1. Definitions And Issues Flashcards
(15 cards)
What happened in the Polly Peck case?
PP was a UK listed company that was placed into administration in October 1990. The chair and CEO was Asil Nadir who also owned 58% shares. He was frustrated with the low price-earnings ratio and announced he was bringing the company private. 5 days later he withdrew the claim leading to a drop in share price following which the company went into administration and liquidity problems. Following the collapse he was sentenced to 10 years in prison but only served one day in Turkey.
What is governance?
Seeing that a company or country is managed properly and to the highest level. Management is the running, governance is seeing that it’s ran properly
What are the two main theories of co.gov?
The Shareholder primacy Theory (and related to this the agency theory) which forms the basis of the shareholder value approach AND the Stakeholder theory which forms the basis of the stakeholder approach.
What is the Shareholder Primacy Approach
Considers maximizing value to SHs before considering other corporate stakeholders such as employees, customers etc.Its based on the promise that SHs own companies and directors, managers and employees are engaged by the company for the purpose of maximizing SH wealth.
What is the average share holding period?
There is evidence that there has been a decline in both UK and US from 6 years in 1950 to six months in 2010. Evidence that SHs are investing more in shares as a traded commodity.
What is the Agency Theory?
The agency theory was developed in 1932 by Berle and Means. The agency principal relationship exists when an agent represents that the principal in a particular transaction and is expected to represent the best interest of the principal above their own. Jensen and Meckling argued that this existed in companies where there was a separation of ownership and control, SHs being the principal, directors being the agent. In such a scenario issues exist due to conflicts of interest
What is “Agency Conflict”?
Agency conflict arises when the principal and agent have differing opinions. The main conflict between SHs and managers is as follows:
- SHs want to see wealth growth year on year
- directors and managers will be looking at more short term annual increases.
Meckling and Jensen identified four areas of conflict:
- moral hazard
-level of effort
- Earnings retention. This is often related to the size of the company rather than profit. This incentives managers and directors to grow the headcount
- Time Horizon: SHs look at long term whereas managers might only look at short term partly because of annual bonuses etc.
Agency theory states that companies should use corporate governance to manage these conflicts which can be achieved as follows:
- the use of long term incentive share award or stock options schemes based on total Sh return
- adoption of conflict of interest and related party transaction policy.
What are considered Agency Costs?
It is argued that agency theory appears to focus exclusively on maintaining value for SHs thereby focusing on short termism. Blair (1995) goes on to argue that “what is optimal for SHs often is not optimal for the rest of society. That is the corporate policies that generate the most wealth for SHs may not be policies that generate the greatest wealth for society.
What is Stakeholder Theory?
Is in direct contrast to Shareholder Primacy Theory, and states that the purpose of corporate governance should be to meet the objectives of everyone that has an interest in the company.
Stakeholder theory also states that companies should act as good corporate citizens when making decisions and carrying out activities. Companies should be accountable to society and should conduct their activities to the benefit of society. This aspect of the stakeholder theory forms the basis of arguments in favor of corporate social and environmental responsibility.
Test yourself
What is the main difference between the agency and stakeholder theories?
How do they affect the objectives of companies?
How can a company manage conflicts of interest between shareholders and directors and managers?
Approaches to corporate governance
- Shareholder value approach
- Stakeholder approach
- Inclusive shareholder approach
- Enlightened shareholder value approach
What is Shareholder Value approach?
SH value approach to corporate governance states that the board of directors should govern their company in the best interests of the owners, the SHs. The main objective is to maximize the wealth of a company’s SHs through share price growth and dividend payments, while conforming to the rules of society as embedded in laws and customs.
Non-corporates can also adopt an investor value approach to their governance
What is Stakeholder approach
The stakeholder or pluralist approach to corporate governance states that companies should have regard to the views of all stakeholders, not just SHs
This approach is also reflected in the New Partnership for Africa’s Developments definition of corporate governance, which states that co gov is concerned with achieving a balance between economic and social goals and between individual and communal goals.
Opponents of the SA argue that if companies were to take into account all Stakeholders conflicting views, they would never come to a decision. However, there is no direct evidence that one approach is superior to the other in terms of the success of the organization.
Inclusive Stakeholder Approach
The supporters of this approach believe that the BOD should consider the legitimate interests and expectations of key stakeholders in the basis that it is in the best interests of the company.
The best interests of the company are defined by the Institute of Directors for South African, King Code of Governance, not in terms of maximizing shareholder value but “within the parameters of the company as a sustainable enterprise and the company as a corporate citizen.
What is the Enlightened Shareholder Value Approach?
The enlightened SH value approach proposes that boards, when considering actions to maximize SH value, should look to the long term as well as the short term, and consider the views of and impact on other Stakeholders in the company, not just SHs.
The enlightened shareholder value approach was introduced in the UK by the acompanies Act 2006, which imposed a statutory duty on directors to “promote the success of the company for the benefit of its members as a whole and in doing so have regard to (among other matters):
- consequences of a decision long term
- interest of the company employees
- need to act fairly between members
- reputation for high business standards
