Description
Corporate governance refers to the system by which corporations are directed and controlled. The governance structure specifies the distribution of rights and responsibilities among different participants in the corporation.
Corporate Governance
Agency costs and governance mechanisms
• Agency costs are the sum of incentive costs, monitoring costs, enforcement costs and individual financial losses incurred by principals because governance mechanisms cannot guarantee total compliance by the agent. • If governance is weak, managerial interest will prevail. • The Sarbanes – Oxley Act 2002 in America – Pros and Cons
Ownership Concentration
• Ownership concentration means large bloc of shareholders holding bulk shares of a firm. • Large block shareholders means those holding at least 5% of the issued shares. • Diffused ownership provides weak monitoring of managerial decisions. • Research indicates that ownership concentration leads to lesser diversification.
Institutional Owners
• They are financial institutions such as mutual fund companies etc that control large block shareholder positions. • They have size and incentive to discipline ineffective top level managers.
Board of Directors
• Shareholders monitor the actions of a firm through the board of directors since they elect the board members. • It is a group of elected individuals whose primary responsibility is to act in the owners best interests by formally monitoring and controlling the corporation's top level executives. • Boards have the power direct the firm’s actions and reward and punish top executives.
Board of Directors
• Board members (directors) can be classified into one of three groups 1. Insiders – Active top level managers who are elected to the board since they are a source of information about the firm's day to day operations. 2. Related Outsiders – They have some relationship with the firm, contractual or otherwise, but they are not involved with the firm’s day to day operations. 3. Outsiders – They provide independent counsel to the firm and may hold top management position in other companies.
Board of Directors – some views
• Its widely believed that a board with high number of firm’s own executives provide weak monitoring, thus a suggestion of more independent directors. • It is also argued that the same person should not hold the post of CEO and chairman of the Board. • Independent director may do a good job but are inhibited with limited knowledge of day to day activities in the firm.
Executive Compensation
• It is a governance mechanism that seeks to align the interests of managers and owners through salaries , bonuses and long term incentive compensation such as stock options. • This option may work since manager’s wealth is linked to shareholder’s wealth • The effectiveness of executive compensation is mixed but stock options and pay for performance still remain popular as executive compensation.
Market for Corporate Control
• It is an external governance mechanism which becomes active when internal control fails. • It is composed of individuals and firms that buy ownership positions in or take over potentially undervalued corporations so that they can form new divisions in established diversified companies or merge two previously separate firms. • Since it is assumed that the firm is underperforming due to poor managers, once market for corporate control operates the managers get disciplined.
Managerial defense tactics
• Market for corporate control gives rise to hostile takeovers and all takeovers are not for underperforming firms. • To ward off such hostile takeovers there are some remedies. They are discussed in the next slide
Defenses
• Poison pill – It permits shareholders (other than acquirer ) to convert shareholder’s right into a large number of common shares if anyone acquires more than a set amount of firm stock ( typically 10-20%). This move dilutes the percentage of shares the acquiring firm purchases. • Golden parachute : Lump sum payments made to senior executives when a firm is acquired. • Corporate charter amendment – it is to stagger the elections of members to the board of directors of the attacked firm so that all are not elected during the same year which prevents the bidder from installing a completely new board. • Litigations – Lawsuits that help a target firm stall hostile attacks quoting areas like antitrust, fraud and inadequate disclosure. • Greenmail – The repurchase of shares of stock that have been acquired by the aggressor firm at a premium in exchange for an agreement that the aggressor will no longer target the company for takeover. • Standstill agreement – Contract between the parties in which the pursuer agrees not to acquire anymore stock of the target firm for a specified period of time in exchange for the firm paying the pursuer a fee. • Capital structure change – Dilution of stock, making it more costly for a bidder to acquire. It may include employee stock option.
doc_804307279.ppt
Corporate governance refers to the system by which corporations are directed and controlled. The governance structure specifies the distribution of rights and responsibilities among different participants in the corporation.
Corporate Governance
Agency costs and governance mechanisms
• Agency costs are the sum of incentive costs, monitoring costs, enforcement costs and individual financial losses incurred by principals because governance mechanisms cannot guarantee total compliance by the agent. • If governance is weak, managerial interest will prevail. • The Sarbanes – Oxley Act 2002 in America – Pros and Cons
Ownership Concentration
• Ownership concentration means large bloc of shareholders holding bulk shares of a firm. • Large block shareholders means those holding at least 5% of the issued shares. • Diffused ownership provides weak monitoring of managerial decisions. • Research indicates that ownership concentration leads to lesser diversification.
Institutional Owners
• They are financial institutions such as mutual fund companies etc that control large block shareholder positions. • They have size and incentive to discipline ineffective top level managers.
Board of Directors
• Shareholders monitor the actions of a firm through the board of directors since they elect the board members. • It is a group of elected individuals whose primary responsibility is to act in the owners best interests by formally monitoring and controlling the corporation's top level executives. • Boards have the power direct the firm’s actions and reward and punish top executives.
Board of Directors
• Board members (directors) can be classified into one of three groups 1. Insiders – Active top level managers who are elected to the board since they are a source of information about the firm's day to day operations. 2. Related Outsiders – They have some relationship with the firm, contractual or otherwise, but they are not involved with the firm’s day to day operations. 3. Outsiders – They provide independent counsel to the firm and may hold top management position in other companies.
Board of Directors – some views
• Its widely believed that a board with high number of firm’s own executives provide weak monitoring, thus a suggestion of more independent directors. • It is also argued that the same person should not hold the post of CEO and chairman of the Board. • Independent director may do a good job but are inhibited with limited knowledge of day to day activities in the firm.
Executive Compensation
• It is a governance mechanism that seeks to align the interests of managers and owners through salaries , bonuses and long term incentive compensation such as stock options. • This option may work since manager’s wealth is linked to shareholder’s wealth • The effectiveness of executive compensation is mixed but stock options and pay for performance still remain popular as executive compensation.
Market for Corporate Control
• It is an external governance mechanism which becomes active when internal control fails. • It is composed of individuals and firms that buy ownership positions in or take over potentially undervalued corporations so that they can form new divisions in established diversified companies or merge two previously separate firms. • Since it is assumed that the firm is underperforming due to poor managers, once market for corporate control operates the managers get disciplined.
Managerial defense tactics
• Market for corporate control gives rise to hostile takeovers and all takeovers are not for underperforming firms. • To ward off such hostile takeovers there are some remedies. They are discussed in the next slide
Defenses
• Poison pill – It permits shareholders (other than acquirer ) to convert shareholder’s right into a large number of common shares if anyone acquires more than a set amount of firm stock ( typically 10-20%). This move dilutes the percentage of shares the acquiring firm purchases. • Golden parachute : Lump sum payments made to senior executives when a firm is acquired. • Corporate charter amendment – it is to stagger the elections of members to the board of directors of the attacked firm so that all are not elected during the same year which prevents the bidder from installing a completely new board. • Litigations – Lawsuits that help a target firm stall hostile attacks quoting areas like antitrust, fraud and inadequate disclosure. • Greenmail – The repurchase of shares of stock that have been acquired by the aggressor firm at a premium in exchange for an agreement that the aggressor will no longer target the company for takeover. • Standstill agreement – Contract between the parties in which the pursuer agrees not to acquire anymore stock of the target firm for a specified period of time in exchange for the firm paying the pursuer a fee. • Capital structure change – Dilution of stock, making it more costly for a bidder to acquire. It may include employee stock option.
doc_804307279.ppt