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MGST 451 > Chapter 1 > Flashcards

Chapter 1 Flashcards

1
Q

What is a corporation?

A

Lawyers: is a legal business structure that established the business as being a separate entity from the owners

Economics: a bundle of contract

General: mechanism that allows different parties to contribute capital, expertise and labour for mutual benefit

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2
Q

Types of Corporation

A
  1. sole proprietorship
  2. Partnership
  3. Corporations
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3
Q

Essential characteristics of a public corporation?

A
  1. limited liability for investors
  2. transferability of investor ownership
    - through trading
  3. legal personality (has legal rights)
  4. separation of legal ownership and management control
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4
Q

Difference between ownership and management?

A

Ownership: people who own the business
management: people who take care of day-to-day activities and management operations

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5
Q

Issues with Separation and Ownership Control

A
  • growing business–> need more skilled workers, and maximize returns more effectively
  • need to seek outside capital
  • the shareholders act as an agent and the director appoint officers
  • top management are not willing to bear responsibility for their decision unless they own stock
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6
Q

What is a principle?

A

they are the ones who hire the C-suit and decide
- monitoring

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7
Q

the agent

A

they are the people in the c-suit and are reviewed by the board of directors
- performs the duties

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8
Q

princple-agent problem

A
  1. information asymmetry
  2. conflict of interest
  3. lack of trust
  4. different objectives
  5. agency cost
  6. adverse selection: inferior alternatives being selected
  7. Moral hazard
  8. Free Cash Flow
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9
Q

what is agency cost?

A

The value the company losses due to misalignment of interest and dissonance

monitoring all activities of agents is really costly. therefore full monitoring is not optimal

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10
Q

What is the moral hazard?

A
  • the incentive of one party increased, as a result, leads to taking unnecessary risks
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11
Q

Free Cash Flow importance

A
  • the cash remaining after operations is invested in projects with a positive NPV

managers–> over diversify
shareholders–> distribution on dividends

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12
Q

Product Diversification (example of agency problem)

A

Benefit for managers
- increase firm size
- increase portfolio diversification reduces employment risk, job loss, and loss of competition and managerial reputation
- managers are less vulnerable to the reduction of demand with a single product

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13
Q

Building Empire (Agency Problem Example)

A
  • impoverish stockholders is to overpay and takeover
  • mergers do not work due to profit being relative to peer groups and mergers are reversed within a few years
  • acquiring firms managers are not as thrilled as the stockholders as firm prices tend to decline after takeover announcements
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14
Q

EXAMPLES OF ACQUISITION

A
  • HP bought autonomy 60% more than what it was valued –> misstep
  • Refusing to sell: Microsoft tried to buy yahoo but refused because Yahoo overestimated what they were worth
  • Ultra sonic: CEO disappearing
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15
Q

Examples of agency cost

A
  1. consuming excessive perks
  2. managers with fixed salaries do not put in extra effort
  3. hiring friends
  4. taking no risks or chances to avoid being fired
  5. taking excessive risk to earn large bonuses
  6. having a short-run horizon due to managers retiring
  7. managing earnings and self-dealing
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16
Q

Evidence of self-interested behaviour

A

Bankruptcy: linked to fraud and several agency problems
Financial restatements
Class action lawsuits
Violating foreign corrupt practices
Massaging earings

17
Q

Fraud Examiners Red Flags

A
  1. living beyond one’s means (ceo)
  2. financial difficulties
  3. usually close association with vendors
  4. control issues and lack of willingness to share duties
  5. a wheeler-dealer attitude
  6. family problems
  7. addiction and irritability
18
Q

Prevention of Stealing

A

Legislation: legal structure (common vs civil law)

Financial structure (market vs bank(

both have shown to be important in protecting investor rights

  • functioning legal system and allowing for lawsuits
  • accounting laws, conflict of interest laws, and reporting and regulations
19
Q

Issues with the going through the legal system

A
  • the cost of legal requirements outweighs the benefit
  • laws can have unintended consequences
  • you can not legislate corporate governance, it supplements the legal framework
20
Q

Corporate Governance

A

corporate governance prevents expropriation of outside investors (controlling and minority shareholders, debt holders, etc.)

21
Q

History of Corporate Governnace

A
  • started in the UK1992 with Cadbury report
  • this was a result of several high profile companies failing
22
Q

Cadbury Report

A

titled financial aspects of coporae governance

  • sets out recommendation on the arrangement of company boards and accounting system to lessen failures
  • adopted by the European union, us and the world bank
23
Q

Main reco of Cadbury report

A
  • wider use of independent directors
  • audit committee
  • separation of chairman and CEO
  • loyal to the code of best practices
  • protect shareholders rights
    -recognize the rights of stakeholders
  • timely and accurate disclosure
  • responsibility of the board of directors
24
Q

Accountability

A
  • managers accountable to a board of directors
  • board of directors are accountable to shareholders
25
Q

Fairness

A
  • protect shareholders’ rights
    -treat shareholders equitably
  • provide effective redress for violation
26
Q

Transparency

A
  • timely, and accurate disclosure

financial performance, ownership, and current situation of the company

27
Q

Independence

A

independent directors and advisers free from the influence of others

28
Q

Importance of Corporate Governance

A
  • better access to external finance
  • lower capital cost
  • improved company performance
  • higher firm valuation and share performance
  • reduced risk of corporate crisis
  • higher valuation of human capital in companies
  • avoidance of costly litigation through adherence to laws
  • promote efficient use of scacre resources
  • trust in inventors
  • positive link to economic development and performance
  • international recognition
29
Q

Some best practices

A
  • independent audit committee
  • penalties for misrepresentation
  • shareholders approve executive pay
  • pay a premium for well-governed

Higher premium: weaker legal protection
lower premium: countries w stronger protection

30
Q

negative of poor governance

A
  • reduced shareholder value
  • job reduction
  • reputation damage
  • reduce morale
  • anger for users and lawmakers

MGST 451 (9 decks)

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