Final exam Flashcards
(82 cards)
What is corporate governance?
- The system of controls, regulations, and incentives designed to minimize agency costs between managers and investors and prevent corporate fraud
- The role of the corporate governance system is to mitigate the conflict of interest that results from the separation of ownership and control without unduly burdening managers with the risk of the firm.
What makes bonitoring by the Boards of Directors effective?
✅ What Makes a Board Effective?
Independence: Majority of directors should be independent from management.
Expertise: Members with financial, legal, or industry-specific knowledge.
Committees: Audit, compensation, and governance committees ensure more focused oversight.
Diversity: Broader perspectives lead to more balanced decision-making.
📌 In short:
Monitoring by the board is a critical check on managerial power and a cornerstone of accountability in corporate governance.
Role of compensation policies regarding governance
To incentivize managers to act in the best interests of shareholders, rather than prioritizing their own short-term gains, job security, or perks.
- Performance-Based Pay
Ties executive compensation to firm performance (e.g., EPS, ROE, stock price).
Aligns management’s rewards with the company’s success.
🟢 Example: A CEO gets a bonus only if net income increases by 10%.
- Equity Compensation (e.g., Stock Options or RSUs)
Gives managers a direct stake in the company.
Encourages long-term value creation, since the value of their holdings depends on share price growth.
🟢 Example: Executives are awarded stock options that vest over 4 years.
What are direct actions that can be taken by shareholders in the context of governance?
Vote at AGM - Approve or reject key decisions
File resolutions - Influence policies and transparency
Activism - Push for operational or strategic change
Proxy fights - Replace board members
Litigation - Enforce accountability
Selling shares - Signal dissatisfaction
What is the Sarbanes-Oxley act and what did it set out to achieve?
Cadbury Commission and its key recommendations?
Following the collapse of some large public companies, the U.K. government commissioned Sir Adrian Cadbury to form a committee to develop a code of best practices in corporate governance.
Triggered by: Major corporate scandals in the UK in the late 1980s and early 1990s — e.g., Polly Peck, BCCI, Maxwell Communications, where poor board oversight and weak financial controls led to fraud or collapse
Separation of Roles
Clear division between the Chairman and the CEO roles to avoid concentration of power.
Board Structure
Boards should include a majority of non-executive directors (NEDs), some of whom must be independent.
Audit Committees
Companies should have an independent audit committee to oversee financial reporting.
Internal Controls
Directors must maintain a system of internal controls and report on its effectiveness.
Code of Best Practice
Introduced a voluntary code (the Cadbury Code) for companies to follow, on a “comply or explain” basis.
Dodd-Frank Act
Dodd-Frank added a number of new regulations designed to strengthen corporate governance, including
Independent Compensation Committees
Nominating Directors
Vote on Executive Pay and Golden Parachutes
Clawback Provisions
Pay Disclosure
What are the two types of conflict of interest?
Who wrote about Agency costs?
Jensen 1986
What are four types of agency costs? (references as well)
Insufficient effort
* Not hours spent at work but the allocation of these hours to various tasks
* Cost cutting not done enough or frequently
* Insufficient effort on oversight of sub-ordinates → large losses inflicted by traders (Amaranth Advisors, LME/China State Reserve Bureau)
Extravagant investments
* Pet projects / empire building: large non-core investments by oil companies in the 1970s (Jensen (1988))
* Large acquisitions by managers despite shareholder concerns (Shleifer and Vishny (1997), Andrade et al. (2001))
* Firms which earn windfall cash returns in court spend it inefficiently (Blanchard et al. (1994))
Entrenchment strategies
* Managers may invest in projects which make them indispensable (Shleifer and Vishny (1989))
* “Creative” accounting techniques to make performance look better than it truly is
* Excessive risk-taking or insufficient risk-taking
* Managers routinely resist hostile takeovers as this threatens their long term positions
* Managers may lobby for environments that limit shareholder activism, design complex ownership patterns to make it harder for outsiders to gain control
Self-dealing
* Perk consumption
* Costly private jets, plush offices, private boxes at events etc.
* Pick successors among their friends or like-minded individuals
* Business based on past relationships
* Finance political parties of their liking
* More examples
* RJR Nabisco’s fleet of 10 aircrafts with 36 company pilots to which the CEO, his friends and HIS DOG had access (Burrough and Helyar (1990))
* CEO of Tyco Inc. and close collaborators are assessed to have stolen over $100 million
What is tunneling?
A conflict of interest that arises when a shareholder who has a controlling interest in multiple firms moves profits (and hence dividends) away from companies in which he has relatively less cash flow toward firms in which he has relatively more cash flow rights (“up the pyramid”)
Tradeoff of Corporate governance
Corporate governance is a system of checks and balances that trades off costs and benefits.
* This trade-off is very complicated. No one structure works for all firms.
* Good governance is value enhancing and is something investors in the firm should strive for.
