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Business School 2nd December, 2013

Msc. Finance and Business Management Over time shareholders have found it difficult to hold directors responsible for their action. The only real way of removing directors is at the Annual General Meeting (AGM) by mustering majority votes, which, in light of institutional shareholders, is almost impossible.

Using FTS 500 Listed companies as an example, investigate ways shareholders can and have held directors responsible for their actions. You should take the role of a consultant advising a group of shareholders

Using the above Scenario you are required to formulate a ( or a set Of) research questions for which you can use either qualitative and/or quantitative data in order to address this issue within your AMP.

Submiitted By: Student ID:

Mark G. Tagwai 1223320

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Contents Executive Summary ................................................................................................................................. 4 CHAPTER ONE ......................................................................................................................................... 5 1.0 Background of the study ............................................................................................................. 5 1.3 Aims and Objectives .................................................................................................................... 6 1.4 Research question ....................................................................................................................... 7 Chapter Two ............................................................................................................................................ 8 2.0 Literature Review ........................................................................................................................ 8 2.1 Agency Theory............................................................................................................................. 8 2.2 Monitoring Mechanisms ............................................................................................................. 9 2.3 Development and Meaning of corporate governance ............................................................. 10 2.4 Components of Corporate Governance .................................................................................... 12 2.4.1 Board of Directors: ............................................................................................................ 12 2.4.2 Monitoring by Top Management: ..................................................................................... 12

2.4.2 Supervisory Board: ................................................................................................................ 13 2.4.3 Remuneration Committee: ............................................................................................... 14 2.4.4 Nomination Committee: ................................................................................................... 15 2.4.5 Audit committee: .............................................................................................................. 15

2.5 Monitoring by Large Shareholders ........................................................................................... 17 2.6 Disciplinary Measures ............................................................................................................... 18 2.7 Means of Enforcing Disciplinary Actions on Director ............................................................... 19 2.7.1 Director’s removal ............................................................................................................ 19 2.7.2 Director’s Disqualification: ................................................................................................ 19

2.8 Legal perspective ...................................................................................................................... 19 2.8.1 Shareholder Derivative action .......................................................................................... 20

2.9 Empirical Evidence of Enforcing Directors’ Liabilities in the United Kingdom and the United State 22 2.10 Director Indemnification and Officer Insurance ....................................................................... 23 Chapter three ........................................................................................................................................ 24 3.0 Introduction .............................................................................................................................. 24 3.1 CASE STUDY ONE: HBOS ........................................................................................................... 24 3.2.1 Case study Analysis ............................................................................................................... 28 3.3 CASE S TUDY TWO: Royal Bank Of scotland .............................................................................. 30 3.3.1 Case Study Analysis ............................................................................................................... 31

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CHAPTER FOUR ..................................................................................................................................... 33 4.0 INTRODUCTION ......................................................................................................................... 33 4.1 RECOMMENDATIONS................................................................................................................ 33 4.3 CONCLUSION ............................................................................................................................. 34 References: ........................................................................................................................................... 36

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Executive Summary

Looking back at the recent corporate failure during the financial crisis of 2008 and the consequential effects on shareholders’ wealth, one is left to wonder if corporate companies are worth investing into, since shareholders’ investment does not gives them right to directly manage the company and there is no guarantee that their investment would be well manage by those entrusted with such managerial responsibilities. The shareholders are always at the receiving end of corporate failure while the people responsible for the collapse of corporate companies often go unpunished. This research work is written to address the issues relating to how shareholders can effectively hold directors accountable for their actions. This called for a critical literature review in areas relating to this subject. An understanding on the kind of relationship that exists between shareholders and directors is presented with the help of agency theory. This explained why conflict of interest regarding to corporate companies exist between the two parties. A review of corporate governance is also given in an attempt to align the interest of the shareholders with that of the management. It has been observed that an effective practice of good corporate governance often reduce the deviation of interest from that of the shareholders to that of the management, and also create a balance between the interest of both parties. This can be achieved through the effective monitoring of management activities via the structure lay down by corporate governance. Issues regarding to directors liabilities led to an examination of the legal components available for the shareholders to use. It has been observed that director can be personally held responsible through a successful lawsuit launch by shareholders on behalf of the company. Two case studies of corporate failure were used to further enhance our understanding and to also know how successful shareholders were, in holding the directors of these companies responsible for their business misconduct. In both case studies shareholders actions were observed through various ways like; refusal to subscribe for right issues, removal of director through resolution, and launching of lawsuit against former directors of the company.

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CHAPTER ONE

1.0 Background of the study

It is an undeniable fact that a publicly quoted company cannot be manage by the entire shareholders, hence the responsibilities of running a public company is dedicated to only some few individuals often refer to as the executive board of directors. As a result we have the suppliers of finance to a firm being separated from the management of the firm. The shareholders delegate the responsibilities of conducting the firm’s business and the taking of strategic decisions to the Managers. This has often resulted to a conflict of interest between the shareholders and the top management. This has been rightly noted by Shleifer and Vishny (1997), that the conflict existing between shareholders and the management of a company is one of the major features of public companies. Bearly and Means (1992) pointed out that the existence of information asymmetries often result to managers taking decisions which only maximise their own utility and not that of the shareholder interest, whose main aim is wealth maximization. Thus, the shareholders often find it difficult in getting the management act in accordance to their interest.

The rising case of corporate failure has call for a major concern across the globe. This concern is on how the providers of finance can be effectively protected from the hand of defaulting management. This is because of the negative effects that are accompanied with corporate failures. The diversion from the interests of the shareholders to that of the managers may occur because of various reasons; it could be due to differences in the level of managerial effort, differences in attitude towards risk, or differences due to time management (Smith and Watts, 1992). So far there has not been an effective way in which the shareholders can hold the management accountable for actions taken not in their interest. Hence this research is written in order to explore ways in which erring managers can be held responsible for their actions.

Thus scholars around the world are now finding ways in which this lost confidence can be regain once more. As a result various systems are now being scrutinized starting from accounting standards (which has a strong impact in passing information

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to shareholders), issues with the legal structure and the issues of corporate governance codes. Some major changes might have to take place in some of the areas mentioned above, even though this may vary from country to country. But the main concern of this research is how effective can these systems be in providing the shareholders with a conducive environment where by they can easily hold director accountable for either committing the wrong action or for not committing the right action which is also known as director’s negligence

It is imperative for us to note that; it is not possible for the entire shareholders to be able to monitor the actions of the directors; hence we shall be focussing on the body responsible and systems available for such monitoring. This should lead us to reviewing the nature of relationship that exists between the shareholders and the Management of the firm who are being refer to as the principal and agent respectively according to the agency theory, as well as reviewing the impact of corporate governance on the firm. But the most critical parts of this research is how directors can be held accountable for their actions by shareholders. I shall therefore be looking at this from a legal perspective of the United Kingdom since different countries have different laws and different mood of applications regarding to their corporate bodies. This is necessary because shareholders need to have some legal backing before they can be able to legally hold directors accountable for their actions. This stresses the point that as is important as it is for shareholder to be able to enforce liabilities on directors, it cannot be done out of the provisions of the law, as doing that may lead to another offence in the eyes of the law.

