Lecture 2 Flashcards
(10 cards)
Outline what Adverse Selection, Signaling, and Moral Hazard are
Define Corporate Governance
The system of controls, regulations, and incentives designed to minimize agency costs between managers and investors and prevent corporate fraud
Please differentiate between owner-manager conflicts and intra-shareholder conflicts
Owner-manager conflicts: Conflict between the company’s equity owners and the company’s senior management
Intra-shareholder conflict: Conflict between equity owners who hold controlling shares and equity owners who own noncontrolling shares in the company
What are some examples of agency costs?
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
Extravagant investments:
-Pet projects / empire building (large non-core investments)
-large acquisitions by managers despite shareholder concerns
-Firms which earn windfall cash returns in court spend it inefficiently
Entrenchment strategies:
-Managers may invest in projects which make them indispensable
-Creative accounting techniques to ‘improve’ performance
Self-dealing:
-Perk consumption: P-jet, plush offices, private boxes at events etc.
-Successors being friends and like-minded individuals
What advantages do institutional investors have over individual investors in corporate governance?
How do institutional investors influence corporate decision-making and governance structures?
Institutional investors have greater financial resources, access to management, ability to influence board decisions, and voting power in shareholder meetings.
They vote on key issues, engage in shareholder activism, monitor management performance, and push for changes in corporate policies, executive compensation, and strategic direction.
What is the Sarbanes-Oxley Act (SOX)?
The overall intent of SOX was to improve the accuracy of information given to both boards and to shareholders
SOX attempted to achieve its goal in three ways:
1. By overhauling incentives and independence in the auditing process
2. By stiffening penalties for providing false information
3. By forcing companies to validate their internal financial control processes
-Mandates fully independent audit committees
-This law also regulates auditors and mandates auditor review of disclosures about a company’s control systems
Types of directors
Inside directors:
Members of a board of directors who are employees, former employees, or a family members of employees
Gray 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 (independent) directors:
-Any member of a board of directors other than an inside or gray director
Staggered board
In many companies, a board of directors whose three-year terms are staggered so that only one-third of the directors are up for election each year
Please list some other monitors
Security analysts, lenders, the SEC, and employees
Proxy Contests
Disgruntled shareholders can hold a proxy contest and introduce a rival slate of directors for election to the board
