Corporate governance: Conflicts, Mechanisms, Risks And Benefits

Question 1

Principal-Agent Relationship

Answer 1

When one party (principal) hires another (agent) to carry out a task, that relationship is called Principal agent relationship. Eg: Board of directors (agent) hired by shareholders (principal)

Question 2

Principal Agent conflict

Answer 2

Conflict due to difference in interests of principal and agent

Question 3

Agency costs

Answer 3

Cost of principal agency conflict; can be direct (hiring someone to monitor agents) and indirect (cost of lost business)

Question 4

Why do principal agent or conflict between shareholder and BOD/managers arise

Answer 4

Due to difference in interests
1. Job security: they want to keep the company safe and running so that their job is secured.
2. Extra Compensation tied to profits: may take unnecessary risks to rake up profit as they do not have downside as they will still earn salary if the new idea fails.
3. Empire building : may take unnecessary acquisitions to increase company size for incentive.
4. No new ides and mimicking competitors.
5. Self dealing: using firms resources for personal benefits eg giving a tender to your own relative at an inflated price

Question 5

Principal vs principal conflict

Answer 5

Arises when majority shareholders have different interests than minority. Minority may have more voting power in case of dual class structure

Question 6

Dual class structure

Answer 6

When one share has more than one vote. This can lead to minority shareholders becoming controlling shareholders due to more voting power

Question 7

Shareholders vs creditors conflict

Answer 7

Creditors have no benefit if a company takes more risk to earn more profits

Question 8

Corporate Governance

Answer 8

Internal controls and procedures by which a corporate or individual companies are managed i.e the framework used to govern a corporation

Question 9

Stakeholder Management

Answer 9

Refers to the management of a company’s relationships with its stakeholders by considering their interests and maintaining effective communication

Question 10

Extraordinary general meeting

Answer 10

The general meeting that is called to discuss urgent matters that require shareholders vote and can not wait for the annual general meeting. Eg. board election, liquidation of firm, bylaw amendments

Question 11

Mechanisms

Answer 11

Mechanism are the means used to avoid conflicts

Question 12

Creditor vs shareholder conflict mechanisms

Answer 12

Using positive and negative covenants in indentures ( agreement) and using collateral

Question 13

BOD/Management vs shareholder mechanism

Answer 13

Using core and non core committees, like audit committee, remuneration committee and nominating committee, it is ensured that the interests are aligned

Question 14

Employee mechanisms

Answer 14

Labor laws and unions

Question 15

Government mechanisms

Answer 15

Enactment of laws and appointing regulators

Question 16

Risks of poor governance

Answer 16

Operational Risk
1. Weak monitoring and oversight by auditors and board
2. Some stakeholder might’ve advantage over other stakeholders
Financial Risks
3. Mangers may serve their own interests
4. Chances of self dealing
5. Increase risk of default
6. Financial loss
Legal and regulatory risk
8. Reputation harm
9. Penalties

Question 17

Benefits of effective governance

Answer 17

1. Improve operational efficiency
2. Interest are aligned
3. Effective control and monitoring
4. Avoid legal and regulatory risks
5. Better operating results
6. Reduced risk of default or bankruptcy
7. Greater company value