Chapter 3

Question 1

Definition

Answer 1

• A Corporate Governance System is a set of mechanisms, institutions, and practices used to solve or mitigate these conflicts of interests

o These mechanisms could be either internal or external to the firm

o We can compare Corporate Governance Systems within and between countries

Question 2

Market vs Bank based

Answer 2

Question 3

Outsider vs Insider

Answer 3

Question 4

Validity of different Classifications

Answer 4

Question 5

Social Implication of common ownership

Answer 5

Due to their common ownership, owners have incentives to reduce competition and create monopoly
structures, leading to a deadweight loss for the economy

− Azar et al. (2018) investigate ownership structures and product market competition in the US airline industry

Find evidence of a relation between within-route changes in common ownership concentration and route-level changes in ticket prices

Anticompetitive behavior of common ownership is limited to specific examples, but not a general matter of concern

Question 6

Empirical Evidence for Corporate Governance Mechanisms – Dividends

Answer 6

Dividend policy is more flexible in insider system
− Firms are less reluctant to cut/omit dividends when profits are down temporarily
− Goergen et al. (2005) find that German firms controlled by banks cut/omit their dividends even more frequently
− Andres et al. (2009) show that compared to the UK and US, German dividends are more volatile, and dividend omissions/cuts occur more frequently

Managers in the outsider system commit to high dividends
− Free cash flows are limited
− Less funds for empire building
− Firms raise external funds periodically and face scrutiny of capital market (Easterbrook 1984)

Question 7

Empirical Evidence for Corporate Governance Mechanisms – Boards

Answer 7

Boards of directors are to ensure that managers maximize shareholder value
− Duties are the hiring and firing of managers and monitoring and compensating management
− One-tiered (e.g., US) vs. two-tiered (e.g., Germany) board structure
− In Germany, employees have the right to be represented on the board (the Co-determination Law
 Consistent with Franks and Mayer’s (2001) description of the insider system

Bankers on the board  Banks used to hold 11 percent of the seats and 26 percent of the chairmanships in German companies (Franks and Mayer 2001)
− Kroszner and Strahan (2001) find that 75 percent of German firms have at least one banker on the board compared to 53 percent of Japanese firms, and only 32 percent of U.S. firms
 Monitoring role vs. creating new agency problem – changes in the role of banks in Germany

Question 8

Cross-Border Mergers and Acquisitions

Answer 8

− Firms may improve their corporate governance and access to capital via cross-border mergers and acquisitions
− Question of whether the target benefits from the stronger corporate governance of the bidder or vice versa (Martynova and Renneboog, 2008)

• Positive spillover effect if a bidder with better corporate governance improves the corporate governance of the target
• Negative spillover effect if a bidder with weaker corporate governance reduces that of the target
   The opposite of the latter is the bootstrapping effect

Empirical evidence suggests that:
- Targets in cross-border acquisitions tend to be from countries with weak corporate governance
- Targets with better shareholder protection require a higher premium when being taken over by bidders with weaker governance ( increased risk)
- Targets tend to benefit from being taken over by a bidder with better governance, but bidders lose value when taking over weaker targets ( positive spillover)

Question 9

Cross-Listings

Answer 9

− According to the bonding hypothesis (Coffee 1999, 2002), firms from weaker corporate governance regimes cross-list on the US market to credibly signal to commit to higher governance and disclosure standards
 If the bonding hypothesis holds, cross-listed firms will trade at a premium
- Virtually all of the empirical finance literature focuses on firms cross-listing in the US
- Studies find strong support for the bonding hypothesis:
- Firms based in countries with weak investor protection tend to cross-list on better markets to signal good
governance / high degree of disclosure
- However, the US Sarbanes-Oxley Act of 2002 seems to have changed investors’ and academics’ views on the benefits from cross-listings
- While SOX may benefit some firms, it generates significant costs, outweighing in many cases the benefits from a US cross-listing (e.g., Zingales 2007