lecture 2

Question 1

Four types of conflict

Answer 1

Shareholders vs managers

Shareholder vs debtholder

Shareholders vs non-fin-shareholders

Large shareholders vs minor shareholders

Question 2

Defining corporate governance (4)

Answer 2

Corporate governance system is the combination of mechanism which ensures that the management runs the firm for the benefit of one or several stakeholders. such stakeholders may cover shareholders, creditors, suppliers, clients, employees and other parties with whom the firm conducts business

Question 3

moral hazard

Answer 3

Once a contract is signed, it may be interest of the agent to behave badly or less responsibly

Agency problems arises when an agent acts on behalf of a principal

her act may not be the best interest of the principal

Question 4

examples principle agent problem

Answer 4

Insufficient effort

Extravagant investment

Entrenchment

Self dealing

Lack of transparency

Accounting manipulations

Question 5

how to mitigate the principal agent problem

Answer 5

Complete contracts

Question 6

Complete contracts should specify

Answer 6

What the managers must do in each future contingency of the world

What the distribution of profits will be innn each contingency

Question 7

asymmetric information (moral hazard)

Answer 7

The principal cannot keep track of the agents actions at all times

usually the agent has more information

Question 8

separation of ownership and control (principal agent problem)

Answer 8

Owner manager: no conflict of interest

Maximum incentive to work harder

Additional revenue will always be accrued by her

Agent: She has only a% of the shares

Conflict of interest starts

Less incentive to work harder

If she works harder, the fruits will go to the shareholders

Question 9

separation of ownership and control (knowledge)

Answer 9

Principal: he has the required funds but is not qualified to run the firm

Agent: Knows how to run the firm but lacks the funds to fiance its operations

Question 10

agency cost (3)

Answer 10

1. monitoring costs
2. Bonding costs
3. residual loss

Question 11

monitoring costs

Answer 11

It consists of the principal observing the agent and keeping a record of the agents behavior

Also intervening in various ways to constraint the agents behavior and to avoid unwanted actions

Question 11

bonding costs

Answer 11

The costs is incurred by the agent in order to signal credibly to the principal that she will act in the interest of the principal

e.g. buy shares of the firm

Question 12

Residual lost

Answer 12

Incurred by the principal

Agent may not make the decision that maximize the value of the firm

Question 13

Agency problems (two forms)

Answer 13

Perquisites: consumption by the management

Empire building: Free cash flow problem
The management pursuing growth rather than shareholder maximization

Question 14

Perquisites

Answer 14

Consumption by the management

benefit –> accrue to the management
Cost –> Borne to the shareholder

E.g. CEO mansions, giving job to family members or corporate jets

Question 15

empire building

Answer 15

Free cash flow problem

The management pursuing growth rather than shareholder maximization

Management should invest only project NPV>0 otherwise destroy shareholder value

Question 16

why does managers enjoy increasing size of the firm

Answer 16

Power and social status

Managerial compensation grows with the company size

Question 17

total agency costs are

Answer 17

The sum of the agency cost of debt and equity

Question 18

two types of shareholders

Answer 18

Controlling shareholders

Minority shareholders

Question 19

it is about expropriation of minority shareholders 4 forms

Answer 19

Tunneling

Transfer pricing

Nepotism

Infighting

Question 20

Tunneling

Answer 20

Consists of the large shareholders transferring the firms assets or profits into his own pockets

Question 21

Transfer pricing

Answer 21

The large shareholders may also expropriate the minority shareholders via transfer pricing I.e. by overcharging the firm for services or assets provided

Question 22

Nepotism

Answer 22

Nepotism consists of the large family shareholder appointing family members to top management positions rather than the most suitable candidates on the job market

Question 23

infighting

Answer 23

May not necessarily be a wilful form of expropriating the firms minority shareholders, but nevertheless is likely to deflect management time as well as other firm resources

Question 24

what is ownership

Answer 24

Cash flow rights give the holder a pro rata right to the firms earnings

In case of liquidation, cash flow rights gives the owner a pro rate right to the firms assets (after the claims of all the stakeholders have been met)

Question 25

Voting rights

Answer 25

Give the holder the right to make certain decisions about the firm and/or vote in favor of members of the companys board of directors

Question 26

Other channels of ownership

Answer 26

Founder: may have the right to appoint specific number of board members - as long as the founder keeps a particular percentage of the assets

Question 27

Golden share (other channels of ownership)

Answer 27

another channel –> sometimes held by gov’t which enables the gov’t to block the takeover of the firm by a foreign investor

Question 28

management’s de factor control (other forms of ownership)

Answer 28

Management can control firm de facto in the absence of a large shareholder

Question 29

Alternative forms of organization and ownership (stock ownership)

Answer 29

Traditional stock exchange corporations

P&A problem is low

1$ = 1 vote

Stock price as a measure of performance

High conflict of interest btw stakeholders and owners

Stock market has disciplinary funciton; large shareholders monitors the management a lot

Members can sell their stocks; just a replacement

Question 30

Alternative forms of organization and ownership (mutual organization)

Answer 30

Building society or bank –> they can be savers and borrowers

e.g. UK building societies
Rabobank
Some insurance companies

P&a problem is severe

1 person = 1 vote

Not listed in stock market

Low degree of conflict; because owners are the stakeholders

Lower market discipline

Members can withdraw their money any time –> pure loss in fund