerable incentive schemes Tied to exchange quotation Source:Mika Ihamuotila,Mandatum Asset Management considerations in European corporate activities. 7 financing (European companies have depended setting its objectives a company should also con- on debt financing as the capital market opened sider the well being of these1 groups.In Germany and developed much later) and also partly to social the right to codetermination is believed to have attitudes (American society, with its emphasis on increased the productivity of workers because it personal freedom, favours the quick repatriation has encouraged them to invest in the skills of profits, whereas Europe's more socially-con- required by the company. scious culture sets other objectives for business- The shareholder value and stakeholder views es).In Europe,management thinking has tradition- are most clearly differentiated when considering ally been more socially oriented and considerate of in whose interest corporate governance functions. wider stakeholder interests than in America. The shareholder value view emphasises owner-ori- Continuity and employment are primary consider- entation and the realisable benefit of share value, ations in European corporate activities. in the case of joint-stock companies, whereas the stakeholder view is that others than the owners Stakeholder versus shareholder value have legitimate demands and expectations on approach management. This antithesis has occasionally led to the belief European thinking stresses that not only owners that shareholder value thinking has completely dis- are affected by company decision making, but placed and disregarded all other stakeholders. Its also other stakeholders, such as employees, cus- defenders, however, deny this, stressing that the tomers, suppliers and the local community. When maximisation of profit not only enables a compa- The effect of different financing systems on corporate operations Bank-based Market-based Japan Germany Finland UK USA Business objectives Stakeholders Shareholder value Restructuring of Via internal pressure Market for corporate control operations Takeovers and their threat Crisis restructuring Bank to the rescue Bankruptcy and Chapter 11 Business openness Closed Transparent Business time span* Long-term Short-sighted interim report fixation Business risk* Low High Bank safeguard own Maximisation of share capital receivables value Company structure Multi-sector Concentration on core business MBO’s Profitability of Nobody knows if there is a difference between the systems in the business operations long run * Considerable differences of opinion Source:Mika Ihamuotila, Mandatum Asset Management 1 Codetermination means that all companies in Germany with more than 2000 employees are required to have an equal 8 number of employee and shareholder representatives on the supervisory board. ny to pay wages,but also to consider other groups. Furthermore, the goal of a cooperative is to pro- The advantage of emphasising increasing prof- duce the goods and services required by its mem- its and shareholder value is that it sets clear and ber-owners. Thus owner-based thinking is highly effective decision-making criteria for manage- suitable when considering corporate governance ment. The problem of stakeholderism is how it in cooperatives.Owner value, however, is defined should be implemented (either as wide-based differently in a cooperative from a listed compa - objectives for management that balance the vari- ny. ous stakeholder interests or by involving the dif- In the listed companies it is natural to measure ferent groups in the decision-making process as in owner value in terms of share value. For coopera- the German model) and how to measure the tives, however, there is no equally clear way of achievement of the objectives. The dangers are measuring it and neither does the same method that matters become more open to interpretation, apply to all types of cooperatives. For instance, responsibility is blurred and decision-making is owner value in an agricultural cooperative is slowed down. formed by the difference between the market The fear in shareholder value thinking is that price and that paid to the members,the monetary it may lead to shortsighted operations and a "fix - value of the services produced and the assets ation with interim reports".To retain its competi- retained by the cooperative.What is essential is tiveness,a company must invest in long-term prod- that owner value is expressed as a monetary quan- uct de velopment and innovation, so the question tity that can be monitored and measured. Future has been how can producing sufficient profits for profit expectations cannot be taken into consid - the owners and securing long-term innovativeness eration in the value of a cooperative because the be adjusted to each other. shares are not transferable. Therefore, it is never Even though stakeholder considerations and possible to compare the owner values of listed bank-based financing are more common in companies and cooperatives. Continental Europe than in Anglo-American coun- The challenge to the members and managers of tries, there are also major national differences a cooperative enterprise is to recognise how it dif- between European countries.The structure of the fers from a publicly quoted company and how capital market, legislation and operating environ- good board practice can best be implemented.An ment factors have produced that system of owner- excellent example of the topical importance of ship and corporate management best suited to this debate is the conference organised in the each country at each time.The integration of the United States in November 1999 in which 135 capital market has changed the European owner cooperative leaders in agriculture met to discuss governance mechanism,but not necessarily in the and devise ways of organising cooperative gover- same way in each country. Neither was there any nance (see http://www.wisc.edu/uwcc/events/ need to do so because economic research has not 2000-99tc.html). yet proved a connection between an corporate The topics discussed at the conference includ- governance mechanism and economic success. ed the use of outside directors and advisory boards,board size and qualification of board mem- bers, selection and development of board mem- Ownership policies also concern bers, governance in special cases such as joint ven- cooperatives tures and alliances,and governance issues related Owner-based policies and emphasis on sharehold- to using outside capital.These subjects all reflect er value originate in listed companies. In respect the changes in operating environments that have to cooperatives,emphasising shareholder value is forced cooperatives, worldwide,to improve gover- sometimes thought misleading and a more natural nance and adopt new organisational methods to approach would be to think in terms of stakehold- counteract increasing competition. ers. In examining the cooperative movement as a Basically, corporate governance is the same in whole, it is more natural to stress stakeholders, cooperatives as in publicly quoted companies. In because cooperatives often try to offer services order to be competitive, a cooperative must have that the market fails to produce effectively. owner governance organisations (boards) that However, a member in a cooperative society nor- support the success of the enterprise, as well as mally has the full rights and duties of ownership. incentive mechanisms that operate in the inter - 9 ests of the owners. tions, and ownership in the sense of capital Even though the question of controlling man- input is normally considered subordinate,capi- agers is basically the same in both cooperatives tal investment and profit distribution is normal - and other types of companies,the cooperative has ly in proportion to the services used. Due to many special features that make governance dif- this business relationship,cooperatives are also ferent and challenging. Cooperatives differ from able to distribute the