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CORPORATE GOVERNANCE Flashcards

1
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

What are Private Benefits of Control?

A

Benefits that are not shared among all shareholders in
proportion of the shares owned, but are EXCLUSIVELY ENJOYED BY PARTIES IN CONTROL (“psychic” value, outright theft, transfer pricing, using insider info for personal gain)

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2
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

What are the two main ways of
measuring PBOC? What are their drawbacks?

A
  1. CONTROL PREMIUM - the difference between the price per share of the control block and the market price per share.
    Drawbacks: Sales of control blocks are rather rare; delay in incorporating public information to the market price.
2. PRICE DIFFERENCE between shares in a DUAL - CLASS system. Extra voting rights as a proxy for corporate control.
Drawback: dual class shares are not allowed in every country.

Both measures capture only common value component.

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3
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

What tells about the fact that PBOCs are difficult to measure?

A

If PBOC were easily observable and quantifiable, they would not be private and would be claimed by minority shareholders in court

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4
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

What affects the size of PBOC premium? (name 5)

A
  1. The SIZE of block traded.
  2. PRESENCE of ANOTHER LARGE SHAREHOLDER.
  3. SELLERS BARGAINING POWER
  4. INDUSTRY.
  5. TANGIBILITY OF ASSETS.
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5
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does size of the block traded affect the size of PBOC premium?

A

You will pay more for 51% of shares than 30% because when you have 51% you are in total control. If you have only 30% your dominance might be contested. YES EVIDENCE by the authors.

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6
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does presence of another large shareholder affect the size of PBOC premium?

A

If there is another large shareholder - you have to share your PBOC – you are not happy - you pay
less. NOT SIGNIFICANT.

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7
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does sellers bargaining power affect the size of PBOC premium?

A

Reflects whether seller is in a position to demand more money from the buyers.
- If the company is in a FINANCIAL DISTRESS, a large seller is willing to sell shares for less. PBOC are then undervalued. YES EVIDENCE.

  • Whether the buyer is a FOREIGNER. Foreigners pay more (less information and connections => more bargaining power for the seller). YES EVIDENCE.
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8
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does industry affect the size of PBOC premium?

A

PBOC also differ across industries. Controlling a media company gives you enormous power of manipulating public opinion in personally beneficial ways. NOT SIGNIFICANT.

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9
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does tangibility of assets affect the size of PBOC premium?

A

If company’s assets are mostly tangible, they are harder to expropriate due to their visibility, thus lowering PBOC. Finance industry as a contrast. NOT SIGNIFICANT.

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10
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

How PBOC affects financial development (3)?

A
  1. LESS IPOs -> UNDERDEVELOPED EQUITY MARKETS. In countries showing high PBOC, entrepreneurs are reluctant to make their companies public because investors do not factor in the control value.
  2. CONCENTRATED OWNERSHIP -> LESS WIDELY HELD COMPANIES. Potential buyers of smaller stakes also attribute less value to shares taking into account being exploited by majority shareholders.
  3. PRIVATELY NEGOTIATED DEALS. Selling control in private negotiation is more profitable than in the market with dispersed buyers buying many noncontrolling stakes. (To maximize profit, governments should sell companies privately rather than in public offerings).
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11
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

How legal institutions restrain PBOC? (3)

A

LEGAL INSTITUTIONS ARE STRONGLY ASSOCIATED WITH LOWER LEVELS OF PRIVATE BENEFITS

  1. The LEGAL ENVIRONMENT.
  2. DISCLOSURE STANDARDS.
  3. ENFORCEMENT.
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12
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does legal environment restrain PBOC?

A

Greater ability to sue controlling shareholders and greater shareholder protection in general translate into smaller PBOC. WORKS.
(Anti-director rights: the process of director appointment, length of their tenure, ability to protest decisions of the majority, etc.)

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13
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why do disclosure standards restrain PBOC?

A

The more extensive and accurate disclosed information is, the more it curbs appropriation by increasing the risk of legal consequences or reputational costs. WORKS.

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14
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does enforcement restrain PBOC?

A

Quicker, smoother and more predictable enforcement results in stronger legal protections of shareholders (e.g. the level of corruption and bureaucracy of courts in the country). WORKS.

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15
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

How do extra-legal institutions restrain PBOC?

A

The possibility of extracting private benefits is related to managerial discretion (the freedom managers have to pursue their own objectives), courts cannot always restrict that, but others can.

  1. PRODUCT MARKET COMPETITION
  2. PUBLIC OPINION PRESSURE
  3. MORAL NORMS
  4. LABOR AS MONITOR
  5. GOVERNMENT AS MONITOR
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16
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does product market competition restrain PBOC?