The research work is written using a case study of two corporate bodies to serve as live examples of the problem its aim at addressing. The first company to be consider is HBOS bank, a bank that was led to corporate failure due to poor managerial decisions. While Royal Bank of Scotland is to be used as the second case study which aggressive expansion strategy was one of the reasons for it almost collapse if not for the intervention of the Government.

1.3 Aims and Objectives The aim of this study is to determine ways in which shareholders can effectively monitor the actions of top management, so that defaulting directors can be held

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responsible for their actions and also propose some disciplinary measures that can be taken against such directors.

The following objectives are set to be achieved at the end of this research work;

To critically analyse existing monitoring systems available for the shareholders to use in curtailing the activities of top management

To determine effective mechanism that can be use by shareholders to hold default directors accountable for their misconduct.

To ascertain disciplinary actions that can be impose on defaulting directors

1.4 Research question The research question is developed in line with the aims and objectives stated above. The research question serve as a focussing tool into the area of enquiry, it is the foundation of the entire study.

What are they effective measures and actions that can be taken by shareholders in order to enforce directors’ liability?

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Chapter Two

2.0 Literature Review

This chapter presents the work and views of other researchers on issues relating to the aims and objectives of this dissertation. It discusses the nature of relationship between shareholders and directors. It also provide a frame work of corporate governance as a monitoring tool and finally discusses ways that shareholders can enforce directors liabilities taking into consideration the legal aspect.

2.1 Agency Theory

The agency theory was proposed by Jensen and Meckling (1976). it focuses on the relationship that exists between agents and principals. Hence, it is define as a contract whereby one of the parties (principal) bestowed onto the other party (agent) the right to perform a service on his behalf (Jensen and Meckling, 1976). Through this contract decisions making authority is been assigned to the agent by the principal. The firm has been recognised as a nexus for a set of contracts among individual factors of production (Alchian and Demsetz, 1992, Jensen and Meckling 1976). It is further observed by Jensen and Meckling (1976) that if they two parties involved in the contract are utility maximizers there is the possibility that the agent would act differently from the interest of the principal. Padilla (2002) argues that because of the opportunistic behaviour, the agent may make decisions that suit only his interest and not that of the principal. Therefore it is difficult to align the interest of principal with that of the agent. Thus the main role of the principal is to try to prevent deviation from his best interest by setting up incentives for the agents, this actions obviously lead to the incurrement of certain monitoring cost. Monitoring cost are cost that arise from monitoring activities such as measuring, observing and controlling the activities of the agents in order to ensured that the agent act in accordance to the best interest of the principal. Such costs may include auditing measures and corporate governance codes (McColgan, 2001). Alternatively the

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agent may disburse some resources in order to ensure that the interest of the principal is not prejudice, or that compensation is made available to the principal in the event of any loss. Such expenditures incurred are referred to as bonding cost. Despite the two types of cost mentioned above, another component of agency cost known as the residua loss will always be incurred due to the conflict of interest that exit between the principal and the agent. This is due to the fact that the implementation of the total principal - agent contract will supersede the derive benefits (Jensen and Meckling, 1976).

As claimed by Jensen and Meckling (1976) Agency cost is made up of monitoring cost, bonding cost and residual loss incurred. Information asymmetry is considered as one of the sources of the problem existing between the principal and the agent. This occurs when a party to a contract in this case the agent is more knowledgible about critical information needed in the contract than the other party in this case the principal (Douglas, 1989). Because the shareholders are not engage in the day to day running of the firm, they lack adequate knowledge of the firm’s operation. Whereas the top management who actively participate in the running of the firm have first hand information about the firm, hence there exits the possibilities that top management can use this information to get undue advantage of the shareholders.

Due to the fact that the corporation must continue to exist, a system must be developed in order to align the interest of shareholders with that of Top management. Therefore the next section presents the monitoring mechanisms that can be used to reduce the extent of deviation of interest between that of the shareholders and that of the management. Through the application of good corporate governance the agency problem can be manage in a way that ensure both the satisfaction of shareholders and top management interest. This bring us into the next section of the dissertation “monitoring systems”.

2.2 Monitoring Mechanisms This section of the research work discusses the various monitoring mechanisms available for shareholders to use in other to make sure that top management does not deviate from its duties and responsibilities. For the purpose of this research work; these monitoring mechanisms are also considered as part of control mechanisms. Monitoring deals with management and supervisory functions, this can be done in

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form of observation, inspection, confirmation and enquiry, computation and analytical procedures (Walters and Dunn, 2001). Yang (2008) Affirmed that monitoring mechanisms are capable of reducing the problem arising between agents and principals and therefore, suggested that top organizational structures such as supervisory board or the auditors should be used in monitoring top management. They presence of such mechanisms restrain management from expropriating activities and ensure the pursuance of profit maximisation which is the main goal of shareholders as seen by classical economist (Friedman, 1957). The major beneficiaries of these mechanisms are the shareholders (Fama and Jensen, 1976), although other stakeholders such as bondholders and even the firm’s management within the corporate environment also benefit from the investment of resources into such control mechanisms (Fama, 1980).Most of these monitoring mechanism to be considered are embedded in the codes of corporate governance. Denis, Denis & Yost, (2002) affirmed that; corporate governance encompasses a set of institutional and market mechanisms that provide self-esteem managers the incentive of maximising the residual value of the firm’s cash flow in favour of the shareholders. Hence the need for us to critically examined the concept of corporate governance and its impact as a monitoring mechanism on the corporate structure.

2.3 Development and Meaning of corporate governance According to Mallin (2013) the term corporate governance was not that prominent in the business world until the last fifteen years or there about when it seems to appear in almost every day financial news. Notwithstanding, the theories that led to the development of corporate governance are dated far back into the years, these are drawn from various areas of disciplines such as Finance, Economics, accounting, law, management and organizational behaviour. Various theories are responsible for the development of corporate governance, these includes; Agency theory, Transaction cost economics, Stakeholder, Stewardship, Class hegemony Managerial hegemony.

Corporate governance has been considered as one of the sole way in which a balance can be maintain between the interest of managers and that of the provider of finance, mainly shareholders. This has been affirmed by Mallin (2013) that the answers to why corporate collapse? What can be done to prevent corporate collapse?

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How to restore investor confidence? Are all linked to corporate governance. Aguilera (2005) equally observed that “Corporate governance systems provide several mechanisms to ensure that firms are run effectively in order to maximize shareholder and/or stakeholder value”.

