The problem type 2. [10] In contrast to type

The world
of public companies is nuanced – on the one hand they can generate cash from
the sale of equity to investors worldwide, but on the other they have to comply
with stricter rules and often people lose the governing power over their
company. It is frequently the case, especially with large public companies that
the people who own the company, don’t actually participate in the management of
that very company. Furthermore, this is also true for the British publicly
traded company Sainsbury’s. The major shareholders in Sainsbury’s are Qatar
Holdings LLC and Blackrock Inc, as of the 8th of November. 1 – both
of which are holding companies, which means that they do not directly run the
company’s day to day business.

This is
what it’s called an agency problem type 1 – they’re may be a conflict of
interest between the owners of the company and the agents they have chosen to
manage it. 2 Moreover, Qatar Holdings owns 22% of Sainsbury’s and they are by
far the biggest shareholder. In these situations, companies might also
encounter what is known as agency problem type 2. 10 In contrast to type 1,
this is conflict of interest that may arise between majority and minority
shareholders. This is a situation in which the majority shareholders may act in
their best interest, executing their higher voting power (by owning a larger
part of the company) in ways that may not necessary benefit owners with a
smaller stake in the company. However, agency problem type 1 is more widely
spread and I am going to focus on that. In general, the managers tend to have
more short-term goals, while the shareholders tend to want the best for the
company in the long-term. According to Villalonga and Amit, however, many of
the family owned public companies tend to deal with this agency problem a lot
better than those businesses owned by big institutions – banks, investment
funds, Governments. This comes as no surprise as usually when the ownership of
the company is concentrated in a smaller group of people – they tend to take
care more due
diligently of the business. Whereas, when a company is owned by a large
institution, who invest on behalf of others that are not really connected in
any way with the company – they tend to be more distant from the soul and the heart of the
company. Moreover, in
many cases the managers of the company are also family members, which results
in stronger connection between owners and agents.

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However, it
is also worth mentioning that too much involvement of the owner in the
management of the business may not be a great thing, as noted by Warren Buffet
in his 1993 annual letter to the investors in Berkshire Hathaway. 3 If the
owner of the company is also the manager of the company, it would be hard for
the other directors and board members to take drastic measures if the company
is not doing well. The owner will probably not see fit to fire himself and this
might cause problems for other minority shareholders with no voting power.

Furthermore,
Buffet notes that the best way to run a company, in his opinion, is if the owner
is in the board of directors, but not in management. This really makes sense,
because that way you get all the positives of having the owner involved in the
process of running the company – vigilantly watching if the managers are
working in the best interest of the shareholders (his own interest), but also
all the negatives I mentioned in my previous paragraph are gone. If other
directors are not happy with the performance of the managers – they can fire
them and find more suitable replacements.

Sainsbury’s
also partially family owned – David Sainsbury owns almost 4% of the business. However,
it seems that he has not been involved with the management of the company since
1998. 4 And as I have already mentioned, overall the largest shareholders are
two investment funds, so I could see there being a potential agency problem of
type 1. It is often the case that when the majority shareholders are
institutional investors, the managers could get ahead of themselves and start
making rash decisions. A lot of people would argue that this problem could be
tackled by tying their remuneration to their performance – for example if part
of their salary is paid in the form of stocks or options to buy the share in a
future date at a discount. This way they will have the incentive to make sure
that share’s value appreciates in the future. This is the case with a lot of
large companies. Apple is a good example for this – the CEO, Tim Cook, owns
over 900,000 shares! 8 There are even more extreme cases of this. Recently
Tesla announced that the remuneration of the CEO of the company, Elon Musk,
will be entirely paid in the form of stock options. He will reportedly receive
no salary at all. 9 Moreover, this logic follow for the lower levels of the
company as well. When your retirement plan, as an employee of the company, is tied
to the results that your employer produces, this would be a great motivating
factor for any man to make sure that they do well. This is the case with many
companies in the US, as a lot of their employees 401K’s are invested in stocks.

Furthermore,
similar seems to be the case with the management of Sainsbury’s, as their bonus
will be in the form of shares as well. 7 However, they did in fact have
an agency problem scandal after it acquired Argos’s parent company – Home
Retail Group. 5 There were many concerns over the necessity of the
acquisition, as in many cases managers tend to push these deals to increase
their remuneration in the future and they tend to be good for the shareholders
of the acquired company and bad for the shareholders of the acquiring company.
Furthermore, a KPMG study found that 83% of mergers don’t result in the
enhancement of shares value. 6 

However,
this doesn’t seem to be the case with Sainsbury’s acquisition of Home Retail
Group. After reading their annual report, I came to the conclusion that on the contrary
– it may help Sainsbury in the long term and after the merger and further proof
of this is the fact that the stock of the company has appreciated in value.
This may actually turn out to be a good example of the opposite of an agency
problem, as the managers and directors seem to have acted in the best interest
of the owners, because it seems that deal overall will probably increase shareholders
value in the long-term.

