Part 1 Theoretical foundations - Theories of the firm (4/4) - Corporate Governance SLIDESHOW 5 Flashcards
What is corporate governance?
Instruments or mechanisms available to the providers of finance to make sure that their investments are either safe, or that they will yield the maximum possible return.
Broader: ensuring that management runs the firm in accordance with the objectives of several relevant groups of stakeholders.
What is the essence of the firm according to Jensen and Meckling?
The entire set of contractual relationships
What do this contractual relationships raise as issues?
Issues of agency, incentives and monitoring
When does an agency problem arise?
When there is a separation within the firm of ownership from control. Therefore, there is a potential conflict of interest between the principal (shareholders) and the agent (manager).
What are the 2 most common sources of agency problem?
1\ Perquisites –> expenditures (Williamson)
2\ Empire-building –> pursuit of own growth (Marris)
What are other types of agency problems that may arise within the firm?
Conflicts of interest between large and small shareholders or between bondholders (debt holders)
What is the current value of the equity?
The difference between the value of the firm’s assets and the value of its debt
What do shareholders want to do if the current value of the equity is small?
There is a risk-shifting incentive to permit investments in high-risk projects
What do bondholders prefer regarding investments?
Low-risk investments
What is the second type of debt agency problem? And what does it lead to? First one was risk-shifting incentive
Underinvestment incentive leads to demand in higher return for bondholders resulting in an agency cost on the firm
What kind of problem does duality bring?
May tend to give rise to a lack of independence of the board from the senior management
What are the positive and negative aspects of separation of these 2 roles? (Chairman and CEO)
Robust, independent oversight of management performance but possible conflict between them
What does shareholder activism stand for and what does it really stands for?
Create pressure, achieve policy changes but actually vehicle for punishing management that has already failed
What type of problem could arise from a widely dispersed ownership?
Free-rider problem
What is the free-rider problem?
Not any shareholder has enough incentive to devote effort to monitoring, because most of the benefit would accrue the other shareholders. Therefore, they gain by free-riding
What happens when high dividends are distributed?
Less discretionary behaviour but happy shareholders and maybe rise in management compensation
What are compensation packages?
Cash bonuses related to firm performance or share ownership
What is a call option?
A right given to the holder to purchase shares at a pre-determined price called the strike price on a specified future date
What does help align shareholder and managerial interests?
Call options to CEO. Even if encourage risk-taking behaviour on the part of executives
To what is the value of an option positively related?
To the volatility of the share price
What does happen to the share price of an under-performin firm in a liquid stock market?
It tends to fall
What is the competitive discipline?
Managers could be replaced by appointees
What are the 4 key principles for good corporate governance?
1\ fairness
2\ transparency
3\ accountability
4\ responsibility
What are the 6 headings of the corporate governance codes of practice?
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