profits or surplus continu- traditional investor-owned companies in respect ously as part of buying or selling transactions, to their ownership character, goal setting, meth - and not only after the closing of the accounts. ods of financing and profit distribution, and For this reason, performance ratios based on decision making. These differences not only bind cost accounting, originally developed for joint- members more effectively to the activities and run- stock companies but also used extensively in ning of the cooperative, but also blur the owner- cooperatives, give an inadequate picture of a ship role and bring to the owners many other cooperative's condition.This means that a coop- interests in addition to the success of the enter- erative must think more deeply about how sets prise. its objectives and measures their achievement. • The dispersion of ownership, as well as the It is important for cooperative members to separation of ownership and management, is be conscious of their dual roles as customers equally present in cooperatives and in joint- and owners. This dual role can lead, at one stock companies. The characteristically dis- extreme,to total "managerialism",ie,to an over- persed ownership of cooperatives means that emphasis on managerial objectives.And at the the divorce of decision-making from financing, other extreme, stressing customer relations in as well as the one member and one vote princi- the division of the surplus can lead to pressure ple,make it impossible for any single owner to for the rapid repatriation of the cooperative's predominate in decision-making, and likewise profits, especially when the funds allocated for guarantees an equal voice for all members. its development cannot normally be realised by • Goal setting appears to the first thing that dif- the individual member. ferentiate cooperatives from joint-stock compa- Cooperativee governance is also complicated nies.The goals of a cooperative might be very by the pressures on their operating environment, diverse whereas in a publicly quoted company which have forced them to adopt new organisa- efficiency and economic added value accrues tional modes. Examples of this are the partial or to the owners in the price of their shares. From total incorporation of the operations of coopera- the owner's point of view, a cooperative is more tives and the fundamental re-evaluation of cooper- than an investment.The core activity of a coop- ative principles initiated by the new generation erative is determined by the services the mem- cooperatives in the United States.There has been bers require and not by the return on invest- also widespread discussion on how to expand the ment. capital input of member-owners.All these trends At the same time cooperative lacks the have added new ideas for cooperative models and essential channel of information and control are proof of the way in which member-owners are of the listed company:the share.The stock mar- searching for more efficient ways of producing kets have proved to be highly effective in real- added value. locating capital between widely divergent sec- To enable cooperatives to understand their tors of the economy and thus functioning as the position and the key issues in the corporate gov- engine of structural change.In cooperatives the ernance debate, the following chapter discusses pressure to redirect capital and its efficient the main mechanisms in relation to the special usage is not always so great as in a listed com- character of cooperatives. Because they are pany. Cooperatives are forced to ask whether, becoming ever more complex in structure,the dis- under prevailing conditions where business is cussion also touches on the joint-stock and family faced by strong pressures to change, they can company, of which the latter resembles a coopera- find a signal similar to stock market informa - tive in its goal setting and financing structures. tion. • A further difference is that,as cooperatives tra- 10 ditionally stress customer and business rela- 2 Corporate governance mechanisms 2.1 External corporate governance and its meaning in cooperatives Corporate governance mechanisms can be divided into external and internal, as well as those that combine both levels:2 • Legislation External corporate • Nature of capital markets governance • Financial structure • Ownership structure Cooperative society rules Articles of incorporation/ • Articles of incorporation and the Board of Directors can be thought to function as the link between external and internal corporate gov- Board of Directors ernance • Incentive schemes Internal corporate • Reporting practices • Hierarchy and organisation governance • Structure • Corporate culture Legislation (Cooperative Societies Act, Capital markets Companies Act,Securities Market Act,Auditing Act, The nature of capital markets radically influences competition legislation, etc.) determines the gen- the form which corporate governance takes.In the eral framework and rules on how business is car- United States, financing is traditionally based on ried out. Because legislation contains the general the securities market and equity plays a major part rules g overning the running of a company (what in corporate financing.Similarly, securities market boards it should have and how are their members information and control are emphasised.In Europe elected, what to disclose concerning the compa- and Finland,the role of banks as major lenders of ny's operations, etc.) it plays a central role in the capital and as shareholders, is very important and control of the company. How advanced legislation in this way they have exerted significant control is in respect to some form of enterprise may deci- over companies.The greater weight accorded to sively influence the form business assumes in a banks and debt financing is partly explained by dif- particular country. In respect to boards, for ferences in legislation. The capital markets and instance, Finnish cooperative and company legisla- related legislation (Securities Market Act) in tion is very similar. Finland, for instance,de veloped much later than in 2 The diagram is based on the one presented by Dr. Mika Ihamuotila of Mandatum Bank in his paper to the Working Group. 11 the United States. In some countries, cooperative tile takeovers in particular lead to a change in man- lending institutions can be important sources of agement,one could also talk about the market for capital for cooperatives operating in other sectors, managers. A cooperative cannot be taken over by in which case control takes place via them. acquiring a majority share holding on the stock Cooperative banks in Finland do not, however, market and then replacing the management.The have this role. importance of this mechanism for listed compa- Financial structure is closely connected to the nies has been reduced by the introduction of leg- nature of the capital markets and also to the legal islation making takeovers extremely difficult. The form of company the business takes.3 The equity absence of the threat of a takeover in a coopera - or share capital of a cooperative differs from that tive is actually considered as a positive feature, of a joint-stock company in that: as it protects the original purpose of serving the • Share capital varies in size (it is not fixed in members. the same way as the capital of a joint-stock com- It is unlikely that the takeover mechanism pany) would work in regard to cooperatively owned • Share capital is accumulated either in propor- incorporated and listed companies, because the tion to member purchases or investments of the cooperative society usually retains the majority of same sum (members do not invest according on the shares (and votes). In this respect, coopera- the basis of risk as in joint-stock companies) tives and their incorporated subsidiaries closely • An investment in share capital is not freely resemble familial companies. transferable (sellable) to another person as is a In addition to equity and retained pro fi t normal