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corporate governance > Lecture 5 > Flashcards

Lecture 5 Flashcards

1
Q

Mechanisms improving corporate governance quality:

A

Law enforcement

Product market competition

Internal governance

Capital marekts (shareholders, creditors and market for corporate control)

Whistleblowers, mdedia, short seller activism and academics

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2
Q

internal auditors

A

Provide assurance on the internal control process, risk management and governance

Detect violations

Reduce agency costs within an organization

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3
Q

External auditors

A

Appointed by shareholders

Provide assurance on the quality of financial and non financial reports of a company

Reduce information asymmetry between management and investors

Improve trust and transpacency

External auditors play a crucial role in the well function of financial markets

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4
Q

Who are the external auditors

A

Former big five:

Arthur anderson (fall out after enron)

Pricewaterhousecoopers

Deloitte

Ernst & young

KMPG

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5
Q

What are the advantages of auditors in detecting fraudulent behaviors

A

Independent, imparcial and professional

Standardized approach to validate companys financial reports

Fresh look at the companys operation than insiders

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6
Q

What are the disadvantages in digging fraudulent behaviors

A

Difficult to obtain sensitive data

Hard to comprehend the complexity of an organization with time pressure

Challenging audit quality

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7
Q

Audit independence

A

Are paid by their audit clients

Advice their audit clients on tax, strategy and M&As

Invest in audit clients, beneficiary of the clients financial well being

Work later for the firms for career advances

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8
Q

External auditors could effectively spot fraudulent behaviors in a company:

How to solve this: regulation:

A

Mandatory audit rotation, but can be hacked as well

Higher auditing standards for increased costs of audit by 5-20%

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9
Q

External auditors could effectively spot fraudulent behaviors in a company:

How to solve this: shareholders vot on auditor ratification during general annual meeting

A

In recent years, more and more shareholders vota gainst managements choice of auditors

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10
Q

Credit rating agencies (similar incentives like auditors)

A

Paid by the issuing company (of corporate bond)

Provide rating on the financial solvency of the company

Heavily regulated since the financial crisis in 2008

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11
Q

Governance rating agencies

A

Paid by investors

Provide rating on the corporate governance quality

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12
Q

ESG rating agencies

A

Paid by investors

Providing rating on the ESG impacts firm profitability (single materiality)

Many players in an unregulated field

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13
Q

Key users of ESG ratings

A

Institutional investors base their investment on ESG ratings

Firm level decision making, CEO compensations liked to ESG ratings

Academics use ESG ratings for empirical studies

ESG ratings increasingly influence financial decisions, with potentially far-reaching effects on asset pricing and corporate policies

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14
Q

ESG investing: rationale of asset managers

A

Growing investor demand

Reduce risk of fines

Avoid costs from reprecussions of investees externalities

Immprove ability to benefit from sustainability megatrends

Higher fees for ESG funds (5 times the normal funds…)

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15
Q

Key providers of ESG ratings

A

Sustainalytics

Moodys ESG

S&P global

Refinitiv

MSCI

Bloomberg LP
trucost

CDP etc.etc.

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16
Q

Single materiality

A

How environmental and social changes may materially affect firms profitability

17
Q

Double materiality

A

It is not just climate related impacts on the company that can be material but also impacts of a company on the climate and society - or any other dimension of sustainability, for that matter

18
Q

msci’s ESG rating

A

No universal standard

Compared to industry peers, default rating BBB, above average, lower than average

Arbitrary weights assigned on E,S,G issue

Single materiality, only about ESG impacts on firms profit

MSCI ESG indicies are widely used but rarely understood

Heavy polluters still included in the MSCI sustainability index

19
Q

ESG rating an aggregate confusion –Berg et al (2022) WP
Challenges

A

Low correlation (0.38-0.71) across ESG ratings

Difficult to evaluate ESG performance of firms, funds and portfolios

Lead to under investment in real ESG activities that matter

Hard to ocnduct meaningful research on ESG

DIvert attention and efforts from really fighting climate change

20
Q

ESG rating an aggregate confusion – Berg et al (2022) WP

Sources of difference

A

Measurement (56% of the divergence)
Scope (38% of the difference)
Weight (6%)