Claessens & Hsiang (2003) observed that the definition of Corporate governance falls into two aspects, the first one deals with measures such as performance, efficiency, growth, financial structure, and treatment of shareholders and other stakeholders while the second aspect deals with issues such as the legal system, the judicial system, financial markets, and factor (labor) markets. This second part is more concern about the rules use in operating a firm often refer to as the nomantive frame work. Hence, a good number of people have attempted defining the term corporate governance using different words but the meaning is not far fetch from each of the definitions.

According to the Cadbury Committee (1992), corporate governance is defined “as a system by which companies are directed or controlled”. This is a broader definition as is concern about the general way in which corporation are run as a result of the separation that exists between ownership and management.

In Shleifer and Vishny (1997) definition; “corporate governance deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment” this definition focuses on the providers of finance which is compose of both shareholders and creditors. The main interest of shareholders in any given corporation is for wealth maximization, hence the need for them to monitor and protect their interest in the corporation against any form of expropriation.

A more recent definition is given by Aguilera and Jackson (2003) “Corporate governance refers to the distribution of rights and responsibilities among the different actors involved in the corporate organization”. This definition look at the relationship that exist between the provider of finance and the management of the firm in a more broader way as both parties have their rights and obligations regarding to the firm.

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2.4 Components of Corporate Governance Corporate governance is composed of various components that ensure the smooth operations of the firm, by checking the activities of top management creating a balance between the interest of shareholders and that of management. Hence we have the followings as components of corporate governance;

2.4.1 Board of Directors: The board of director plays a vital role in the management of a firm. The board is responsible for the running of the company, part of the functions of the board include; policy making and implementation, as well as formulation of business strategies and managing of strategic risks. Mace (1971) concluded that directors serve as a source of advice and counsel, serve as some sort of discipline, and act in crisis situations”. The board of director ratifies and monitors management decisions and performance respectively, the board is also responsible for decision management and control functions (Fama and Jensen (1983). The board is composed of two bodies; the Executive directors (management) and the None-Executive directors (supervisory)

2.4.2 Monitoring by Top Management: The management board is responsible for the day to day running of the business, with the obligation of reporting to the supervisory board on a periodic basis. In performing these duties and responsibilities as directors, they often deviate from their ultimate objective which is shareholder maximization of wealth. Hence the major question is how to monitor and align the interest of shareholders with that of the Managers by the managers? This can be achieved through mutual monitoring mechanism operated by management members. This has been recognised by Fama and Jesen (1983) as an important internal monitoring system among the firm’s top management. Individual members of the board can actively monitor the decisions taken by any of the board member that does not align with the overall goal of the firm. Fama (1980) states that "each manager has a stake in the performance of the managers above and below him and, as a consequence, undertakes some amount of monitoring in both directions”. As an obstacle to this monitoring system Rediker and Seth (1995) observed that the concentration of power in the hands of a single board member may hinder the effectiveness of the system. As a result members of the board may lack the potential information or power needed to monitor the activities of the chief executive.

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Jesseng and Meckling (1976) observed that managers with a significant equity stake in the firm are more likely to align their interest with that of the shareholders. Hence there are little chances of agency problem arising. This has further been affirmed that directors with a significant equity stake in the firm are more effective in monitoring the decisions of the firm’s management (Brickley & Smith 1988, Brown and Maloney, 1999). But a contrary view has been argued by Morck, Shleifer & Vishny (1988) that directors with a significant equity stake in the firm may tend to provide managers with security against interference by other shareholders groups. Thus, protecting the management’s decisions that may only be beneficial to them without any concern for the typical shareholders of the firm.

2.4.2 Supervisory Board: This is the board that represent the interest of the shareholders and that of the employees as well, also known as the non executive board of directors. According to Fama and Jensen (1980) “Such boards always have the power to hire, fire, and compensate the top-level decision managers and to ratify and monitor important decisions”. The supervisory board has no executive power but has the right to select endorse or subtract a member of the management board (Mcconvill et al, 2005). The board cannot interfere with the day to day running of the corporation it can only advise and control the management board. The non executive board of director is responsible for the assessment of managerial performance. Hubbard (2005) pointed out that it is part of the director’s obligations to be on guard against managerial malfeasance. The board is designed as a means of shielding shareholders from expropriation by top management. A well structured board of director will serve the interest of the shareholder through effective board supervision (Baldwin, 1984). It has been acknowledged by Fama and Jesen (1983) that the direct monitoring of top management by the external members of the board may limit the conflict in the area of shareholder’s interest and that of the top management. The Higgs report (2003) lays more emphasis on the importance of the supervisory board. The board is to carry out its function through three sub-committee which includes; remuneration, nomination and Audit Committees. These committees are expected to be independent of the firm’s management. It has been put forward by Fama and Jensen (1983) that members of this board have adequate incentive enabling them to perform

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their functions because of their acquisition of the skills and expertise required for the job; also their position as external directors gives them the freedom to judge managerial decisions in an unbiased manner. The same view was put forward by Weisbach (1998) that for the sake of the external directors’ reputation they tend to be more effective in monitoring the firm’s resources against mismanagement than the internal directors. However, these views have been argued against by Gibson(2003) and Hermalin & Weisbach (2001) that the external directors lack the incentive of monitoring the top management unless when face with strong evidence of mismanagement. An explanation of this could be due to the overriding power of the CEO, as he tends to dominate the nomination process and is less supportive of the independence of the external directors (Mace 1986). But this disagreement among the directors (executive & none executive) is seen by Gabaix & Landier (2006) as a key feature of good governance. Another contradicting point about the functions of the Non- executive is that their engagement with other commitments make them too busy to be involve with the company’s business, as a result they only do that on a part time basis. Bosch (1995) argues that an average non-executive director only spends like twenty two days annually in performing his duties.

The post Cadbury report era of 1992 have witness an increase in the members of the supervisory board to 46% as against the pre era with only 35.5% in the composition of the whole board of directors Dahya et al (2002).

2.4.3 Remuneration Committee: The remuneration committee plays a vital role in the design and management of the remuneration package for the executive directors of the company. According to the size of the company the committee is to be made up of at least two or three independent non-executive director (Financial reporting council 2012). The main reason for the existence of this committee is to prevent executive director from deciding their own remuneration package. Hence the committee is to be composed of none executive directors; with the expectations that they none-executive directors would be more objective and fair in designing remuneration package for the executive director (Cadbury, 1992). The absence of remuneration committee could result to directors writing their own contract with one hand and signing it with the other hand (Williamson 1985, p. 313). The main principle of this committee is that remuneration package has to be attractive in other to retain and motivate directors to

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give their best input for the best possible outcome, but should prevent the company from paying more than necessary for this purpose (Financial reporting council 2012). But the recent raise in the take home pay of executive directors has call for more transparency in executive remuneration (Charkham, 2005).

