Our next topic is market discipline. What does the market do to keep corporations on track, to keep companies honest? We've already seen that corporations continue to engage with the equity market after the initial public offerings when shares get listed on the exchange. Corporations need to release relevant information on a real time basis. So when is management, in fact, being held to account? The owners, the new investors in the shares of the corporation have an opportunity once a year to come to the annual general meeting which is providing then with a forum where the company business can be transacted. Shareholders have an opportunity to ask questions at the annual general meeting. And they can also comment on the performance of the company's board of directors, or on the company's management, and also of its auditor. Management, and the board of directors, take the opportunity at the AGM to present about the corporation, and by implication, their own performance. By presenting the annual financial report, the director's report, the auditor's report, and transact the auditor's appointment and remuneration at the same time. So what exactly happens at AGMs? Well as we've just seen, shareholders have the opportunity to ask questions. And the chair of the annual general meeting does in fact have to allow for a reasonable opportunity for those shareholders to ask those questions. Or to make those comments on the performance of management of the corporation. But funnily enough, there's no obligation for any of the directors or the officers of the corporation to answer any of those questions. Yet it only takes one share to ask the question. Second activity that shareholders can engage in at the AGM is to move a motion to ask for a resolution. But for that to happen, a single share is no longer enough. So shareholders need to have at least 5% of the votes, or at least 100 shareholders that are entitled to vote, and then they can notify the corporation in writing beforehand, before the annual general meeting, that they propose to move a resolution. Passing of such a resolution would, in fact, require a full ownership majority, 51% of all the votes. Sounds difficult? Well, yes, particularly if you keep in mind that so many of the shares of the large corporations nowadays are being held by institutional investors. And by proxy votes in fact, many shareholders do not bother to show up to the annual general meeting and would allow the chair to vote on their behalf. So yes absolutely, very difficult to move a resolution. So if management doesn't respond to the questions, and if you can't find support for your resolution, what's next? Well in Australia, there's something newly introduced called a two strikes policy, where directors are being held accountable for the proposed executive compensation. If executive compensation, always a difficult point for shareholders, attracts a no-vote of more than 25% on the remuneration report, then the directors are being sent back to the drawing board and prepare an amended remuneration report. If at the second occasion, the subsequent remuneration report also attracts a no vote of more than 25% then shareholders will have the opportunity to vote on a spill of all of the directors, but for that to happen they will actually require a majority vote, more than 50%. Still difficult? So if all of this fails then there's only one thing left to do for our investor. Sell the shares. If in fact the protest voters have sufficient support of other investors who will then also proceed to sell their shares, then inevitably the price will start to drop. If the price drops far enough below intrinsic value, then all of a sudden these shares will look cheap. And competitors, private equity funds and corporate raiders will take an interest. And potentially that might lead to a take over of the corporation. Moving from the AGM to a broader role for shareholders, let's consider what is known as shareholder activism where investors use their share ownership to put public pressure on the corporation's management. There's a variety of reasons why they may want to do so. It could simply be because of financial gain, pay higher dividends. It could be because of environmental concerns, stop logging old growth forests. It could be social concerns, stop using cheap labor or it could be government concerns, related to the compensation of the Board of Directors, for example. Mostly, shareholder activists focus on divestment of loss-making divisions. That would be the financial gain. Excessive executive compensation, a governance concern. Irresponsible or unsustainable investment, or divestment from sin investments like tobacco and carbon. Environmental and social concerns. Employee welfare, again social concerns. Unethical overseas business practices. Examples abound of social concerns in that context and board directorships. All of those have triggered shareholder activism. Shareholder activism is, in fact, not a new phenomenon. From a bad 1980s reputation when corporate raiders were using leveraged buyouts to subsequently restructure traditional corporations, to a much more benign 2010s reputation of agents for corporate change. Shareholder activism can be achieved either directly by moving resolutions at the annual general meetings or through the more aggressive share proxy battles that we've seen in the corporate greatest days of the 1980s. To the more indirect approach where the activists are using public relations and media campaigns to get their message across. Or they're engaging directly in a dialogue with management. All of that is possible with relatively small stakes of ownership, unlike the direct approach. Institutional investors in fact are playing a key role as shareholder activists. One example is the California pension fund. So all of that relates to the interaction between corporations and the investors in equity. But what about investors in the corporations debt? Do debt markets also have the opportunity to discipline corporations? Well, superficially, no. Not really. Because debt holders do not own the corporation, as long as the corporation is able to repay its debt, it doesn't need to justify itself to the debt holders. It's not being held to account so to speak, by the debt holders. So corporations participate mostly in the primary debt markets, not so much in the secondary debt markets. But of course, occasionally corporations have got free cash flows that they can either utilize to buy back shares, but they can also buy back debt. They would do that on the secondary market. Alternatively, corporations that are successful would have new investment projects arise all the time. And, they would occasionally have to find new sources of financing for those cases. Alternatively, they would have to periodically refinance their existing debt. Something particularly pertinent during the global financial crisis. It's also worth keeping in mind that when issuing debt, in fact there is a raft of conditions attached to the debt issue, called covenants. So bond issues carry covenants. Covenants that stipulate when a corporation is technically in default and what the corporation could then be prevented to do. That could in fact lead to a downgraded rating by the rating agencies. And lastly, yield changes as they occur on the secondary market for corporate debt would give a broader signal as to the corporation's liquidity and solvency to the shareholders, but also to the debt holders.
