Corporate Governance Flashcards
What are the three main types of businesses?
1) Sole Proprietorship
2) Partnership
3) Limited corporation
What is corporate governance?
The system of internal controls and procedures by which companies are managed
Two types of board structure
1) One-tier board structure
2) Two-tier board structure
What is the agency relationship?
A relationship involving two parties, the principals and the agents.
What is the indirect agency cost?
Loss opportunity due to risk the agent wasn’t willing to take.
What are the agency problems?
Type 1- the costs from the principal and agent which arise from competing interests
Type 2- costs that arise as a result of monitoring actions
How to mitigate agency problem?
1) Leverage executives’ pay by giving more long-term incentives
2) Majority shareholders can use their voting power to elect directors who will take benefitting actions
3) The 2004 OECD principles of corporate governance
Explain the shareholder and debtholder agency relationship
When the CEO favours one type of principle over the other (shareholder over debtholder)
How to mitigate debt and share issues?
Debtholders can set up debt covenants, which are restrictions to limit the shareholders’ possible risky decisions
What is sensitivity analysis?
Provides the best and worst expected scenarios according to underlying assumptions.
Drawbacks of sensitivity analysis
1) Assumptions are subjective
2) Several variables may be correlated and impact each other
Risk analysis techniques
1) Sensitivity analysis
2) Break-even analysis
3) Monte Carlo simulation
4) Real options
5) Decision tree
What are the two types of break-even analysis?
1) Accounting break-even analysis- where does accounting loss stop
2) Present value break-even analysis- all new investments must have positive NPV
Equation for accounting break-even analysis
Sales price * X = VC * X + FC + Depr
Present value break-even analysis equation
(Sales price * X) * (1-tc) = (VC*X) * (1-tc) + EAC + FC * (1-tc) - Depr * tc
What is the Monte Carlo simulation?
A computerised method where computers randomly simulate different scenarios for you to solve the subjectivity drawback.
Steps for the Monte Carlo simulation
1) Specify the basic model
2) Specify distribution of each variable
3) Computer draws one outcome
4) Repeat the procedure
5) Calculate possible distribution of NPV
What are the two direct agency costs?
Expenditures to monitor managerial actions- Hiring external auditors, creating internal control systems, setting up performance-based compensation
Bonding expenditures- Purchasing liability insurance, Agreeing to contractual obligations that limit their actions, Providing regular and transparent reports
