W2: Lecture 3 Flashcards
"Corporate Governance" (15 cards)
What is corporate governance?
*Way to control companies
*Way to encourage efficiency
*Balance the economic and social goals of a company.
Corporate governance creates the overall system for the company to function in the best possible way.
Recover the efficient equilibrium attained:
CG controls the fact that individuals are likely to make decisions based on self-interest.
Agency problems and agency costs
Costs that arise from the agent (manager) maximising their utility rather than the principals (shareholders) —> agency costs
< hierarchy issue>
In public corporations, separate control and ownership create an agency problem.
–> In private corporations, this is not the case because usually the owner is also the main manager.
Internal forms of governance
- Board of Directors
- Executive Compensation
External forms of governance
- Auditors
- Lenders
- Shareholders
- Takeovers
*Public market competition
Corporate Governance tool: Monitoring
Watching and evaluating managers’ behaviour.
*One way to reduce agency costs such as reduce effort and perks.
BUT costs time and money
joint costs= agency costs + monitoring costs
Issues:
*disrupts the work.
It might slow down some processes and also limit the freedom of creative ways to solve problems, risk-taking, etc.
*So, if all the work is work 2 times (monitoring and monitored person), why do we even need some part of the management?
Who does the monitoring?
- BoD
Elected by shareholders and represent shareholder interests.
Mostly independent.
When managers underperform board can replace them
—> can create its own agency issues: personal connection to managers - Auditors
Hired by the firm to audit financial statements.
Negotiate changes, and if management disagrees –> qualified opinion is issued and markets react negatively. (Undetected issues are even worse.) - Lenders
Track financials to protect their loans, which is also in the shareholders’ interest.
Monitor liquidity risk. - Shareholders
Nominate candidates for the board.
Activist shareholders specialise in finding underperforming companies and forcing them to restructure.
Smaller shareholders “vote with their feet” - Takeovers
If assets are used inefficiently, outsiders can take over and reap efficiency gains.
Highly unlikely that the current management will survive the transition.
Pie-Growing vs. Pie-Splitting Mentality
*Pie-Splitting: often traditional view to see profits and societal value as competing interest.
*Pie-Growing: investing in stakeholders can create greater overall value to be shared, benefiting society and shareholders.
- Long-term value creation
Short-term profit maximisation at the expense of stakeholders may hurt the company’s long-term projects.
- Purpose-driven leadership
purpose should go beyond profit max, broader impact on society. - Executive compensation
focus on compensation structure. High CEO pay is not a problem it creates value. - Role of investors
can be allies in promoting purposeful business practices (be monitors).
What corporate governance IS
*Promotes great companies
–> ensure gains are fairly distributed
–>Create long-term value for both investors and stakeholders
*Addresses errors in commission
–> overpay CEO etc.
*Addresses errors of omission
–> failure to innovate and take risks
What corporate governance IS NOT
*Promoting the longevity of a company
–> The company only creates value for society if it delivers more value than resources could elsewhere.
*Not about corporate immortality, but should enable creative destruction.
How to measure CG: example
“G-index”
Give a score for each of the governance provisions ( rules, structure, etc. ) and add one point for each provision that reduces shareholder rights.
—> G-index created
“democracies” low score vs. “dictatorships” high score
Defence tactics CEOs use to decrease corporate governance and gain more power.
- Delay: make hostile takeovers harder by slowing them down
- Voting: Make harder for shareholders to organize or influence decisions
- Protection: Protect directors and executives from legal or financial consequences of being removed.
- Incorporate in states that favour management.
G-Index strengths and weaknesses
strengths:
+First large-scale empirical measure of governance quality
+ based on 24 observable governance provisions
+ easy to compute and replicate
weaknesses:
- Treats all provisions as equally important
- Focused on takeover defences, not broader governance aspects
- Assumes shareholder empowerment is always optimal.
Other (“next-generation”) governance measures
*Entrenchment index (E-Index)
+more predictive of firm value and performance
+ easier to interpret and avoids noise from less relevant rules
*ESG Governance scores (MSCI, Sustainalytics…)
+multidimensional
Does corporate governance add value?
Most research finds that yes, it adds value:
* Well-governed firms beat poorly governed firms
* Stock price increased. Acquisitions and investments fall, but long-term firm value increases.
But the results are unambiguous
Only matters in non-competitive industries? (market concentration is a stronger governance mechanism).
No one-size fits all.
Flexible governance
Comply or explain