A

Through prices, competitive markets can verify manipulated transfer prices. Competition also makes tunneling more harmful to firm’s survival. WORKS.

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17
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does public opinion pressure competition restrain PBOC?

A

Value appropriation can be limited by expected reputational losses. WORKS.

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18
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why should moral norms restrain PBOC? Do they?

A

Value appropriation can not be undertaken due to moral considerations. Religious traditions as a proxy? Crime rate? DO NOT WORK.

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19
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why should labor as monitor mechanism restrain PBOC? Does it?

A

The risk of employees quitting due to dishonest

activities by majority shareholders. What if employees benefit from PBOC? DOES NOT WORK.

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20
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

Why does government as monitor mechanism restrain PBOC?

A

Through taxes the state acts as an investor to all companies. It does not have agency/freerider problems, and has power unavailable to regular shareholders –
better tax enforcement can reduce PBOC. WORKS

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21
Q

Private Benefits of Control: An International Comparison
Alexander Dyck, Luigi Zingales

What is the effect of legal origins on PBOC?

A

Legal traditions differ in their respect for property rights and thus in their ability to protect minority shareholders.

▪ PBOC are the HIGHEST IN FORMER COMMUNIST countries (36% extra value on equity).
▪ MEDIUM in countries with a FRENCH code (21%): France, Mexico, Luxembourg, Netherlands, etc.
▪ LOWEST in countries with a GERMAN(11%), ENGLISH (5.5%) and SCANDINAVIAN (4.8%) code.

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22
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are institutional investors? Give examples

A

Entity which pools money to purchase securities, real property, and other investment assets or originate loans.

Banks, insurance companies, hedge funds, investment advisors, endowments, and mutual funds.

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23
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

According to previous research, what are 2 activities institutional investors do when they are unhappy with the company’s performance?

A
  1. VOICE – engaging with management to try to initiate changes.
  2. EXIT – leave the firm by selling shares.

▪ THREAT OF EXIT can also serve as a disciplinary action.

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24
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Are institutional investors active in expressing their opinion about the firm the invest in? Provide detailed % of results.

A

Institutional investors are ACTIVE OVERALL: ONLY 19% of the surveyed HAVE NOT taken any corrective ACTIONS in the past 5 years.

> 50% have used discussions with management and board and voting against management as corporate governance channel (voice)

39% have sold shares due to dissatisfaction with corporate governance (exit)

15% have used legal actions

13% have used public criticism

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25
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are the potential determinants of voice intensity?

A
  1. Liquidity
  2. Investment Horizon
  3. Size (that’s what she said)
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26
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why is liquidity a determinant of investor’s voice intensity?

A

Theory:
- Higher liquidity of shares held encourages investors not to bother with activism and liquidate.

+ On the other hand, higher liquidity makes it easier to sell at increased price that reflects engagement efforts. If I can sell at a higher price already tomorrow, why not be active?

Paper:
- Indicates negative relationship between liquidity and voice: the more liquid shares institutional investors hold, the less they intervene (simply use exit strategy more)

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27
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why is investment horizon a determinant of investor’s voice intensity?

A

Theory:
+ Long-term shareholders might be incentivized to intervene, because they can reap the long-term benefits. Long-term investors might also have more time to gather information for effective intervention.

  • Contrary, it is claimed that hedge funds (short-term mostly) sometimes push for actions that are profitable in the short run, but detrimental in the long run.

+ Paper: Positive relationship between horizon and voice: long-term orientation provides more incentives to monitor and intervene.

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28
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why should the size of the stake in the company be a determinant of investor’s voice intensity? Is it?

A

Theory: Positive relationship - Larger share of company means more absolute payoff for intervention – encourages more activism. Larger funds might also have more resources to engage.

Paper: No significant relationship.

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29
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why should voice and exit be complements (used simultaneously)?

A

“The chances for voice to function effectively… are
appreciably strengthened if voice is backed up by the threat of exit.”

Managers tend to take discussions with shareholders more seriously in the face of a threat to exit.

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30
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why should voice and exit be substitutes (used separately)?

A
  1. Some investors might lack the expertise of intervention and thus rely solely on the exit strategy.
  2. Investors might face capital gains costs when exiting, which makes the option of voice more attractive.
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31
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Does the paper find that voice and exit are complements or substitutes?

A

Complements. Robust positive correlation between the two variables.

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32
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

Why is threat of exit effective?

A

Shareholders can collect private information on the fundamental value of a firm, which is then impounded to the price they offer in case of an exit.

