Part 1. Intro to Corporate Governance and other ESG Considerations Flashcards
Corporate governance
The system of internal controls and procedures by which individual companies are managed.
The arrangement of checks, balances, and incentives a company needs in order to minimise and manage the conflicting interests between insiders and external shareholders.
Shareholder theory
This takes the view that most important responsibility of company’s managers is to maximise shareholder returns.
Stakeholder theory
Broadens a company’s focuses beyond interests of only its shareholders to its customers, suppliers, employees and others who have interest in the company.
Shareholders
The most junior class of capital providers, in case of company bankruptcy, where they receive proceeds only after all creditors claims are paid.
Focus on growth in corporate profitability that maximises the value of company’s equity.
Maintain control over company through power to elect the BOD, and vote for specified resolutions.
Controlling shareholders
A shareholder/block of shareholders may hold a percentage of shares that gives them sufficient voting power to control election of BOD, and influence approval/blockage of company resolution.
Minority shareholders
They hold a much smaller proportion of company’s outstanding shares, resulting in more limited ability to exercise control in voting activities.
Creditors
They are company lenders, and providers of debt financing.
Do not hold voting power.
Exert control by using covenants, which restrict activities of borrower, in return for capital provided, they expect to receive interest and principal payments.
Payment to creditors is companies ability to generate cash flows.
Prefer stability in company operations.
Managers and employees
They are normally compensated through salary, bonuses, equity-based remuneration (compensation), and certain perquisites.
Managers are motivated to maximise the value of their total renumeration, while also protecting their employment positions.
Lower employees seek fair renumeration, good working conditions, access to promotions, job security etc.
Conflict of interest between shareholder and managers - takeover offer
Board of directors
Elected to protect shareholder’s interests, provide strategic direction and monitor company and management performance.
1 tier structure - single BOD composed of executive and non-executive managers (non-employees).
2-tier structure, with 2 separate boards:
- Supervisory board (non-executive directors) - oversees management board.
- Management board (executive)
Director concerns over exposure to liability for breach of duty; exposure can be mitigated by exercising appropriate control over operations, management, and independent access to company docs.
Customers
They expect company’s products and services to satisfy their needs, and provide appropriate benefits given price paid, and meet applicable standards of safety.
Suppliers
The primary interest in being paid as contracted or agreed on in a timely manner.
Concerns are with company’s ability to generate sufficient cash flows to meet its financial obligations.
Governments/regulators
They seek to protect the interest of general public and ensure well-being of their nations economies.
The collector of tax revenues from companies and their employees; gov can be considered on of companies major stakeholders.
Principle agent relationship
When the principal hires an agent to perform a particular task or service.
This involves obligations, trust and expectations of loyalty; with agent expected to act in best interest of principal.
Conflicts: when managers do not act in best interests of shareholders.
Breaches of principal-agent relationship: (shareholder vs manager)
- Managers seek to maximise their personal benefits (i.e. renumeration and perquisites) to the detriment of shareholder interests.
- Managers risk averse corporate decisions to protect employee status, differs from company’s value creation objective.
- Information asymmetry, as managers greater access to information about company, gives them ease to make strategic decisions not in best interest of shareholders.
- Shareholder vs directors - conflict of interest if board is influenced by insiders, where ability to monitor role may be hindered.
Breaches of principal-agent relationship: (minority -shareholder vs controlling shareholder)
- Opinions of minority shareholders often outweighed by controlling shareholder, i.e. straight voting.
Examples:
- takeover transactions
- related party transactions e.g. 3rd party supplier deal owned by shareholder spouse.
- multiple class structure = enables controlling shareholders to mitigate dilutions of voting power when shares are issued.
Breaches of principal-agent relationship: (manager vs BOD)
- Boards monitoring role compromised in event of limited info provided by managers to board.
- Deepened for non-executive directors.
Breaches of principal-agent relationship: (shareholder vs creditor)
- Shareholder prefer riskier projects with strong likelihood of higher potential return, but creditors prefer stable performance and lower risk activities.
- Creditors more exposed to default risk, if company attempts to increase borrowings they may be unable to pay back.
- Distribution of excess dividends to shareholders conflicts with creditors interest if impairs company’s ability to pay interest and principal.
Other stakeholder conflicts:
- Customers vs shareholders - company decides to charge higher price for p/s or reduce safety features to lower cost.
- Customers vs suppliers - company offers overly lenient credit terms to customers, but company’s ability to repay suppliers on time may be affected.
- Shareholders vs gov/regulators - company adopting accounting and reporting practices reduce tax burden, whereas regulators prefers higher capital position.
Legal infrastructure
This defines framework for rights established by law and availability or ease of legal recourse for any violation of these rights.
