Download pdf - Mechanism and Realtion Ship of Frim With Corportae Governance

8/8/2019 Mechanism and Realtion Ship of Frim With Corportae Governance

1/23

11

Corporate GovernanceCorporate Governance

Corporate governance isCorporate governance is a relationship among stakeholders that isa relationship among stakeholders that is

used to determine and control the strategicused to determine and control the strategic

direction and performance of organizationsdirection and performance of organizations concerned with identifying ways to ensureconcerned with identifying ways to ensure

that strategic decisions are made effectivelythat strategic decisions are made effectively

used in corporations to establish orderused in corporations to establish order

between the firms owners and its top-levelbetween the firms owners and its top-levelmanagersmanagers


2/23

22

Corporate Governance MechanismsCorporate Governance Mechanisms

Board of DirectorsBoard of Directors

Internal Governance MechanismsInternal Governance Mechanisms

Managerial Incentive CompensationManagerial Incentive Compensation

Ownership ConcentrationOwnership Concentration

External Governance MechanismsExternal Governance Mechanisms

Market for Corporate ControlMarket for Corporate Control


3/23

33

Separation of Ownership andSeparation of Ownership and

Managerial ControlManagerial Control Basis of the modern corporationBasis of the modern corporation

shareholders purchase stock, becomingshareholders purchase stock, becomingresidual claimantsresidual claimants

shareholders reduce risk by holdingshareholders reduce risk by holdingdiversified portfoliosdiversified portfolios

professional managers are contracted toprofessional managers are contracted toprovide decision-makingprovide decision-making

Modern public corporation form leads toModern public corporation form leads toefficient specialization of tasksefficient specialization of tasks risk bearing by shareholdersrisk bearing by shareholders strategy development and decision-makingstrategy development and decision-making

by managersby managers


4/23

44

Firm ownersFirm owners

Agency Relationship:Agency Relationship: Owners andOwners and

ManagersManagers

ShareholdersShareholders

(Principals)(Principals)


5/23

55

Decision makersDecision makers


ManagersManagers

ManagersManagers

(Agents)(Agents)





6/23

66

Risk bearing specialist (principal)Risk bearing specialist (principal)

pays compensation to apays compensation to a

managerial decision-makingmanagerial decision-making

specialist (agent)specialist (agent)


ManagersManagers

An AgencyAn Agency

RelationshipRelationship

ManagersManagers

(Agents)(Agents)



Decision makersDecision makers



7/2377

Agency Theory ProblemAgency Theory Problem

The agency problem occurs when:The agency problem occurs when: the desires or goals of the principal and agentthe desires or goals of the principal and agent

conflict and it is difficult or expensive for theconflict and it is difficult or expensive for theprincipal to verify that the agent has behavedprincipal to verify that the agent has behaved

inappropriatelyinappropriately Solution:Solution:

principals engage in incentive-basedprincipals engage in incentive-basedperformance contractsperformance contracts

monitoring mechanisms such as the board ofmonitoring mechanisms such as the board ofdirectorsdirectors enforcement mechanisms such as theenforcement mechanisms such as the

managerial labor market to mitigate the agencymanagerial labor market to mitigate the agencyproblemproblem


8/23

88

Manager and Shareholder Risk andManager and Shareholder Risk and

DiversificationDiversification

RiskRisk

DiversificationDiversification

DominantDominant

BusinessBusiness

UnrelatedUnrelated

BusinessesBusinesses

RelatedRelated

ConstrainedConstrained

RelatedRelated

LinkedLinked

ManagerialManagerial

(employment)(employment)

risk profilerisk profile

BB

ShareholderShareholder

(business)(business)

risk profilerisk profileSS

AA

MM


9/23

99

Governance MechanismsGovernance Mechanisms

Board ofBoard of

DirectorsDirectors

InsidersInsidersThe firms CEO and other top-levelThe firms CEO and other top-level

managersmanagers

Affiliated OutsidersAffiliated Outsiders Individuals not involved with day-Individuals not involved with day-

to-day operations, but who have ato-day operations, but who have a

relationship with the companyrelationship with the company

Independent OutsidersIndependent Outsiders

Individuals who are independentIndividuals who are independentof the firms day-to-dayof the firms day-to-day

operations and other relationshipsoperations and other relationships


10/23

1010


Board ofBoard of

DirectorsDirectors

Role of the Board of DirectorsRole of the Board of Directors

Monitor Are managers acting inMonitor Are managers acting in

shareholders best interestsshareholders best interests

Evaluate & Influence examineEvaluate & Influence examine

proposals, decisions actions,proposals, decisions actions,

provide feedback and offerprovide feedback and offer

directiondirection

Initiate & Determine delineateInitiate & Determine delineate

corporate mission, specifycorporate mission, specify

strategic options, make decisionsstrategic options, make decisions


11/23

1111


Board ofBoard of

DirectorsDirectors

ExecutiveExecutiveCompensationCompensation

Salary, bonuses, long term incentiveSalary, bonuses, long term incentivecompensationcompensation

Executive decisions are complex andExecutive decisions are complex andnon-routinenon-routine

Many factors intervene making itMany factors intervene making itdifficult to establish how managerialdifficult to establish how managerialdecisions are directly responsible fordecisions are directly responsible foroutcomesoutcomes


