Chapter 1

Question 1

What is a corporation?

Answer 1

a mechanism established to allow different parties to contribute capital, expertise and labor for their mutual benefit

Question 2

3 types of corporations

Answer 2

sole proprietorship
partnership
corporations (public and private)

Question 3

Essential characteristics of public corps?

Answer 3

• Limited liability for investors
• Transferability of investor ownership
• Through the trading of shares of stock on exchanges
• Legal personality
• Has legal rights and obligations
• Separation of legal ownership and management control

Question 4

Historically, who are firms managed by?

Answer 4

founder-owners and descendants

Question 5

what issues do firms face with separation of ownership and control?

Answer 5

• As they grow, they may not have access to all needed skills to manage the growing firm and maximize its returns, so may need outsiders to improve management
• May need to seek outside capital (whereby they give up some ownership control)

Question 6

small firm problems with separation/control?

Answer 6

the managers own large amounts of stock, little separation between management and ownership control

Question 7

Because shareholders (thousands of investors) cannot make daily decisions, who does?

Answer 7

elect directors as agents in supervising the firm, and directors appoint officers/executives to run the firm day-day

Question 8

What reasons will agents bear risks for their company?

Answer 8

agents (top management) are not willing to bear risks unless they own a large amount of stock

Question 9

What is the principal-agent problem?

Answer 9

lack of trust on the good faith of agents.
- shareholders: increase firm value and dividends
- managers: own utility and their own benefits (bonus)

directors: high value in firm
C suite: money for themselves

the misalignment of values between the principal (BoD) which asks the agent (C suite) to act on its behalf

Question 9

who is better informed? agents or principals

Answer 9

asians

Question 9

what is an agency cost?

Answer 9

value forgone due to imperfect optimal monitoring is an explicit agency cost

Question 9

adverse selection

Answer 9

increases the likelihood of selecting inferior alternatives (when one party has information the other party lacks)

Question 10

moral hazard

Answer 10

increase incentive of one party to take undue risks or shirk (avoid) other responsibilities, costs incur to another party (risks that someone will take because they have reason to believe that an insurer will cover the costs of damages or failure) - if you put it all on black cause your buddy is spotting you

Question 11

what is a firms FCF

Answer 11

resources remaining after the firm has invested in all projects that have positive NPV’s within its current business

Question 12

what does management do with available cash flows? agency problems with FCF

Answer 12

• Managerial inclination to overdiversify can be acted upon (invest into the company)
• Shareholders may prefer distribution as dividends, so they can control how the cash is invested

Question 13

agency problems with diversification, what are the 2 manager benefits that shareholders “dont enjoy”?

Answer 13

• Increase in firm size
• Firm portfolio diversification which can reduce top executives’ employment risk (i.e., job loss, loss of compensation and loss of managerial reputation)

Diversification reduces these risks because a firm and its managers are less vulnerable to the reduction in demand associated with a single or limited number of product lines or businesses

Question 14

Agency problems with building empires, what is the quickest way to impoverish stakeholders?

Answer 14

overpay for a takeover,
The stockholders in acquiring firms do not seem to share the enthusiasm of the managers in these firms. Stock prices of bidding firms decline on the takeover announcements a significant proportion of the time.

Question 15

Mergers?

Answer 15

• The profitability of merged firms relative to their peer groups, does not increase significantly after mergers.
• An even more damning indictment is that a large number of mergers are reversed within a few years, which is a clear admission that the acquisitions did not work.

Question 16

What happened to the HP Deal?

Answer 16

HP overpaid for a company and goodwill was much larger than it should be, ie: a problem with agency costs that impoverish stakeholders

Question 17

what happened with microsoft and yahoo?

Answer 17

1. microsoft offered to buy at 62% premium
2. yahoo said they were undervaluing them (yahoo)
3. microsoft surpassed yahoo anyway, and yahoo lost its value

Question 18

list some agency costs:

Answer 18

• Consuming excessive perks
• Managers with fixed salary will not put extra effort, shirking
• Hiring friends
• Taking no risks or chances to avoid being fired
• Taking excessive risk to earn large bonuses
• Having a short-run horizon if the managers is near retirement
• Managing earnings and self-dealing

Question 19

What happened to Valeant pharmaceuticals?

