1. Corporate Governance Flashcards

Question

Active Ownership Elroy Dimson, Oguzhan, Karakas Xi Li Please compare CG and ES activities effects on the firm

Answer 1

1. Abnormal returns are highest on corporate governance (8.6%) and climate change issue (10.3%) engagements. 2. Compared to CG, ES (environmental and social) activism results in higher sales and employee efficiency – consistent with the argument of higher customer base and employee loyalty.

Answer 2

1. Targeted firms have poorer corporate governance hindering the initiation of ESG policies. 2. In the absence of active owners, companies might fail to identify ESG opportunities.

Answer 3

1. ESG activism increases stakeholder value when engagements are successful and does not destroy value even when activism fails. It’s a win-win lottery. 2. Responsible investment initiatives are less confrontational, more collaborative and benefits society at large.

Answer 4

Benefits that are not shared among all shareholders in proportion of the shares owned, but are EXCLUSIVELY ENJOYED BY PARTIES IN CONTROL ("psychic" value, outright theft, transfer pricing, using insider info for personal gain)

Answer 5

1. CONTROL PREMIUM - the difference between the price per share of the control block and the market price per share. Drawbacks: Sales of control blocks are rather rare; delay in incorporating public information to the market price. 2. PRICE DIFFERENCE between shares in a DUAL - CLASS system. Extra voting rights as a proxy for corporate control. Drawback: dual class shares are not allowed in every country. Both measures capture only common value component.

Answer 6

If PBOC were easily observable and quantifiable, they would not be private and would be claimed by minority shareholders in court

Answer 7

1. The SIZE of block traded. 2. PRESENCE of ANOTHER LARGE SHAREHOLDER. 3. SELLERS BARGAINING POWER 4. INDUSTRY. 5. TANGIBILITY OF ASSETS.

Answer 8

You will pay more for 51% of shares than 30% because when you have 51% you are in total control. If you have only 30% your dominance might be contested. YES EVIDENCE by the authors.

Answer 9

If there is another large shareholder - you have to share your PBOC – you are not happy - you pay less. NOT SIGNIFICANT.

Answer 10

Reflects whether seller is in a position to demand more money from the buyers. - If the company is in a FINANCIAL DISTRESS, a large seller is willing to sell shares for less. PBOC are then undervalued. YES EVIDENCE. - Whether the buyer is a FOREIGNER. Foreigners pay more (less information and connections => more bargaining power for the seller). YES EVIDENCE.

Answer 11

PBOC also differ across industries. Controlling a media company gives you enormous power of manipulating public opinion in personally beneficial ways. NOT SIGNIFICANT.

Answer 12

If company’s assets are mostly tangible, they are harder to expropriate due to their visibility, thus lowering PBOC. Finance industry as a contrast. NOT SIGNIFICANT.

Answer 13

1. LESS IPOs -> UNDERDEVELOPED EQUITY MARKETS. In countries showing high PBOC, entrepreneurs are reluctant to make their companies public because investors do not factor in the control value. 2. CONCENTRATED OWNERSHIP -> LESS WIDELY HELD COMPANIES. Potential buyers of smaller stakes also attribute less value to shares taking into account being exploited by majority shareholders. 3. PRIVATELY NEGOTIATED DEALS. Selling control in private negotiation is more profitable than in the market with dispersed buyers buying many noncontrolling stakes. (To maximize profit, governments should sell companies privately rather than in public offerings).

Answer 14

LEGAL INSTITUTIONS ARE STRONGLY ASSOCIATED WITH LOWER LEVELS OF PRIVATE BENEFITS 1. The LEGAL ENVIRONMENT. 2. DISCLOSURE STANDARDS. 3. ENFORCEMENT.

Answer 15

Greater ability to sue controlling shareholders and greater shareholder protection in general translate into smaller PBOC. WORKS. (Anti-director rights: the process of director appointment, length of their tenure, ability to protest decisions of the majority, etc.)

Answer 16

The more extensive and accurate disclosed information is, the more it curbs appropriation by increasing the risk of legal consequences or reputational costs. WORKS.

Answer 17

Quicker, smoother and more predictable enforcement results in stronger legal protections of shareholders (e.g. the level of corruption and bureaucracy of courts in the country). WORKS.