12/23

1212


Board ofBoard of

DirectorsDirectors


Stock ownership (long-termStock ownership (long-termincentive compensation) makesincentive compensation) makesmanagers more susceptible tomanagers more susceptible tomarket changes which are partiallymarket changes which are partially

beyond their controlbeyond their control Incentive systems do not guaranteeIncentive systems do not guaranteethat managers make the rightthat managers make the rightdecisions, but do increase thedecisions, but do increase thelikelihood that managers will do thelikelihood that managers will do the

things for which they are rewardedthings for which they are rewarded


13/23

1313

CEO Pay and PerformanceCEO Pay and Performance

Firm Performance

CEO Pay

Classic pay forClassic pay for

performanceperformance

relationshiprelationship

Unfortunately, thisUnfortunately, this

relationship is weakrelationship is weak

The strongerThe stronger

relationship is withrelationship is with

firm sizefirm size


14/23

1414

CEO Pay and Firm SizeCEO Pay and Firm Size

Firm Size

CEO Pay

Relationship betweenpay and firm size is

curvilinear.

CEO pay increases ata decreasing rate


15/23

1515

Relationship Between FirmRelationship Between Firm

performance and Firm Sizeperformance and Firm Size

Firm Size

Firm

Performance

Relationship betweenRelationship between

firm performance andfirm performance and

firm size is curvilinearfirm size is curvilinear..

Beyond some point, asBeyond some point, as

size increases, firmsize increases, firm

performance declinesperformance declines

BUTBUTFrom the graph of CEOFrom the graph of CEO

pay vs. firm size, paypay vs. firm size, pay

doesnt declinedoesnt decline


16/23

1616

Relationship Between FirmRelationship Between Firm

performance and Equity Ownershipperformance and Equity Ownership

Managerial Ownership in %

Firm

Value

Relationship betweenRelationship between

firm performancefirm performance

(Tobins Q) and(Tobins Q) and

managerial ownershipmanagerial ownership

is curvilinearis curvilinear..

Beyond some point, asBeyond some point, as

ownership increases,ownership increases,

firm value declinesfirm value declines


17/23

1717


OwnershipOwnership

ConcentrationConcentration

Large block shareholders (oftenLarge block shareholders (ofteninstitutional owners) have ainstitutional owners) have astrong incentive to monitorstrong incentive to monitormanagement closelymanagement closely

Exit vs. Voice Cannot costlesslyExit vs. Voice Cannot costlesslyexit due to equity stakeexit due to equity stake(transaction costs) so they press(transaction costs) so they pressfor change (exercise voice)for change (exercise voice)

They may also obtain Board seatsThey may also obtain Board seatswhich enhances their ability towhich enhances their ability tomonitor effectively (althoughmonitor effectively (althoughfinancial institutions are legallyfinancial institutions are legallyforbidden from directly holdingforbidden from directly holdingboard seats)board seats)


Board ofBoard of

DirectorsDirectors


18/23

1818


OwnershipOwnership


Types of institutional investorsTypes of institutional investors

- Mutual funds, pension funds,- Mutual funds, pension funds,

foundations, churches,foundations, churches,universities,universities,

insurance companiesinsurance companies

Pressure-resistant versusPressure-resistant versuspressure-sensitivepressure-sensitive

- Mutual and pension funds are- Mutual and pension funds are

pressure resistantpressure resistant Are Institutional investors theAre Institutional investors thesame?same?

-- Short vs. long termShort vs. long term

Components of voice:Components of voice:

- Pension fund hit lists- Pension fund hit lists- Shareholder liability suits- Shareholder liability suits


Board ofBoard of

DirectorsDirectors


19/23

1919


OwnershipOwnership


Board ofBoard of

DirectorsDirectors

ExecutiveExecutive

CompensationCompensation

Market forMarket for

Corporate ControlCorporate Control

Firms face the risk of takeoverFirms face the risk of takeoverwhen they are operated inefficientlywhen they are operated inefficiently

Many firms begin to operate moreMany firms begin to operate moreefficiently as a result of the threatefficiently as a result of the threat

of takeover, even though the actualof takeover, even though the actualincidence of hostile takeovers isincidence of hostile takeovers isrelatively smallrelatively small

Changes in regulations have madeChanges in regulations have madehostile takeovers difficulthostile takeovers difficult

Acts as an important source ofActs as an important source ofdiscipline over managerialdiscipline over managerialincompetence and wasteincompetence and waste


20/23

2020

Managerial Defense TacticsManagerial Defense Tactics

Designed to fend off the takeover attemptDesigned to fend off the takeover attempt Increase the costs of making the acquisitionsIncrease the costs of making the acquisitions

Causes incumbent management to becomeCauses incumbent management to becomeentrenched while reducing the chances ofentrenched while reducing the chances ofintroducing a new management teamintroducing a new management team

May require asset restructuringMay require asset restructuring

Institutional investors oppose the use ofInstitutional investors oppose the use ofdefense tacticsdefense tactics


21/23

2121

Takeover Defenses:Takeover Defenses:

FinancialFinancial

MechanismsMechanisms

Poison pills Leveraged recapitalizations Greenmail

Litigation


22/23

2222


Asset-BasedAsset-Based


FinancialFinancial


Scorched earth defense Crown jewel sales Pac-man defense

Poison pills Leveraged recapitalizations Greenmail Litigation


23/23

2323


Asset-BasedAsset-Based


FinancialFinancial


Scorched earth defense Crown jewel sales Pac-man defense

Poison pills Leveraged recapitalizations Greenmail Litigation

Third PartyThird Party


White knight defense Other bidder (competitive bid situation)