If a firm is crap, but the public does not know it yet, managers are strongly incentivized to increase firm’s value to avoid exit by informed shareholders.

This happens behind the scenes – threat of exit is in fact empirically unobservable, thus survey results are the only data.

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33
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are the factors that discourage shareholder activism? (4) Explain.

A
  1. FREE RIDER PROBLEM - they would personally incur costs of activism while the benefits would be shared among all shareholders.
    - Higher stake size increases net payoff for activism and hinders the “free rider” problem (when you have more money in one company and others have less, you will benefit more from the company performing better than others)
  2. INADEQUATE LEGAL RULES
  • Diversification requirements for mutual funds
  • Engagements can lead to legal consequences (when you too loud yelling and do smth bad)
  • Weak disclosure requirements limits the amount of information that shareholders get providing less opportunities for activism.
  1. CONFLICTS OF INTEREST: Investors might be concerned that aggressive engagement might affect their future relations with firms (private costs).
  2. Fund managers might not bother engaging if they are NOT SUFFICIENTLY REWARDED for activism (compensation problems).
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34
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are the factors that encourage shareholder activism? (4)

A
  1. FRAUD
  2. INADEQUATE CORPORATE GOVERNANCE, EXCESSIVE COMPENSATION
  3. DISAGREEMENT WITH STRATEGY, specifically large mergers and acquisitions.
  4. CONTRIBUTIONS TO POLITICIANS

In general, shareholders tend to engage more over long-run strategic issues (e.g. firm’s strategy for overseas markets) than over short-term issues (e.g. low dividends, underperformance).

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35
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are proxy advisors?

A

Proxy advisory firms provide institutional investors with research, data, and recommendations on management and shareholder proxy proposals. It reduces the costs of being informed by monitoring, collecting information and using professional judgment in recommendations.

60% of respondents use at least one proxy.

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36
Q

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
Joseph A. McCathery, Zacharias Sautner, Laura T. Starks

What are problems with proxy advisors?

A
  1. Proxy advisors ONLY COMPLEMENT INDIVIDUAL JUDGEMENT and do not imply that investors take passive governance role.
  2. Recommendations of proxy advisers can be TOO STANDARDIZED and ignoring firm-specific cases.
  3. Recommendations are also HARD TO EVALUATE due to LACK OF TRANSPARENCY in their criteria.
  4. They are profit-seeking organizations, are INCENTIVIZED TO CONDUCT LOW-COST ANALYSIS
  5. Some PROXY ADVISORS serve as CORPORATE GOVERNANCE ADVISORY FIRMS firms and make recommendations on voting at the SAME TIME. CONFLICT OF INTEREST might arise.
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37
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What is the motivation of the paper?

A

Socially responsible investing that seeks to deliver social as well as financial benefits, has attracted increasing attention.

$59tn assets (in 2015) are estimated to be managed by companies incorporating environmental, social and governance (ESG) concerns in their decisions.

While traditional activism of mutual and hedge funds focuses on issues related to shareholders only, ESG activism advocates for the interest of a broader range of stakeholders (e.g. employees, customers, creditors).

However, there is a general ambiguity surrounding the most basic principles of ESG activism: what companies are targeted, what determines its success, how does it affect firm performance

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38
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

Describe typical ESG activities

A

Environmental engagements (E) - climate change, water issues.

Social concerns (S) - human rights, public health and labor standards.

Governance (G) - audit and control, executive compensation

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39
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

Describe Theoretical Effects of Corporate Social Responsibility (CSR) (3).

A
    • CSR practices are based on LONG-TERM STRATEGY on company value, consistent with the interests of institutional investors (e.g. pension funds). Firm value should increase!
    • CSR businesses act as a CHANNEL TO EXPRESS PERSONAL VALUES on behalf of their stakeholders. Delegated philanthropy saves time and information costs of doing charity on one’s own. Firm value should increase!
    • CSR activities are management-initiated, opposed by shareholders, thus revealing AGENCY PROBLEMS. Milton Friedman: corporation should not do charity with others’ money. Firm value should decrease!
40
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

Describe 4 channels through which ESG activities can
increase firm value.

A
  1. CONSUMERS: Socially conscious consumers have a greater customer loyalty and are willing to pay premium for ESG-induced product differentiation.
  2. EMPLOYEES: Firms with higher employee satisfaction due to social engagement (e.g. diversity) tend to outperform the market.
  3. MORALS: More “virtuous” companies attract broader clientele than “sinful” companies.
  4. PROGRESSIVENESS: Successful ESG interventions signal similarly successful future interventions as well as firm’s openness to improvements in other areas.
41
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are 2 types of engagement in ESG issues by managers?

