Corporate Governance
Definition
- the set of mechanisms used to manage relationships among stakeholders and to determine and control the startegic direction and perfromance of organizations
Other features
- concerned with identifying ways to ensure that strategic decisions are made more effectively
- used in corporations to establish harmony between the firms owners and its top level managers whose interest may be in conflict
Separation of Ownership and Managerial Control
Ownership Concentration
- Relative amounts of stock owned by individual stakeholders and institutional investors
Board of Directors
- Individuals responsible for representing the firms owners by monitoring top-level managers strategic decisions.
Executive Compensation
- The use of salary, bonuses, and long-term incentives to align managers interests with shareholders interests
Market for Corporate Control
- The purchase of a firm that is underperforming relative to industry rivals in order to improve its strategic competitiveness
Agency Relationship
Stakeholders (Principals) Eg. Owners hire Managers (Agents) Eg. Decision makers and create An Agency Relationship which is (1) Risk-bearing specialist (principal) paying compensation to (2) A managerial decision making specialist (agent)
Agency Relationship Problems
- Principal and agent have divergent interests and goals
- Agent makes decisions that result in the pursuit of goals that conflict with those of the principal
- It is difficult or expensive for the principal to verify that the agent has behaved appropriately
Managerial Opportunism
- The seeking of self-interest with guile (cunning or deceit)
- Managerial opportunism is:
- an attitude (inclination)
- a set of behaviours (specific acts of self-interest)
- It prevents the maximisation of shareholder wealth (the primary goal of owner/principals)
Response to Managerial Opportunism
- Principals do not know beforehand which agents will or will not act opportunistically
- Thus, principals establish governance and control mechanisms to present managerial opportunism
a) Ownership Concentration
- Large block shareholders have a strong incentive to monitor management closely
- Their large stakes make it worth their while to spend time, effort and expense to monitor closely
- They may also obtain board seats which enhances their ability to monitor effectively
- Financial institutions are legally forbidden from directly holding board seats
b) Board of Directors
- They are a group of elected individuals that acts in the owners interests to formally monitor and control the firms top level executives
- Board has the power to:
- direct the affairs of the organization
- punish and reward managers
- protect owners from managerial opportunism
- Composition of Boards:
- Insiders: the firms CEO, and other top level managers
- Related Outsides: individuals uninvolved with day-to-day operations but who have a relationship with the firm
- Outsiders: Individuals who are independent of the firms day-to-day operations and other relationships
- Criticisms of Board of Directors
- Too readily approve managers self-serving initiatives
- Exploited by managers with personal ties to board members
- Not vigilant enough in hiring and monitoring CEO behaviour
- Lack of agreement about the number of and most appropriate role of outside directors
c) Executive Compensation
- Forms of compensation
- Salaries, bonuses, long-term performance incentives, stock awards, stock options
- Factors complicating executive compensation
- Strategic decisions by top-level managers are complex, non-routine and affect the firm over an extended period
- Other variables affecting the firms performance over time
- Limits on the effectiveness of executive compensation
- Unintended consequences of stock options
- Firms performance not as important as firm size
- Balance sheet not showing executive wealth
- Options not expensed at the time they are awarded
d) Market for Corporate Control
- Forms of compensationIndividuals and firms buy or take undervalued firms
- Ineffective managers are usually replaced in such takeovers
- Threat of takeover may lead firm to operate more efficiently
- Changes in regulations have made hostile takeover difficult
International Corporate Governance
Germany
- Owner and manager are often the same in private firms
- Public firms have a dominant shareholder frequently a bank
- Frequently there is less empahsis on shareholder value than in USA firms although this may be changing may be changing as German firms are gravitating toward US. governance mechanisms
Japan
- Important governance factors
- Obligation
- Family
- Consensus
- Keiretsus: strongly interrelated groups of firms tied together by cross shareholdings
- Banks (especially “main bank”) are highly influential with firms managers
- Other governance characteristics
- Poweful government intervention
- Close relationships between firms and government sectors
China
- Corporate governance practices have been changing and evolving with increasing privatisation of businesses
- Development of internal equity markets has been hampered by inside trading
Global Corporate Governance
- Organizations worldwide are adopting a relatively uniform governance structure
- Board of directors are becoming smaller with more independent and outside members
- Investors are becoming more active
- In rapidly development, minority shareholder rights are not protected by adequate governance controls
- It prevents the maximisation of shareholder wealth (the primary goal of owner/principals)