Corporate Governance Flashcards
What is corporate governance?
Corporate governance refers to the system of rules, practices, and processes by which a public stock company is directed and controlled, ensuring strategic goals are met while complying with laws and regulations.
How does governance differ from management?
Governance involves oversight by the board of directors to protect shareholders’ interests, while management handles day-to-day operations carried out by executives like the CEO and CFO.
What are the key benefits of a public stock company?
Limited liability for investors.
Transferability of ownership through stock.
Legal personality (separate legal entity).
Separation of ownership and control.
What is the typical hierarchy of authority in a public company?
State charter.
Shareholders.
Board of Directors.
Management.
Employees.
What is the principal-agent problem in corporate governance?
The principal-agent problem occurs when the interests of the principals (shareholders) and the agents (managers) do not align, leading to potential conflicts.
What is agency theory in corporate governance?
Agency theory views the company as a nexus of legal contracts and focuses on minimizing conflicts between shareholders and management through contracts, task design, and performance monitoring
What are the two key issues caused by information asymmetry?
Adverse Selection: Increased likelihood of selecting inferior alternatives due to incomplete information.
Moral Hazard: When one party takes undue risks because another party bears the consequences.
What is the role of the board of directors?
The board of directors oversees management, ensures the company pursues shareholders’ interests, and provides strategic oversight.
What are inside directors and outside directors?
Inside Directors: Part of the company’s management, such as the CEO or CFO, with intimate knowledge of the company.
Outside Directors: Senior executives from other firms who provide independent oversight.
What are the key responsibilities of the board of directors?
CEO selection, evaluation, and succession.
Executive compensation.
Reviewing and approving strategic initiatives.
Risk management.
Ensuring financial accuracy.
Ensuring compliance with laws and regulations.
How can executive compensation negatively impact performance?
Overemphasis on short-term incentives (STI) may cause managers to focus on immediate gains, potentially harming long-term stability. Long-term incentives (LTI) are designed to counter this risk.
What are external governance mechanisms?
Market for Corporate Control: Activist investors taking control of underperforming companies.
Financial Auditors, Regulators, Analysts: Ensuring financial accountability, compliance, and providing performance evaluations.
What potential issues arise when the CEO is also the chairman of the board?
This dual role may blur the line between governance and management, creating conflicts of interest if not properly managed.
Why is corporate governance important?
Good corporate governance ensures ethical, effective operations, balances stakeholder interests, minimizes risks, and enhances overall company performance.
