Corporate Governance

Question 1

what does it mean when an economy is Pareto efficient

Answer 1

no one can be made better without making someone else worse off

Question 2

stewardship theory

Answer 2

stresses how honor, reputation, customs, religion, etc. can prevent agents from making NPV < 0 decisions, is sometimes presented as an alternative to agency theory.

Things within religion and reputation can make someone act differently because it affects their stewardship and standing in the community … instead of acting in the principals best interest

Question 3

ceo hubris

Answer 3

when the excessive self esteem of a CEO leads to underperformance as a result of making NPV < 0 decisions, wrongfully thinking that they’re NPV > 0

worsened by CEO awards, confusing luck with talent

Question 4

ceos and FCF problems

Answer 4

this relates to CEOs keeping more FCF as cash rather than paying it out in the form of dividends

they believe that a bird in the hand is better than a bird in the bush

leads to firms putting that cash towards NPV < 0 projects which reduces shareholder value, when they could’ve just paid a dividend

Question 5

ceos based on life experience

Answer 5

personal life experience greatly impact CEO risk tolerance and decision making

if exposed to highly traumatic/difficult events as a child (1950s famine in China or Great Depression) then they tend to pursue safer strategies and have lower firm WACCs

opposite is true if the person didn’t experience these same events growing up

Question 6

debate between risk averse CEOs and generating shareholder wealth (reference to principal agent problems)

Answer 6

CEOs should act in the best interest of shareholders (maximize wealth)

CEO life experience, risk tolerance, hubris, gender, age can impact the decisions they make

CEOs are incentivized to keep their job & reputation, while shareholders just want highest risk-return payoff

this can cause the CEO to begin acting outside of the shareholders’ best interest by pursuing safer projects, not investing in R&D, hindering potential wealth creation

Question 7

T/F: Firms that spend more on R&D have higher Q ratios

Answer 7

true!

Firms’ share prices rise sharply on announcement of R&D budget increase

Question 8

why don’t firms innovate more than they do today?

Answer 8

• CEOs fear of looking inferior (losing their expertise to other new ppl)
• labor unions preventing them
• rigid bureacracy

Question 9

Carnegie conjecture on why CEOs aren’t very good

Answer 9

don’t live normal lives and don’t understand the needs and wants and behavior of ordinary people

Question 10

why do talented CEOs avoid working for family firms? particularly in the western world

Answer 10

even if a smart new CEO is added to replace the existing family CEO, it’s hard for them to enact positive change since the family still owns enough controlling shares to tell the CEO what to do

so they leave and go

Question 11

what’s the issue with CEOs who want to be liked too muc

Answer 11

always want to please people and aren’t capable of making hard decisions that will improve Q ratio but hurt some people (layoff workers)

corporate raiders often make the hard decisions that past CEOs failed to make for decades

otherwise leaves firms in NPV < 0 ventures

Question 12

describe CEOs as herd animals (Keynesian corporate governance)

Answer 12

CEOs don’t really know what they’re doing

CEOs won’t be blamed for a decision that everyone made but will be blamed for a decision that they just made … leads to herding of decision making

common in banks especially as they’ll all get bailed out if they all make a mistake but won’t bail out one if one makes a mistake (assuming it’s not a large bank)

Question 13

CEO myopia

Answer 13

making a decision in the short term and not seeing the long term

Question 14

are independent boards really independent

Answer 14

no,they can still pull their college roommate or friend’s spouse to be their independent director who gives them the decision that they want to hear

Question 15

talk about the 1940s merger wave

Answer 15

JK Galbraith made the economy centrally planned and set prices himself, throwing free markets out of the equation

this led to a mismatch of prices and firms had to do vertical M&A to counter the pricing challenges

like news paper companies not being able to afford news print … so they would buy a news print company to produce newspaper

Question 16

talk about the 1960s merger wave

Answer 16

was a high tech boom caused by the invention of transistors and computing technology

also driven by the regulatory residue from firms being mandated to acquire 100% of other firms (for more stability)
- only in the US, not in Canada

Question 17

what are octopus companies

Answer 17

during the 1960s merger boom there were a number of companies that had to acquire others outright which led to firms being involved in several industries at once (like tentacles)

Question 18

name the 3 facts of M&A

name the distribution of M&A by % in accordance to the purpose of each transaction

Answer 18

1. mergers come in waves
2. target share prices
3. bidder share prices

10% for hostile takeovers
50% for internalization of synergies
40% for bad managers acquiring other firms

Question 19

after the 1960s wave, then 1980s wave happened…

Answer 19

this M&A wave was driven by many firms having low Q ratios, so PE firms began pursuing junk-bond financed LBOs to fix these companies

they often bought large conglomerates created in the 1960s wave that were spread too thinly … PE firms would sell of their assets at higher valuations and make money

Question 20

what started the junk-bond financed LBO wave

Answer 20

Mike Milken got a job at Drexel Burnham in the late 1970s, then became interested in the junk bond market where companies could get loans despite being smaller, less credit worthy companies

this had huge demand and Milken benefitted personally from underwriting so many junk bonds

led to a wave of M&A financed by this type of debt in 1980

Question 21

how did firms perform post-takeover in the 1980s?

Answer 21

there was significant CEO pay packages if they outperformed, no pay if they didn’t

many LBOs were successful at this time. Firms also benefitted from being private (less reporting and public scrutiny)

Question 22

what is stock parking and who was accused of it

Answer 22

Milken’s brother William was charged of stock parking, whereby you buy 5% of stock then give it to someone else, by another 5% and give it to someone else. Over time you accumulate a large position without disclosing it, allowing you to takeover the target

Question 23

talk about the second LBO wave

Answer 23

this was during the early 2000s leading up to 2007 and included a number of marquee transactions
- JPM / Bank One
- Royal Dutch / Shell

Question 24

difference between the first and second LBO waves in PE?

