I, CORPORATE GOVERNANCE

Question 1

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What is corporate control?

Answer 1

Ownership concentration/power of shareholders

Question 2

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What are the main determinants of corporate control?

Answer 2

1. Investor protection rights
2. Legal origin
3. State of the economy

Question 3

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What is the aim of the research?

Answer 3

To fix the empirical (data) problems and find (robust) correlation between corporate control and its determinants.

The problem with previous literature: reliance on strict definition – widely held corporations and firms with a dominant shareholder; heterogeneity of firm size – small firms differ from mid-sized firms that differ from large firms (big differences).

Question 4

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

How does legal system affect the corporate governance?

Answer 4

From the highest levels of ownership concentration to the lowest:
1. French civil law countries
2. German civil-law countries
3. Scandinavian civil-law countries
4. Common-law countries

Question 5

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What are equity blocks? How often do they appear?

Answer 5

Equity blocks are present in >80% of non-controlled firms, consistent across regions. Share of firms with widely held firms with blocks is highest in French civil-law countries and lowest in common-law countries.

Question 6

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What are shareholder protection rights? How are they linked to dispersed ownership?

Answer 6

Shareholder protection rights is possibility to take legal action against managers who abuse their position.
Weak minority shareholder protection results in fewer widely-held companies (and correlation in general).

Question 7

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

How does GDP per capita linked with dispersed ownership?

Answer 7

The correlations is negative between income and corporate control is pronounced only for large corporations (top 10%). Correlation = 0 for small and medium listed companies.

Question 8

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What are creditor rights? What is the link between them and corporate control?

Answer 8

It is the legal rights that a creditor has in the event that the borrower fails to pay back the money or fulfill other obligations under the loan agreement.
It has small and statistically insignificant correlation with corporate control.

Question 9

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

How is labor regulation and corporate control correlated?

Answer 9

Strong correlation. Labor legislation imposing restrictions on overtime, firings and union membership power are relatively high in countries with high percentage of corporate control. (Political theories of corporate control say that labor laws has an effect on interaction between the controlling shareholders, workers, and outside investors).

Question 10

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

What are the characteristics of corporate control around the world?

Answer 10

1. Families control firms in all countries.
2. State ownership an important factor especially in some countries (Russia, China, Brazil, India)

Question 11

CORPORATE CONTROL AROUND THE WORLD
Aminadov, Gur, and Elias Papaioannou, 2020

Question 12

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

Imagine a public company that manufactures and sells solar panels. Its ownership structure is: F. Ounder (40%), GreenRock (7%), R. Etail (5%). All other shares belong to minority investors with stakes lower than 1%. A hedge fund called Enlightenment Technologies wants to buy 15% of shares from minority investors.
(i) What are the three possible explanations for the willingness of an investor to purchase a stake in this green company rather than in, for example, an oil company with similar financials? Please explain them briefly, referring to the paper “Do investors value
sustainability. A Natural Experiment Examining Ranking and Fund Flows”. (3p)
(ii) What is the most likely explanation in the case of Enlightenment Technologies (a hedge fund)? Why?

Answer 12

i)
1. Institutional constrains;
2. Non-monetary motives;
3. Belief that ESG friendly security will generate higher returns.

ii)
1. institutional investors are often limited and told not to purchase low ESG score stock.

Question 13

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

What is morningstar globe rating?

Answer 13

The Globe Rating for companies is a visual representation of the Sustainalytics ESG Risk Classification that will allow investors to easily identify securities with low ESG risk.

Question 14

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

What are the institutional constrains?

Answer 14

Limits to hold low ESG score securities for institutional investors.

Question 15

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

There appears that there is no difference between institutional and noninstitutional investors. What are the explanations for that?

Answer 15

1. Institutional share classes face constraints that force them to behave like other investors.
2. Their preferences are similar to those of other investors.

Question 16

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

Another reason for choosing highly rated funds is rational performance expectation. What is it & do the expectations differ from reality.

Answer 16

Investors might rationally believe that sustainability is a positive predictor of future fund performance. If investors believe sustainable funds will outperform the market, funds will flow to high sustainable funds.
Actual evidence: inverse relation or no relation between globe ratings and returns.

Question 17

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

Comment on irrational Expectations and Nonpecuniary Motives of investors. Are they really irrational?

Answer 17

Investors might have naively assumed that a high sustainability rating would lead to high future fund returns OR they simply had nonmonetary preference for holding more sustainable mutual funds (e.g., altruism, warm glow, social motives). The authors run an experiment using high-level professionals and find that despite no significant differences in fund performance, risk, etc. high-globe ratings are associated with better future performance = the authors find evidence on irrational expectations and non-monetary motives.