share - although in Finland share capital reserves, cooperatives and joint-stock companies is in a limited sense "sellable",because the coop- can finance their operations by borrowing. In eratives return a member's share upon his res- recent times, the importance of debt financing ignation. as a management control mechanism has been • Unlike equity shares, the value of an invest- emphasised as the burden of debt ties managers' ment in share capital is not determined by the hands and forces them to work efficiently in order market (repayment of shares is at par value), to service the debt at regular intervals. There is neither does it reflect any appreciation arising also less cash flow available at their disposal.The from expected future earnings.In other words, controlling effect of debt is firstly that,as it is nor- any added value in a cooperative enterprise mally granted for a relatively short period, man- cannot be realised by the sale of shares but only agement must make a real effort to find productive by winding up the society. ways of operating in order to amortise the loan, There have, however, been changes in recent and secondly, if the company is una ble to meet its years in regard to the share capital element in the debts, the creditors have the right to apply for financial structure of cooperatives.The new gener- bankruptcy and realise the loan guarantees. ation cooperatives in the United States have tried With their narrower ownership basis,coopera- to solve the problem of collective ownership4 tives (and familial companies) have limited oppor- associated with share capital in traditional cooper- tunities for accumulating capital,because this has atives by taking into use transferable and appre- to be collected from the members (or the family) ciable investment shares in addition to closed rather than via the securities market.This tends to membership. In addition, certain cooperatives increase the importance of debt financing in coop- have incorporated all or some of their operations. eratives. Debt, however, also means the risk of Because traditional cooperatives do not have bankruptcy, which is, perhaps, the reason why publicly quoted shares, they naturally lack the cooperatives in sectors susceptible to cyclical fluc- related corporate control mechanisms. One of tuations and requiring heavy investments, like the these is the takeover, which played such an impor- forest industry, seek to spread risk through restruc- tant role in the United States in the 1980s. As hos- turing (joint-stock subsidiaries and becoming list- 3 Other factors,such as the tax treatment of various financing instruments,are also important. 4 The problem of collective ownership means here that a member who resigns cannot realise the society’s assets arising from retained earnings or any appreciation in the value of the enterprise in general.Therefore a member no long feels that it is his 12 or her enterprise and ma y, under certain conditions,try to benefit from the enterprise at the expense of other members. ed) rather than debt financing.When considering the enterprise is managed in the general interest of the role of debt financing, it is necessary to bal- all the owners and not just the largest one.On the ance the incentives debt provides against the risk other hand,dispersed ownership can weaken the of decision-making power passing to the creditors individual member-owner’s desire to control the when the company is unable to repay its debt. activities of management, because the benefits There is,however, no single answer to the optimal arising are divided equally among all of the own- ratio between share capital and loan capital. ers. Many cooperatives have grown into major cor- Cooperatives, therefore, lack the control over porations that increasingly face the problem of management exercised by large (share) owners. where to obtain the necessary growth capital.The This does not mean that member control in a normal method of growth is through takeovers cooperative is nonexistent.Many cooperatives are and company shares play a central role in financ- direct extensions of the occupations or businesses ing them.Moreover, in growth sectors share-based of their members,which means that they are pre- incentives function as a way to recruit manage- pared and motivated to take an active interest in ment as well as a governance mechanism. Each the operations.Another factor that makes member cooperative enterprise must consider when set- control effective is the local character of many ting its goals - striking a balance between the effi- cooperatives. cient use of capital,and continuity and security 5 Moreover, ownership in a cooperative has a - whether the efficient use of capital be secured by ”face”, because of its close connection to mem - other means than capital markets pressures. bership and the use of services. The exit and voice control rights associated with shares in a list- The nature of ownership ed company are used anonymously via the market. Ownership structure refers to the people who In a cooperative,the equivalent exit and voice con- own a company and how dispersed ownership is. trols (resignation from the society 6) are both in Ownership structure varies between countries the hands of the members.As the individual mem- and company type.In the United States,listed com- ber’s voice is mostly limited to one vote,and mem- panies have extremely dispersed ownership, bership is otherwise dispersed, the face factor is whereas in Europe (and also Japan) ownership is not necessarily of any practical importance in con- traditionally more concentrated, with blockhold- trolling management. ings of shares in the hands of banks and families. The simultaneous linking of the customer and Cross-shareholding between companies is also business relationship to ownership can also more common in Europe. Part of the reason for function as a management control mechanism these national differences is legislative, as in in a cooperative. Member-owners are in constant, America there are legal restrictions on corporate often daily contact with the cooperative enter- shareholding by the banks and insurance compa- prise. Ownership in a cooperative is also long- nies. term, often lifelong. Both these factors involve The ownership structure of cooperatives members in the long-range development of the resembles that of dispersed-owned joint-stock cooperative.However, by detaching decision-mak- companies,because the democratic decision-mak- ing (voice) from financing and tying financing and ing process of the former pr events any concentra- profit distribution to the use of services, the cus - tion of ownership.This has two consequences.On tomer relationship is emphasised but the role of the one hand, a cooperative has none of the ten- ownership is blurred.The mana gement of a coop- sion between majority and minority shareholders erative does not have the same clearly defined pur- that arises from the concentration of decision- pose as a listed company of maximising the return making.This means that the member-owners of a on owners’ investment and this complicates the cooperative are in a better position to ensure that control of management. 5 What is decision is the degree to which these two objectives (efficient capital – continuity) cancel each other out.That is, to what extent stressing one of them will prevent the other’s achievement. 6 How effective resignation or the withdrawal of custom is as a control mechanism largely depends on the other options available on the market:other food stores or purchasers of raw materials.Another limitation on their effectivity may be the obstacles and restrictions on resignation contained in the rules. 