A
  1. RAISING AWARENESS – warning companies about certain ESG issues.
  2. REQUEST FOR CHANGE – specific changes are asked (more strict step).
42
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

Why do engagements on environmental and social issues have lower success rate than on corporate governance?

A
  1. Managers doubt the value of engaging in costly project to potentially benefit non-shareholders.
  2. ESG engagement is less aggressive compared to hedge funds’ activism.

Engagements on environmental and social issues have
considerably lower success rate (13.1%) than on corporate governance (24.2%). CG success rate still lags far behind hedge funds’ track record.

43
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are 2 factors when the likelihood of the successful engagement increases?

A
  1. There is successful prior engagement with the same firm.

2. Other shareholders collaborate

44
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are 4 determinants of successful ESG engagement?

A
  1. LARGE AND MATURE FIRMS. Economies of scale enable such companies to consider investing to ESG practices. Constant public coverage also increases reputational concerns.
  2. INSTITUTIONAL OWNERSHIP. Other socially conscious investors (e.g. pension funds) increase the chances of collaboration.
  3. UNDER PERFORMING FIRMS. Lower profitability, stock returns, inferior corporate governance – potential room for improvement.
  4. CONSUMER INDUSTRIES. Consumer-facing and brand-driven firms are more likely succumb to reputational concerns (e.g. Nike).
45
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are factors more important for environmental and social engagement than for corporate governance activism?

A

Compared to CG activism, ES engagement specifically prefers large sized, consumer-based firms, having financial capacity to change and caring for reputation. Collaboration with other shareholders is more important than the stake size.

46
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are the firm benefits to engagement in ESG?

A
  1. Mere ESG engagement generates 2.3% abnormal RETURN of firm stock value. If engagement is successful, abnormal one-year return increases to 7.1% and flattens after.
  2. Successful ESG activism also DECREASES stock VOLATILITY (the firm becomes less risky).
  3. There is NO REACTION market reaction AFTER UNSUCCESSFUL engagement. (win-win situation)
  4. Effect on stock market values: ESG activism lies between traditional shareholder activism and hedge fund activism.

Side note: ESG improvements in the target firms are not a result of superior future performance (as argued before)

47
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

Please compare CG and ES activities effects on the firm

A
  1. Abnormal returns are highest on corporate governance (8.6%) and climate change issue (10.3%) engagements.
  2. Compared to CG, ES (environmental and social) activism results in higher sales and employee efficiency – consistent with the argument of higher customer base and employee loyalty.
48
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

If ESG policies are so beneficial, why firms might not voluntarily pursue these strategies? (2)

A
  1. Targeted firms have poorer corporate governance hindering the initiation of ESG policies.
  2. In the absence of active owners, companies might fail to identify ESG opportunities.
49
Q

Active Ownership
Elroy Dimson, Oguzhan, Karakas Xi Li

What are the main conclusions? (2)

A
  1. ESG activism increases stakeholder value when engagements are successful and does not destroy value even when activism fails. It’s a win-win lottery.
  2. Responsible investment initiatives are less confrontational, more collaborative and benefits society at large.
50
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Describe how institutional investors have evolved.

A

Widely held corporations with dispersed ownership among small shareholders have been prevalent in the US since early 20th century.

Times are changing: institutional investors saw a rise in the recent decades (from 6.1% of US corporate equity in 1950 to 63% in 2016).

By aggregating the assets of investors, institutional investors hold substantial stakes in corporations to have non-negligible effect when voting.

51
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What are stewardship activities? Name 3

A

Engagement with public companies to promote corporate governance practices that are consistent with encouraging long-term value creation for shareholders in the company.

  1. Voting in shareholder meetings (and being informed when voting)
  2. Monitoring corporate managers
  3. Engaging with the management (using voice and exit)

Stewardship activities, expected from the funds, require substantial costs. Performance of these duties is under the discretion of the investment manager. Is he/she fully reliable?

52
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What kind of institutional investors are looked at in this reading? (3)

A

Investment funds - Investment funds pool together the assets of many individuals and invest them in a diversified portfolio of securities.

  1. Index funds (Passive)
  2. Active funds (most of them are “closet indexers”)
  3. Hedge funds (very active)
53
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Why have Index Funds been growing in popularity?

A
  1. Recognition of their low costs
  2. Tax advantages
  3. Evidence that they actually outperform actively managed funds.
54
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What are the agency problems named in the reading? Name 4

A
  1. Costs and compensation
  2. Index Tracking
  3. Active Funds
  4. Private costs
55
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Why are costs and compensation agency problems leading to less engagement in stewardship activities?