Answer 18

The possibility of extracting private benefits is related to managerial discretion (the freedom managers have to pursue their own objectives), courts cannot always restrict that, but others can. 1. PRODUCT MARKET COMPETITION 2. PUBLIC OPINION PRESSURE 3. MORAL NORMS 4. LABOR AS MONITOR 5. GOVERNMENT AS MONITOR

Answer 19

Through prices, competitive markets can verify manipulated transfer prices. Competition also makes tunneling more harmful to firm’s survival. WORKS.

Answer 20

Value appropriation can be limited by expected reputational losses. WORKS.

Answer 21

Value appropriation can not be undertaken due to moral considerations. Religious traditions as a proxy? Crime rate? DO NOT WORK.

Answer 22

The risk of employees quitting due to dishonest activities by majority shareholders. What if employees benefit from PBOC? DOES NOT WORK.

Answer 23

Through taxes the state acts as an investor to all companies. It does not have agency/freerider problems, and has power unavailable to regular shareholders – better tax enforcement can reduce PBOC. WORKS

Answer 24

Legal traditions differ in their respect for property rights and thus in their ability to protect minority shareholders. ▪ PBOC are the HIGHEST IN FORMER COMMUNIST countries (36% extra value on equity). ▪ MEDIUM in countries with a FRENCH code (21%): France, Mexico, Luxembourg, Netherlands, etc. ▪ LOWEST in countries with a GERMAN(11%), ENGLISH (5.5%) and SCANDINAVIAN (4.8%) code.

Answer 25

If protection of shareholder rights is STRONG –> PBOC is LOW -> shareholders can expect to get a proper financial return If protection of shareholder rights is WEAK –> PBOC is HIGH -> shareholders will get less money

Answer 26

Anti-takeover provisions (aka takeover defenses) are actions taken by a firm's management to prevent unwanted takeovers. (Unwanted takeover - acquisition of one company by another that is accomplished by: --going directly to the company's shareholders OR; --fighting to replace management to put in a new management that will be more likely to get the acquisition approved. Key characteristic of an unwanted takeover - target company's management does not want the deal to go through, so it will defend against takeovers by using several strategies) MORE takeover defense means LESS rights for the shareholders.

Answer 27

Higher antitakeover defenses---> ---> managers who run firms inefficiently cannot be thrown out ---> decrease in firm’s value through lower operating performance.

Answer 28

1. Charter amendments 2. Golden parachute 3. Poison pills 4. Pac man defense

Answer 29

Charter amendment OR Shark Repellent (anti-takeover technique) Imposing conditions in a firm's charter ("a legal document that formally establishes a corporate entity") on control transfer. Ex: requiring over 2/3 shareholder vote to approve a merger/acquisition. (how to remember the name: "when a shark attacks, shark repellent can send the shark away from its place of attack" - so charter amendment a company's way on HOW to send away the sharks)

Answer 30

Golden parachute: Substantial benefits (compensation) that is guaranteed to a firm’s senior management if the firm is taken over and the managers are let go.

Answer 31

Poison pills: Strategy to make the company's stocks seem less attractive to the acquirer. Accomplished by making the company's stock more costly to acquire. Ex1: Allowing existing shareholders to buy more stock at a discount which increases the number of shares that the acquirer will have to buy. Ex2: Creating employee stock option plan that shows up only when the company is taken over which makes it more difficult to retain key employees after a takeover.

Answer 32

Pac-man defense: Company trying to acquire the acquirer in an attempt to scare off them (Tinder buying Bumble, Bumble threatening to buy Tinder - not irl) During the takeover phase, the acquirer may begin a large-scale purchase of the target company’s stocks to gain control of the target company. As a counter-strategy, the target company may begin buying back its shares and purchasing shares of the acquiring company.

Answer 33

The authors argue that the existence of dual-class stocks in a company ALSO can be an anti-takeover strategy (it has apparently been forgotten). Authors look at how being dual-class company in the US influences the firm's value. Background info: Dual-class company has two types of shares: 1. Superior shares with more votes per share 2. Inferior class, with one vote per share Superior class of shares is usually owned by company insiders which provide insiders with a majority of votes. Thus, insiders of dual-class firms have effective control over all corporate decisions which makes them virtually immune to hostile takeovers. Additionally, inferior shareholders have less control and thus can be more easily expropriated, leading to a worse performance of the firm.