Question 18

Do Investors Value Sustainability? A Natural Experiment Examining Ranking and Fund Flows
Hartzmark, Samuel M. and Abigail B. Sussman, 2019

How do investors’ belief that ESG scores influence security’s returns impact the actual returns and the volatility of the stock?

Answer 18

The sustainability ratings of stocks do not prove to represent the financial performance of the company, however, many investors still choose to invest in them. In the situation of an economic downturn, stocks with a good ESG rating experience less volatility.

Question 19

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

The Economist (February 10, 2018): “Active managers have become more active, making bigger bets on individual stocks. This makes their portfolios less like the index”. Please explain how a shift from “closet indexing” to a more concentrated ownership encourages active funds to engage into stewardship activities in their portfolio companies. Based on your argumentation, are active funds becoming more or less risky? Why?

Question 20

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What is stewardship activities?

Answer 20

Engagement with public companies, promoting corporate governance practices that encourage long term value creation for shareholders.
1. voting in shareholder meetings (and being informed when voting),
2. monitoring corporate managers
3. engaging with the management (using voice and exit).

Question 21

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What are the disadvantages of stewardship activities?

Answer 21

Stewardship activities (expected from the funds) mean more costs. Performance of these duties is under the discretion of the investment manager.

Question 22

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What problems do arise in the index funds?

Answer 22

1. Investment managers of index funds bear full costs of stewardship yet capture only a fraction (as low as 0.12%) of benefits created, because compensation is based on fixed % of assets under management. No incentive fees on the change of portfolio value - the manager is not incentivized to make the portfolio grow more.
2. Arising from index tracking. One way to increase the capacity of stewardship is to increase AUM. To do it, relative performance matters.

Question 23

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

Why are the advantages of index funds?

Answer 23

Low costs, tax advantages and the evidence that they actually outperform actively managed funds.

Question 24

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

One of the agency problems in index funds is arising from index tracking. One way to increase the capacity of stewardship is to increase AUM. To do it, relative performance matters. How to measure the performance?

Answer 24

The performance is:
1. Relative to the index (If an index fund spends on stewardship and increases the value of a portfolio this also increases the value of the tracked index, leaving performance relative to it unchanged)
2. Relative to the rivals (rivals following the same index experience the same % increase in value).

Question 25

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What are closet indexers?

Answer 25

Most of the active funds whose holdings highly overlap with the benchmark index, differing only by under- and over- weighting some stocks.

Question 26

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What are the agency costs arising in active funds?

Answer 26

1.Private costs. Investment managers often run both investment fund and investment services (e.g., cash management, short- and long-term investments) firms. Retirement plans are a huge part of funds’ portfolios and significant revenue driver for investment managers.
2. Investment managers might be bearing additional private costs (e.g., losing revenue, having notorious reputation among corporations) from taking positions that corporate managers disfavor.

Question 27

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

Why does the costs problem in active funds arise?

Answer 27

1) Small monetary benefit from stewardship
2) Investing in stewardship activities can reduce relative performance of the fund (i.e. the fund would perform
worse than other funds),
3) Institutional investors want to keep good relationships with the managers because managers can in return provide more business. (Private costs).

Question 28

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

How do hedge funds differ from index or mutual funds in terms of capturing excess value from stewardship?

Answer 28

Hedge funds hold significant stakes, capturing much more value from stewardship activities relative to mutual or index.

Question 29

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

What are the agency costs in the hedge funds?

Answer 29

Managers spend on stewardship only when the resulting value increase are high enough to still give investors a reasonable return after higher fees is charged. Opportunities giving smaller returns are ignored. To win proxy fights (unfriendly contest for the control over an organization, changing corporate governance), hedge funds need to acquire support from other institutional investors (many are not willing to oppose the management) = without mutual fund support, hedge funds are hardly a threat to the corporate management.

Question 30

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

The rise of index funds, while having been seen as a positive development, raise serious costs for corporate governance. Modern corporations suffer from too little shareholder intervention. What can improve the corporate governance?

Answer 30

1. Adopting disclosure regulations (e.g., on how voting takes place) that would enable beneficial investors identify and assess agency problems themselves (e.g., business ties)
2. Adopting incentive-based compensation for mutual fund managers.

Question 31

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

“In 2007, legendary investor Warren Buffett made a $1 million bet against Protégé Partners that hedge funds wouldn’t outperform an S&P index fund, and he won.” (CNBC, 2018). While it seems that passively managed index funds in some instances can outperform hedge funds, the reading outlines that index funds might have significant agency problems. What are some of the potential sources of these agency problems? Please name and briefly explain three sources/reasons.

Answer 31

Managers of index funds are not interested in taking part in stewardship activities since
1. they are not compensated with excess inflows: work on fixed % of AUM
2. the relative index is never changing as it is tracked and rivals are adapting to the new returns (even if manager starts spending money on stewardship).