Answer 24

the first was highly driven by cash acquisitions (milken) while the second had much more equity transactions

Question 25

winner’s curse in M&A

Answer 25

Often firm’s pay too much in M&A
When bidding, the winner’s shares usually fall the most after announcement
Competing firms see their shares decline with each high bid

Question 26

SPACs and the Vancouver Stock Exchange

Answer 26

SPACs have historically been unsuccessful since you’re handing money to a firm with no assets (no expertise) to takeover poorly run business

the VSE used to be the scam capital of the world they say … from all the SPACs

Question 27

difference in takeover premiums in Canada compared to the US/UK

Answer 27

in the US and UK its common for a firm to see a 30-40% increase in its share price post-announcement

in Canada, the higher prevalence of leaked info leads to run ups in share prices before announcement (less of a delta upon the takeover announcement)

Question 28

describe the effect of monopoly power and regulation on corporate takeovers (what metrics are used)

Answer 28

using the HH index or the concentration ratio by measuring the amount of firm sales / industry sale, regulators can measure the level of industry consolidation

• when they see it rising, they’re more likely to block a larger takeover

Question 29

over recent years, how have HH indexes trended during merger waves

Answer 29

during some of the recent merger waves, HH indexes have actually gone down due to large companies being broken down (divested off) which increases fragmentation

• lower HH index the better

Question 30

monopsony vs monopoly

Answer 30

reverse of a monopoly

• a monopoly is a single seller that can sell to customers at whatever price
• a monopsony is a single buyer that can ask whatever they want

Question 31

example of a monopsony

Answer 31

when your country only has one large employer, they can pay wages of whatever they want

Question 32

how do wages and employment change post merger and LBO waves historically?

Answer 32

during merger waves, no change

during LBO waves, more layoffs and lower wages

Question 33

how do Canada and the US differ on tax law for pooled / unspent CCA deductions

Answer 33

in Canada you’re not allowed to change your business model to get tax deductions, i.e. buying an irrelevant business just for their tax deductions

but in the US you can do that

Question 34

how does the size of a firm change with regards to the cost of services in markets (boundary of firms)

Answer 34

as markets become more costly, firms in-source processes and become larger (add staff)

as markets become less costly, firms outsource and downsize

Question 35

T/F: costs of command and control go down during mergers

Answer 35

Yes

Question 36

one of the four potential reasons for why companies do M&A is that they buy companies when prices are cheap

Answer 36

this is exactly the opposite

mergers are most common when markets are soaring (rates are often lower, NPVs higher, and financing accessible)

and are least common when valuations are cheap

Question 37

re. the question of whether labor is negatively impacted post acquisition (wages falling, unemployment rising) is this true? and what’s the one exception>

Answer 37

it’s not true that wages fall and layoffs ensue. it remains constant following mergers based on empirical evidence

however, in the 1980s LBO boom, firms did see layoffs and wage cuts, largely due to the overstaffed nature of firms at the time

Question 38

answer using evidence on share price reactions from merger announcements - do firms merge to become monopolies?

Answer 38

while it is true that firms in the same industry often rise upon announcement of a merger in their sector, it is not true that horizontal mergers cause higher price increases compared to other types of mergers

thus, firms don’t do M&A to become monopolies or to oppress consumers

Question 39

second LBO wave: describe it and how it was financed

Answer 39

2000s-2007 M&A included finance sector firms merging to better deal with deregulation (maybe bigger banks had more political rent-seeking power?) and takeovers by private equity firms borrowing low interest rates.

Question 40

acquirers with FCF problems, how to calculate FCF from this

Answer 40

difference between optimal dividend and actual dividend

companies mistakenly hold onto this cash when they don’t know what to invest in … instead of paying optimal dividends

this leads to more NPV < 0 projects

Question 41

what are zombie acquirors and what’s their price reaction post-announcement

Answer 41

as a product of creative destruction, firms start to get phased out

to stay relevant and competitive, they acquire a young innovative firm

but shareholders’ dislike this and prices fall on announcement

Question 42

talk about the reasons behind doing a SPAC

Answer 42

1. tax advantage of a company in a high tax country getting taken public via a SPAC in a low tax country
2. circumventing listing requirements, whereby a private company can be taken over by the SPAC to go public (avoids listing process and costs toO)

Question 43

of all the takeover defense mechanisms present, which result in a positive share price reaction

Answer 43

only golden parachutes are positive

all others result in declining share prices: poison pills, shark repellant, white knight, pac-man, restructuring,

Question 44

white squire vs a white knight

Answer 44

white knight is where another (better) buyer acquires your shares, while a white squire is the same concept but it buys just enough voting shares to take you over

Question 45

describe the 1920s M&A wave in Canada and the US

Answer 45

in Canada it started later, but was characterized by bank combinations after a few banks failed, and pyramiding of large conglomerates

in the US, it started earlier and involved many high tech M&A transactions

Question 46

describe US Gilded age M&A and how Morganization was used

Answer 46

the Gilded Age involved the consolidation of many businesses into Standard Oil, General Electric, and this was driven by Morganization which was that a company ran by JPM would perform better in the long run

Question 47

what were voting trusts and how were they used. what are antitrust laws today?

Answer 47

firms could gain control of other firms without spending money by offering trusts for someones shares (like contractual claims to a $ amt for each share)

this allowed mass control for Standard Oil over other companies

today anti-trust laws are still used to prevent monopolistic power of companies