Class 12 - VC activism and compensation

Question 1

what is governance

Answer 1

“ways in which the suppliers of finance to corporations assure themselves of getting a return on their investment.”

thats what governance is all about, ensuring you get the return on your investment. you want to maximize the change you get the fair return you are entitlted to

takes the shareholders perspective. he does not discuss the morality of business management

in order to solve the agency problem, you can insight the management to do what you want them to do, incentivize them (options), or control them with board

but you can also imply that good management would be good for them because its the right thing to do : but thats the not the way he tackles the problem

Question 2

what is the fundamental issue

Answer 2

Lack of transparency

if the investors had full access to how its managed, there woulnd be agency problem pcq il verrait comme cest géré
le probleme cest quil y a de lasymétrie dinformation, les managers savent des choses et peuvent agir en fonction de ces informations

Question 3

2 types of solutions

Answer 3

Incentives
Monitoring

with the right incentives, the mgnt will have the same interests of the investors : allignment of interests

if you can get involve, you will have a say and thus will be able to monitor the company (not able for public companies)

Question 4

incentives

Answer 4

• Monetary incentives
  if shareholders want the stock price to go up, if managers are payed with optinosn, they will also have that interests.

Do stock options encourage undue risk-taking?
par contre incite a prendre plus de risque pcq on un upside et pas de downside

value is greater when there a lot of vol

Is it better for executives to own stocks rather than stock options?
not obvious

its better to own stocks than options pcq that way they are exposed to the downside.

• Dismissal
  the managers dont want to be dismissed! so they have an incentive to keep the investors interests in mind
• Takeovers
• Bankruptcy

Question 5

What is the importance of stock option plans, and other forms of compensation in companies funded by VCs?

Answer 5

the management of companies that vc funds invest in have a lot portion of the equity of the company so they are exposed to the upside and the downside, and highly motivated so its different than stock options

but small innovative companies ressemble to stock options

but theres an allignement of interests because they have a large portion of equity, and therefore work with the interests of the investors in mind

Question 6

monitoring

Answer 6

the thighter the financial constraints (difficulté davoir du financemnet), they will accept concessions and give a lot of rights to the vc investors

Question 7

Does the relationship between the tight control VCs exert and the concessions that corporate executives are willing to make hold true?

Answer 7

oui, on besoin de financement donc vont vonner aux investisseurs plein de clauses quils aiment

Question 8

types of monitoring

Answer 8

active :
Prospective information (forward looking)
Participate in the value creation effort (the management of the firm)
for providers of capital that have a say in the company. they have access to the information

they willl have an active role in the management of the firm

speculative :
the invesotrs will only be able to look backward, they wont have access to the forecast numbers. they wont have access to the inside information (any invesotr of the stock market is in that position)
they are speculating as to how will the company look in the future
passive form of controle

Question 9

role of C.A

Answer 9

The center of attention for governance enthusiasts!
The problem with the board members

→ Independence of directors

considered as to representing the shareholders of the company

the board is not a perfect solution beucause some are not indepent.

board decisions cant be reviewed by a court of law

if the board makes a wrong decision that has an impact on the value of the firm, they cant be sued for a wrong decision. some decisions are bad but that does not give the right to be sued. the board is on its own to the mangement of the company

Question 10

What kind of control do VCs exercise?

Answer 10

active monitoring : they have to seek control, require some sort of control over the company

vc managers are active. they will give themselves rights that consolidate their management of the company. they give themselve a level of control

Question 11

Position of the management of the firms

Answer 11

To constrain investor activism
they dont want the investors to involved, they want activism restricted
fund managers are agents , they have to monitor, but they also monitor vc fund managers.

Question 12

Are VC fund managers themselves subject to control by investors entrusting them with capital?

Answer 12

yes, lp agreement has different types of controls

Question 13

Distinction between legal traditions

Answer 13

the better the country is organized to facilitate raising capital, the better the investors will be

designed to protect property rights and investments
they want to make sure that investors will get their investment return
other jurisdiction is more based on commercial banking thinking

vc funds will rather be in jurisdiction that control property rights

common law is defined on principles rather than specific norms

civil norm : explicit norms estalished in the civil code

common law contries protect more invesotsr and attract more investors

in the us, shareholding is spread out, generelly the control is spread out
presence of institutionnal presence, provide adequate level of protection

Question 14

Do the characteristics of the legal system in which the VCs find themselves matter?

Answer 14

yes, studies show gains done in ivnestment in common law countries

Question 15

“Formal control is enjoyed by (…) a venture capitalist with explicit control rights over a start-up company”

(p. 36)
Question
What formal control mechanisms do VCs have? Examples?

Answer 15

vc give themselve explicit control rights

Question 16

“… illiquidity, promoted, say, by privately placed equity, large blocks with limited marketability (…) equity with limited resale rights, would enhance the quality of monitoring.”

Would the relationship between liquidity and control hold true for VCs?

Answer 16

when an invesotr invest in a company, theres not liquidity so they cant resell easily, hence they will involve themselves

Question 17

“Active monitoring requires a long-term involvement; (…) properly structuring the active monitor’s incentive may entail some illiquidity costs.”

Would the costs associated with the lack of liquidity be offset by appropriate incentives among VCs?

Answer 17

nature of vc investmets to be illliquid, so active mngt counterbalances the illiquidity

Question 18

“There may be over monitoring and a reduction in initiative (…) and the firm’s managers may become overly preoccupied by short-term news that will determine their tenure in the firm.”

Can the level of control exercised by VCs be a problem?

Answer 18

if you monitor too much your entrepreneurs, they wont be able to do what atually brings value.