mechanism and realtion ship of frim with corportae governance
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8/8/2019 Mechanism and Realtion Ship of Frim With Corportae Governance
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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
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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
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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
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Firm ownersFirm owners
Agency Relationship:Agency Relationship: Owners andOwners and
ManagersManagers
ShareholdersShareholders
(Principals)(Principals)
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Decision makersDecision makers
Agency Relationship:Agency Relationship: Owners andOwners and
ManagersManagers
ManagersManagers
(Agents)(Agents)
ShareholdersShareholders
(Principals)(Principals)
Firm ownersFirm owners
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Risk bearing specialist (principal)Risk bearing specialist (principal)
pays compensation to apays compensation to a
managerial decision-makingmanagerial decision-making
specialist (agent)specialist (agent)
Agency Relationship:Agency Relationship: Owners andOwners and
ManagersManagers
An AgencyAn Agency
RelationshipRelationship
ManagersManagers
(Agents)(Agents)
ShareholdersShareholders
(Principals)(Principals)
Decision makersDecision makers
Firm ownersFirm owners
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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
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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
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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
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Governance MechanismsGovernance Mechanisms
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
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Governance MechanismsGovernance Mechanisms
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
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Governance MechanismsGovernance Mechanisms
Board ofBoard of
DirectorsDirectors
ExecutiveExecutiveCompensationCompensation
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
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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
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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
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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
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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
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Governance MechanismsGovernance Mechanisms
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)
ExecutiveExecutiveCompensationCompensation
Board ofBoard of
DirectorsDirectors
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Governance MechanismsGovernance Mechanisms
OwnershipOwnership
ConcentrationConcentration
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
ExecutiveExecutiveCompensationCompensation
Board ofBoard of
DirectorsDirectors
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Governance MechanismsGovernance Mechanisms
OwnershipOwnership
ConcentrationConcentration
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
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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
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Takeover Defenses:Takeover Defenses:
FinancialFinancial
MechanismsMechanisms
Poison pills Leveraged recapitalizations Greenmail
Litigation
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Takeover Defenses:Takeover Defenses:
Asset-BasedAsset-Based
MechanismsMechanisms
FinancialFinancial
MechanismsMechanisms
Scorched earth defense Crown jewel sales Pac-man defense
Poison pills Leveraged recapitalizations Greenmail Litigation
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Takeover Defenses:Takeover Defenses:
Asset-BasedAsset-Based
MechanismsMechanisms
FinancialFinancial
MechanismsMechanisms
Scorched earth defense Crown jewel sales Pac-man defense
Poison pills Leveraged recapitalizations Greenmail Litigation
Third PartyThird Party
MechanismsMechanisms
White knight defense Other bidder (competitive bid situation)
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