13 The situation is somewhat different if a coop - operations. On the other hand, the objectives of erative has transferred its operations to a joint- management in changing ownership structures stock company in which there are also outside may well be contradictory to the member-owners’ investors. Just as in a family firm,such companies opinions and interests 7. Particularly in coopera - are forced to strike a balance between the differ - tive enterprises, in which the ownership basis is ent groups of owners. The very existence of one very solid, it is essential to ensure the compati - large majority owner may arouse concern about bility of strategies and ownership structures. A corporate goals among the minority owners.This cooperative’s board should evaluate which activi- is particularly true when the majority owner (or its ties are most important from the point of view of members) is also the raw material supplier, for custom-based membership.Retaining control over then an incorporated and listed company must the most essential parts of the business may be place special emphasis on the transparency of its particularly important,but with regard to the less operations and also disclose how it tries to benefit essential ones the aim should be either elimination the different groups of owners so as to avoid any or reorganisation. One topical problem concern- negative reflection on share prices.Thus the distri- ing ownership structures is globalisation,because bution of the profits must be in the form of a many cooperatives have expanded abroad through return on investment and not in the price paid for takeovers.As globalisation increases the risks, so raw material deliveries. member-owners should clearly see the compara- ble added benefit accruing to them and decide how to reduce the risks. Ownership structures and cooperative Occasionally, long-term changes in the dynam- strategies ics of a sector may necessitate new ownership Globalisation has also led to the standardisation of structures.This is often a question of the sector corporate governance mechanisms. Even so, demanding a certain company size or growth rate depending on the circumstances and sector, there or resources or even the development of a brand may be variations between ownership structures which is beyond the capabilities of a cooperative- and methods of owner governance. For a company based enterprise due to its limited capital.Here it to succeed it requires the correct type of owners could be in the long-term interest of the owners to and ownership structures. The ownership struc- relinquish the great part of its interest,that is also tures and the company’s sector and strategies their corporate governance powers,particularly if must be in harmony. Although it has become cus- the market in this sector functions so that the tomary to talk of a company having the wrong members do not need their own enterprise in kind of owners,it is more natural,when consider- order to access the market. ing ownership structure, to say that it is in the wrong field.One Finnish example of this was the agricultural supply cooperative Hankkija (later Novera), which quite clearly expanded its opera- 2.2 Internal governance tions into the wrong field when it moved into the construction sector under the influence of its Composition of the boards strong-willed and growth-oriented CEO. The own- Large Finnish cooperatives normally have a two- ers’opportunities and resources were not in tune tier governance structure consisting of a super - with the company’s strategies and owner gover- visory board 8 and a board of directors, or a nance was too weak to effect any change. three-tier one in which the annual cooperative As the years pass by, the competitive strategies meeting is replaced by a council of representa - developed within a cooperative may no longer be tives in harmony with its ownership structures. Member-owners are often rather slow in shedding The position of the supervisory board has been easily form “odd pairs”with the latter being over- much discussed in recent times. Some non-coop- shadowed by the former, particular if one of them erative Finnish corporations have abandoned them is the chief executive.In practice,the chief execu- and introduced the Anglo-American model with its tive always attends board meetings even if not a single board of directors.This model stresses the member, so membership is not necessary to responsibility of board members and their famil- ensure the flow of information. iarity with the company’s sector and operations, Many cooperatives use a model in which there and has led to an increase in both the amount of is both a supervisory board and a board of direc - the time worked and levels of remuneration. tors formed by the member-owners.The owners At the same time, boards on which solely com - are thus represented at two levels. This kind of pany manager s sit have become more rare.The multi-tier structure could be justified when the trend is to relinquish boards occupied by opera- owners are very different and require a forum to tive management and where corporate gover- express their joint intent concerning core strate- nance is transferred to supervisory boards. gies.Cooperatives often have a situation like this in The problem of such boards arises from the which the supervisory board represents the whole powerful position of the executive directors and membership and its voice.The supervisory board particularly the chief executive.As the other board can be considered as a joint body of the member- directors are answerable to the chief executive, owners, taking a stand and deciding on all long- they feel themselves in a subservient position and range issues and committing itself to the owners’ this can easily lead to conflicts of interest within decisions.The democratic nature of cooperatives the board.The situation in which operative man- presupposes member communication. Member agement is responsible to a body composed of its commitment and the related information and dis- subordinates is hardly conducive to being critical. cussion are the necessary requirements for quick For this reason, it is recommended that a chief decision taking, which is often problematic in executive does not have the dual role of being the cooperatives.To do this a cooperative needs a net- (supervised) chief executive and the (supervising) work and formal bodies like supervisory boards chairperson of the board. 9 are part of this network. When there are such boards,controlling power In practice,the question concerns the degree to is nominally the responsibility of the supervisory which a narrower but more competent board can board. At its infrequent meetings, the latter is fulfil the same task of bonding the members as a dependent upon information supplied by opera- broader supervisory board with a shallower tive management,and few of its members have the knowledge of the company’s sector and situation, ability or time to study the issues in depth. One as well as the reasons and circumstances for its solution here has been to use small working decisions. In large cooperatives, member commu- groups,but as they confuse the issue of responsi- nication can be very expensive, so it is useful to bility, they are no longer recommended.Thus the consider the cost benefit of alternative systems. model in which there is a supervisory board and a It is important to understand the pitfalls of a board of directors composed of the operative man- multi-tier structure. One essential matter is the agers is considered problematic and no longer nor- division of responsibility between the various bod- mally recommended. ies, firstly between the board of directors and In addition to the above, there are also mixed operative management,and secondly between the boards with inside executive and outside non- board of directors and the supervisory board.Each executive directors, normally representatives of body must make a positive contribution to the the members.The operative management member development of the company. Furthermore, the is often the chief executive,but in some coopera- members of each body must have a clear under- tives 10 also the chairperson of the board. In this standing of their own role. A board of directors kind of mixed boards inside and outside members must act in the overall interest of the owners and 9 A board of directors should be able to dismiss,when necessary, the chief executive – how can this succeed if he is also the chairperson of the board? 