Answer 34

1. The insiders (the ones who hold superior shares) of own a majority of the voting rights (~60%) 2. The insiders own a minority of the cash flow rights (~40%), meaning that they bear considerably smaller financial consequences for their decisions. 3. Dual-class firms are BIGGER than one-class firms on median terms of firm value 4. Dual-class firms are MORE LEVERED, possibly due to their reluctance to engage in equity offerings not to lose ownership (If I issue more stock, my control gets weaker) 5. Dual-class firms are OLDER, possibly due to less possibility of being acquired.

Answer 35

1. Name (A company named after a founder indicates a more “personal” stake involved); 2. Media (Control of a media company provides opportunities for self-advertising, manipulating the public opinion); 3. Activity of the founder (PBOC and also dual-class structure is more likely if the firm is young and the founder is still active); 4. Firms in the area & Sales of the area (the less firms there are in firm’s area, the more likely the firm is a major employer in town which entails private benefits for insiders with dual-class shares - additionally, firms with an important local presence may use dual-class status as a promise to local authorities that the firm will resist takeovers in order to honor implicit contracts with local governments and other stakeholders).

Answer 36

Endogeneity/Loop of Causality– it is not only that ownership structure determines firm's value, but it can also be that the firm's value influences the ownership structure

Answer 37

Nevertheless, the paper finds that: 1. Firm's value is positively associated with insiders’ cash-flow rights. (insiders have more cash flow rights - (possibly) more incentivized to make good decisions because of monetary risk - firm's performance, and, thus, value increases) 2. Firm value is negatively associated with insider voting rights (more insider voting rights decreases the firm's value) 3. Firm value is negatively associated with the wedge between the two (insider voting rights – insider cash flow rights). - The more imbalanced they are, the more negative firm's value is.

Answer 38

1. If majority owner deems establishing PBOC more important that maintaining firm value, he will rationally choose to sacrifice some of firm value to maintain PBOC. 2. PBOC from controlling a newspaper, news agency or brand identity can outweigh financial losses of the firm.

Answer 39

Morningstar Sustainability Ratings show the sustainability level of funds. Funds are ranked depending their holdings of sustainable stocks. The result in website is portrayed in scale of "five-globes": Top 10% - Most Sustainable - 5 globes; Between Top 10% and 32.5% - Above AVG - 4 globes; Between Top 32.5% and 67.5% - AVG - 3 globes; Between 67.5% and 90% - Below AVG - 2 globes; Worst 10% - Least Sustainable - 1 Globe

Answer 40

If a fund is generally viewed as more desirable after its rating becomes public, money will flow into it and it will grow. If it is viewed as less desirable, we will see money flow out of it and it will shrink.

Answer 41

Yes, they do. Investors mostly look at GLOBE RATINGS rather than pure measure of percentile or sustainability score (investors often focus on discrete rather than continuous measures) Investors focus on EXTREME outcomes - 1 globe and 5 globe rating funds see the largest impact Prior to the rating publication, funds received similar levels of flows, so there were no fundamental differences.

Answer 42

1. they face institutional constraints; 2. they have rational performance expectations; 3. they have irrational expectations and non-quantifiable motives The authors find evidence consistent with nonpecuniary (non-quantifiable, non-monetary) motives of being an important driver when choosing to invest in sustainable stocks.

Answer 43

Reason: Institutional investors are often OBLIGED to hold high sustainability stocks or constrained not to hold low sustainability stocks Discussion in article: If institutional constraints are the reason for the increased fund flows in high sustainability funds, we should see more fund flows from institutional share classes than from non-institutional share classes; however, there is NO difference between the fund flows.

Answer 44

Yes! If investors believe sustainable funds will outperform the market, funds will flow to high sustainable funds Real life: Evidence is more consistent with an INVERSE relation or NO relation between globe ratings and returns rather than the positive relation (high sustainable ratings are not necessarily associated with better future performance) Therefore, investors have irrational expectations?