A

Investment managers of index funds bear full costs of stewardship, but capture only a fraction (as low as 0.12%) of benefits created, because compensation is based on fixed % of assets under management.

Thus, investment manager only undertakes a stewardship if its cost is less than its payoff for her, still based on a fraction of increased value of assets.

56
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Funds try to increase the capacity of stewardship by increasing assets under management. How do they measure it?

A
  1. Relative to the index:
    If an index fund spends on stewardship and increases the value of a portfolio this also increases the value of the tracked index, leaving performance relative to it unchanged.
  2. Relative to the the rivals:
    Rivals following the same index experience the same % increase in value.
57
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Why are Index funds engaging stewardship activities creating a free-rider problem?

A

Index funds engaging in stewardship do not improve relative performance to attract more assets (because they improve the whole index that others have invested in). Their investors are in fact incentivized to switch to their competitors that free ride on others’ expenses, as they offer the same return without higher fees to finance it.

Example:Index fund Vanguard employs only about 15 staff for voting and stewardship at its 13,000 portolio companies.

58
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Describe the agency problem of active funds

A

Most of the active funds are “closet indexers” (i.e. they are not so active) whose holdings highly overlap with the benchmark index, differing only by under- and over- weighting some stocks.

They also capture only a small fraction of benefits arising from stewardship activities.

If stewardship increases the value of an underweight company, index (and funds that track it) benefits more than the active fund, even decreasing its performance relative to the index.

On the contrary, to improve performance relative to the index, increasing the value of an overweight stock actually works.

These relationships are more complex for mutual fund families that organize several funds under one management where multidimensional decision-making takes place, i.e. which funds would be favoured by certain actions.

59
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Why are private costs driver of agency problem?

A

Investment managers often run both investment fund and investment services (e.g. cash management, short and long term investments) firms

Investment managers might bear additional private costs (e.g. losing revenue, reputation) from taking positions that corporate managers disfavor.

If stewardship opposes corporate management, investment managers are only willing to undertake a stewardship if the fraction-based payoff is larger than stewardship costs plus private costs.

Investment funds with more business ties with corporations are in fact documented to make more pro-management decisions and avoid aggressive stewardship.

60
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What is considered the agency problem in the reading?

A

Institutional investors might not act in the best interest of their clients – institutional investors might not engage in stewardship activities or might not invest enough in stewardship activities because they have no incentives to do so.

Agency problems of institutional investors prevent the full realization of the potential benefits of the increased concentration of shareholders.

61
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

Why are hedge funds not faced with the agency problem as much as mutual funds?

A
  1. Typical hedge fund manager fee is based on the “2 and 20” scheme. Thus, hedge funds capture a larger value increase compared to the mutual funds.
  2. Hedge funds do not offer consulting or money management services for corporations, thus are not afraid of taking positions adverse to corporate managers- no conflict of interests.
  3. Hedge funds hold significant (10%+) stakes in a few companies, capturing much more value from stewardship activities relative to mutual funds or the index.
  4. Hedge funds devote more person-per-hour and have representatives on the board of directors in each company in their portfolio
  5. The returns of activist hedge funds are weakly correlated with each other. Every slight performance difference signals fund superiority.
62
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What are the limitations of hedge funds regarding solving the agency problem?

A

Hedge fund managers spend on stewardship only when the resulting value increase is high enough to still give investors a reasonable return after higher fees are charged. Opportunities giving smaller returns are ignored.

To win proxy fights, hedge funds need to acquire support from other institutional investors, many of which suffer are not willing to oppose the management.

Some scholars argue that hedge funds focus on short term returns at the expense of long term value. Mutual funds, on the other hand, prefer long investment horizons.

Without mutual fund support, hedge funds are hardly a threat to the corporate management.

63
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What are the main conclusions in the reading?

A

Investment managers have incentives to spend less on stewardship and side with managers than would be optimal for beneficial investors.

The rise of index funds, while having seen as a positive development, raise serious costs for corporate governance.

Modern corporations suffer not from too much shareholder intervention, but rather from too little.

64
Q

The Agency Problems of Institutional Investors
Lucian A. Bebchuk, Alma Cohen, Scott Hirst

What could be possible systematic improvements?

A
  1. Adopting disclosure regulations (e.g. on how voting takes place) that would enable beneficial investors identify and assess agency problems themselves.
  2. Adopting incentive-based compensation for mutual fund managers.
65
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What has been concluded in the previous literature about the relationship between the power protection of shareholder rights and PBOC?

