C-Org. forms + Investors & Stakeholders + Governance & Risk Flashcards
(34 cards)
1
Q
What are the key features that distinguish different organizational forms of businesses?
A
- Legal separation from the owner(s)
- Owner involvement in management
- Liability type (limited or unlimited) (separate entity or not)
- Tax treatment of profits/losses
- Access to capital and risk-sharing opportunities
2
Q
(1) What is a sole proprietorship and what are its main features?
A
- Business owned and operated by one individual
- Not a separate legal entity
- Unlimited liability for the owner (personally responsible)
- Profits taxed as personal income
- Limited scalability due to financing constraints
3
Q
(2) How does a general partnership differ from a sole proprietorship?
A
- Involves two or more owners
- Unlimited liability shared among partners
- Profits taxed as personal income
- Responsibilities defined by a partnership agreement
4
Q
(3) What defines a limited partnership?
A
- General partners: manage the business and have unlimited liability (active involvement)
- Limited partners: liability limited to investment, passive role
- Profits shared per agreement and taxed as personal income
5
Q
(4) What are the defining features of a corporation form?
A
- Separate legal entity from owners
- Shareholders have limited liability
- Ownership via shares
- May be subject to double taxation (corporate and dividend levels)
- Easy transfer of ownership through share trading
6
Q
What is double taxation and how does it affect shareholders?
A
- Corporation pays taxes on earnings
- Shareholders pay tax again on dividends received
- Effective tax burden depends on payout ratio
7
Q
How do public and private corporations differ in ownership and regulations?
A
- Public: shares listed on exchanges, high regulatory requirements, transparent pricing
- Private: shares not traded on exchange, limited investors, lower disclosure requirements, illiquid shares
8
Q
What are the methods through which a private company can become public?
A
- Initial Public Offering (IPO)
- Direct Listing: Doesn’t raise any new capital. (Quicker)
- Acquisition by a Special Purpose Acquisition Company (SPAC) (raise money with the sole purpose of making an acquisition without disclosing the company)
9
Q
What is ‘free float’ in the context of public companies?
A
- Portion of outstanding shares available for trading
- Excludes insider and strategic holdings
10
Q
What are the advantages of a corporate structure for large firms?
A
- Greater access to both debt and equity capital
- Limited liability for shareholders
- Separation of ownership and management enabling professional governance
11
Q
What is the difference in financial claims and motivations between lenders and shareholders?
A
- Lenders have a legal claim to interest and principal payments (higher priority). Focus more on the ability to repay
- Shareholders have a residual claim to net assets (after all obligations are paid). Focus more on the upside and expected return.
- Lenders have limited upside, while shareholders have unlimited upside potential.
- This difference can create conflicts of interest between the two groups.
12
Q
Who are the main stakeholder groups in a company according to stakeholder theory?
A
- Shareholders (residual interest)
- Debtholders (public bondholders and private lenders-access to private info)
- Board of Directors (inside directors and independent).
one-tier = everyone on the same level with criteria
two-tier = independent is supervising management board
Staggered board (portion of the board is re-elected each year) *the rest is usually for a specified term. - Senior management
- Employees
- Suppliers
- Customers
- Government and regulators
13
Q
How does stakeholder theory differ from shareholder theory?
A
- Shareholder theory: Focuses on maximizing shareholder value.
- Stakeholder theory: Aims to balance the interests of all stakeholder groups.
- Corporate governance under stakeholder theory addresses multiple conflict points beyond shareholders vs management.
14
Q
What are environmental factors considered by investors in ESG analysis?
A
- Climate change impact
- Pollution (air, water)
- Deforestation
- Energy efficiency
- Waste management
- Water scarcity
- Physical and transition risks due to environmental changes
- Risk of stranded assets
15
Q
What are social factors considered in ESG evaluations?
A
- Data privacy and security
- Customer satisfaction
- Employee engagement
- Diversity and inclusion
- Labor and community relations
- Impacts productivity, loyalty, and litigation risks
16
Q
What governance factors are evaluated under ESG?
A
- Board composition and independence
- Executive compensation
- Internal audit functions
- Bribery and corruption risks
- Political contributions and lobbying
- Systems to ensure ethical management in shareholders’ interest
17
Q
Why do investors consider ESG factors when analyzing corporate issuers?
A
- Regulatory shifts increase ESG relevance
- ESG factors can impact company performance and reputation
- To mitigate risks (legal, operational, reputational)
- Align with values of a growing base of socially conscious investors
18
Q
What are stranded assets in the context of ESG?
A
- Assets that lose value or become unusable due to regulatory, environmental, or market changes (e.g., coal plants becoming obsolete due to climate laws)
19
Q
How do ESG risks impact equity vs debt investors differently?
A
- Equity holders face full risk from adverse ESG outcomes.
- Debt holders are exposed mainly if ESG issues threaten debt repayment.
- Long-term debt holders may face greater ESG risk than short-term ones.
20
Q
What is a principal-agent relationship, and what types of conflicts can arise?
A
- A principal-agent relationship arises when one party (agent) is hired to act in the best interests of another (principal).
- Conflicts occur when the agent’s interests differ from the principal’s.