Answer 45

YES! Investors might assume that a high sustainability rating would lead to high future fund returns OR they simply had a non-monetary (social) preference for holding more sustainable mutual funds Authors run an experiment and find evidence on irrational expectations: Environmentally and socially conscious participants (therefore, people with non-quantifiable goals) when making their investment decisions, invest more money in 5-globe funds and less money in 1-globe funds, comparing with those not environmentally and socially conscious.

Answer 46

Entity which pools money to purchase securities, real property, and other investment assets or originate loans. Banks, insurance companies, hedge funds, investment advisors, endowments, and mutual funds.

Answer 47

1. VOICE – engaging with management to try to initiate changes. 2. EXIT – leave the firm by selling shares. ▪ THREAT OF EXIT can also serve as a disciplinary action.

Answer 48

Institutional investors are ACTIVE OVERALL: ONLY 19% of the surveyed HAVE NOT taken any corrective ACTIONS in the past 5 years. >50% have used discussions with management and board and voting against management as corporate governance channel (voice) 39% have sold shares due to dissatisfaction with corporate governance (exit) 15% have used legal actions 13% have used public criticism

Answer 49

1. Liquidity 2. Investment Horizon 3. Size of the stake (that's what she said)

Answer 50

Theory: - Higher liquidity of shares held encourages investors not to bother with activism and liquidate. + On the other hand, higher liquidity makes it easier to sell at increased price that reflects engagement efforts. If I can sell at a higher price already tomorrow, why not be active? Paper: - Indicates negative relationship between liquidity and voice: the more liquid shares institutional investors hold, the less they intervene (simply use exit strategy more)

Answer 51

Theory: + Long-term shareholders might be incentivized to intervene, because they can reap the long-term benefits. Long-term investors might also have more time to gather information for effective intervention. - Contrary, it is claimed that hedge funds (short-term mostly) sometimes push for actions that are profitable in the short run, but detrimental in the long run. + Paper: Positive relationship between horizon and voice: long-term orientation provides more incentives to monitor and intervene.

Answer 52

Theory: Positive relationship - Larger share of company means more absolute payoff for intervention – encourages more activism. Larger funds might also have more resources to engage. Paper: No significant relationship.

Answer 53

“The chances for voice to function effectively… are appreciably strengthened if voice is backed up by the threat of exit.” Managers tend to take discussions with shareholders more seriously in the face of a threat to exit.

Answer 54

1. Some investors might lack the expertise of intervention and thus rely solely on the exit strategy. 2. Investors might face capital gains costs when exiting, which makes the option of voice more attractive.

Answer 55

Complements. Robust positive correlation between the two variables.

Answer 56

Shareholders can collect private information on the fundamental value of a firm, which is then impounded to the price they offer in case of an exit. If a firm is crap, but the public does not know it yet, managers are strongly incentivized to increase firm’s value to avoid exit by informed shareholders. This happens behind the scenes – threat of exit is in fact empirically unobservable, thus survey results are the only data.

Answer 57

1. Exit or exit threat by OTHER INVESTORS for the same reason signals that the issue is significant enough to force numerous exits. 2. In the PRESENCE of MULTIPLE INFORMED SHAREHOLDERS, their trading incorporates more information on firm’s fundamentals, thus, poses more threat to firm’s value in case of the exit. 3. If MANAGERS OWN EQUITY in the company, exit threat is even more convincing. 4. SIZE OF THE EQUITY STAKE should be significant for the threat to be effective. (If you are a small shareholder, you will be hardly heard and your exit will have marginal effect on price).

Answer 58

1. FREE RIDER PROBLEM - they would personally incur costs of activism while the benefits would be shared among all shareholders. - Higher stake size increases net payoff for activism and hinders the “free rider” problem (when you have more money in one company and others have less, you will benefit more from the company performing better than others) 2. INADEQUATE LEGAL RULES - Diversification requirements for mutual funds - Engagements can lead to legal consequences (when you too loud yelling and do smth bad) - Weak disclosure requirements limits the amount of information that shareholders get providing less opportunities for activism. 3. CONFLICTS OF INTEREST: Investors might be concerned that aggressive engagement might affect their future relations with firms (private costs). 4. Fund managers might not bother engaging if they are NOT SUFFICIENTLY REWARDED for activism (compensation problems).

