4. Corporate Governance Flashcards
Which are the two major objectives of corporate governance?
1) Eliminate or reduce conflicts of interests
2) Use the company’s assets in a manner consistent with the best interests of investors and other stakeholders.
explain ‘principal-agent relationship (PAR)’.
An agency relationship occurs when an individual, who is referred to as the agent, acts on behalf of another individual, who is referred to as the principal. Such a relationship creates the potential for a principal-agent problem where the agent may act for his own well being rather than that of the principal.
An effective corporate governance system will:
1) Define the rights of shareholders and other important stakeholders
2) Define and communicate to stakeholders the oversight responsabilities of managers and directors
3) Provide clear and measurable accountability for managers and directors in assuming their responsabilities
4) Provide for fair and equitable treatment in all dealings between managers, directors, and shareholders
5) Have complete transparency and accuracy in disclosures regarding operations, performance, risk, and financial position
Which are three major business forms?
1) Sole proprietorship
2) Partnership
3) Corporation
Corporation differ from sole proprietorships and partnerships in that the corporation is a separate legal entity from its owners
Explain the principal-agent problems between managers and shareholders.
Shareholders want management to make decisions that maximize shareholder wealth, but managers, left on their own, may well make decisions that maximize their own wealth. Examples of ways that management may act for their own interests include using funds to expand the size of the firm, granting excessive compensation and perquisites, investing in risky ventures, or not taking enough risk.
Explain the principal-agent problems between directors and shareholders.
The conflict between directors and shareholders occurs when directors align more with management interests rather than those of shareholders. The following factors may cause this to occur: lack of independence, board members have consulting or other business agreements with the firm, interlinked boards, or directors are overcompensated.
The board of directors for a corporation has the responsability to:
1) Institute corporate values and corporate governance mechanisms that wil ensure business is conducted in a proficient, ethical, and fair manner
2) Ensure firm compliance with all legal and regulatory requirements in a timely manner
3) Create long-term strategic objectives for the company that are consistent with the shareholders’ best interests
4) Determine management’s responsabilities and how they will be held accountable
5) Evaluate the performance of the chief executive officer (CEO)
6) Require management to supply the board with complete and accurate information in order for the board to make decisions for which it is responsible
7) Meet regularly to conduct its normal business, and meet in extraordinary session if necessary
8) Ensure that board members are adequately trained
Corporare governance best practices includes the following:
1) 75% independent board members
2) CEO and Chairman are separate positions
3) Directors knowledgeable/experienced, serve on only two or three boards
4) Annual elections (not staggered)
5) Evaluate/asses board annualy
6) Meet annually without management
7) Independent directors with finance expertise on audit committee; meet auditors annually
8) Independent directors on nominating committee
9) Most senior manager pay is tied to performance
10) Board use independent/outside counsel
11) Board approves related-party transactions
Investors and analysts should assess the following policies of corporate governance:
1) Codes of ethics
2) Directors’ oversight, monitoring, and review responsabilities
3) Management’s responsability to the board
4) Reports of directors’ oversight and review of management
5) Board self-assessments
6) Management performance assessments
7) Director training
The nontraditional ESG factors that must be considered to get a full picture of a company’s long-term risks are most accurately described as:
Environmental, social and governance risk
The risks from ESG factors can be categorized as:
1) Legislative and regulatory risk: risk that the government will pass new laws or regulations (e.g., emissions standards)
2) Legal risk: potential for lawsuits resulting from management’s failure to adequately deal with one of the ESG factors
3) Reputational risk: valuation impact of management’s insufficient past attention to ESG factors
4) Operating risk: possibility that a firm’s operations will be negatively impacted by ESG factors
5) Financial risk: risk of incurring a monetary cost due to ESG risk factors
