lecture 2 Flashcards
Four types of conflict
Shareholders vs managers
Shareholder vs debtholder
Shareholders vs non-fin-shareholders
Large shareholders vs minor shareholders
Defining corporate governance (4)
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
moral hazard
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
examples principle agent problem
Insufficient effort
Extravagant investment
Entrenchment
Self dealing
Lack of transparency
Accounting manipulations
how to mitigate the principal agent problem
Complete contracts
Complete contracts should specify
What the managers must do in each future contingency of the world
What the distribution of profits will be innn each contingency
asymmetric information (moral hazard)
The principal cannot keep track of the agents actions at all times
usually the agent has more information
separation of ownership and control (principal agent problem)
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
separation of ownership and control (knowledge)
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
agency cost (3)
- monitoring costs
- Bonding costs
- residual loss
monitoring costs
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
bonding costs
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
Residual lost
Incurred by the principal
Agent may not make the decision that maximize the value of the firm
Agency problems (two forms)
Perquisites: consumption by the management
Empire building: Free cash flow problem
The management pursuing growth rather than shareholder maximization
Perquisites
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
empire building
Free cash flow problem
The management pursuing growth rather than shareholder maximization
Management should invest only project NPV>0 otherwise destroy shareholder value
why does managers enjoy increasing size of the firm
Power and social status
Managerial compensation grows with the company size
total agency costs are
The sum of the agency cost of debt and equity
two types of shareholders
Controlling shareholders
Minority shareholders
it is about expropriation of minority shareholders 4 forms
Tunneling
Transfer pricing
Nepotism
Infighting
Tunneling
Consists of the large shareholders transferring the firms assets or profits into his own pockets
Transfer pricing
The large shareholders may also expropriate the minority shareholders via transfer pricing I.e. by overcharging the firm for services or assets provided
Nepotism
Nepotism consists of the large family shareholder appointing family members to top management positions rather than the most suitable candidates on the job market
infighting
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
what is ownership
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)
Voting rights
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
Other channels of ownership
Founder: may have the right to appoint specific number of board members - as long as the founder keeps a particular percentage of the assets
Golden share (other channels of ownership)
another channel –> sometimes held by gov’t which enables the gov’t to block the takeover of the firm by a foreign investor
management’s de factor control (other forms of ownership)
Management can control firm de facto in the absence of a large shareholder
Alternative forms of organization and ownership (stock ownership)
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
Alternative forms of organization and ownership (mutual organization)
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