Contrary to the committee being composed of only non executive members, are the findings of Newman and Mozes (1999), in their effort to established the effects of the committee being composed by either insider or outsider in relation to higher or lower remuneration package respectively; they carried a samples of 161 USA firms and concluded that the presence of an insider in the committee does not result to higher remuneration package surprisingly the discovered that a committee composed of purely outsider favours higher pay for the CEO than that with an insider influence.

2.4.4 Nomination Committee: This committee is responsible for the nomination of individuals to serve on the company’s board of directors. This committee reduces interference from other board members including the chief executive in the nomination processes. The importance of this committee is the possibilities of nominating individuals to the board of director that are likely to protect the interest of shareholders. While maintaining the view that a nomination committee composed of mainly external directors are likely to nominate individuals as directors that are free from management pressure or interference and would be able to challenge CEO decisions, Shivdasani and Yermack (1998) observed that firms without such a nomination committee or firms that allow the CEO to participate in the nomination of director are likely to select individuals that would be inclined to act according to the director’s interest. Hence Charkham (2005) argued that the committee prevent the appointment of “sycophants or buddies” by the executive director and thus, encourage objectivity.

2.4.5 Audit committee: This is an essential part of the provision of corporate governance. The audit committee plays a vital role in ensuring the integrity of the firm’s financial statement. The audit committee are in a better position of protecting the interest of the shareholders because of the role the play in monitoring the financial position of the firm. An unambiguous role of the Audit committee is that of financial oversight and the protection of shareholders interest among other things (Lin, Xiao & Tang, 2007).

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Thus, the committee plays a vital role in ensuring reliability of the company’s financial statement. The uncovering of poor financial performance by the audit could be an indication of ineffective management, hence the need for an intensive monitoring of the firm’s top management (Hermalin and Weisbach, 1988). Mahoney, (2000) attributed 70% of corporate failure to be as a result of ineffective management.

The committee is to be composed of at least three or two members depending on the size of the company selected from the company’s board of directors. It is part of the requirement of the United Kingdom code of corporate governance, that at least one out of the audit committee members should be endowed with recent and relevant financial experience (Financial reporting council 2012). It has been argued by Bedard et al. (2004) that the effectiveness of the audit committee is directly associated with their level of expertise, experience or knowledge. Members of the committee are required to have sufficient expertise in order for them to fully understand what issues are to be investigated or discussed. One of the major loopholes of the regulatory requirement is the absence of adequate explanation on what constitute financial expertise; hence it is left at the discretion of the board of directors to decide on what constitute financial expertise (Barra, 2010). Therefore the

An important feature to be considered about the effectiveness of the Audit committee is the independence of its members (Abbott et al. 2000). It has been observed by Leftwich et al. (1981) that the presence of independent director in the audit committee may result to an effective monitoring of the financial reporting process in order to protect the reputation of members as well as their market value as decisions experts. For the committee to be effective in carrying out its functions, members of the audit committee have to be highly independent or free from any form of interference or pressure from management. This has also be affirmed by Sharma (2004) in order to ensure effective monitoring and management’s accountability; members of the committee should be composed of outsider or none executive directors. It has been suggested that the audit committee should hold separate meetings with the management, internal and external auditors in order to ensure effective monitoring of the financial reporting processes (Beattieet al., 2000; Braiotta, 2003; Song and Windram, 2004) . In their contribution Beasley, Carcello &

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Hermanson (1999) discovered that external and independent directors reduce the possibilities of the occurrence of financial fraud taken place within the firm.

2.5 Monitoring by Large Shareholders It is commonly held that large shareholders play a vital role in monitoring the activities of top management by directly or indirectly engaging in strategies that may result in positive monitoring effects on the firm (Shleifer and Vishny, 1997). From the market perspective large or institutional shareholders are consider as a positive signal for investment. Individual shareholders with small equity stake may lack the incentive to monitor the activities of top management in a firm with diffused ownership across huge numbers of shareholders. Roe (1994) argued that diffused shareholders who have limited holding do not have the incentive as well as the means to monitor top management. The little amount invested by them is not worth interfering with management and incases where they want to interfere, they only have little power over the firm. On the other hand institutional shareholder with relatively large equity stake would have greater incentive in monitoring the actions of top management, because they have greater voting power that can be use as corrective tools and are likely to enjoy greater benefits from these monitoring activities (Shleifer and Vishny 1986). According to Mintzberg (1983) the size of investor’s equity stake is directly related to the amount of influence exerted over the management. It is the interest of every shareholder to witness an increase in the value of his/her equity stake in the corporation, hence large shareholders have strong motivation to effectively monitor management and ensure that their interest is protected. The growth witnessed in pension and insurance funds have resulted to an increase in institutional ownership to approximately 62% in 1993, while there has been a declined in individual ownership from 54% in 1963 to less than 18% in 1993 in the United Kingdom (Short and Keasey, 1993). This group of investors are likely to vote against managerial decision that does not result to profit maximisation (Brickley, Lease and Smith 1988).

Contrary to these views mentioned above are the views of (Black, 1992; Admati, Pfleiderer and Zechner, 1994), that the effects of free riding among large investor does not give room for collective action, hence institutional investor have limited interest in monitoring the actions of managers. This has been affirmed by coffee

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(1991) that rather than taking corrective action, institutional shareholders may have incentive in selling off their shares at the emergence of poor managerial performance. Despite this criticism, the impact of institutional shareholders in monitoring management activities in the United Kingdom can be observe in listed companies through the support of organizations such as National Association of Pension Funds (NAPF) and Association of British Insurer (ABI) thess organizations play vital roles in the development of guidelines on severance payments and directors’ remuneration in order to prevent manager from getting rewarded for poor performance (Wood, 2008).

Despite the existence of these monitoring mechanisms discussed above, which can be channel through the practice of good corporate governance code, we still have cases of bad management, excessive remuneration package as well as corporate failures. All these are done at the expense of the shareholders. The effect of these on they shareholders are; none payment of dividend, loss in the value of shares or at worst loss of their entire investment in cases involving bankruptcy. Hence the next section would be looking at the remedies actions available for shareholders to use in order to recover their wealth either wholly or partly from the hands of defaulting directors.

2.6 Disciplinary Measures Due to the classical agency problem that arises from the entrustment of authority to the agents by the principals, the principal want to be able to hold the agents accountable for not completing his assigned task or for the abuse of the duties given to him. For the principal to be able to do this, the principal must first of all know what the agent must have done wrong and at the same time must have the ability to enforce adverse penalty on the agents. The general view is that shareholders who are dissatisfied with management performance have three primary means of expression; exiting the stock, voicing their grievances, or remaining loyal (Davis & Thompson 1994). Robert etal. (2001) that “measures to assure accountability require mechanisms for transmission of information as well as enforcement.” There are various disciplinary actions that can be enforced on fraudulent directors but the processes of enforcing such actions are often difficult for the shareholders to endure. The duties and liabilities of a company’s director are governed by statutory and

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common laws. Hence any failure on the side of the director for not performing any of these duties might result to criminal or personal liabilities. Therefore a director can be dismissed, be made to pay for the company’s losses, be banned from holding such positions or be imprisoned for his misconduct.

