Lecture 4: Corporate governance and accountability

Question 1

What is the shareholder theory? Q

Answer 1

The shareholder theory is presented and criticized as an alternative to shareholder control.

Question 2

What happened the the Cracker Barrel Case?

Answer 2

• Cracker Barrel, an American company, fired 11 employees because they were gay or lesbian
• Ruling in a subsequent court case found that shareholders have no right to vote on any resolution dealing with a companies employment policies, even when morally objectionable
• Shareholders only have the right to elect the board of directors, who in turn select the management team, who subsequently determine employment policies

Question 3

What is the definition and key issue in relation to corporate governance?

Answer 3

Definition: In whose interest should corporations be run?
Key issue: The critical question is not why shareholders have the rights they do - this is definational - but why equity capital providers should generally be the shareholders with these rights
> shareholders v stakeholders interests?

Question 4

What are the four theories in relation to whose interest should corporations be run?

Answer 4

1) The property rights theory
2) Social institution theory
3) Contractual theory
4) Stakeholder theory

Question 5

What does the property rights theory state?

Answer 5

• The property rights theory states that shareholders own a firm
• Extension of property rights: as owned, shareholders should be entitled to receive the full proceeds

Question 6

What did the Doge v Ford Motor Co case find?

Answer 6

Found that shareholders have the right to operate a corporation solely in their own interests

Question 7

What did Berle and Means suggest and how did this relate to the property right theory?

Answer 7

• They said that shareholders are no longer owners in any meaningful sense and have lost a claim that corporations should be run in their own interests
• Undermined the power of the property rights theory

Question 8

Under the Berle and means theory, why do managers still act in the interests of shareholders?

Answer 8

Everyone else would benefit by this effective check on managerical power

Question 9

What does the social institution state in relation to whose interests the corporation shall be run?

Answer 9

• Determines a corporation as a public entity
• Corporations are not created solely for personal enrichment, but a public enterprise that is intended to serve some larger social good
• State grants individuals the right to do business in the corporate form in order to serve some social good

Question 10

What does the contractual theory state in relation to shareholders?

Answer 10

Firm is a nexus of contracts, as shareholders are residual risk bearers, they will seek maximum profitability which will benefit society as a whole, firm has contracts with other stakeholders to ensure their needs are met

Question 11

What does the contractual theory state is the role of shareholders?

Answer 11

Their role is to provide capital, however they have residual risk of the business (taking whatever is left over) - therefore most important rights to shareholders is corporate control

Question 12

What are the arguments for shareholders having control?

Answer 12

• greater value to residual claimants than other stakeholders
• Return to shareholders is dependent on profitability - non shareholders have little to gain from control as they have fixed, not residual claims
• Society as a whole benefits when shareholders of a corporation
• firms will create more wealth with the shareholders interests in mind and as a result all groups will benefit

Question 13

What are the four objections to the contractual theory?

Answer 13

1) Externalities - serving only the interests of shareholders may lead to externalities
2) implicit contracts - serving the interests of shareholders may lead to a breach of implicit contracts with other stakeholders
3) Residual risk - not all residual risk is borne to shareholders - some control rights should go to non- shareholders
4) Distribution and power: Unequal distribution of wealth and power may result in unequal outcomes in corporate governance

Question 14

What does the stakeholder theory suggest?

Answer 14

Suggests that corporations should be operated accordingly to all those who have a stake in the company

Question 15

What are the three uses for the stakeholder theory

Answer 15

1) Descriptive: Can be used to answer questions about how corporations are organised and managed
2) Instrumental: Used as a tool for management for how to conduct business in the interests of stakeholders, rather than aiming at maximising profit for shareholders
3) Normative: an account for how corporations ought to treat various stakeholder groups

Question 16

What are the four criticisms of the stakeholder theory?

Answer 16

1) Is the corporation obligated to accommodate all shareholders merely because they affect the firm
2) Corporations have obligations only to respect the rights of each stakeholders, not act in their own interests
3) Igor Ansoff: argued that stakeholders are merely constraints on the pursuit of profit objectives
4) Kenneth Goodpaster: argued that managers have a fiduciary duty to shareholders but obligations to employees, customers and other stakeholders are non- fiduciary

Question 17

What are the intentions of corporate ethics programs?

Answer 17

1) Guide individual conduct

2) Shape the corporate environment

Question 18

What are the five components of ethics programs?

Answer 18

1) Code of ethics
2) Ethics training
3) Communication with employees
4) Mechanisms for reporting, investigating and correcting wrongdoing
5) Possibly: the employment of an ethics officer

Question 19

What are the four benefits of implementing an ethics program?

Answer 19

1) Reducing the risk of losses from wrongdoing
2) Enabling organisational change
3) Managing external relations
4) Fulfilling obligations to shareholders

Question 20

What are the three components of corporate accountability?

Answer 20

1) Financial reporting
2) Board of directors
3) Criminal law

Question 21

What are the three types of codes of ethics?

Answer 21

• code of conduct: rules and standards that apply in certain situations
• credo or mission statement: statement of core values or mission of an organisation
• corporate philosophies: guide to beliefs governing an organisation

Question 22

What is the role of corporate directors?

Answer 22

• elected by shareholders, to exercise their rights of control in an organisation
• BOD themselves are responsible for appointing CEO, overseeing strategic plan and ensuring control mechanisms in place