A

If protection of shareholder rights is STRONG –> PBOC is LOW -> shareholders can expect to get a proper financial return

If protection of shareholder rights is WEAK –> PBOC is HIGH -> shareholders will get less money

66
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is an anti-takeover provision?

A

Anti-takeover provisions (aka takeover defenses) are actions taken by a firm’s management to prevent unwanted takeovers.

(Unwanted takeover - acquisition of one company by another that is accomplished by:

  • -going directly to the company’s shareholders OR;
  • -fighting to replace management to put in a new management that will be more likely to get the acquisition approved.

Key characteristic of an unwanted takeover - target company’s management does not want the deal to go through, so it will defend against takeovers by using several strategies)

MORE takeover defense means LESS rights for the shareholders.

67
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What has been concluded about anti-takeover defense influence on the firm’s value in the previous literature?

A

Higher antitakeover defenses—>

  • –> managers who run firms inefficiently cannot be thrown out
  • –> decrease in firm’s value through lower operating performance.
68
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

Please name all types of takeover defenses that you know!

A
  1. Charter amendments
  2. Golden parachute
  3. Poison pills
  4. Pac man defense
69
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is a charter amendment and what is another name for it?

A

Charter amendment OR Shark Repellent (anti-takeover technique)

Imposing conditions in a firm’s charter (“a legal document that formally establishes a corporate entity”) on control transfer.

Ex: requiring over 2/3 shareholder vote to approve a merger/acquisition.

(how to remember the name: “when a shark attacks, shark repellent can send the shark away from its place of attack” - so charter amendment a company’s way on HOW to send away the sharks)

70
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is a golden parachute?

A

Golden parachute:

Substantial benefits (compensation) that is guaranteed to a firm’s senior management if the firm is taken over and the managers are let go.

71
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is a poison pill?

A

Poison pills:

Strategy to make the company’s stocks seem less attractive to the acquirer. Accomplished by making the company’s stock more costly to acquire.

Ex1: Allowing existing shareholders to buy more stock at a discount which increases the number of shares that the acquirer will have to buy.

Ex2: Creating employee stock option plan that shows up only when the company is taken over which makes it more difficult to retain key employees after a takeover.

72
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is a pac-man defense?

A

Pac-man defense:

Company trying to acquire the acquirer in an attempt to scare off them (Tinder buying Bumble, Bumble threatening to buy Tinder - not irl)

During the takeover phase, the acquirer may begin a large-scale purchase of the target company’s stocks to gain control of the target company. As a counter-strategy, the target company may begin buying back its shares and purchasing shares of the acquiring company.

73
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What is the main motivation of this paper?

A

The authors argue that the existence of dual-class stocks in a company ALSO can be an anti-takeover strategy (it has apparently been forgotten). Authors look at how being dual-class company in the US influences the firm’s value.

Background info:
Dual-class company has two types of shares:
1. Superior shares with more votes per share
2. Inferior class, with one vote per share

Superior class of shares is usually owned by company insiders which provide insiders with a majority of votes.
Thus, insiders of dual-class firms have effective control over all corporate decisions which makes them virtually immune to hostile takeovers. Additionally, inferior shareholders have less control and thus can be more easily expropriated, leading to a worse performance of the firm.
74
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What are the main characteristics of a publicly listed dual-class company in the US?

A
  1. The insiders (the ones who hold superior shares) of own a majority of the voting rights (~60%)
  2. The insiders own a minority of the cash flow rights (~40%), meaning that they bear considerably smaller financial consequences for their decisions.
  3. Dual-class firms are BIGGER than one-class firms on median terms of firm value
  4. Dual-class firms are MORE LEVERED, possibly due to their reluctance to engage in equity offerings not to lose ownership (If I issue more stock, my control gets weaker)
  5. Dual-class firms are OLDER, possibly due to less possibility of being acquired.
75
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What predicts larger size of PBOC and, thus, a dual-class status?

A
  1. Name (A company named after a founder indicates a more “personal” stake involved);
  2. Media (Control of a media company provides opportunities for self-advertising, manipulating the public opinion);
  3. Activity of the founder (PBOC and also dual-class structure is more likely if the firm is young and the founder is still active);
  4. Firms in the area & Sales of the area (the less firms there are in firm’s area, the more likely the firm is a major employer in town which entails private benefits for insiders with dual-class shares - additionally, firms with an important local presence may use dual-class status as a promise to local authorities that the firm will resist takeovers in order to honor implicit contracts with local governments and other stakeholders).
76
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

Why are empirical studies of firm valuation and insider ownership criticized?

