Corporate Governance

Question 1

define the stewardship theory.

Answer 1

agents (managers) mainly act in the best interest of the company.

Question 2

define the agency theory.

Answer 2

agents act in their own self-interest.

Question 3

what is managerial opportunism?

Answer 3

when managers act in their own self-interest (agency theory)

Question 4

how can the company prevent managerial opportunism?

Answer 4

1. owners establish governance

2. control mechanisms

Question 5

state 4 examples of the agency theory.

Answer 5

1. business diversification
   - — works when managers != shareholders (employment vs business risk)
   - — ↑ diversification of company → mistakes of one manager are less visible → lowest employment risk
   - — ↓ diversification → ↑ time+effort allocation for shareholders, but they have to expand personal portfolio
2. managers want fast company growth, don’t care about consequences
3. reduction of managerial employment risk (protection in contracts)
4. use of free cash flows (managers want to reinvest, shareholders want dividends)

Question 6

state three internal governance mechansims

Answer 6

1. ownership concentration (having few strong owners)
2. board of directors (if 1. is not possible; = representatives of owners)
3. executive compensation (use of money to prevent misbehaviour)

Question 7

state an external governance mechanism

Answer 7

market (when a company is underpreforming, another company might buy it)
-> problem is time (it takes a while to show)