Answer 19

was the biggest company on the TSX, and kept growing until it was prosecuted by SEC, and lost all value. Re-branded to Bausch Health to regain stock value,
also happened to SNC Lavalin, Nortel Networks, and Sino Forest

Question 20

how are countries corruptions ranked?

Answer 20

transparency international, ranked canada from 9-12, now 11th in 2020

Question 21

Recent failures related to risk? some companies like:

Answer 21

• Fannie Mae & Freddie Mac
• BearSterns
• Merryll Lynch
• AIG
• Lehman Brothers
• Wells Fargo

Question 22

What are some severe agency costs?

Answer 22

* Financial restatements * Class action lawsuits * Violations of the foreign corrupt practices act * “Massaging earnings” * bankruptcy

Question 23

How to prevent stealing?

Answer 23

Legislation * Legal structure (common versus civil law) and financial structure (market versus bank-based) have been shown to be important in protecting investor rights * A functioning legal system that allows shareholders to file lawsuits against directors for breach of fiduciary duty * Enforcement of accounting laws, conflict of interest laws, reporting regulation

Question 24

can you legislate good corpgov

Answer 24

no! it supplements the legal framework

Question 25

what is corpgov?

Answer 25

the collection of control mechanisms that an organization adopts to prevent or dissuade potentially self-interested managers from engaging in activities detrimental to the welfare of shareholders and stakeholders. In short, good corporate governance prevents expropriation of outside investors (controlling & minority shareholders, debt holders, financial markets, employees, customers, supplier, and society at large).

Question 26

where did corpgov start?

Answer 26

contemporary corpgov started in 1992, UK, with the Cadbury report (result of several high profile company collapses)

Question 27

What is the Cadbury Report?

Answer 27

Financial Aspects of Corporate Governance, is a report that sets out recommendations on the arrangement of company boards and accounting systems to lessen corporate governance risks and failures

Question 28

what are the cadbury report recommendations

Answer 28

* Wider use of independent directors * Introduction of audit committee * Separation between Chairman and CEO * Loyalty to detailed code of best practices * Protect rights of Shareholders * Recognize the rights of Stakeholders * Timely and accurate Disclosure * Responsibility of the Board of directors

Question 29

what are the four principals of corpgov

Answer 29

Accountability. * Ensure that management is accountable to the Board of Directors. * Ensure that the Board of Directors is accountable to shareholders. Fairness. * Protect Shareholders rights. * Treat all shareholders including minorities, equitably. * Provide effective redress for violations. Transparency. * Ensure timely, accurate disclosure on all material matters, including the financial situation, performance, ownership and corporate governance. Independence. * Independent Directors and Advisers i.e. free from the influence of others.

Question 30

why is corpgov important????

Answer 30

In general terms, the consequences of the lack of appropriate governance, oversight and supervision is reduced shareholder value, job reductions and reputational damage, along with reduced morale amongst employees and anger amongst users and lawmakers. * Better access to external finance * Lower costs of capital – interest rates on loans * Improved company performance – sustainability * Higher firm valuation and share performance * Reduced risk of corporate crisis and scandals * Higher valuation of human capital in companies that are well governed * Avoidance of costly litigation through adherence to laws and regulations

Question 31

why is corpgov important p2?

Answer 31

* Promote the efficient use of scarce resources * Promote the trust of investors * Good corporate governance has a positive link to economic development and good corporate performance * Funds will flow to countries which are seen to have internationally accepted standards of corporate governance * Good corporate governance, therefore, becomes a prerequisite for national economic development

Question 32

What does the NYSE rule in regard to an audit committee?

Answer 32

majority of independent directors and an independent audit committee

Question 33

The difference between high/low premiums in regard to good governance?

Answer 33

* Higher premium: countries with weaker legal/regulatory protections for minority shareholders. * Lower premium: countries with stronger protections

Question 34

is there a payoff for better corpgov?

Answer 34

Firms that scored high in investor protections also had higher profits, higher sales growth and made fewer acquisitions.