Rely too much on self reported data by assessed company

Lack of universal standard

21
Q

Challenges with regulations

A

Lagging behind, mostly triggered by big scandals or crisis

Lacking holistic perspective, singular measures that twist incentives

Political swings

Subject to obby and bribery by interest groups

Highly costly, compliance and enforcement costs

Regulatory arbitrage by firms

Reduce the willingness of managers to take risks

unregulated markets are feeding grouds for frauds

22
Q

Importance of regulation: Laws and regulations are the cornerstone of financial markets

A

Fiducary duty + business judgement (of managers)

Legal limitations on takeover defenses

Information disclosure

Investor protection

Countries with better law and enforcement tend to have better functioning financial markets and therefore higher economic competitiveness

23
Q

Shleifer et al (2000) key messages:

Civil law is associated with

A

Greater government invervention in economic activities

Weaker investor protection compared to common law

24
Q

Implications of civil law:
Ownership structure

A

Firms in countries with weaker investor protection may need more concentrated control

25
Q

Implications of civil law:
Financial markets

A

Stronger shareholder protection boosts equity market development

Stronger creditor protection enhances lending market

The condition of financial markets also affects firms capital structure decisions

26
Q

Implications of civil law:
Real econmomcy

A

Stronger investor protection encourages savings

Financial markets channel the savings to more productive use and factor accumulation

This in turn boosts real economic growth

27
Q

Dodd-frank act 2010:
After the financial crisis of 2008, dodd-frank act 2010 aimed to ensure financial stability and protect consumers: changes include:

A

Proxy access for investors to nominate executives

Explain CEO and director nomination in Proxy Statements

Eliminate majority voting for director election

Say-on-pay and say-on-golden-parachute for shareholders

Claw back clause for executive compensation
 ….

 Regulation of the credit rating agencies..

28
Q

Corporate governance codes around the world

A

Guidance on good practices in corporate governance disclosure

OECD principles of corporate governance

Corporate governance in europe

UK 1992 “Code of best practices”

Corporate governance principles for US listed companies

29
Q

Gender diversity laws: benefits of female leadership

A

More corporative

Less risk taking

emotional support/mentorship

Higher ethical standards

30
Q

EU regulation female diversity

A

2022 mandate 40% of female non-executives in publicly listed companies by jun 30, 2026

Binding regulation (delist or comply): Belgium, france, italy, norway

Non-binding regulation (guideline): Germany, Spain, the netherlands, UK, US

31
Q

ESG regulations EU corporate sustainability reporting directive

A

Enacted in jan 2023

Mandatory disclosure for public, large private and SMEs - 50,000 companies affected

Double materiality - firms impact on environment as well as climate impacts on the firms profit

32
Q

US SECs climate related disclosure for investors:

A

Proposed 2022:

Single materiality - how climate changes affects the companys profit

33
Q

International sustainability standard board (ISSB)

A

Proposals issued in late march 2022 on sustainability disclosure and climate related disclosures

Single materiality, but vaguer than SECs rules

34
Q

Law of unintended consequences

A

Outcomes that are not the ones forseen and intended by a purposeful action

Examples: 2009 quantitative easing in china, intended to provide much needed liquidity to the private sector, led to high inflation and housing bubble

SOX 2002 intended to increase effectiveness of auditors gave the auditors a windfall profit

35
Q

Typical executive compensation package

Base salary:

A

This is the non-variable part of the renumeration package

The level of risk for the executive is driven by factors such as the ratio fixed versus variable pay and the incentive design (E.g. options versus shares, volatility of company performance, etc.)

36
Q

Typical executive compensation package

Short term incentive

A

Choice of payment instrument (e.g. cash, shares, options)

Weight financial versus non-financial KPIs (e.g. 75%-25%)

Choice of KPIs (e.g. TSSR, ROIC, EPS, ESG)

Target setting for the relevant time window (e.g. 3 years)

37
Q

Typical executive compensation package

Other elements

A

Pension allowance

Car, medical, etc.

Severance (good versus bad leaver)

Change in control provisions

corporate governance (7 decks)

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