Question 32

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

SoftBank Group Corp. is a Japanese conglomerate holding company founded by Masayoshi Son. Son has a greater than 25% stake in the conglomerate. The second largest shareholding group owns only 5.3% of the shares. Other shareholders are mostly institutional investors. Last week, the activist hedge fund Elliott Management disclosed a $2.5bn stake in SoftBank.
a) Why might Softbank suffer from a lack of shareholder activism before the entry of the activist hedge fund?
b) How could Elliot Management’s entry potentially address the issue of shareholder activism?

Answer 32

a) Compensation policies of institutional investors or free-rider problem arising in dispersed ownership firms.
b) Adopt incentive based compensation for institutional investors or disclosure regulations so institutional investors could themselves address problems in voting.

Question 33

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

GreenRock is an index fund that holds stakes in several thousand companies across the globe. Are they likely to actively intervene and try to dissuade the managers from buying the startup? Support your answer with at least two arguments.

Question 34

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

In what way might GreenRock and minority shareholders benefit from having the Enlightenment Technologies (a hedge fund) among the owners of the company? Link the answer to the concept of free-rider problem of shareholders, as well as the treatment of hedge funds,

Question 35

The Agency Problems of Institutional Investors
Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017

• Index fund Vanguard: 15 staff for stewardship in 13,000 portfolio companies.
• Hedge fund Pershing Square Capital Management: 8 staff for stewardship in 12 portfolio companies.
  Why are hedge funds (compared to index funds) incentivized to have a relatively larger number of staff for stewardship activities relative to the number of their portfolio companies?

Answer 35

Index fund managers have zero monetary incentive to be active

Question 36

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

Explain the tradeoff the founders and insiders face when they decide to adopt or not to adopt dual class shares at the IPO stage. What are the reasons behind such a tradeoff?

Question 37

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

Name and explain two traditional antitakeover defenses.

Question 38

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

Can having a dual-class share structure be considered as a takeover defense? Why?

Answer 38

Because the premium block will haven more voting rights, while the owners of the block are usually the insiders of the company. Thus, there is no opposition for the management & takeovers are quite impossible.

Question 39

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

What evidence do the authors find on relationships between the dual-class firms’ value and insiders’ (1) cash-flow rights, (2) voting rights, and (3) the wedge between cash-flow and voting rights?

Question 40

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

Higher PBOC are associated with an increased willingness to obtain a dual class status in company XYZ. Having no additional information about company XYZ, what are the main determinants that could have led the company to consider a dual-class status (due to increased PBOC)?

Question 41

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

What are the characteristics of dual class shares/firms?

Answer 41

Stocks whose holders have different rights to participate in the ‘life’ of the company
Dual-class company:
1. Superior shares with ten votes per share, non-publicly traded. Owned by company insiders. It provides insiders with a majority of votes despite much lower cash flow rights in their possession. Insiders of dual-class firms have effective control over all corporate decisions. It makes them virtually immune to hostile takeovers.
2. Inferior class, with one vote per share, publicly traded.

Question 42

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

What kind of firms are dual class ones compared to single-class?

Answer 42

1. Bigger
2. more levered, possible due to their reluctance to engage in equity offerings not to lose ownership or it is
   possible that debt is used as an alternative control mechanism
3. older, possibly due to less possibility of being acquired (12.9 years versus 9.6). = No abnormal returns by dual-class companies are documented.

Question 43

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

What predicts larger size of PBOC and thus dual-class status?

Answer 43

1. Name. If the company is named after a founder, this might indicate a “personal” stake involved.
2. Media. Control of a media company (e.g., newspaper, TV network) provides opportunities for self-advertising, manipulating the public opinion.
3. Activity of the founder. If the firm is young and the founder is still active, PBOC and also dual-class structure is more likely.
4. Firms in the area & Sales of the area. The less firms there are in firm’s metropolitan area, the more likely the firm is a major employer and “the only game in town”, which entails private benefits for insiders with dualclass shares.

Question 44

Extreme Governance: An Analysis of Dual-Class Companies in the United States
Gompers, Paul A., Joy L. Ishii, and Andrew Metrick, 2010

What can be done to make takeovers difficult and expensive?

Answer 44

1. Charter amendments: in firm’s charter, impose conditions on control transfer (“shark repellent”). For example, Supermajority amendments – require over 2/3 vote to approve merger.
2. Golden parachute: an extremely lucrative severance package that is guaranteed to a firm’s senior management in the event that the firm is taken over and the managers are let go.
3. Poison pills: securities with embedded rights to buy shares in either the target or an acquirer at a deeply discounted price: creates massive dilution for a potential corporate raider thereby making an acquisition prohibitively expensive.
4. Pac man defense: target firm counteroffers for bidder firm: effective if target much larger than bidder.

