Lecture 4 Flashcards
(36 cards)
Balance sheet of a firm
Snapshot of the financial assets and liabilities of a firm on the reporting date
Corporate finance studies how a firm finances its investment and business activities
typically a firm finances in one of the following ways
Investment from shareholders
Borrowing from creditors
Using short term resources from suppliers and employees
Equity
A financing tool (normally in forms of common shares, ownership)
Has residual claim (low priority) on the firms free cash flow
Has no fixed maturity and rate of return (soft budget contraint)
Shareholders can vot on company strategies and hiring and firing of management
Debt
A financing tool (normally in the forms of bank loans, bonds and commercial papers)
Is a contractual priority claim on the firms cash flows than equity
Has a fixed maturity date and predetermined interest rate
Has tax deductibility on interest payments
Creditors have no voting rights over the firms strategies
Has different senioriteis:
senior debt , subordinate and junior
Conflicts of interest arise in several ways:
1) disagree on investemnt projects and risk taking
Creditors prefer safe projects while shareholders prefer risky projects
2) Disagree on project finance
When financing new projects, shareholders prefer to issue new debts, while creditors are concerned about their seniority in the debt claims
3) Disagree on dividend polity
Shareholders prefer higher dividend while creditors want to be paid first
how many types of shareholders are there
Small individual investors:
dispersed, small stake and high turnover
Large shareholders/institutional shareholders:
Banks (acquire ownership via proxy voting - delegated by other shareholders to attend voting on their behalf)
Private equity
Assets managers:
pension funds, insurance companies, mutual funds and hedge funds
What are the control/voting rights (shareholders and corporate governance)
To vote on major investment decision
To appoint board of directors and CEO and executive compensation
To vote in case of liquidation of the companys assets
To vote on auditor ratification
is there any value in voting rights
Empirical studies show that shares with voting rights are traded at a premium to normal shares 45-100% on slide
shareholders incentive to actively control:
Small investors:
lack of expertise
Costly: many legislations require shareholders to attend voting personally
Hard to coordinate with dispersed ownership
Free riding problem
Concentraded investors/institutional investors:
Have the incentive and the capacity (experise and manpower) to collect information and control
Have bargaining power to influencem anagement
Institutional investors can easily sell their shares if they are unhappy with the management, leaving the problem unsolvd
Selling may not work if having too much staek or invested in index
But it also depends on the degree of legal protection in a country
INstitutional investors have stewardship role towards their clients
Responsible allocation, management and oversight of capital to create long-term value for clients, leading to substainable benefits for the economy, the environment and society
Legal and ethical obligations towards investors
Active ownership via voting and engagement
How institutional investors invest:
no engagement with management
Passive investing: track index
Negative screening: avoid firms, industries with poor financial/ESG performance
Positive screening: seeking best performers and include those in the portfolio
How institutional investors invest:
Engaging management
Corporate governance issues (CEO, board seats, divestment etc.)
Environemtnal and social issues on the rise
Ways to influence:
Collaborate with other institutional investors
private negotiations with management on ESG, corporate governance issues (most frequent, effective and not observable)
Threat to divest
Most institutional investors rely on proxy advisory firms:
key functions
Research on corporate governance and executive compensation
Publish guidelines on shareholder voting
Proxy advisory firms:
Challenges
Market dominance (top two counts for 97%)
Conflict of interest (proxy firms also work with issuer and investors)
Untraparent guidelines
shareholder activism
A shareholder activist is a shareholder who uses his or her equity stake to bring change withing the company
Key plays (shareholder activism):
pension funds
Mutual funds are regulated investement funds offered to the public and availbale for daily trading
Key plays (shareholder activism)
hedge funds
Pooled investemnt funds for accredited investors that make extensive use of risky investment strategies like short selling, leverage and derivatives to achieve high returns
Shareholder activism
Motivation
Financial performance: reduce cost divestment, strategic M&A, divident policy
Governance quality: board composition, compensation, provisions etc.
Esg practices: labor rights, environmental impacts
Shareholder activism: approach
Acquire 10% shares or less to gain a board seat of a company
Shareholder engagement - private dialogues
Shareholder proposals (to be voted at annual general meeting)
Vote no campaign
Proxy contest
Shareholder proposals
SEC shareholder proposal rule 14a-8 allowed shareholders to file proposals (proxy) to be voted at annual general meeting
Proposals may be filed after private negotiations failed
More ESG proposals are being voted on
Proposals getting majority voting results are not binding for the management
Proxy voting
During the proxy seasons (april-june) public companies hold general annual meetings:
Management prepare proxy statement, providing voting guidelines for shareholders before annual meetings
Shareholders, activist file proxy proposals on corporate governance, ESG, and other issues before meeting
Historically most shareholder proposals were not passed, or not implemented after passing
In recent years, the number of ESG proposals increase significantly and are often supported by shareholders
Shareholder activism example
Activist investor christopher hohn, founder of childrens investment fund, targeted abm amro in 2007 that lead to the sale of the bank
Annual proxy statements of companies before annual general meetings dislcosure about:
Executive compensation
Nomination of board of directors
Ratification of auditors
(Proposals from management and shareholders, voting procedures and voting guidelines for shareholders)
Proxy fight
A dissident shareholder fights against management adn tries to persuade the other shareholders
Its a costly undertaking because:
Free-riding probblem: dissident shareholder incurs huge costs launching proxy fight while other shareholders benefit from the success of the proxy fight.
Incumbent management more likely to get votes
Incumbent management can use company funds to promote themselves
