4.2 Investors and other stakeholders

Question 1

Prospective investors can compare the risk and return characteristics of equity and debt along the following lines:

Answer 1

Upside potential: Unlimited for equity, limited to contractual payments for debt

Maximum loss: Both debtholders and equity owners cannot lose more than the value of their investment

Investment risk: Higher for equity compared to debt, which has a higher priority claim

Investment interest: Lenders seek only timely repayment, while equity investors want to maximize the value of net assets

Question 2

the shareholder theory of governance

Answer 2

a company’s primary obligation is to maximize shareholder value

Relationships with any other groups are only considered to the extent that they impact a company’s ability to pursue this objective.

Question 3

the stakeholder theory of governance

Answer 3

shareholders are just one of the stakeholder groups that should be considered

Question 4

Banks and private lenders

Answer 4

important capital providers for small- and mid-size companies.

They invest with the intention of holding the debt to maturity.

Although they do not have voting rights like shareholders, creditors in this category typically have direct access to a company’s managers, which reduces their disadvantage with respect to information asymmetry.

This access also gives private lenders some ability to influence managers, as well as the flexibility to relax debt restrictions if they deem this to be appropriate.

Question 5

Public debtholders (bondholders)

Answer 5

typically do not have access to non-public information, so they usually rely on the assessments provided by credit rating agencies.

Bondholders also lack voting rights and it is much more difficult for them to adjust credit terms (compared to private lenders).

Therefore, creditors in this category have little ability to influence a company’s manager other than requiring debt covenants.

Question 6

supervisory board of directors

Answer 6

oversees a management board made up of internal directors

non-executive directors representing stakeholders such as employees, unions, the general public, or shareholders

Question 7

The management board

Answer 7

responsible for the company’s strategic direction and management oversight, but its members must be approved by the supervisory board.

Question 8

staggered boards

Answer 8

multiple classes of board members that are elected at different times

The staggered approach is generally perceived as limiting the potential for significant changes because it would take shareholders several years to replace the entire board.