Chapter 2 Flashcards
what are some of the factors that are inherent to the business environment?
- efficiency of local capital market
- protections afforded by legal systems enforcement
- reliability of accounting standards
- enforcement of regulations
- societal and cultural values
Differences in these factors may lead to agency costs
why are governance factors diverse?
- legal traditional
- efficiency of the capital market
- regulatory enforcement s
- accounting standards
- societal and cultural values
explain capital market efficiency
when the capital market is efficient, prices are correct and this improves decision-making
efficient market protects against adverse selection and moral hazard
competition plays a key role in this, heightened competition demonstrates governance quality in order to obtain external financing
how does an efficient market discipline corporation
- poor decisions are punished
- stock prices decline
- the cost of capital increases
- the risk of bankruptcy
adverse selection
one party has more information advantage and uses it to receive preferential pricing or risk transfer
moral hazard
one party does not bear the full risk of its actions and so engages in excessively risky transactions
what happens when a country lacks capital markets
other things must take place
- wealthy families
- large banking institutions
-other companies - governments
they also discipline corporations but their interests are different than traditional shareholders, thus less effective in monitoring
Family owned business
KMPG research shows that 70% of global GDP and 50% of all jobs. they are economically really helpful but they lack external oversight and can mask financial problems
Legal tradition
legal system provides rights and implications for business
- protection of property against expropriation
- predictability of claims
- enforceability of contracts
- efficiency and honesty of the judiciary
mitigates agency problems because self-interested managers know illegal actions will be punished
legal enforceability allow for stocks to high prices
corruption in the legal tradition
negative impact on economic development
alternative measures may be implemented (threat, bypass of legal system having directors on their supplier’s and customer side)
Reliability of accounting standards
give investors confidence that financial reports are correct and can be relied upon to evaluate risk and reward
- independent audit, IAS and GAAP
reliability of accounting standards compromised
governance quality decreases, poor decision-making, reduced efficiency of capital market
- less effective in detecting agency problems
- oversight is reduced
-manage incentives are inappropriate
enforcing of regulations
- shows that management is being monitored, which increases investor confidence
- application of more conservative accounting when regulation is strong
- participation in the equity market increases when countries adopt insider trading laws
Societal and Cultural Values
individualism (act more in self-interested actions)
collectivism (might not take risk at the same level and look for the greater good)
influences if the company is more stakeholder centric or shareholder centric
US
- has a large and liquid capital market, an active market for corporate control
- Investor interest is protected by the Securities and Exchange Commission
- accounting standards defined by a professional body (FASB) and then GAAP
- governance established by NYSE and NASDAQ
Legislation sarbanes oxley and dodd frank
shareholder centric