Answer 59

1. FRAUD 2. INADEQUATE CORPORATE GOVERNANCE, EXCESSIVE COMPENSATION 3. DISAGREEMENT WITH STRATEGY, specifically large mergers and acquisitions. 4. CONTRIBUTIONS TO POLITICIANS In general, shareholders tend to engage more over long-run strategic issues (e.g. firm’s strategy for overseas markets) than over short-term issues (e.g. low dividends, underperformance).

Answer 60

Proxy advisory firms provide institutional investors with research, data, and recommendations on management and shareholder proxy proposals. It reduces the costs of being informed by monitoring, collecting information and using professional judgment in recommendations. 60% of respondents use at least one proxy.

Answer 61

Paper tests what drove firms to be social responsible in response to war in Ukraine. They basically find that corporate leaders tend to promote stakeholder interests to avoid reputational damage (that could affect shareholder wealth), or when it represents a good marketing move- "Woke washing"; the use of social media magnifies this pressure from stakeholders and it is effective, but it tends to focus only on big companies.

Answer 62

WOKE WASHING- using social activism as marketing tool to obtain positive returns.

Answer 63

Public support translated into political pressure--> social media activity punished companies that remained in Russia--> stock market seemed to reward companies who left Russia, and penalized ones who stayed.

Answer 64

Corporate leaders tend to prioritize social objectives only when they believe that it maximizes returns, and not obtaining the said social objectives. JPM Morgan and Goldman sach used woke washing as a marketing tool to obtain positive returns, even though they continued to trade Russian debt after the withdrawal. Therefore, this supports the fact that corporate leaders tend to prioritise social objectives to maximise returns but not for purpose of attaining them.

Answer 65

Lately a heated debate revolves around “stakeholderism” and the need for companies to be managed for the benefit of a broader set of stakeholders and not solely with the goal of maximizing profits. And here stakeholder activism played an important role in companies cutting ties with Russia. Article proves that stakeholder pressure is an effective instrument to promote responsible management because of corporation return impact.

Answer 66

*Small exposure firms in Russia quickly announced their withdrawal *Twitter-based “virality” played boycott campaigns are positively correlated with operational withdrawal. Stakeholder pressure is an effective instrument to promote responsible management (but only as a compliment). *Corporate leaders tend to prioritize social objectives when they believe it maximizes returns, and not obtaining the said social objectives. (JP Morgan said they withdrew and continued trading debt) *Smaller companies are left free to operate without the important managerial constraint from stakeholder pressure. (important because small companies (here small means mid cap companies) can be just as harmful as big companies if they conduct a significant portion of business in Russia)

Answer 67

There are a number of influencing factors that determine corporate control concentration. Influencing factors are legal, economic development, shareholder protection and labor legislation.

Answer 68

1) To fix the existing data available from the literature, which had overreliance on strict definitions and mixed together small, medium and large corporations. 2) Find correlation between corporate control and its determinants

Answer 69

1) investor protection rights 2) legal origin 3) state of the economy

Answer 70

A corporation, which is owned by a large number of shareholders

Answer 71

Corporate control = ownership concentration or power of shareholders

Answer 72

1) Equity blocks are present in 80%+ of non-controlled (companies with a large number of competing shareholders) corporations 2) Shareholder protection: If it is possible to take legal action against managers for misconduct, ownership is more dispersed 3) Labour regulation: If a country has strong labour regulation, the corporations will tend to have higher corporate control (not owned by a lot of shareholders)

Answer 73

An equity block is a block of shares sold to someone all at once. These blocks are often sold off privately not to impact the stock prices.

Answer 74

To assess whether shareholders drive the environmental and social (E&S) performance of firms around the globe° Are the shareholders the ones, who press for the change in the E&S performance?

Answer 75

E&S investments are beneficial to shareholders if they are a driving force behind firms’ E&S choices.

Answer 76

Yes, but only in countries with high E&S social norms.

Answer 77

1) They become signatories to UN Principles of Responsible Investment. 2) When firms have low E&S score to begin with.

Answer 78

1) Exit and selection - Exclude low E&S scoring companies OR include only companies above a certain threshold. (However, not very significant effects) 2) Voice - tell the management to adapt towards better E&S scores. This method should become more popular.