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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
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Corporate Governance Mechanisms
Ownership Concentration
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Separation of Ownership and Managerial
Control
Shareholders
(Principals)
• Firm owners
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Agency Relationship: Owners and
Managers
Shareholders
(Principals)
• Firm owners
Managers
• Decision makers
(Agents)
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Agency Relationship: Owners and
Managers
Shareholders
(Principals)
• Firm owners
Managers
• Decision makers
(Agents)
Shareholder Managerial
(business) (employment)
S risk profile risk profile M
Risk
A B
Dominant Related Related Unrelated
Business Constrained Linked Businesses
Diversification
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Governance Mechanisms
Board of Insiders
• The firm’s CEO and other top-level
Directors managers
Affiliated Outsiders
• Individuals not involved with day-
to-day operations, but who have a
relationship with the company
Independent Outsiders
• Individuals who are independent
of the firm’s day-to-day
operations and other relationships
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Governance Mechanisms
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Governance Mechanisms
• Salary, bonuses, long term incentive
Board of compensation
Directors • Executive decisions are complex and
non-routine
Executive • Many factors intervene making it
Compensation difficult to establish how managerial
decisions are directly responsible for
outcomes
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Governance Mechanisms
• Stock ownership (long-term
Board of incentive compensation) makes
Directors managers more susceptible to
market changes which are partially
Executive beyond their control
Compensation • Incentive systems do not guarantee
that managers make the “right”
decisions, but do increase the
likelihood that managers will do the
things for which they are rewarded
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CEO Pay and Performance
Unfortunately, this
CEO Pay
relationship is weak
The stronger
relationship is with
firm size
Firm Performance
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CEO Pay and Firm Size
Relationship between
pay and firm size is
curvilinear.
Firm Size
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Relationship Between Firm performance and
Firm Size
Relationship between
firm performance and
firm size is curvilinear.
Performance
BUT…
From the graph of CEO
pay vs. firm size, pay
doesn’t decline
Firm Size
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Relationship Between Firm performance and
Equity Ownership
Relationship between
firm performance
(Tobin’s Q) and
managerial ownership
is curvilinear.
Firm Value
Managerial Ownership in %
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Governance Mechanisms
• Large block shareholders (often
Board of institutional owners) have a
Directors strong incentive to monitor
management closely
Executive
Compensation • Exit vs. Voice – Cannot costlessly
exit due to equity stake
(transaction costs) so they press
Ownership for change (exercise voice)
Concentration
• They may also obtain Board seats
which enhances their ability to
monitor effectively (although
financial institutions are legally
forbidden from directly holding
board seats) 18
Governance Mechanisms
• Types of institutional investors
Board of - Mutual funds, pension funds,
Directors foundations, churches,
universities,
Executive insurance companies
Compensation
• Pressure-resistant versus
Ownership pressure-sensitive
Concentration - Mutual and pension funds are
pressure resistant
• Are Institutional investors the
same?
- Short vs. long term
• Components of voice:
- Pension fund hit lists 19
- Shareholder liability suits
Governance Mechanisms
• Firms face the risk of takeover
Board of when they are operated inefficiently
Directors • Many firms begin to operate more
efficiently as a result of the “threat”
Executive of takeover, even though the actual
Compensation incidence of hostile takeovers is
relatively small
Ownership • Changes in regulations have made
Concentration hostile takeovers difficult
• Acts as an important source of
Market for discipline over managerial
Corporate Control incompetence and waste
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Managerial Defense Tactics
Designed to fend off the takeover attempt
Increase the costs of making the
acquisitions
Causes incumbent management to become
entrenched while reducing the chances of
introducing a new management team
May require asset restructuring
Institutional investors oppose the use of
defense tactics
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Agency cost
An agency cost is an economic concept that relates to the
cost incurred by an entity (such as organizations) associated
with problems such as divergent management-
shareholder objectives and information asymmetry. The
costs consist of two main sources:
The costs inherently associated with using an agent (e.g.,
the risk that agents will use organizational resource for their
own benefit) and
The costs of techniques used to mitigate the problems
associated with using an agent (e.g., the costs of
producing financial statements or the use of stock
options to align executive interests to shareholder interests).
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Agency cost
Agency costs mainly arise due to divergence of control,
separation of ownership and control and the different
objectives (rather than shareholder maximization) the
managers.
There are various actors in the field and various objectives
that can incur costly correctional behavior.
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Agency cost
Management
Bondholders
Board of directors
Labour
Other stakeholders
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Thank you
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