10 At least in those Finnish retail cooperatives where the rules state that the chief executive is also the chairperson of the board of directors. 15 not in that of the different groups behind the ent interests are represented on the boards. members. Non-executive directors,especially those taking The necessity for supervisory boards in coop - part in board decision making,are always faced eratives has seldom been questioned. In produc- with the question of whose view to keep in the er cooperatives they could be thought to repre- foreground and how to strike a balance sent the owners, at least in that sense that the between contending interests. To what extent members are the users of the society. In consumer they should concentrate on the long-term conti- cooperatives,however, the question of who should nuity of the enterprise, and to what extent on sit on the supervisory boards and whom do they other factors,such as the momentary interests of represent is not quite so obvious as in a producer different groups of members? cooperative.There are cooperatives in which the Non-executive directors may have the tenden - seats on the supervisory board are divided on a cy to strictly control its background interests. It party political basis.Whereas this does not make is important to recognise this characteristic fea- the members any less competent or biased in rep- ture of cooperatives,because the board of direc - resenting the owners’ interests, it easily leads to tors may well be the guardian of specific inter - the problem of outside interests conflicting with ests rather than the body concerned with the those of the owners. development and running of the enterprise. Finally, it is useful to remember that no organi - The worst scenario here is that the board could sational structure automatically guarantees fail to take the decisions essential to the compa- good corporate governance. Neither does the ny’s success.This problem does not arise as eas- cooperative form of enterprise make all coopera- ily in purely investor-owned, joint-stock compa- tives so similar that they would be justified in hav- nies because all members of the board have one ing the same system.There are considerable varia- and the same aim,to increase shareholder value. tions in the operating environments and also in Similarly, board members represent other own- the nature of member relations.Due to the conti- ers who have the same aim. nuity of business, relations are very close in pro- • Under normal circumstances, non-executive ducer cooperatives,whereas in consumer cooper- directors in a cooperative cannot, unlike atives they may be loose or random. investor owners in a listed company, define their The basic question in running a cooperative is task simple as the control of shareholder value, how to effectively organise the boards, particu - profits and liquidity. However, cooperative non- larly the board of directors, and what kind of executive directors must set equivalent objec- added value they should produce for the cooper - tives and evaluate the results accordingly. To ative? In addition to those matters that apply to all make monitoring possible, the goals must be types of enterprises,cooperatives have the follow- measurable, with clear and objective criteria ing special questions. established in advance. • Non-executive directors are often highly com - mitted to their cooperative: they frequently have a business relationship and possibly also Should board members occupy many various personal goals vis-à-vis the society. A positions? cooperative may well be an important employer In many countries,large corporations have moved in the area. Non-executive directors are not in the direction of making board membership, or neutral outsiders.In an ideal situation,the inter- at least the chair, a fulltime occupation.The dis- ests of the all the society’s members converge, cussion on efficient board practice has brought which diminishes the significance of the per- forth recommendations concerning the maximum sonal aspirations of non-executive directors. 11 number of different company boards on which • Cooperatives have certain “unwritten” rules one and the same person can sit in order to be concerning the grounds on which non-execu - time- effective.Attention has also been called to tive directors are elected (typically regional) or cross-board membership:to the interdependences arrangements aimed at guaranteeing that differ- that occur when the representatives of the senior 11 Professor Henry Hansmann (Yale Law School) shows that this is why cooperatives in practice often operate in a narrow 16 field of business. managements of two companies sit on each pendence of board members,there is no common other’s boards and,in the worst case,decide each stand on the issue of non-executive directors from other’s emoluments. To ensure the independence outside the membership. Extreme caution has of boards this kind of cross-membership should be been shown throughout the cooperative world in eliminated. Members should not have conflicts of appointing people from outside the membership. interest and thus should not sit on the boards of A successful choice means that the know-how of competitor or client companies. non-executive directors from outside the mem - The process of electing board members has bership can supplement that of the board. They also come in for criticism. Concern has been can give the board the benefit of their special skills expressed over how to ensure that the owners’ or independent judgement. Typically, non-execu- interests are specifically represented vis-à-vis the tive directors from outside the membership are management if the chief executive has,in practice, those with considerable experience in corporate a major say in the appointment of board members leadership and international business. but the owners only a minimal voice. For this rea- Appointing outside non-executive directors, son,a special appointments committee composed however, is not without its problems. Who will of non-executive directors is recommended. instruct them in their tasks? Can they fully appre- ciate the owners’interests? 13 It is still typical for cooperatives to have a Board members from outside the strong member representation on their boards. membership This could be though to give the members of the Numerous reports published in the 1990s dealing board of directors (or advisory board) a powerful with good board practice stressed the need to motive to supervise management, because they increase the number of non-executive board mem- themselves are member-owners. Ownership in bers, not employed by the company. Even though cooperatives is,however, confused by being linked a company’s operative management is usually the to the business relationship and also that profits best informed concerning the business,it has been are distributed in proportion to the use of ser- emphasised that the board should consist mainly vices.This tends to emphasise the customer view- of independent members in order to guarantee point.Accordingly, goal setting and owner interest managerial responsibility. is a more complicated process in a cooperative In recent times, cooperatives have also dis- than a listed company. cussed the idea of appointing members to the A system of corporate governance that rests on board from outside the membership,and this has member representation works best when the occurred in a few cooperative-based enterprises. 