Lecture 1

Question 1

Sole proprietorship

Answer 1

Owner = Firm

Unlimited personal liability

Question 2

partnership

Answer 2

All partners are liable for the debt

Question 3

Limited liability company

Answer 3

Firm as a legal entity with contractual rights and obligations

Limited liabilities

Separate ownership and control

Joint-stock

Question 4

Corporate governance

Answer 4

The process, structures and mechaniss that influence control and direction of corporations

Involves a set of relationships between a companys management, its baord, its shareholders and other stakeholders. Corporate governance also provides the structure through which the objectives of the company are set, and the means of attaining those objectives

Provide the assurance that managers give the capital providers their money back

Question 5

Corporate governance quality affects:

Answer 5

Firm value

Shareholder rights

(If investors dont get adequate returns, would they invest)

Question 6

Governance and economic wellbeing

Answer 6

Development and health of a countrys capital markets

Question 7

Governance and political well being

Answer 7

How are the international organizations being organized

How to prevent the next financial crisis

Question 8

Governance of multinational corporations

Answer 8

What are the common characteristics of successful corporations

How to win and maintain trust from investors

Question 9

Agency theory

Answer 9

Separation of ownsership and control: Managers (the agent) control the firm while shareholders (the principals) own the firm

Question 10

Who controls the company?
Residual control means the right to decide on

Answer 10

Cash flows
Key resources
Company strategy
Management hire and fire
Voting rights

Question 11

Key conflicts of interest
Shareholders vs manager

Answer 11

Ownership and control; minority investor protection: voting rights; large investors; board of directors; executive compensation, dividend policy, change of ownership, etc.

Question 12

Key conflicts of interest
Shareholders vs creditors

Answer 12

Optimal capital structure; cost of capital, debt overhang, risk taking etc.

Question 13

Key conflicts of interest
Shareholder vs. stakeholders

Answer 13

corporate social responsibilities; employee rights and regulations (national and internationally), social and environmental externalities of business etc.

Question 14

Key conflicts of interest
Institutional shareholders vs. individual shareholders

Answer 14

Large shareholders may influence firms at the expense of others shareholders

Question 15

Main challenges of the investors to ensure their financial return:
Contract incompleteness:

Answer 15

Investors and managers cant write contract on all future contingencies and specify all the potential solutions

Question 16

Main challenges for the investors to ensure their financial return

Information asymmetry:

Answer 16

Managers know more about the company than investors. Its costly for investors to effectively monitor managers efforts or verify the managers claims

Question 17

Agency costs

Answer 17

Monitoring costs by the principal
Bonding costs by the agent
Residual losses

Question 18

Monitoring costs

Answer 18

1) borad of directors to monitor managers and represent shareholders interest

2) Large shareholders monitor management

3) Shareholder activism to monitor annd influence management

Question 19

Signaling costs

Answer 19

1) Managers pay dividends, signal to shareholders that the firm is profitable

2) Timely and honest disclosure of crucial information to stakeholders

3) Auditing of the financial and non-financial statements

Question 20

Residual costs

Answer 20

1) Managers pursue their own interest at the cost of the principals

Question 21

Shareholder theory (Friedman 1970)

Answer 21

By maximizing shareholder value, all other stakeholders also improve their welfare in the neo-classic model

That responsibility is to conduct the business in accordance with … the basic rules of the society, both those embodied in law and those embodied in eithical custom

Question 22

Stakeholder theory (freeman 1984)

Answer 22

An organizations effectiveness is measured by its ability to satisfy not only the shareholders, but also those stakeholders who have a stake in the organization

Question 23

Stakeholder theory

Answer 23

The implied governance structure and monitoring mechanism of shareholder and stakeholder theories are different

In the US and UK one tier board contains only shareholder elected executive and non-executive members

In France and germany, employees, government and banks have representatives on the supervisory board

Question 24

Resource dependence theory

Answer 24

Corporations and thier external environment interdepend on each other

The relationship with stakeholders like employees, suppliers, customers, investors and regulators must be managed with care in order to ensure access to critical resoureces

Question 25

stewardship theory

Answer 25

Managers are intrinsically motivated to act in the best interests of the corporation and its stakeholders

The firm should run as a team with shared vision and strong sense of commitment from the managers

In contrast with managers under agency theory that need to be monitored and incentivezed

Many corporate governance codes also require the stewardship role of managers

Question 26

Institutional Theory

Answer 26

Corporations are embedded in a broader institutional environment

Corporations must confirm to the institutional norms and expectations to gain legitimacy to operate

Question 27

Gompers, Ishii & metrick 2003 created G-index (G for governance)

Answer 27

Research question: how does corporate governance index affect firms financial returns, operation performance and firm value

Data: corporate governance provisions: investor repsonsibility research center publishes firm and state corporate governance provisions for 1500 US firms in 1990, 1993, 1995,1998

methedology: 24 governance provisions, equal wieght1 score for each provision 5 categories:

Delay (Takeover)
Protection (of manager job security)
Voting (rights that impede takeovers)
other (takeover defence)

Key findings:

The lower the G, the better shareholder rights, therefore higher governance quality

Democratic firms (less than 5 provisions) outperform dictatorship firms (with more than 14 provisions by 8,5% per year)

Min 2 prov

mean 9 prov

max 17 prov

Question 28

Bebchuk E-index (for entrenchment) findings

Answer 28

Firms with higher E-index are associated with negative firm value

Trading strategy that long E=0 firms and short E= 5,6 firms, would yield positive returns

The other 18 provisions do not influence firm performance

Question 29

Corporate governance indices - limitations

Answer 29

Corporate governance indices may proxy some unidentified factors which are correlated to governance quality

Low comparability across firms with the same number of provisions

To be used with caution by investors and regulators

Too complicated

Institutional shareholder service has governance metric based on 61 factors

Governance metric international GMI based their ratings on 600 provisions