Overview of Corporate Governance

Question 1

Corporate governance

Answer 1

Mechanisms to ensure the actions of managers are consistent with the interests of shareholders

Question 2

5 major responsibilities of the board of directors

Answer 2

Setting overall corporate strategy
Appointing CEO and top management
Monitoring top management
Reviewing major resource allocation
Looking after shareholder interests

Question 3

Benefits of effective corporate governance

Answer 3

-Stronger corporate reputation
Greater trust and confidence of investors and customers
Ability to raise new capital
Lower cost of capital due to access to capital markets

-More effective strategic oversight
More efficient operations, minimised risks
More sustainable business

Question 4

Agency theory

Answer 4

Shareholders’ and managers’ interests are not always aligned and therefore managers may not always act in shareholders’ best interests,

Question 5

Managers may not always act in shareholders’ best interests, due to:

Answer 5

• Knowledge imbalances (the hired agents know more)
• Practical limits on monitoring of agents
• Misaligned incentives

Question 6

Managers may:

Answer 6

Take riskier decisions than owners
Be excessively risk averse
Practise managerial opportunism

Question 7

Espoused remedies

Answer 7

Knowledgeable principals
Effective monitoring
Well-designed incentives

Question 8

What are vulnerable links in governance chain?

Answer 8

• Investment institutions
• Information intermediaries
• Investor knowledge limitations

Question 9

Investment institutions

Answer 9

-Historically accused of being inactive shareholders who do not challenge the board and CEO
-Have recently tended to become more active
E.g. voting against excessive executive pay; supporting climate-responsible policy.

Question 10

Information intermediaries

Answer 10

Social norms among analysts …
Potential for information available to small investors to lack true independence
Over-reliance on ratings agencies (2008 crisis)

Question 11

Investor knowledge limitations

Answer 11

Feltex, NZ finance company cases, Dick Smith, …..

Question 12

Vulnerabilities in Boards

Answer 12

• Independence of board and executive
• Effectiveness of Independent Directors is sometimes questioned: ability to combine
• Effectiveness and independence

Question 13

Independence of board and executive

Answer 13

Often the same person is Board Chair and CEO (especially in USA)

Question 14

Effectiveness of Independent Directors is sometimes questioned: ability to combine

Answer 14

Independence
Knowledge
Leadership

Question 15

Effectiveness and independence of

Answer 15

Nominating Committee
Audit Committee
Remuneration Committee

Question 16

The collapse of Enron: Alleged causes included

Answer 16

• Hiding debts in ‘partners’ (misleading accounts)
• Failure of auditing process
• Board ineffective as a check on the executive

Question 17

Potential agency problems

Answer 17

• Empire building
• Buying businesses that increase the size of the company without increasing shareholder wealth
• Risk taking (Lehman, Enron)
• Rewards based on share price generate distorted incentives
• Creative accounting (profit boosters, balance sheet distortions)
• Board ‘interlocks’ with related parties
• Insider trading (usually unlawful)

Question 18

Moral hazard

Answer 18

-When managers do not bear the full consequences of their decisions, they have an incentive to make reckless decisions
Example: government guarantees a bank’s deposits, but the government does not oversee its lending practices

Question 19

Stewardship theory

Answer 19

• Agency theory takes a narrow ‘rational-economic’ view of managers and ignores other motivations
• Senior executives invest their career in the firm and hence identify with its fortunes
• Shareholders can easily buy and sell, and might not know what is good for them

Question 20

Shareholder view of governance:

Answer 20

Responsibility is to shareholders above all other stakeholders
+Undiluted focus on financial returns; support for innovation
-Risk of short-termism, and reliance on active institutional investors in the governance chain

Question 21

Stakeholder view of governance:

Answer 21

A broader view of which parties contribute to and benefit from the firm’s prosperity
+Longer time horizons and less reckless risk-taking
-Less decisive or innovative

Question 22

What are the three types of board:

Answer 22

Inactive boards in owner-managed firms
Active boards with representation from venture capital investors
Advisory boards to provide advice and perspective to owner-managed firms

Question 23

Why did Dick Smith collapsed in 2016

Answer 23

The firm collapsed in early 2016 because it had to taken too much debt in order to build up its stock of goods