12 cooperative is local and its operations an exten- Large cooperatives operating in highly competi- sion of its members’ businesses. The members’ tive sectors have adopted organisational structures interests are then convergent and there is a gen- (incorporated operations), which have loosened uine enthusiasm for developing the enterprise. the restrictions on the use of outside experts in traditional cooperatives.In cooperatives with non- executive directors, their number has been nor- Who should be chairperson? mally limited to 1 to 3 persons. In deciding upon the composition of the board, Even though the practice has become more the members of a cooperative should pay partic - widespread and more emphasis is being placed on ular attention as to who is appointed chairper - the importance of the professional skills and inde- son. The qualities of a good chairperson should- 12 In Finland,HK Ruokatalo Oyj,a limited meat processing company owned by a holding cooperative,has an outside direc- tor on its board.The owners have a majority on the board of the forest owners’Metsäliitto (parent cooperative) (6 owner rep- resentatives,the CEO and one outside director under an alliance agreement),but its subsidiary, Metsä-Serla Oyj,has both owner and outside representatives.Dutch cooperatives may have 2-3 outside non-executive directors,and in the USA some of the largest cooperatives have them. 13 The question has been much discussed in respect to joint-stock companies.It has been noticed in the United States that the vast majority of outside directors have but a nominal stake in their companies. Perhaps this is why certain companies in Finland (e.g.Nokia) have decided to pay part of the annual remuneration of board members in shares.In Nokia this amounts to 40 per cent.Setting the limit at 40 % is motivated by taxation considerations. 17 include enjoying the widespread confidence of ment control mechanisms. the owners and the necessary respect both within In publicly quoted companies the capital mar- and outside the board.The board,and particularly kets comes to the aid of the board. In respect to its chairperson, should have the know-how and cooperatives, the ef fectiveness of the market as a experience that gives authority vis-à-vis the chief management control mechanism is diminished by executive. Although members of the board are the fact that share capital cannot be traded and the expected to have a reasonable ability to interpret rules often place obstacles in the way of resigna- statistical information relating to the company, tion. they are not expected to be concerned with its Cooperatives lack the market signals that show day-to-day operations. On the other hand, the how outside investors and their representatives board should have the resources to use outside evaluate the company’s plans and decisions.This experts when necessar y. has made board working in large cooperatives The attributes of board members can be listed more demanding than in other large corpora - as follows: tions, so particular attention should be paid to 1) Foresight and extensive knowledge board practices. 2) Criticality, independent judgement and A board should not run the everyday affairs of autonomy the compan y, but it must have a good knowl - 3) Cooperative , edge of the sector of the company’s strategic posi - 4) Diligence and time-effective tion and competitive edge, in order to appraise its 5) Specialised know-how in some part area. operations and decisions. Although the board Thus, in addition to a sound professionalism, should question and control the managers, it board members, and particular the chairperson, should also support them in fulfilling their tasks. A are required to possess a number of other person- competent, informed board supports the chief al qualities. executive in defining the strategic direction. A clear division of responsibilities between the dif ferent parties is essential.It is necessary to Efficient board practice establish clear rules stating which matters concern The board of directors is the body elected by the the board (the owners’representatives) and which owners to carry out the tasks of controlling and ones the professional managers.A good line to take supervising management on their behalf. One of is that the board deals specifically with major its most demanding tasks is to attempt a balance of issues. power (responsibilities, freedom of movement) However, drawing the border between the between the owners and the professional man- board and mana gement territories is by no means agers. straightforward.Although the board should ensure The effectiveness of a board in supervising that the company is run efficiently, it should not management depends largely on whether the interfere too much in the detail of its day-to-day shareholders really use their voting rights and management. Thus efficient boarding working threat of replacement. Even in publicly quoted requires the availability of sufficient, timely infor- companies, the concept of efficient board prac - mation and careful preparation. As in practice tice is by no means clear. Many institutional and even many strategic decisions have to be taken portfolio investors in publicly quoted companies very quickly, there must be continuous interac - have been unwilling to use their voice or concern tion between the board and management. themselves with board practice. Institutional In addition to the above, effective control by investors wish to retain their opportunity to quick- the board also requires solving a number of other ly change the composition of their portfolios 14 practical problems.The decisive ones concern the and so place more faith in the securities market size of the board,the frequency of its meetings and and selling (“voting with their feet”) as manage- 14 Some institutional investors maintain a stock exchange index of all the shares in their portfolio.This restricts their free- dom to sell the shares,so the only way they can express dissatisfaction with a company’s management is by voting.Whether 18 an institutional investor has a holding lar ge enough to exert a real influence on the company is another matter. the term of office of its members. 1 and 2 above also concern the pertinent issue of Efficient board working starts with the defini - deciding on strategies.This requires a familiarity tion of its tasks. A certain number of formal tasks with the operating environment, a knowledge of are set down in legislation. But the new owner- the company’s competitive edge and an ability to based culture involves much more than a decision make careful judgements, particularly nowadays on hiring or firing the chief executive. In today’s when the larger cooperatives are becoming glob- management culture,the board has a much clearer alised.A board must, for example, be able to cor- responsibility for the success of the enterprise rectly evaluate the company’s know-how and than hitherto. resources in relation to the risks of takeovers and The general tasks of the board are: globalisation.A board’s task is to assess and mea- 1 Ensure that the company produces the sure the risks arising from its decisions. added value required to appreciate its value and Cooperatives should take the evaluation and economic benefits to its member-owners. development of board practice onto their work 2 To ensure that the company does not take on programmes. This starts with the setting of the too great or dangerous risks. objectives and working principles for the work 3 Ensure that the owner governance and and the critical evaluation of board working.The management control and remuneration systems means available are the usual ones for developing operate in the interests of the owners. management group working,such as post-appoint- Thus the primary task of a board of directors is ment orientation, task training, feedback manage- to produce sufficient added value for the owners ment, team working and so on.The initiative for without taking on excessive risks. Economic evaluating board working rests primarily with the added value here means that the restricted capital chairperson,and numerous guides exist as to how of a company produces more than it costs. Points this can be improved. 