Question 45

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

There are four types of private benefits of control (PBC) according to “Private Benefits of Control: An International Comparison”. List all of them. Describe what affects the size of PBC. The authors define the private benefits of control as “added value (positive or negative) obtained from having the controlling share”. Explain what is implied by negative added value (costs of extracting PBC). Explain under what circumstances PBC are the most efficient way of extracting value.

Answer 45

exam q

Question 46

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

A company can be privatized either through a public offering by issuing shares on a stock exchange or a private placement by offering shares directly to an individual or a small group of investors. In a country where private benefits of control are high, which of the two methods is a revenue maximizing government more likely to choose?

Question 47

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

It has been three months since the FE has finished. You find yourself engaged in an online argument with a proponent of nationalization of large firms in the United States. They advocate for the state control over industries. You passionately disagree. Your opponent cites the example of privatizations in Russia as an argument against private ownership of industries. Use the information from “Private Benefits of Control: An International Comparison” to establish the link between privatization and PBOC (private benefits of control) premia. Additionally, list two legal and one extra-legal factor that could incentivize Russian government to facilitate wider ownership of privatized businesses.

Question 48

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

What costs might PBOC impose?

Answer 48

Maintaining a control block means lack of diversification + distressed companies might inflict reputational losses or even legal liabilities to the controllers.

Question 49

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

Why PBOC might be a good thing?

Answer 49

Managers exploiting profitable investments without company’s assent might actually create value. PBOC makes value enhancing and socially beneficial takeovers possible.

Question 50

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

How can PBOC be captured?

Answer 50

1. Control premium: the difference between the price per share of the control block and the market price per share. Drawbacks: Sales of control blocks are rather rare; delay in incorporating public information to the market price.
2. Price difference between shares in a dual-class system. Extra voting rights as a proxy for corporate control. Drawback: dual class shares are not allowed in every country.
   Both measures capture only common value component.

Question 51

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

What does affect the size of PBOC premium?

Answer 51

1. Size of block traded.
2. Sellers bargaining power - reflects whether seller is in a position to demand more money from the buyers. If the company is in a financial distress, a large seller is willing to sell shares for less. PBOC are then undervalued/can be negative because of lack of investor’s diversification.
3. Case if the institutional buyer is a foreigner. Foreigners pay more (less information and connections = more bargaining power for the seller).
   Controlling a media company gives you enormous power of manipulating public opinion in personally beneficial ways.
   Authors do not find significance of tangibility of assets. If company’s assets are mostly tangible, they are harder to
   expropriate due to their visibility, thus lowering PBOC. Finance industry as a contrast.

Question 52

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

What effects on countries economical development does PBOC have?

Answer 52

In countries showing high PBOC, entrepreneurs are reluctant to make their companies public because investors do not factor in the control value (less IPOs). Potential buyers of smaller stakes also attribute less value to shares taking into account being exploited by majority shareholders. As a result, selling control in private negotiation is more profitable than in the market with dispersed buyers buying many noncontrolling stakes.

Question 53

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

What are significant measures while curbing PBOC?

Answer 53

Legal institutions:
1. The legal environment. Greater ability to sue controlling shareholders and greater shareholder
protection = this works.
2. Disclosure standards. The more extensive and
accurate disclosed information is, the more it curbs appropriation by increasing the risk of legal consequences or reputational costs (SEC in the US) = this works.
3. Enforcement. Quicker, smoother and more predictable enforcement, the stronger the legal protections of shareholders = this works. Legal institutions are strongly associated with lower levels of private benefits

1. Product market competition. Through prices, competitive markets can verify manipulated transfer prices. = this works.
2. Government as a monitor through tax enforcement. Through taxes the state acts as an investor to all companies. It does not have agency/free-rider problems, and has power unavailable to regular shareholders: better tax enforcement can reduce PBOC= this works.

Question 54

Private Benefits of Control: An International Comparison
Dyck, Alexander and Luigi Zingales, 2004

What are insignificant measures while curbing PBOC?

Answer 54

Courts cannot easily restrict managerial discretion. BUT! Extra-Legal institutions may play an important role in
constraining private benefits, both in settings with legal protections as well as in settings where legal protections are nonexistent or not enforced.
2. Public opinion pressure. Value appropriation can be limited by expected reputational losses = this works.
3. Moral norms. Value appropriation cannot be undertaken due to moral considerations. Religious traditions? Crime rate? = this doesn’t work.
4. Labor as monitor. The risk of employees quitting due to dishonest activities by majority shareholders. What if employees benefit from PBOC? = this doesn’t work.