CORPORATE GOVERNANCE

• Corporate governance is defined as the set ofrules and procedures that ensure thatmanagers do indeed employ the principles ofvalue-based management.

• Corporate governance involves the manner inwhich shareholders’ objectives areimplemented

• It is reflected in a company’s policies andactions

• TWO models of Corporate Governance:– Shareholder model

– Stockholder model

• In its narrowest sense (shareholder model),corporate governance often describes theformal system of accountability of seniormanagement to shareholders.

• In its widest sense (stakeholder model),corporate governance can be used to describethe network of formal and informal relationsinvolving the corporation.

• According to the shareholder model theobjective of the firm is to maximizeshareholder wealth through allocative,productive and dynamic efficiency i.e. theobjective of the firm is to maximize profits.

• The criteria by which performance is judged inthis model can simply be taken as the marketvalue (i.e. shareholder value) of the firm.

• The stakeholder model takes a broader viewof the firm.

• According to the traditional stakeholdermodel, the corporation is responsible to awider constituency of stakeholders other thanshareholders.

• According to this model performance isjudged by a wider constituency interested inemployment, market share, and growth intrading relations with suppliers andpurchasers, as well as financial performance.

• TWO primary mechanisms used in corporate governance:

– Sticks : threat of removal of a poorly performingmanagement

– Carrots : type of plan used to compensateexecutives and managers

• Corporate governance is closely connectedwith shareholders’ welfare maximization

• Poorly performing managers can be removedeither by a takeover or by the company’s ownBOD

• Provisions in the corporate charter affect thedifficulty of a successful takeover

• The composition of BOD affects the likelihoodof a manager being removed by the board

MANAGERIAL ENTRENCHMENT

• Managerial entrenchment is most likely whena company has a weak BOD coupled withstrong anti-takeover provisions in its corporatecharter

• In cases of managerial entrenchment, thelikelihood that badly performing seniormanagers will be fired is low

NONPECUNIARY BENEFITS

• Nonpecuniary benefits are noncash perkssuch as lavish offices, memberships at countryclubs, etc.

• Some of these expenditures may be costeffective, but others are wasteful and simplyreduce profits.

• Such fat is almost always cut after a hostiletakeover.

• Targeted share repurchases, also known asgreenmail, occur when a company buys backstock from a potential acquirer at a higher-than-fair-market price.

• In return, the potential raider agrees not toattempt to take over the company.

• Shareholder rights provisions, also known aspoison pills, allow existing shareholders topurchase additional shares of a stock at alower than market value if a potential acquirerpurchases a controlling stake in the company.

• Restricted voting rights provisionautomatically deprives a shareholder of votingrights if the shareholder owns more than aspecified amount of stock.

• Interlocking BOD occur when the CEO ofCompany A sits on the board of Company B,and B’s CEO sits on A’s board.

• Stock option provides for the purchase of ashare of stock at a fixed price, called theexercise price, no matter what the actualprice of the stock is.

• Stock options have an expiration date, afterwhich they cannot be exercised.

• An Employee Stock Ownership Plan (ESOP), isa plan that facilitates employees’ ownership ofstock in the company for which they work.

Corporate Governance for Corporate Performance and Growth

• It is useful to have a framework with which tounderstand how corporate governance can affectfirm behavior and economic performance.

• An effective corporate governance frameworkcan minimize the agency costs and hold-upproblems associated with the separation ofownership and control.

• There are a number of potential channels ofinfluence through which governance can affectperformance.

• The principle-agent model suggests thatmanagers are less likely to engage in strictlyprofit maximizing behavior in the absence ofstrict monitoring by shareholders.

• Therefore, if owner-controlled firms are moreprofitable than manager-controlled firms, itwould seem that insider systems have anadvantage in that they provide bettermonitoring which leads to betterperformance.

• large shareholders are active monitors incompanies, and that direct shareholdermonitoring helps boost the overall profitabilityof firms.

• This result is also borne out by studies ofmanagerial turnover.

• However, there are many cases wheremanager-controlled firms significantlyoutperform owner-controlled firms in terms ofprofitability, but that owner-controlled firmshad higher growth rates.

• We must also keep in mind that corporate governancestructures are not static but dynamic in nature.

• Different owners will have different objectives, and it ishighly likely that the identity of owners will matter forfirm performance.

• For example, managers of corporations undergovernmental or quasi-governmental control are likelyto have different incentives and will, therefore, behavedifferently to managers of corporations in the privatesector.

• For this reason, ownership concentration and theidentity of owners should be viewed as variables thatexert a simultaneous, but different, influence on firmperformance.

• The finding that owner-controlled firms are moreprofitable than manager-controlled firms is alsoconsistent with the life-cycle model of the firm.

• As firms grow and mature, this provides greaterincentives for the increasingly unmonitoredmanagement to expropriate rents. The dilutionand dispersion of equity stakes in this case,implies that as firms mature effective corporategovernance mechanisms become increasinglyimportant in assuring firm performance.

• Managerial incentives, market control and othersuch factors of corporate governance alsoinfluences a firm’s performance and growth.