Furthermore,
corporate governance is a very important part of a company’s structure. It is
crucial that the management and the board have good practices. These may
include appeasing all shareholders – not only the largest institutional
investors. They should encourage a regular and constructive dialogue with key
shareholders and encourage participation by the owners of the business. It
should also promote a transparent and ethical way of doing business. It’s
clinical that the board is effective in its workings. There should be clear
division of responsibilities to make sure that there is no conflict of interest
between non-executives and executives. The board is also responsible for
managing the performance of executives.

Corporate
governance is one of the pillars that hold a company together. As I have
already mentioned, there is an inherent problem with public companies – the gap
between the owners and the directors. Corporate governance is the bridge
between them and it has to be a very strong one if the company is to succeed.
It is crucial that directors follow the ethical behaviour that is expected of
them, as no company is looking forward to public scandals. If the trust from
investors to management is broken, in most cases it could never be repaired
again. This is exactly what happened to Enron. There were no appropriate
corporate governance safety nets to keep the directors from misguiding and
ultimately destroying the lives of thousands of people that had invested in the
company. 11

So it comes
as no surprise when I say that every public company should comply with the UK
Corporate Governance Code. It is one of the pillars of ensuring that people can
trust that a company’s management and board team is acting in good faith. After
reviewing the annual report from 2017, I can say that Sainsbury’s is complying
with the code. In their words the board is responsible for setting the goals of
the company, insuring their long-term success and setting and leading by
example for honest and ethical behaviour from the bottom down. This is what
every investor wants to see from a functional board. Furthermore they have 4
separate committees that are responsible for sensitive matters – such as audits,
remuneration, nomination of board and management members and last but not least
– responsibility and sustainability.

One thing that made a very good impression on me, was
the fact that the board hired an external audit committee to review the data
they’ve provided in their annual report. You would always like to see that an
external source has reviewed everything that the management team has presented
to investors. Furthermore, the board has expressed its openness to shareholders
by conducting meetings with large investors and institutional shareholders
throughout the year. They also post they’re quarterly conference calls, in
which they answer investors questions. Any smaller shareholders can open
Sainsbury’s investors relations website and contact the company with any
questions they might have.

I was particularly impressed with their nomination committee. This is the
committee responsible for planning the succession in the company’s highest
echelon positions. In their annual report, they have emphasized how important
it is for a modern day company to be inclusive. 30% of the senior managers in
the company are women – this is one of the highest numbers in the UK. Investor
can be assured that the management team is relatively well diverse, which means
that at managers meeting there would be varied opinions and different
perspectives on how to service both women and men in Sainsbury’s stores. Overall
55% of their employees are women as well.

However, a company does not only have responsibility to the investors,
but to the general public as well. That’s why Sainsbury has set up its
corporate responsibility and sustainability committee. Their main job is to
make sure that the company doesn’t damage the environment or the wellbeing of
individuals. For that matter, the committee has invested more than 173£ million
in promoting a healthy and fitness positive lifestyle.

One of the most important committees, however, is the audit one. They
are responsible for making sure that all the information provided in the
financial statements represents a fair and true view of the facts. As an
investor, this is probably the most important part of the annual report, so the
committee has to be certain that the information provided to the public is
correct in every way. The management of the company should help and assist the
audit team in any way necessary. It’s crucial that they don’t hide any
information from them and that they act in an open and positive manner. There
is also and external audit team that double checks everything. This is always a
good idea and a positive safeguard against colluding and scheming. The external
audit team also came to the conclusion that the board has acted with accordance
to the UK corporate code of governance.

The remuneration committee is the last one that I have still not
commented on. As I already mentioned, all bonuses to key managers in the
company have been in the form of stocks of the company and no cash. This aligns
with the committees views that managers’ salaries should be directly aligned
with the results from their performance.

A failure to comply with the UK code of corporate governance would send
all the wrong messages to investors and will have dire result for the future
careers of all members of the board and the management team. However, this
doesn’t seem the case with Sainsbury’s. From everything I have gathered they
seem to be a well functioning company with a competent board. Important
decisions have been discussed with key shareholders and the most crucial
decision this year – the purchase of HRG has been well communicated to other
shareholders as well. Directors have also shown great integrity throughout the
year and have made their best efforts to disclose everything about the purchase
of HRG. The sheer fact that Home Retail Group is mentioned 108 times in the
reports tells you a lot. It has been a big decision to make and it seems that
it was made the right way – through total transparency.

I have to say that after extensively studying assurance and governance,
going into this essay I already kind of knew what you should be looking for in
an annual report. I am familiar with the UK corporate governance code and with
the appropriate safety nets and procedures companies should follow in order to
reassure investors that they’re acting in their best interests. All in all, I
have to say that after reading a couple of times over their last annual report,
I am very pleased with what I read. Sainsbury’s seems to have a very
responsible board of directors and management team that knows how things should
be done in the right way and is acting with integrity with regards to their
jobs. I would recommend this company to a family member and I could assure them
that on the surface at least, they seem to be a positive, ethical company that
works in the best interest of the shareholders.