Lesson 2 Flashcards
(27 cards)
2 general function of corporate law
1 establishment of corporate form as well as auxiliary housekeeping rules necessary to support its structure
2 attempts to control conflicts or interest among corporate actors
- insiders (controlling shareholder and top managers) vs outsiders (minority shareholders and creditors)
-agency problem: when hiring someone to act on your behalf you need to make sure they don’t act in their own interest
3 types of agency problems
1 between firms owner (principal) and hired manager (agents) - owners interest should come before personal interest
2 owners w majority controlling interest (agent) and non controlling owners (primcipals) - minority not being expropriated by majority whenever majority can make thecision that impacts also minority
3 between firm and its owners (agent) and parties w whom the firm contracts (principal) - incl suppliers, employees, etc
#make sure that the firm doesn’t behave opportunistically
Principal and multiple principals
People who are supposed to control the agent
Multiple: many different principals, w many ideas and so on
Multiple principals’ issues
- Information and coordination cost - dispersion of infos whenever there is many people
- Delegating more to the agent (manager/bom) - in terms of power
- Uncharitable of expectations lead to difficulty for agent in doing the right thing
- Trade off: coordination costs (organization) vs agency problem (leaving freedom to agency, at ur own risk)
Legal strategies for reducing agency costs
Basic set of strategy to reduce the vulnerability of principals to the opportunism of agents
1 mandatory rule
2 default rule
3 one rule among a menu of rules
4 contracting
The whole set is divided in regulatory or governance strategies
Regulatory strategies
Prescriptive
Direct constraint of agents behavior via legal provisions that govern the content of the principal agent relationship (law itself puts rules on what the agent can and cannot do)
-need of external authority to monitor, decide if it was lawful and enforce penalties when needed
The authority needs to have enough expertise and be able to judge complex behavior
Governance strategy
Aims at facilitating the principal’s control over agency behavior
-depends on ability of principal to exercise control rights (control mechanisms) over agency
But coordination costs negatively related to efficiency of gov strategy: ex few vs dispersed shareholders
Legal strategies
Use of law instrumentally, in a functional way: mitigate vulnerability of principals to opportunism of agents behavior via
1 rules and standards
2 setting terms of entry and exit
3 trusteeship and reward
4 selection and removal
5 initiation and ratification
6 ex posts and ex ante strategies
Rules and standards
Regulatory strategy: constraining agents via rule and laws that command them not to harm the interest of their principals
1 rules: require or prohibit specific behaviors
2 standards: general expectations (more flexible and lest foreseeable - judged after the fact) of compliance - ex of reasonable person standard etc.
Setting the terms of entry and exit
Regulate the terms on which principals affiliate with agents and regulate the actions of agents when the relationship principal-agent is established - rules and standards
Terms of entry - require agents to disclose infos
Exit opportunities: as a shareholder u can sell ur stocks, as a creditor u can ask for a direct repayment
Entry strategy
Screening out opportunistic agents in public capital market
(Disclosure of infos rule)
Exit strategy
Right to withdraw the value (appraisal right = ask for a fair evaluation) someone’s investment
Right to transfer (sell ur shares)
Incentive alignment strategy: trusteeship and reward
Trusteeship strategy: remove conflicts of interest ex ante to make sure the agent has no personal interest in disserving their principals
Incentive: money (high power) and reputation (low power)
Reward strategy: reward agents for successfully advancing principals’ interests
Sharing rule: agent’s earning directly tied to principal’s earnings
(Ex: pro data dividend distribution - dividends proportional to their ownership)
Pay for performance regime: payment based on how well they do
-reward systems not legally required but either encouraged or discouraged: us stock option plan (employees get the chance to buy stocks at a fixed price, in order for them to make a profit when they resell them at a higher market price)
Examples of trusteeship
1 independent director - no involvement w corporation, no day 2 day inclusion ensure a fair oversee
2 auditor: motivated by reputation
3 court : gives legal approval for company decisions + ensures legality and fairness
Tension between trusteeship and reward
Call for equilibrium between enough money to make sure they work well and not too much to sideline low powered incentives
Appointment right strategy: selection and removal
Power to remove or select directors who run or oversee the company
(Since these directors are delegated to run daily operations)
Hence a good strategy to control enterprise, solving agency probs between:
shareholders and management
Minority shareholders nd majority shareholders
Employees and shareholder class
Decisions right strategy: initiation and ratification
Decisions right grating principals the power to intervene in firms management by initiating or ratifying management decisions
(Less common that appointing rights, also cause shareholders also need to approve only important stuff such as mergers, c shareholders don’t propose, they just say yes/no to management decisions)
Disclosure
Helps reduce agency costs (when mangers don’t act in interest of principals)
Trade off between quality of infos and frequency of disclosure
If no disclosure at all: negative signal to principals
Types of disclosure
- Prospectus disclosure: when offering shares to public, call for appropriate disclosure to help potential shareholders decide on what terms they wanna invest
- Ad hoc disclosure: special infos when important suptuff happens
- Periodic disclosure: regular financial reports
- Related party transactions:business deals w people/firms close to the company
Compliance and enforcement
Relevance of legal strategies only if agents act in favor of principals interests
Each strategy depend on existence of legal institution (court, regulators, etc) to ensure enforcement of legal norms - they can’t be credible unless enforced by well functioning legal institutions
Governance strategies
Legal rules and other company practices to manage control and compliance
Depend on principals (owner/shareholder) stepping in to make sure agent acts in owners’ best interest
Everyone subject to background legal rules: who decides what
Both background and legal rules use penalty to secure compliance
3 modalities of enforcement
1public officials (public enforcement)
2 private parties acting in their own interests (private enforcement)
3 strategicall6 placed private partners (gatekeepers control)
Public enforcement
All legal and regulatory actions brought by organs of the state
Criminal and civil suites brought by public officials and agencies (prosecutor office, national regulatory authority, self regulatory and quasi regulatory authority)
They have ex ante power of approval: can review and approve important actions before they happen
Limitations and role of public enforcement
Limitation: officials may have weaker incentives to sue corporations instead of private shareholders (they wouldn’t keep any money from winning the case, so not great motivation to do so)
Yet still very important figure to ensure that agents follow the rules
