Topic 10 Flashcards
Principal Agent Problem
There is asymetrical information, so the principal can’t moniter the agent efficienty, and even substandard monitering is expensive.
There are also conflicts of interest between the principal and the agent, so the result it for the agent to agree to a contract, then deviate from the expected actions to fit it’s own best intereste - ie, worker being slack, lawyers extending lawsuits.
Adverse selection
A market process in which “bad” results occur the occur, the “bad” products or services are more likely to be products or services are more likely to be
selected (hidden information)
What is moral hazard?
The actions of one party may change to the detriment of another after a transaction.
Corporate Governance
“Rules, processes or laws by which businesses are operated, regulated and controlled.”
Refers to internal factors defined by executive officers, shareholders or constitution of a corporation, as well as to external forces such as consumer groups, clients and government regulations.
What is the core challenge of corporate governence?
To align the incentives of the managers so that they act in the interest of owners rather then themselves. (or really, they act in the interest of themselves and owners).
Examine governence issues under various ownership structures.
- Self Proprietorship: Owner is usually the manager, minimal issues
- Partnerships: A number of people act as both owners and managers. Weaknesses include unlimited liability, Free riding, Limited funds.
- Joint-Stock Corporations (JSC’s). Large firms with very dispersed ownership. Control is seprated from ownership.
What are the major corporate governence measures in JSC’s?
- Ability of directors to oversee the behavior of management
- Audit & Review process internal & external, run by third parties.
- The design of executive remuneration.
- Role of large shareholders to monitor and oversee management.
How has executive compensation changed relative to share values?
In Au, over ten years (2000-2010) share prices increase by 31%, pay packages to CEO’s more than doubled.
What is the tournament rational?
Used to justify increasing pay scheme’s, argues that high pay for top jobs
- Retain and reward it’s most valuable employee’s.
- Induces all othe remployees to exert extra efforts on their job.
Executive stock options
Used to align CEO’s interests with the shareholders.
- Call options: The right to purchase a company’s shares at a specified price (exercise price). Non transferable.
- No dividends
Other compensation methods
- Piece-rate / commmision: used when employee work is easy to measure
- Profit Sharing
- Revenue sharing
- Efficiency wages (increase agents opp. cost of leaving)
- Deferred (back-loaded) compensation. Pay works less than what they are worth early in tenure, more later. Incentivises worker to stay with firm. Helps for firms with lot’s of worker specific training.
Internal management control mechanisms
- Board of directors
- Non-executive directors (monitor directors)
- Annual General Meeting - shareholders votes can sack directors.
External control mechanisms for management
- Bankruptcy - if the company does poorly, debt holders can seek its liquidation to reclaim funds.
- Contestability - the possibility of takeover forces managers to boost profits
- Independent Auditors
- Relationship investing - long term, large stock holders may personally moniter company.
What is the Sarbanes-Oxley 2002 act?
Enforces internal & external control in public corporations.
- *Accuracy & Accessibility of information on a timely basis: *Mandated more rapid disclosure of insider transactions, financial analysts and auditors must provide info on potentual conflicts of interest.
- *Management Accountability: *Increased maximum of monetary sanctions and prison terms for fraud and violations of securities law.
- Auditor Independence: Created a new agency to moniter and regulate auditors of public firms. Sets standards and sanctions auditors who violate them.
ASX Principles of good corporate governance:
- Solid foundation for management & oversight.
- Stucture the board to add value.
- Promite ethical & responsible decision making.
- Safeguards for integrity in financial reporting.
- Timely and balanced disclosure.
- Respect shareholder rights.
- Reckognise and manage risk.
- Rmunerate fairly and responsibly.