2.7 Means of Enforcing Disciplinary Actions on Director

2.7.1 Director’s removal The shareholders of a company have the right to dismiss any of the company’s directors that they feel is not acting in the best interest of the shareholders. It is required that shareholders representing at least 5% of the company voting right is needed to call for a general meeting where a resolution of dismissal can be pass upon the director. More than 50% of the vote is required for such resolution to be effective. But the director must be given special notice ahead of the meeting in order for him to prepare his case and is also entitle to be heard at the meeting(company act, 2006).

2.7.2 Director’s Disqualification: Department for business innovation and skills (DBIS) is saddled with the responsibilities of disqualifying individuals for a specified period of time from acting as directors. The company disqualification Act 1986 provides that a director might be disqualified as a director for a period of two to fifteen years.

2.8 Legal perspective Generally, the law regards a corporation as a separate legal entity. A company has the same capacity just like that of a person to enter into any legal relationship (Mayson, French & Ryan, 2007). Hence, once a company is incorporated the company is then entitled to its own rights and liabilities. Just like an independent person, it can then be able to sue and be sued using its own legal identity. But it is a fact that the company though a legal person cannot represent itself in the court, hence it needs to be represented by a human person. It is now imperative to look at the provisions of the law regarding to how the company can be represented in a court of law in order to claim damages done to it by its management or any other

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person else, but our focus would be on the management as discussing about other persons would be out of the scope of this dissertation.

Legal support is identified as an important aspect of corporate governance (Shleifer and Vishny 1997). It is through legal means that shareholder can be able to enforce personal liabilities on defaulting directors. Hence shareholders need legal backing in order to be successful in holding defaulting directors liable. Except in cases of oppression the shareholders have no right by law to enforce any liability on any management member of the firm, such actions can only be taken on behalf of the company by the shareholders serving as representatives of the company in order to correct the wrong that have be done to the company. Therefore whatever that is recover from such cases goes to the company pocket not that of the shareholders, this is introducing a new term to this dissertation known as shareholders derivative action.

2.8.1 Shareholder Derivative action

Thorne & Walmsley (1995) observed that the available remedy for shareholders to use in holding directors responsible, when they believe that there is a breached of fiduciary duties by top management is “shareholders derivative suite”. Fiduciary duties are the duties owe to the firm by the directors or officers of the firm. These duties require the use of care, loyalty and honesty as they affect the financial interest of the shareholders (Maren and Wicks 1999).

The shareholders have the legal right to make a claim regarding to any actions or proposed act or omission taken in respect of the company by the directors which may include, defaults, negligence, and breach of trust or duty on behalf of the company. Hence section 260 of the Companies Act 2006 provides the shareholders with the ability to hold the director responsible for their actions on behalf of the company on a statutory basis. Provided that the following three conditions must be met before a shareholder can take such actions;

The action must be brought by a member of the company

The cause of action is vested in the company

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Relief is sought on the company’s behalf

It is important to note that these conditions only provide grounds for members of the company to sue the director on behalf of the company but does not guaranteed the success of the litigation, as the same law provides legal protection to the directors. One of the basic obstacles that could be face by shareholders in holding the managers accountable for defaulting the firm is embedded in the business judgement rule. Directors use this rule to repel against shareholders derivative litigation. James, (2013) argued that the business judgement rule protect director from been held responsible for their decisions when they are being challenge by shareholders for business misconduct via derivative litigation. The business judgement rule exist in order to encourage directors to take calculated business risks; which is the most common feature of every business. Individuals are willing to become directors due to the protection they receive from this rule. Thus the business judgement rule has been defined by Giraldo (2006) as “a doctrine that protects officers and directors from personal liability only if they have acted in good faith, with due care, and within the officer or directors’ authority” the business Judgement rule is mostly common in the United State regulations, meanwhile in the United Kingdom a similar provision exist in Section 727 of the companies Act 1985, which provide for a similar relief, as that being offered by the business judgement rule. Section 727 provides that;

“That should in any proceedings it appears to the court that a director may be liable in respect of negligence, default, and breach of duty or trust, but was done honestly and reasonably, and that haven considered all circumstances surrounding the case, he ought to be excuse fairly for the negligence, default, and breach of duty or trust, the court may relieve such director from his liabilities either wholly or partly as the court deem”.

This is a judicial tool used in examining directors ‘ conduct in legal proceedings, should the rule be applied, directors would be free of the derivative claim against them because the court would presume that the actions of the directors were perform in good faith and in the corporations’ best interest.

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2.9 Empirical Evidence of Enforcing Directors’ Liabilities in the United Kingdom and the United State

One of the major means of enforcing director’s liability for business misconduct is through court proceedings as provided by the company act of (2006) the prosecution of directors under the companies Act is the principal way of enforcing directors’ liabilities. Armour etal. (2009) found out that is more common to privately enforce lawsuit against the directors of publicly quoted companies in the united state than in the United Kingdom. They observed in their survey of 27099 claim cases under the United Kingdom companies’ legislation, covering the period between 2004 – 2006, and found out that only one claim was made against the directors of a publicly traded company. The claim was actually struck out because it was filed without a council and does not meet the requirement of the court. Hence they concluded that lawsuits involving the directors of public quoted companies claiming for breach of duties are close to nonexistence in the United Kingdom.

While Romano (1991) examined a sample of shareholder suits of 535 publicly quoted companies in the United State between the periods of 1960 to 1987, and observed that only over half of the law suit settled involved monetary recovery with the majority of the payment being settled by directors and officers (D & O) Insurance. However as observed by Armour (2009), cases involving directors personal liabilities in the United state include that of ICN Pharmaceuticals, HealthSouth and Tenet Healthcare. The entire board of director of ICN Pharmaceuticals was dismissed by shareholders and through the action of the court was forced to pay back bonus amounting to £31million ($50million) which was approved to the board by the board without due process before the board’s dismissal. While in the case of HealthSouth the CEO was forced to pay back bonus that was approved base on false financial statement and consequently jailed for business misconduct. In the last case regarding Tenet Healthcare, the CEO and CFO were made to paid £621 thousand ($1 million) and £310 thousand ($500 thousand) respectively in a derivative suit of £133million ($215 million) while the balance was settled by the director and officer (D & O) insurance . The director may be protected against personal liability under the cover of the D&O insurance.

