Corporate Governance Flashcards
Give a neutral definition of corporate governance
corporate governance deals with conflicts of interests
between the providers of finance and the managers; different types of shareholders (mainly the large shareholder and the minority shareholders); the shareholders and the stakeholders;
and the prevention or mitigation of these conflicts of
interests
Detail the principle agent problem
The agent has been asked by the principal to carry out a
specific duty. However, the agent may not act in the best interest of the principal once the contract has been signed.
The agent may rather prefer to act in his own interest, Economists call this moral hazard
One way of addressing principal–agent problems is via so
called complete contracts
what factors contribute to agency costs
the monitoring expenses incurred by the principal;
the bonding (alignment) costs accruing to the agents;
any residual loss, loss in value for the principal
What are the Agency costs of equity
conflicts between shareholders (i.e., principal) and
managers (i.e., agent).
conflicts between large shareholders (i.e., agent) and
minority shareholders (i.e., principal)
What are the Agency costs of debt
conflicts between shareholders (i.e., agent) and a specific
stakeholder, bondholders (i.e., principal)
The three main types of agency problems in the conflicts
between shareholders and managers are
perquisites
empire building
managerial entrenchment and risk-aversion
What are perquisites
Perquisites or perks consist of on-the-job consumption by
the managers
What is empire building and the problems associated with it
Empire building consists of managers pursuing growth
rather than shareholder-value maximisation.
While there is a link between the two, growth does not
necessarily generate shareholder value and vice-versa.
Empire building is also referred to as Jensen’s free cash
flow problem (1986): managers investing beyond the positive Net Present Value threshold
Why do Managers empire build
Benefits from increasing the size of the firm are increased
power and social status, larger remuneration, more
visibility
What is Managerial entrenchment
Managers shield themselves from hostile takeovers and
internal disciplinary actions (e.g. poison pills, staggered boards,
golden parachutes).
What is Managerial risk aversion
They tend to prefer the quite life.
Managers tend to make inefficient investment decisions: reject positive NPV projects with high risk.
Well-diversified shareholders’ interests: invest in risky
projects so long as they increase the equity value.
Invest in all positive NPV projects.
The main types of agency problems in the conflicts
between large shareholders and minority shareholders are
related to expropriation through:
tunnelling;
transfer pricing;
nepotism;
infighting
What is tunnelling
Tunnelling consists of the large shareholder transferring
the firm’s assets or profits into his own pockets
What is Nepotism
Nepotism consists of the large family shareholder
appointing family members to top management positions
rather than the most suitable candidates on the job market
What is Infighting
Infighting may not necessarily be a wilful form of
expropriating the firm’s minority shareholders, but
nevertheless is likely to deflect management time as well
as other firm resources