A

Endogeneity/Loop of Causality– it is not only that ownership structure determines firm’s value, but it can also be that the firm’s value influences the ownership structure

77
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

What are the main findings of the paper (despite the endogeneity issues)?

A

Nevertheless, the paper finds that:
1. Firm’s value is positively associated with insiders’ cash-flow rights. (insiders have more cash flow rights - (possibly) more incentivized to make good decisions because of monetary risk - firm’s performance, and, thus, value increases)

  1. Firm value is negatively associated with insider voting rights (more insider voting rights decreases the firm’s value)
  2. Firm value is negatively associated with the wedge between the two (insider voting rights – insider cash flow rights). - The more imbalanced they are, the more negative firm’s value is.
78
Q

“Extreme Governance: An Analysis of Dual-Class
Companies in the United States” (Paul A. Gompers, Joy L. Ishi, Andrew Metrick)

Why a negative trend on firm’s value can sometimes not seem important to a majority owner of a company?

A
  1. If majority owner deems establishing PBOC more important that maintaining firm value, he will rationally choose to sacrifice some of firm value to maintain PBOC.
  2. PBOC from controlling a newspaper, news agency or brand identity can outweigh financial losses of the firm.
79
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

How do Morningstar Sustainability Rankings work? How are the funds ranked there? How is the result portrayed in their website?

A

Morningstar Sustainability Ratings show the sustainability level of funds.

Funds are ranked depending their holdings of sustainable stocks.

The result in website is portrayed in scale of “five-globes”:

Top 10% - Most Sustainable - 5 globes;
Between Top 10% and 32.5% - Above AVG - 4 globes;
Between Top 32.5% and 67.5% - AVG - 3 globes;
Between 67.5% and 90% - Below AVG - 2 globes;
Worst 10% - Least Sustainable - 1 Globe

80
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

How can fund flows explain if investors are desiring to be more sustainable?

A

If a fund is generally viewed as more desirable after its rating becomes public, money will flow into it and it will grow.
If it is viewed as less desirable, we will see money flow out of it and it will shrink.

81
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

Do investors value sustainability? What do the authors unveil?

A

Yes, they do.

Investors mostly look at GLOBE RATINGS rather than pure measure of percentile or sustainability score (investors often focus on discrete rather than continuous measures)

Investors focus on EXTREME outcomes - 1 globe and 5 globe rating funds see the largest impact

Prior to the rating publication, funds received similar levels of flows, so there were no fundamental differences.

82
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

What are the three reasons why do investors may want to hold sustainable stocks? Which do the authors prove to be true?

A
  1. they face institutional constraints;
  2. they have rational performance expectations;
  3. they have irrational expectations and non-quantifiable motives

The authors find evidence consistent with nonpecuniary (non-quantifiable, non-monetary) motives of being an important driver when choosing to invest in sustainable stocks.

83
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

Why do institutional investors have an incentive to hold sustainable stocks? Does it hold in real life?

A

Reason: Institutional investors are often OBLIGED to hold high sustainability stocks or constrained not to hold low sustainability stocks

Discussion in article:
If institutional constraints are the reason for the increased fund flows in high sustainability funds, we should see more fund flows from institutional share classes than from non-institutional share classes; however, there is NO difference between the fund flows.

84
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

Can investors have rational performance expectations about sustainable stocks? What happens in real life?

A

Yes!

If investors believe sustainable funds will outperform the market, funds will flow to high sustainable funds

Real life:
Evidence is more consistent with an INVERSE relation or NO relation between globe ratings and returns rather than the positive relation (high sustainable ratings are not necessarily associated with better future performance)
Therefore, investors have irrational expectations?

85
Q

“Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows” (S. Hartzmark, A. B. Sussman)

Can investors have irrational or non-quanitifiable incentive for holding sustainable stocks? Do authors prove it?

A

YES!

Investors might assume that a high sustainability rating would lead to high future fund returns OR they simply had a non-monetary (social) preference for holding more sustainable mutual funds

Authors run an experiment and find
evidence on irrational expectations:

Environmentally and socially conscious participants (therefore, people with non-quantifiable goals) when making their investment decisions, invest more money in 5-globe funds and less money in 1-globe funds, comparing with those not environmentally and socially conscious.

86
Q

Do Institutional Investors Drive Corporate Social Responsibility? (Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019)

What kind of measures do the researchers look at?

A

They look at institutional investors.
Additionally, firm-level environmental and social performance measures are created (covering such areas as CO2 emissions, renewable energy use, human rights violations, and employment quality) from several E&S data providers, as well as these providers’ E&S scores.