19 3 The governance of cooperative groups Federal organisations ing, legislation plays such a determining role. Furthermore, the role of a central organisation Federal, multi-tier structures play a special role in can, strategically and operationally, vary consider- the supervision of cooperatives.In a federal organ- ably. isation, unlike a concern, the central cooperative It is clear, therefore,that the construction of an has not the ownership power of a primary coop- effective governance model for such groups is a erative.On the contrary, it is the primary coopera- demanding task, but it is advisable to observe a tives that own their central cooperative (or joint- few basic principles. stock company).A cooperative group may easily • The most important of these is not to create have many of the features of a concern, alliance, organisations that supervise and control cross-shareholding group or advanced strategic themselves, that is, that the same party or per - partnership.In groupings like this there are many sons both set the objectives, carry them out common objectives,operations and also strategies, and supervise their implementation. The con- and although these offer the benefits of synergy flict of interests that normally arises in these cir- there are also potential contradictions. cumstances prevents effective governance. In A central cooperative is often given the power principle, the use of members from a primary to monitor and even directly intervene in the society in running central organisations creates affairs of the cooperatives that own it.In Finland, the correct supervising/supervisor relation- for example,the Cooperative Banks Act obliges the ship.Whether they have the skills and interest central organisation to instruct and control the to create an effective and genuine corporate member credit institutions to secure the liquidity, governance mechanism is another matter. solvency and risk management of the whole • An effective corporate governance mecha - group.This is the case when the central organisa- nism is based on a clearly defined ”marching tion and the member bank are responsible for order”. As a group formed by a central society each other’s debts and commitments. and its members has a complex hierarchy of The most frequently discussed aspect of coop- responsibilities,it is essential that all the parties erative group governance is should the member- agree on the “marching order”. owners or the management of the primary coop - • The local conditions of member societies eratives be represented in the board of the cen - belonging to a corporate network may often tral organisation. The traditional model based on vary considerably. A system in which the member-owners is probably considered an exten- regional societies’ managing directors have a sion of cooperative democracy. In Finland, con- majority in the central society could threaten sumer cooperatives have a federative structure, the setting of common objectives for the group whereas the agricultural cooperatives have abol- and hamper decision-making.Due to the differ- ished it. Cooperative retail societies and banks ences in regional interests, the creation of a have a two-tier structure (a board of directors and clear owner viewpoint may be difficult.This is a supervisory board) in both their primary and especially so if company management supervis- central societies. In Finnish practice, regional es itself, for then there could be excessive lee- and/or local society managements are represented way in interpreting any differences of opinion. alongside the member representatives in the A particularly awkward situation may arise supervisory boards of the central organisations. when faced with economic difficulties, as There appears to be no simple way of deter - changing circumstances generally inflame hith- mining what is an effective governance mecha - erto concealed tensions.Such a group requires nism or who “genuinely” represents the owners at an operational group management in which the 20 which level, particularly so if, as in fields like bank- managing directors naturally participate. ny’s structures, but only to monitor and question The governance of hybrid its performance from the point of view of the organisations investors. In practice, a cooperative-owned joint- Alongside traditional cooperative societies, new stock company will have a lower share quotation types of cooperative organisations have been cre- in relation to its performance than a completely ated,so the same group can contain a hybrid of dif- investor-owned one (see the attached figure).This ferent types of companies.These range from oper- has its own effect on the takeover situation ations that have been partly incorporated into list- (financed with company shares) and building up ed companies,something that is quite common in incentive schemes. If partly cooperative-owned Finland. Typically, in the case where a coopera - subsidiaries wish to expand rapidly and finance tive owns a listed company the cooperative soci - takeovers with their own shares, the division of ety and/or its members are in a majority and so, shares between the society and the investors has, collectively, fulfil the role of the main owner. due to valuation of shares, an effect on financial Another kind of hybrid organisation is that of the costs. American new generation cooperatives where the There are certain special issues related to the cooperative-corporative border has been blurred management of subsidiaries set up by a coopera- by making the membership closed and by permit- tive.Quite often the cooperative is a holding com- ting transferable shares. pany and the subsidiary is responsible for the busi- As in the case of a federal organisation,so there ness operations or the cooperative is responsible are several ways of arranging group corporate gov- just for those fields of business most closely relat- ernance in the hybrid type of enterprise. In its ed to the activities of the members.Therefore,the basic interests, a hybrid group represents a vari - governance of the holding cooperative and its sub- ety of owners from member-owners to sidiary must act together in monitoring and con- investors.15 This makes for an exceptional system trolling the whole group.Through growth or glob- of internal and external, market control. In order alisation, a subsidiary can distance itself from the that the objectives of the different groups of own- society. There is,therefore,a danger that the mem- ers can be contained, a clear view of corporate bers’ representatives in the governance system can goals is required. no longer evaluate the risks taken on by its sub- In an enterprise with one major owner, external sidiary. Especially in the case of a cooperative or its corporate governance via the market is more subsidiary going international, high demands are intensive than in an ordinary cooperative society, set on the expertise of the member’s representa- but its point is blunted.In an enterprise where the tives. main owner is clearly cooperative, the threat of a Finnish cooperatives incorporated as joint-stock takeover, replacing the board,downsizing and cor- companies, where the main owner is a coopera- porate restructuring are less than in a listed com- tive society, are consolidated. This means that pany with a dispersed ownership,so the pressure owner supervision and control can be organised to produce profits may be lower. in several ways. The basic question, however, is On the other hand, the market supervises the whether this is done by appointing owner repre- company on behalf of the minority investors and sentatives to the boards of the subsidiaries or via a continuously questions its decisions, something group board.The system that has been found to missing from a cooperative society. Passive control work best in Finland is where the same member- via the market thus increases. It is passive in the owner representatives sit on the boards of both sense that it does not seek to change the compa- the cooperative society and the major subsidiary. 