List the three types of directors
Inside directors:
Members of a board of directors who are employees, former employees, or family members of employees
Grey directors:
Members of a board of directors who are not as directly connected to the firm as insiders are, but who have existing or potential business relationships with the firm
Outside directors:
Any member of a board of directors other than an inside or gray director
Distinguish between formal and real control
Formal control
* Family owner with a majority of the voting shares
* VC with explicit control rights
Real control
* Minority owner who can persuade other owners of the need for intervention
* The extent to which a minority owner can persuade others depends on
* Ease of communication and coalition building
* Similarity of interests
Proxy fights + also provide examples
Distinguish between ownership structures in Anglo-Saxon countries and France, Germany and Japan
What are two types of information?
Equityholders acting on news:
Shareholders read about bad earnings results or scandals after they occur.
They respond by selling shares (if bad news) or buying shares (if good news).
But they don’t engage in governance — they aren’t trying to change management or policy.
Think of this as reactive trading, not proactive engagement.
Debtholders reacting to bad news:
If a firm faces credit concerns, bondholders or lenders may pull back funding (e.g., in the commercial paper market).
Again, this response is after the event, not aimed at changing future behavior.
❗ Why It Matters in Governance:
Retrospective information highlights a passive form of oversight. While markets may punish a firm for poor decisions, there’s no guarantee that the feedback will be used to improve governance. That’s why prospective information and active monitoring (e.g., by engaged shareholders or independent directors) are generally more effective at shaping good outcomes.
Please outline how active and passive monitors use information
Outline the role and costs of active monitors
What are the limits of active monitoring?
Who monitors the monitor?
- Cost of providing right incentives to the monitor
Long-term players are more likely to be good monitors
Imposing illiquidity such as private placed equity, taxes on capital gains, or equity with limited resale rights can improve
monitor’s incentives
Congruence with other investors
* Undermonitoring : US pension funds only 1% to 2% of total shareholding of firms have very little incentive to acquire
strategic information about these firms and launch a proxy fight
* Collusion with management: a monitor may enter a quid pro quo with management or be afraid of retaliation if he / she doesn’t
* Self-dealing: Large blockholders may use their private information to extract rents for themselves such as transactions
with affiliate firms which benefit them
Effect on the monitorees
* Over-monitoring can lead to a reduction in manager’s initiative
* Managers may devote more time to earnings management and trying to secure the cooperation of the largest institutional investors
Legal and fiscal obstacles
* Stockholders who sit on a firm’s boards are subject to classaction lawsuits
* Face volume and holding-period restrictions when reselling shares
* Diversification rule: to receive favorable tax treatment, a fund cannot hold more than 10% of the stock of any firm
- What type of a monitor is Trian / Nelson Peltz? Explain with evidence to support your answer.
- Enumerate the reasons why you think Trian may /may not be able to create value within Disney.
Active entrant monitor - activist hedge fund manager
Various arguments both for an agaist Trian being able to provide value within Disney.
Arguments for:
Proven track record (P&G and others)
🧩 2. Reasons Trian may be able to create value at Disney:
✅ A. Governance Pressure
Trian has a history of improving board discipline and focus (e.g., P&G, Mondelez).
Might lead to more accountability in areas where Disney has been criticized (e.g., CEO succession).
✅ B. Strategic Focus
Disney’s content and streaming strategy has lacked clarity.
Trian might push for sharper operational efficiency and streamlining, possibly by influencing Hulu/ESPN strategy or capital allocation.
✅ C. Capital Efficiency
Trian often advocates for cost control and return on invested capital (ROIC).
Could steer Disney toward more disciplined investment, especially in capex-heavy ventures like Disney+.
✅ D. Market Signaling
Even without a board seat, activist pressure can signal to other investors that governance is being taken seriously — potentially lifting confidence (and valuation)
⚠️ 3. Reasons Trian may not create value at Disney:
❌ A. Lack of Industry Expertise
Disney is a complex creative enterprise (media, entertainment, IP, theme parks).
Trian’s financial engineering style may be ill-suited to an IP-driven, innovation-heavy business.
❌ B. Management Distrust
Pushback from Disney’s board suggests they see Trian as disruptive.
Without cooperation, value creation could be hindered by boardroom conflict or distraction.
❌ C. No Guaranteed Plan
Peltz’s 2023 Disney campaign was criticized for being vague (e.g., “we want better capital allocation” without specific suggestions).
That weakens the case for clear, implementable improvements.
❌ D. Market Conditions
Disney’s challenges (e.g., streaming profitability, ad markets, park margins) may not be fixable through governance tweaks alone.
What is hedge fund activism?
- Hedge fund activism: A strategy in which a hedge fund purchases a 5% or greater stake in a publicly traded firm with the stated intent of influencing firm policies.
- The 5% purchase triggers the filing of SEC schedule 13D, which reveals the identity of the buyer, the target firm, the stake in the company and the “purpose” for the purchase.
What is the average abnormal return following the 13D announcement?
10.3% and dividends tend to double in the year following the initial stake
What are typical demands of an activist hedge fund?
- Payout of excess cash
- Getting a board seat
- Divestitures
- CEO replacements
- Preventing an ongoing merger, or force the firm to be taken over by another entity