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2.10 Director Indemnification and Officer Insurance Section 234 of the company act (2006) provides that a director may be indemnified by the company for liability incurred in defence of civil or criminal proceeding, in situation where he has been acquitted or has won judgement in his favour. Whereas section 233 of the company Act provide that an insurance cover may be purchase and maintain against personal liability of director and officer who might be found guilty of negligence, breach of duty or trust against the company. This serves as one of the major tools of protecting directors and officers against personal liabilities. Directors and officers corporate insurance is been argued to attract and maintain qualified and competent individuals to serve as directors/officers. While on the contrary the effectiveness of shareholders lawsuit as a tool for managerial control have been weaken by the corporate insurance for director and officers as argued by the opponents of director and officer insurance (Monteleone & Conca, 2013).

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Chapter three

3.0 Introduction This chapter presents a case study of two corporate bodies that have witnessed serious corporate failure. Causes of the corporate failure of the first company (bank HBOS) and the foundation of the problem are adequately presented. The second company a financial company too Royal bank of Scotland was also involved in scandalous cases that almost led to the collapse of the bank if not for Government intervention. A critical analysis of the two case studies is been presented in the discussion part of each case study.

3.1 CASE STUDY ONE: HBOS Unlike the failure of other corporate bodies around the world that was caused by the world financial crisis present at that time, the failure of one of the British bank “HBOS” has little or no linked with the world economy crisis of 2008 as claimed by its former directors. According to the parliamentary commission on banking standards report; the bankruptcy of HBOS was as a result of the bank’s own strategy on high risk lending and their over- zealousness in setting high growth targets that is accompanied with poor control mechanism, hence should not be blame on the global financial meltdown. It was due to total mismanagement by the bank’s top management. In their efforts to realise short term maximum profit as well as gain maximum executive rewards, not minding about the survival of the bank in the long run as well as the effects of their actions on shareholders and other stakeholders of the bank, the director recklessly indulge into highly risk lending that can never be tolerated by any bank around the world.

The report discovered that; at the time of the bank’s downfall there was a funding gap of more than £200bn between the bank’s loans and its deposit. This gap implied that the bank had to depend on borrowing from other banks in other for the bank to be able to carry out its normal transactions.

Before the merger of Halifax and bank of Scotland that gave birth to HBOS, the management of Halifax bank surprised British big four banks by its introduction of an interest bearing current account with a payment of 4.1% per annum on the conditions that 1000 is deposited into the account on a monthly bases, this program

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was launched On January 12, 2001. Also on February 2001 the bank invested up to £1billion in mutual insurer Equitable Life; a company considered so toxic by other investors. This could be view as signs of aggressive banking by the management of Halifax bank who later maintain top position in new HBOS bank after the merger.

They merger took place on September 10, 2001, and James Crosby; the chief executive of Halifax emerged as the chief executive of the merged bank, while Lord Stevenson the chairman of Halifax bank also maintained his position as the chairman of the new bank, Peter Burt the chief executive of bank of Scotland became the executive deputy chairman of the new bank that was named HBOS.

Immediately after the merger the bank started facing liquidity problem; this was evidence in the offer made by the management of the bank for new shares in order to raise more funds. They made a placement for about 1500 million new shares amounting to £1.3billion; this was not taken lightly by the public as various bank analysts criticize the cash call. This is evidence in the words of John Paul Crutchley at Merrill Lynch as he was quoted in the Guardian of 28 February 2002 saying "It's purely opportunistic. Investors are being asked to give over £1bn so that they can start a price war." This resulted to a fall in the share price by 65p.

The bank drew negative reactions from the eyes of the public once again on February 2002, when it was discovered that it planned to shut down its doors to new business starters, taxi drivers, market traders and supper market; this was discovered in a flipchart that was left in one of its abandoned building. This was accompanied by a wrong policy that was adopted by the bank in its effort to settle the disputes involving one of Halifax’s two-tier mortgage rate; instead of drawing up a compensation plan for all affected customers, the bank agreed to compensate only customer that channeled their complains to the financial ombudsman, claiming the ombudsman’s support in that. The Consequences of this is that customers that didn’t complained are ineligible for the compensation. Ombudsman vehemently denied such alliance with HBOS, but HBOS stick to its words by not changing the information in its website. Thus; only 30,000 customers were eligible for the compensation as against 400, 000 customers; this damaged the banks’ reputation.

At the Annual general meeting on May, 2002, shareholders were able to eliminate one of the bank’s non-executive director; that has a bad record of running down a

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former company; Lord Simpson of Dunkeld, was responsible for the liquidation of a company known as Marconi as a result he was force out of the directorship of HBOS by shareholders. Meanwhile a new bonus scheme was established that allows the chief executive director as well as the executive deputy chairman to earn up to £10million and £7million as a top-up to their salaries for their three years contract term. While other directors bonuses are to range between £6million to £7 million for the same term period.

Meanwhile, in ending 2002, HBOS chief executive; James Crosby joined the membership of Financial Services Practitioner Panel, a body whose main aim is to reduce the monitoring activities of Financial services A… on the banking sector. 6 January 2003 saw the stepping down of Peter Burt from the position of executive deputy director of HBOS, because He seemed not to be contented with the direction the bank was going.

In December 2004 the FSA uncovered an internal control problem within the bank, relating to audit issues and money laundering. Meanwhile in January 2005 early warnings were given to the bank by FSA regarding its expansion policy; quoting the words of Mike Ellis (Iran Fraser, 2010) that HBOS is “an accident waiting to happen”. Because the pace at which the bank was growing outpaced the bank ability to control its associated risks. The same month the bank was fined £1.25million by FSA

In December 2008 shareholders’ lack of confidence in the administration of the bank was revealed by shunning of about 92% right issue of £4 billion issued by the bank. Thus forcing the underwriter of the right issue to underwrite for the remaining shares worth £3.8 billion.

In October, 2004 the head of the group regulatory risk unit of the bank; Paul Moore wrote a report, warning about an impending collapse of the bank due to the nature of sales adopted by the bank and the inadequacies associated with the bank internal control. But the Finance director kept the report from reaching the table of the audit committee as well as that of the board of director. Moore ended up getting himself fired by Crosby in his attempt to complain about the actions of the finance director. In a letter to Moore; Crosby informed him that it was his sole decision to fire and

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replace him with someone that has no knowledge and experience of risk management. Thus the appointment of Jo Dawson by Crosby to replace Moore result to the inactiveness of the group regulatory unit because she lacks the knowledge as and the expertise require for such task.

In December 2004 the bank total exposure to a private company ‘ Murray International Holdings’ rose up to £500 million from £168 million. Meanwhile a complain to the FSA by a Scottish businessman about the irregularities of writing bad debts and its resulting effects on the balance sheet which was hidden by the abuse of ‘ off-balance record’ was shoved under the table by the FSA as the FSA respond that; they do not policy business model. In their effort to boost deposit, HBSOS started offering an annual interest of 10% to its saving account holder. This was a rate more than twice the benchmark of Bank of England.

In 2005, the head of corporate of HBOS George Mitchell retired from the bank. While 2006 Crosby announced his resignation from his position as the chief executive officer and was replace by Andy Hornby; a person who lack the required experience and expertise of running a bank. Lynden Scourfield one of the bank’s directors who through his lending policies was responsible for the loss of about £1billion resigned in march, 2007.