- Examples: inadequate risk-taking, self-dealing, information asymmetry, empire-building.
21
Q
What are common agency costs in principal-agent conflicts?
A
- Direct costs: monitoring expenditures (e.g., hiring auditors)
- Indirect costs: missed opportunities due to inefficient decisions or risk aversion
- Result from misalignment between manager and shareholder interests
22
Q
How can information asymmetry lead to governance problems?
A
- Managers have more information than shareholders
- Limits shareholders’ ability to assess decisions
- Enables self-interested actions, especially in complex or opaque businesses
23
Q
What are the three major types of stakeholder conflicts in corporate governance?
A
- Shareholders vs. managers: risk preferences, effort levels, compensation structures
- Minority shareholders vs. controlling shareholders: dual-class shares, self-dealing
- Shareholders vs. creditors: risk shifting, dividend payouts, debt issuance
24
Q
What is the role of the board of directors in governance?
A
- Acts in the interest of shareholders
- Selects and evaluates senior management
- Approves major strategic decisions
- Oversees financial reporting, internal controls, and risk management
- Ensures governance compliance
25
What governance mechanisms are available to shareholders to protect their interests?
- Proxy voting: Vote on key issues like board elections without being physically present.
- Board elections/removals: Elect or remove directors to influence management oversight.
- Shareholder activism: Push for changes in governance, strategy, or management via campaigns.
- Class-action lawsuits: Legal tool to address misconduct or breach of fiduciary duty.
- Poison pill: Defense tactic against hostile takeovers that dilutes acquiring party’s stake.
- Transparency requirements: Public firms must disclose material info, improving monitoring.
26
What governance mechanisms help creditors protect their interests?
Bond covenants: Legal restrictions to prevent actions that increase credit risk.
Credit rating monitoring: External assessment of creditworthiness alerts risk changes.
Collateral agreements: Credit is secured by assets to reduce loss risk.
Creditor committees: Represent collective interests in restructurings or bankruptcy.
Bankruptcy laws: Provide orderly process for asset claims and priority repayment.
27
What governance mechanisms are related to the board of directors and senior management?
Board of Directors: Elected by shareholders to oversee strategy, risk, performance, and appoint senior management.
Audit Committee: Oversees financial reporting, internal controls, and auditor independence.
Nominating/Governance Committee: Manages board nominations, ethics, and compliance.
Compensation Committee: Sets executive pay and evaluates management performance.
Risk Committee: Recommends risk tolerance and monitors firm-wide risk (where applicable).
CEO Succession Planning: Ensures continuity in leadership.
28
What governance mechanisms protect the interests of employees?
Labor laws: Ensure fair treatment, benefits, and safety standards.
Unions & collective bargaining: Empower employees to negotiate working conditions.
Whistleblower protection: Safeguards employees reporting misconduct.
Employee stock ownership plans (ESOPs): Align employee incentives with firm performance.
Board representation (in some jurisdictions): Allows employees a voice in governance.
29
What governance mechanisms protect customers and suppliers?
Contracts: Define deliverables, pricing, and responsibilities legally.
Consumer protection laws: Safeguard against fraud, defective products, and unfair practices.
Product safety standards: Enforce quality and safety regulations.
Supplier codes of conduct: Ensure ethical and sustainable practices in sourcing.
Dispute resolution mechanisms: Arbitration or mediation to resolve conflicts efficiently.
30
How do governments and regulators enforce governance standards?
Securities regulation: Mandates transparency, fair disclosure, and anti-fraud laws.
Corporate law: Defines fiduciary duties of directors and protects shareholder rights.
Stock exchange listing rules: Require corporate governance standards (e.g., board independence).
Audits & inspections: Verify compliance with accounting and legal standards.
Sanctions & penalties: Enforce rules through fines, suspensions, or legal action.
31
What are the different ways shareholders may experience takeovers?
- Proxy Contest: Shareholders attempt to gain control by voting in a new board of directors.
- Tender Offer: Acquirer offers to buy shares directly from shareholders, usually at a premium.
- Open Market Purchase: Acquirer accumulates shares over time in the market to gain control.
- Negotiated Merger or Acquisition: Target company’s board negotiates with the acquirer and seeks shareholder approval.
- Hostile Takeover: Acquisition attempt made without target board approval, often via tender offer or proxy contest.
- Poison Pill (Shareholder Rights Plan): A defensive tactic used by target firms; allows existing shareholders (except the acquirer) to buy additional shares at a discount, making the takeover more expensive and dilutive to the acquirer.
32
What are the risks of poor corporate governance?
- Accounting fraud
- Legal and reputational risk
- Poor decision-making from misaligned incentives
- Increased risk of default or bankruptcy
- Value destruction for shareholders
33
What are the benefits of strong governance and stakeholder management?
- Better alignment of interests
- Reduced risk of default and legal issues
- Improved financial and operational performance
- Enhanced firm value
- Lower cost of capital
34
How do activist shareholders influence corporate governance?
- Propose changes to board or strategy
- Launch proxy contests or tender offers
- Raise issues publicly to influence other investors
- Can lead to replacement of managers or board members