87
Q

Do Institutional Investors Drive Corporate Social Responsibility? (Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019)

When are investors likely to engage with firm’s E&S issues? For which investors does this not hold?

A

Institutional investors’ exposure to social norms is non-negligible, as they need to network and raise capital locally and they are (at least to some extent) mindful of local E&S social norms.

The tests in the article show that, for independent institutional investors, no impact is evident when considering the firm’s E&S performance if the investor is from a country where E&S social norms are relatively weak (such as the US). This inverse is applicable for countries with high social norms (such as the Netherlands).

Only European institutional investors were shown to impact firms’ E&S performance.

Pension plans consistently influence firms to strengthen E&S performance no matter the country they’re in.

88
Q

Do Institutional Investors Drive Corporate Social Responsibility? (Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019)

What are the two settings in which institutional owners could have a greater impact on firms’ E&S performance?

A
  1. An investor becomes a signatory to the UN Principles for Responsible Investment. Being a signatory requires that investors incorporate ESG issues into their investment analysis and decision making
  2. The firm has greater scope for E&S improvement. Greater effects were expected in the firms with low initial E&S performance.
89
Q

Do Institutional Investors Drive Corporate Social Responsibility? (Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019)

What are mechanisms used by institutional investors to demand change?

A
  1. Exit and selection (use negative screening to exclude poor E&S performers or positive screening to buy only firms above certain E&S thresholds). Authors find that this method does not account for broad, large-scale changes.

2.Voice (voicing their concerns to the management). As exit and selection has not been prevalent, the authors state their assumption that voice will prevail as the more important mechanism for demanding change.

90
Q

Do Institutional Investors Drive Corporate Social Responsibility? (Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019)

What are investors motivated by when they address a firm’s E&S performance?

A
  1. Social returns (but only when these investors are from countries where social norms reveal a greater demand for E&S performance)
  2. Financial returns (but strong enough social norms can overcome market pressures to focus on these)
91
Q

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure? (Pajuste, Anete, and Anna Toniolo, 2022)

What is stakeholderism?

A

Stakeholderism: focusing stakeholder interests – essential for maximizing shareholder values, others believe stakeholders should be the focus regardless of shareholder value.

92
Q

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure? (Pajuste, Anete, and Anna Toniolo, 2022)

What are they researching and why is there a need to do that?

A

Research: What drove firms to decisively respond to the invasion of Ukraine? (support Ukraine by hindering Russia)?

Why is there a need to review it? – Firms that withdraw from Russia are rewarded and those that remain are punished (in Academia and public).

93
Q

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure? (Pajuste, Anete, and Anna Toniolo, 2022)

What are the 2 main hypotheses on why countries withdrew from Russia?

A

Hypothesis 1: Ethical judgment, even at the cost of shareholders.

Hypothesis 2: (Small) exposure to Russia and reputational risks.

94
Q

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure? (Pajuste, Anete, and Anna Toniolo, 2022)

What are the 3 main points this paper makes?

A
  1. Corporate leaders tend to prioritize social objectives when they believe it maximizes returns, and not obtaining the said social objectives. (JP Morgan said they withdrew and continued trading debt + Corporate leaders referred to their decision of leaving or staying in Russia as supportive of stakeholders regardless of what they actually did)
  2. Twitter-based “virality” played an important role in companies cutting ties with Russia. Stakeholder pressure is an effective instrument to promote responsible management (but only as a complement).
  3. Smaller companies are left free to operate without the important managerial constraint from stakeholder pressure. (important because small companies can be just as harmful as big companies if they conduct a significant portion of business in Russia)

Taken together, the evidence presented in this paper supports the view that even though private ordering can contribute to more socially responsible management, external interventions such as legislation, regulation, and policy design are often critical to protecting stakeholder interests.

95
Q

Corporate Control around the World (Aminadav, Gur, and Elias Papaioannou, 2020)

What are the main influencing factors of corporate control concentration?

A

Influencing factors are

-legal system

  • economic development (weak correlation). The correlation is negative between income and corporate control, and it is pronounced only for large corporations (top 10%)
  • shareholder protection (possibility to take legal action against managers who abuse their position) is linked with dispersed ownership.
  • labor legislation (positively correlated to corporate control).
96
Q

Corporate Control around the World (Aminadav, Gur, and Elias Papaioannou, 2020)

Which countries have the most ownership concentration, and which have it the least?

A
  1. French civil law countries
    Most ownership concentration.
  2. German and Scandinavian civil-law countries
    German civil-law countries take 2nd place and then come Scandinavian civil-law countries. All 3 show similar patterns in ownership concentration.
  3. Common-law countries
    Lowest ownership concentration.

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