In December, 2007 Crosby who was earlier appointed as a member of the board of directors by Chancellor Gordon Brown since 2004, became the deputy chairman of the FSA board and chairman of the FSA committee of the non-executive board of directors. This provided the bank with a shield against being properly regulated by the FSA.

After series of share price fluctuations, the price of the share drastically went down and all effort by the management of the bank to raise fund from shareholders became abortive. Hence, it later became obvious in 2008, that the bank cannot longer finance its business. It is then that the management of Lloyds TSB came to the bank rescue through a takeover deal.

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3.2.1 Case study Analysis One is left to wonder about the impact of corporate governance and other regulatory bodies on the corporation. Do these regulations only exit theoretically or are the practically evident? As has been observed in the literature reviewed above, various mechanisms have been provided by regulatory bodies and corporate governance codes to be use for monitoring and ensuring that top management does not override its power in running the affairs of the corporation. But the financial scandals of HBOS presented above tend to prove otherwise. A critical examination of the management board of HBOS after the merger that took place between Halifax bank and bank of Scotland revealed to us that, key position of the bank’s top management were occupied purely on the decisions of the two executive directors of the respective banks. It becomes obvious that the right of the shareholders to nominate and elect the bank directors via the nomination committee was tempered with. It could be that the shareholders of the bank of Scotland would have preferred their wealth to be managed by their executive director and not by the executive director of Halifax bank. The nomination committee whose main functions and duties to shareholder is to see to the nomination of board members was inactive. Furthermore the person that took over from Crosby as the chief executive director of the board was merely appointed by Crosby and note through the nomination board. As he lacks any track records of the banking sectors neither does he have sufficient expertise or knowledge of managing any bank.

The Executive director’s overriding power signifies that he might have been in control of the non executive directors; whose main role is to oversight the activities of the executive board. According to Jensen (1993) a powerful CEO select individuals under his influence to served as director so that he can contain the impact of board monitoring. This is evident in the sacking of a top management member that was raising alarm about the future of the bank. He was personally fired by the CEO and was replaced with a person that lacks the knowledge and the expertise of playing such role. This signified that the CEO was in absolute control of the entire board members. He incapacitated the functions of the audit committee by hiding vital financial documents from their preying eyes. It is the duty of the audit committee to monitor the financial position of the company but lack of access to vital financial documents inhibits their functions. The chairman of the board who was not satisfied

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about the direction the bank was going couldn’t raise an alarm rather he went into retirement living the fate of shareholders in the hands of bad management, hence he fail to perform the internal monitoring function. We also see the influence of the top management in deciding their remuneration package. A duty that is supposed to be entirely left for the remuneration committee. The management decided to increase their bonuses according to their own interest.

Shareholders of HBOS were able to exercise their right by voting out one of the bank’s director with a bad record of running down a former company, the effectiveness of this removal could be base on the provisions of the company acts of 1986 which provide for the disqualification of a director of an insolvent company. Unlike the derivative claim that has an exception due to the business judgement rule, the director disqualification act does not provide any exception to its provisions, provided the director was responsible for the insolvent state of the former company. Another action by shareholders was their refusal to participate in the right issues. That resulted to 98% of the right issue to be underwritten by the underwriter. The shareholders refusal to partake in the right issue signifies their lack of confidence in the bank’s management. Davis & Thompson (1994) shareholder have three means of expressions; It could even be that some shareholders must have taken the exit options, as is the easiest option for them. The second option that can be taken by the shareholders was to voice out their grievances, this is evidence in the actions of the Scottish business man who complained to the FSA about the irregularities with the bank balance sheet but nothing was done about it.

The regulatory body, FSA (now FCA) whose main responsibilities are to regulate and ensured the implementation of good governance in the firm fail to perform their duties judiciously. The regulatory body granted HBOS the power to develop its risk model and stress testing. Despite the fact, that the bank was fine £250,000 and £1.25 million by the FSA in 2003 and 2004 respectively. These fines disappear without any obligation of payment as soon as Crosby the bank CEO was appointed as one of FSA non executive directors. Effectively all such of policing and monitoring by the FSA regarding the bank were put to an end.

After the mismanagement of shareholders resources most of the directors responsible for this tender their resignation letter and that was the end of the storey.

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There was no any action that was taking to enforce any form of liabilities on any of the key directors except for one of the directors that sentence to prison. Shareholders were left to their fate and the new management of Lloyds TSB that rescued the bank were left with a big responsibility of restructuring the. But as of this there have a been a for the personal liabilities of the former directors, the call is coming from financially analyst who took their time to follow up the case, but so far no lawsuit have been file against the directors.

3.3 CASE S TUDY TWO: Royal Bank Of scotland The Royal bank of Scotland was one of the financial institutions that were caught up in the toxic scandals of 2008, which resulted to a tumble in the value of mortgage backed securities with a consequential drop in the value of bank’s share. Because of the huge bonuses that were directly related to short term performance measurement, the management of the bank engaged in excessive risk-taking.

In their effort to win the bid over ABN Amro against their major competitor Barclay, the bank under the management of Sir Fred Goodwin embarked on an aggressive acquisition policy in October 2007 that led to the purchased of ABN Amro at a price that have been considered to be an overgenerous price.

To appease the fears of investors after the acquisition of ABN Amro, the bank write -down 1.5billion, an amount far lower than was expected by investors. Part of this amounting to 250million was set off from the bank’s cash reserves. Later in April 2005 the bank undertook another write – down amounting to 5.9 billion due to credit crunch, this trebles the amount earlier written – off. This had serious impact on the bank financial position.

At the peak of its financial crisis the emergency liquidity Assistance through the sponsorship of the bank of England injected some cash to it on the 7 of October 2008. But the funding was not enough as the bank was force to called for more funds from shareholders through a right issue of 12billion, a right issue that have been tag Europe’s ‘biggest right issue’, but to its disappointment only 0.24% of the right issue was subscribed.

August 2008 witnessed the declaration of the bank’s first loss in 40 years amounting to £619 million before tax. But it was later revealed in 2009 that the actual loss

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realized in 2008 financial year was up to £24 billion as against £691 million that was earlier declared.

As part of its rescue plan the government invested the sum of £15 billion, consequentially taking up to 58% stake in the bank. This saw the replacement of sir Fred with the former Abbey National boss Stephen Hester as the chief executive of the bank. In February 2009 the government had to launch another recues plan after the realisation of the actual trading loss of 2008 financial year. This call for the withdrawal of the pension amounting to 700, 000 that is been paid to the former chief executive.

According to the report published by the FSC, base on the investigation carried out by them the following were among the reasons behind the collapsed of the bank;

Poor managerial decisions

Losses from credit trading

Involvement in risky short term transactions

Apart from the call for a cut in the pension of the former chief executive officer of the bank, both private and public investors have unanimously taken a class action suing the bank and its former directors for, misleading shareholders to believe that the bank was in a good financial condition before it’s collapsed in 2008.

