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Corporate Governance
• Corporate governance is
– a relationship among stakeholders that is used to
determine and control the strategic direction
and performance of organizations
–
– concerned with identifying ways to ensure that
strategic decisions are made effectively
–
– used in corporations to establish order between
the firm’s owners and its top-level managers
2
Separation of Ownership and
Managerial Control
• Basis of the modern corporation
– shareholders purchase stock, entitles them to
income from the firm’s operations after paying
the expenses
–
– shareholders reduce risk by holding diversified
portfolios
–
– professional managers are contracted to provide
decision-making
–
– Modern public corporation form leads to efficient
specialization of tasks 3
Agency Relationship: Owners and
Managers
Shareholders
(Principals)
• Firm owners
Managers
• Decision makers (Agents)
A B
Dominant Related Related Unrelated
Business Constrained Linked Businesses
Diversification
9
Agency Costs and Governance
Mechanisms
• Agency Costs
– 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.
–
• Principals may engage in monitoring behavior
to assess the activities and decisions of
managers.
– However, dispersed shareholding makes it difficult
and inefficient to monitor management’s
behavior.
Corporate Governance Mechanisms
Internal Governance Mechanisms
Ownership Concentration
Relative amounts of stock owned by individual
shareholders and institutional investors
Board of Directors
Individuals responsible for representing the firm’s
owners by monitoring top-level managers’ strategic
decisions
Executive Compensation
Use of salary, bonuses, and long-term incentives to align
managers’ interests with shareholders’ interests
Board of Directors (Contd)
Composition of Boards:
– Insiders: the firm’s CEO and other top-level
managers
– Related Outsiders: individuals uninvolved with
day-to-day operations, but who have a
relationship with the firm
– Outsiders: individuals who are independent of
the firm’s day-to-day operations and other
relationships
–
Enhancing the effectiveness of boards and
directors:
– More diversity in the backgrounds of board
members
3. Executive Compensation
Forms of compensation:
– Salaries, bonuses, long-term performance
incentives, stock awards, stock options
4. Market for Corporate Control
• Individuals and firms buy or take over
undervalued corporations.
– Ineffective managers are usually replaced in such
takeovers.
• Threat of takeover may lead firm to operate
more efficiently.
• Changes in regulations have made hostile
takeovers difficult.
• Managerial defense tactics increase the costs of
mounting a takeover
• Defense tactics may require:
– Asset restructuring
– Changes in the financial structure of the firm
– Shareholder approval
Managerial Defense Tactics
• Poison Pill – preferred stock in the merged firm
offered to shareholders at a highly attractive rate of
exchange
•
• Corporate charted ammendment- an
ammendment to stagger the elections of members to
the BOD of the attacked firm so that all are not
elected during the same year ,which prevents a
bidder from installing a completely new board in the
same year.
•
• Golden Parachute- Lump-sum payments of cash that
are distributed to a select group of senior executives.
•
• Litigation- Lawsuits that help a target company stall
Managerial Defense Tactics
(Contd)
• Greenmail – The repurchase of shares of stock by the
aggressor at a premium in exchange for an
agreement that an aggressor will no longer target the
company for takeover.
•
• Standstill agreement – Contract between the parties
in which the pursuer agrees not to acquire any more
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 , ESOPs,
recapitalization, new depth, stock selling and share
International Corporate
Governance
• Understanding the international corporate
governance is required for assessing the
multinational firm in today’s economy.
• The stability associated with the German &
Japanese governance structures has been viewed
as an asset.
• The main aim is to develop a more global
governance system.
Corporate Governance in
Germany
The owner & manager may still be the same individual.