Part 1 Theoretical foundations - Theories of the firm (4/4) - Corporate Governance SLIDESHOW 5

Question 1

What is corporate governance?

Answer 1

Instruments or mechanisms available to the providers of finance to make sure that their investments are either safe, or that they will yield the maximum possible return.
Broader: ensuring that management runs the firm in accordance with the objectives of several relevant groups of stakeholders.

Question 2

What is the essence of the firm according to Jensen and Meckling?

Answer 2

The entire set of contractual relationships

Question 3

What do this contractual relationships raise as issues?

Answer 3

Issues of agency, incentives and monitoring

Question 4

When does an agency problem arise?

Answer 4

When there is a separation within the firm of ownership from control. Therefore, there is a potential conflict of interest between the principal (shareholders) and the agent (manager).

Question 5

What are the 2 most common sources of agency problem?

Answer 5

1\ Perquisites –> expenditures (Williamson)

2\ Empire-building –> pursuit of own growth (Marris)

Question 6

What are other types of agency problems that may arise within the firm?

Answer 6

Conflicts of interest between large and small shareholders or between bondholders (debt holders)

Question 7

What is the current value of the equity?

Answer 7

The difference between the value of the firm’s assets and the value of its debt

Question 8

What do shareholders want to do if the current value of the equity is small?

Answer 8

There is a risk-shifting incentive to permit investments in high-risk projects

Question 9

What do bondholders prefer regarding investments?

Answer 9

Low-risk investments

Question 10

What is the second type of debt agency problem? And what does it lead to? First one was risk-shifting incentive

Answer 10

Underinvestment incentive leads to demand in higher return for bondholders resulting in an agency cost on the firm

Question 11

What kind of problem does duality bring?

Answer 11

May tend to give rise to a lack of independence of the board from the senior management

Question 12

What are the positive and negative aspects of separation of these 2 roles? (Chairman and CEO)

Answer 12

Robust, independent oversight of management performance but possible conflict between them

Question 13

What does shareholder activism stand for and what does it really stands for?

Answer 13

Create pressure, achieve policy changes but actually vehicle for punishing management that has already failed

Question 14

What type of problem could arise from a widely dispersed ownership?

Answer 14

Free-rider problem

Question 15

What is the free-rider problem?

Answer 15

Not any shareholder has enough incentive to devote effort to monitoring, because most of the benefit would accrue the other shareholders. Therefore, they gain by free-riding

Question 16

What happens when high dividends are distributed?

Answer 16

Less discretionary behaviour but happy shareholders and maybe rise in management compensation

Question 17

What are compensation packages?

Answer 17

Cash bonuses related to firm performance or share ownership

Question 18

What is a call option?

Answer 18

A right given to the holder to purchase shares at a pre-determined price called the strike price on a specified future date

Question 19

What does help align shareholder and managerial interests?

Answer 19

Call options to CEO. Even if encourage risk-taking behaviour on the part of executives

Question 20

To what is the value of an option positively related?

Answer 20

To the volatility of the share price

Question 21

What does happen to the share price of an under-performin firm in a liquid stock market?

Answer 21

It tends to fall

Question 22

What is the competitive discipline?

Answer 22

Managers could be replaced by appointees

Question 23

What are the 4 key principles for good corporate governance?

Answer 23

1\ fairness
2\ transparency
3\ accountability
4\ responsibility

Question 24

What are the 6 headings of the corporate governance codes of practice?

Answer 24

slide 40

Question 25

What is the key component of Enron’s case?

Answer 25

Anticipated future profits were systematically reported as if they had already been realized. Offshore units were hiding the firm’s losses

Question 26

What are the 3 responsibilities in CSR?

Answer 26

1\ economic
2\ social
3\ environmental

Question 27

How does CSR work?

Answer 27

Strike a balance between responsibilities towards non-onvesting stakeholders and agency duties to shareholders

Question 28

What are the components of the 4 level pyramid of Carroll regarding CSR?

Answer 28

1\ economic : answering customer’s needs and maximize the value of the firm
2\ legal : compliance with the law
3\ ethical : act fair (society’s consideration)
4\ discretionary or philanthropic : good corporate citizen –> actively promote society’s well being

Question 29

What are the 4 generic motives for the adoption of a CSR policy?

Answer 29

1\ moral obligation
2\ sustainability
3\ licence to operate : avoid interferences from regulators or governments
4\ reputation