3.3.1 Case Study Analysis Would the shareholders wealth ever be save from the hands of expropriating management? The aim of the shareholder is to maximise their wealth, but the poor management of this wealth in the hands of those entrusted with such responsibilities often end up taken away value from the shareholder than adding value. The nature of risk that the management of royal bank of Scotland were undertaken clearly shows that they were after short term gains that would add more to their pocket in terms of bonus, they were not concerned about the future of the bank, hence jeopardizing the interest of the bank’s stakeholders most especially the shareholders. The management neglect the most important aspect of investment which is risk management, it is their responsibilities to critically analysed the level of risk

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associated to any investment they are engaging into but is obvious that they have forgotten this function.

Shareholders reacted to this indirectly by not participating in the right issue that was offered in which only 0.24% of the right issue was subscribed. This should have send a message to the management of the bank that shareholders were not longer happy with the way the bank was manage. Even though is not evident but it could be that shareholders that were smart enough must have taken the exit way by selling their shares off. Is a fact that the former chief executive of the bank Sir. Fred was forced to resigned after running down the bank, but the question that need to be answer is; was there any disciplinary action enforce on him for the loss he caused shareholders? The answer to is no, rather he was asked to resign with an awesome pension pack, alongside an insurance cover for his fleets of cars, reward for expropriation. Is important to note that tax money was use to rescue the bank, all due to mismanagement while the person responsible for the bank collapsed is being rewarded for it and is now living an extravagant lifestyle.

Shareholders wouldn’t let go, they ought to get their wealth back, and persons responsible for the bank collapsed should be held accountable for their actions. Hence under the umbrella of a class action, shareholder of RBS were able to come together and unanimously lunched a lawsuit against the former RBS and its former director for mismanaging their wealth and also for misleading them to believe that all was well with the bank when the bank made an offered of a right issue worth 12billion in 2008. A class action is a lawsuit that permits a group of people with common interest in a related matter to sue or to be sued. Blockholders, institutional shareholders as well as minority shareholders of RBS have pull resources together in order to finance the lawsuit against RBS and some of its former directors. The case is still undergoing trial but the most important thing to be noted is the willingness and commitment of shareholders in taking this action there by exercising their rights and impliedly sending signals to the directors of corporate bodies that shareholders have waken up from their slumber, hence such actions can be taken against any directors

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CHAPTER FOUR

4.0 INTRODUCTION After a critical reviewed of the existing systems available for the shareholders protection, followed by a critical analysis of the two case studies presented above, it is obvious that there exist some gabs that needs to be cover up. Hence this recommendation generally addresses the problems with the monitoring systems as well as with the enforcement of directors liabilities

4.1 RECOMMENDATIONS In the United Kingdom It is evident that the corporate governance codes are strong and substantive enough as they have been review over and over again to ensured good governance practice. But something very significant is missing; that is the absence of formal shareholders enforcement of these laws against bad directors of publicly quoted companies. This could be due to the nature of procedure rule that have been put in place by the general governance rules as regarding enforcing directors liabilities through the legal systems. I therefore make the following recommendations.

The existence of the business judgement rule in deciding director’s liability narrows the chances of winning a derivative claim by shareholders. The rule devalues the duty of care, as is often use to grant relief to the director (Jones, 2007). As part of the recommendation of this study, this rule should be reconsidered as is the most instrumental tools that directors are using to shield from their responsibilities. Also bases for the definition of “good faith” and “honesty” should be established to everyone’s knowledge and understanding, it should not be left as a duty of the court to decide on what is “good faith” or “honesty” as the Judge might end up being subjective with his definition than being objective. With this shareholders would be able to know if the director acted in “good faith”’ or “honesty” before the filing of any proceedings against the director begin.

Litigation Expenses: the common idea in the United Kingdom is that the loser in the lawsuit pays the fees for the legal proceedings. This rule might discourage shareholders from trying to enforce any personal liabilities on the director’s due to the fact that they may end up paying the complete legal fee (both for the plaintiff and

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defendant) when unsuccessful. I recommend the system practice in the United State whereby each party pays his or her legal fees except in the case of a successful derivative suit where the company pays the legal expenses incurred by the shareholder. This should encourage the shareholders to embark on legal proceedings knowing that if unsuccessful they won’t be ask to pay for the directors legal expenses.

Enlighten the shareholders about their right; this might sound outrageous but is not a surprising thing that not all shareholders know about their legal right regarding the claim they can make against defaulting directors. Shareholders must be aware of these legal rights and the proper procedure to be engaged in enforcing director’s liabilities before they can be interested in holding director accountable for their actions. For instance in one of the cases cited above it was due to lack of proper filling of the case that resulted to the case been struck out by the court.

Shareholder activism should also be encourage among minority and majority shareholders as this would provide an avenue for the shareholders to be able to engage in legal actions against the directors of the companies when the need arises. This would also reduce the cost of individual shareholders lawsuit

In order to ensure director level of competence and to also reduce the possibilities of corporate failure in the banking sector, director should be made to undertake a competency exercise on a yearly basis.

4.3 CONCLUSION In conclusion, the companies Act 2006 provide they shareholders with the legal right to demand for the accountability of their mismanaged resources. This can be achieved via shareholder derivative sue. The share holders can on behalf of the company sue directors for the wrong the perceived must have be done to the company, in which case any benefit arising from the success of such lawsuit goes directly to the company except in cases of oppression whereby a redress is been sought by the affected individuals and in which case any benefit arising from the success of such case goes to the individual directly. But we must acknowledge the fact that although shareholders have this legal right, but enforcing it on the directors is often difficult, is something close to impossible as the court have to ensure that the

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director concern does not act in the company best interest and in honesty before any liability can be enforce on him. In cases whereby the shareholders are successful in the lawsuit the director may not have to personally pay for it as he must have been cover by insurance which was paid for with the same company’s funds

The shareholder can also explored other avenues of monitoring and enforcing disciplinary actions on the directors. An effective corporate governance monitors the actions of management and also aligns the interest of shareholders with that of the top management, thereby reducing the chances of conflict of interest. The management can also be control through remuneration plans as this directly affect their personal financial wealth, the remuneration committee ensures that management don’t get higher than expected but get the best they can get for their performance. Meanwhile the audit and nomination committee are effective in ensuring credibility to the financial statement and the selection of credible individuals into the board respectively.

But in situations where the shareholders observed that their interest is not well represented by top management other measure such as directors dismissal can be use to get rid of such misconduct director. This can be achieved through the passage of a resolution at a shareholders’ meeting which is usually conducted through voting. The success of this depends on the percentage of shareholders voting right hence large shareholder becomes very important in ensuring the success as well as the failure of such resolutions.

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