15 Such public limited companies in Finland include Atria Oyj,HK Ruokatalo Oyj and Metsä-Serla Oyj. 21 Banking sector P/BV P/E 2000 16 4 14 12 3 10 8 2 6 4 1 2 0 0 Merita ÅAB Mandatum OKO Merita ÅAB Mandatum OKO Forest industry 10 2 9 8 7 6 5 1 4 3 2 1 0 0 UPM Stora-Enso Metsä-Serla UPM Stora-Enso Metsä-Serla Food industry P/ BV 4 25 20 3 15 2 10 1 5 0 0 Danisco Chips Lännen Atria HK- Danisco Chips Lännen Atria HK- Tehtaat Ruokatalo Tehtaat Ruokatalo P / E 2000 = Valueofcompany’s capitaldivided by anticipated net profit for 2000 ”High P/Ereflects belief in long-term ability of company toimprove itsresult” P/B = Valueofcompany’s capitaldivided by book net assets ”High P/BVreflects company’sefficientuse of assets.” Grey column = acooperatively owned company Mandatum Asset Management 22 4 Cooperative incentive schemes The remuneration of managers • Share ownership and share value based ones (=no drain on company cash flow). Management (and staff) remuneration schemes The first includes performance- (or payment by have become an important instrument of corpo- results) and profit-related pay schemes. rate governance. Their proliferation is clearly Performance-related pay is a bonus paid above the related to an owner-based management culture. basic salary in accordance with a set of agreed cri- This is not just a desire to motivate managers to teria, such as exceptional work performance. work harder or guarantee them a competitive Performance- or results-related pay schemes can salary (thereby obtaining the best people), but a be individual or based on a unit or enterprise.They way of getting them to work in the interests of the are short-term incentives. The profit-related pay owners. scheme is based on company profitability as mea- Owners and managers should have parallel sured, for instance, by return on capital. Personnel objectives and these should be reflected in the funds,tied to the company’s net profit,may also be governance and remuneration mechanisms. The considered a cash-based system. remuneration scheme is the signal of owner Among the share-based systems,the most com- expectations from management. In order to con- mon are stock options.There are more than a hun- struct an incentive scheme, the owners have to dred stock option schemes operating in Finland decide what they want from some measurable for management and staf f. Recently it has become objective.The agreements then drawn up must be more usual to pay board members with shares. tied to the achievment of these goals. It is best that Stock options are long-term incentives, normally incentive schemes are for short-, medium- and supplementing short-term schemes like perfor- long-term periods. mance-related pay. Economic value added (EVA) A remuneration scheme is based on the schemes may be used in the medium term. • Corporate goals and their correct measure- The linking of management remuneration to ment the stock exchange value of the company is con- • Definition of the required level of perfor- sidered the best method of bonding managerial mance (criteria levels) and rules concerning and owner interests.As Bengt Holmström (MIT) how “bonus points”accumulate observes: • Definition of the monetary equivalent of the “Stock options have completely transformed criteria;“how bonus points are converted into managers’thinking because they now have a sig - money” nificant amount of their own money at stake.” 16 In order to be supportive and directive, those Short- and medium-term incentive pay schemes within a remuneration scheme – whether senior are available in cooperatives,but they do not have or middle managers or staff – must be able to iden- the long-term ones based on shares. tify those of their actions that will affect goal In the absence of market signals, cooperatives achievement.There is no point, for instance, for a have to think very carefully in setting their objec - staff incentive scheme to be tied to capital yield or tives, as well as the criteria and means for their operating profit. achievement. Actually they have been very hesi- Incentive and commitment salaries can be tant in applying performance-related schemes, divided between although no comprehensive survey has been car- • Cash-based ones (= tied to operational perfor- ried out. mance) and Furthermore,a cooperative society as the main 16 Helsingin Sanomat,21.2.2000,p.C7. 23 owner of its incorporated parts, may find it diffi- from the company’s profits,after deduction of the cult to build up an option-based incentive scheme. required return on invested (share) capital and In a mature sector, the share price is usually so other capital,is the economic value added created steady that a stock option scheme is not so attrac- by the company.The advantage of EVA,compared tive as in a growth sector. In addition,the market with many other performance indicators,is that it price of shares in a company with concentrated measures the efficient use of capital. ownership tends to be lower than in one with a dispersed ownership. The remuneration of non-executive Cooperative societies, and often also joint-stock directors companies largely owned by cooperatives, are The demands on the skills and time of non-execu- thus forced to develop other incentive schemes. tive directors in large cooperatives are increasing. Those based on economic value added suit coop - A board chairperson is often required to work for eratives.17 Future profit expectations are not several months of the year and this must be paid included in the EVA but the ex post facto long- for. Finnish salaries have hitherto been rather mod- term share price has a high correlation to the est. But if the work of non-executive directors index of economic value added.The idea of EVA is makes heavy demands on time then this could be very simple:A company’s management has at its paid for in proportion to the salary of the chief disposal both share and loan capital.What remains executive. 17 In Kone Oyj,a part of mana gement remuneration is determined on the basis of a three-year cumulative EVA (Talouselämä, 24 19.5.2000 p.35).Nokia also used EVA-based schemes in the 1980s. 5 Conclusion There has been a clear increase in recent years in 2) How to draw the line between board and the level of competence required of non-executive management tasks? directors.The operating environment of coopera- 3) How best to train board members in their tives has become more complex and global. In tasks following their appointment? order to comprehend a company’s strategies,non- The answers to these questions are indubitably executive directors must be able to identify the relevant to Finland once a system of owner gover- success factors in their sector and company.These nance is carried out in practice. in turn provide the bases for discovering the cor- Whether a cooperative is large or small,the fol- rect relationship to the company’s operating envi- lowing recommendations for a system of good cor- ronment and its institutional solutions, competi- porate governance practice are equally applicable: tive corporate structures, as well as setting mea- • An increase in annual report and similar dis- surable objectives for management and supervis- closure, especially in respect to profit and its ing their implementation. To achieve these objec- distribution tives,it is necessary to create within a cooperative • More information concerning the tasks of environment, incentive schemes that are techni- board members and promoting the efficient cally feasible and culturally acceptable. working of both the board of directors and the An unofficial enquiry made among the partici- supervisory board through training and devel- pating board members at the American Farmer oping self-evaluation Cooperatives Conference in November 1999 18 • Development and presentation of manage- revealed particular concern with the following ment control systems (control concerns both three questions: financial performance and goal monitoring) 1) How to involve professionally competent • Development and evaluation of remuneration people in the work of the board in view of schemes. the competing demands on their time? 18 For more information about the conference see http://www.wisc.edu/uwcc/events/2000-99tc.html 25