Week 8-Corporate governance Flashcards
What are the free types of corporation?
1) sole proprietorship
2) partnership
3) limited corporation
Describe sole proprietorship
• Owned and Managed by one person • Very easy to form • Profits taxed as personal income • Unlimited liability • Life of company linked to life of owner • Amount of funding is limited by owner’s personal wealth
Describe partnership
• Easy to form • Requires a partnership agreement • Limited and unlimited partners • Partnership is terminated when a partner dies or leaves the firm • Difficult to raise cash • Profits taxed as personal income • Controlled by general partners – sometimes votes are required on major business decisions
Describe limited corporation
• Articles and Memorandum of Incorporation Required • Limited Liability • Profits taxed at corporate tax rate • Board of Directors • Life of company hypothetically unlimited • OBJECTIVE: maximisation of shareholders’ wealth • (stakeholders’ interests)
What are the information required for LTD?
1) Articles of Incorporation • Name of the corporation. • Intended life of the corporation (it may be forever). • Business purpose. • Number of shares that the corporation is authorised to issue, with a statement of limitations and rights of different classes of shares. • Nature of the rights granted to shareholders. • Number of members of the initial board of directors.
2)Memorandum of Association
• The rules by which the corporation
is organised
Describe the board of directors in two-tier countries and single-tier countries
formula sheet
Describe an unitary board structure and give a country example
UK
• Board Reports to Shareholders
• Shareholders elect directors at AGM
• Directors nominate/hire managers
Describe a dual board structure and give a country example
Germany -Board reports to supervisory board • Supervisory board elects directors • Supervisory board consists of representatives from banks, government, trade unions, other stakeholders
What is the difference between partnerships and corporations in terms of 1)liquidity and marketability 2) voting rights 3)taxation 4) reinvestment and dividend payout 5)liability 6) continuity of existence
1)• Partnership: Restricted Trading
• Corporation: Traded easily sometimes on stock
exchange
2)• Partnership: Partners have control
• Corporation: Each share gives a voting right
3)• Partnership: Profits taxed at personal tax rate
• Corporation: Profits taxed at corporate tax rate
4)• Partnership: All profits allocated to partners Reinvestment and • Corporation: Total freedom in dividend decisions
5)• Partnership: General Partners have unlimited
liability Liability
• Corporation: Shareholders have limited liability
6)• Partnership: Limited life
Corporation: Unlimited life
What is type I relationship?
•Relationship between
managers and
shareholders
What is type II relationship?
•Relationship between
majority shareholders
and minority investors
What is type I agency problem and information?
One party (managers) is an agent and makes decisions for its principal (shareholders): principal – agent problem
One party (managers) has information that the other party (shareholders) does not have regarding the daily running of the firm: asymmetric information leading to moral hazard and adverse selection
=Managers want to maximise their own wealth and power (size of the firm)
=Shareholders want managers to maximise the value of the company
What are agency costs?
The costs of (resolving)
problematic agency
relationships
What re type I agency costs?
Direct Costs: 1. Corporate expenditure that benefits managers at the expense of shareholders (e.g. private jet) if managers not sufficiently monitored
- Corporate Expenditure to monitor and control manager activities (for example, payment of auditors)
Indirect Costs: Lost business opportunities because of the conflict of interest
What are the 5 ways in which shareholders can ensure that managers act in their interest and lower agency costs?
A. Managerial Compensation
• Performance based pay
B. Control through the Board
• Shareholders elect members of the Board of Directors (who then hire and fire managers)
C. Classes of Shares • Some firms have more than one class of ordinary equity. Often the classes are created with unequal voting rights. Original owners could have more votes per share to keep control
D. Pre‐Emptive Rights
• A company that wishes to sell equity must first offer it to the existing shareholders before
offering it to the general public. The purpose is to give original shareholders the opportunity
to protect their proportionate ownership in the corporation and therefore control.
E. Dividends
• Payments by a corporation to shareholders, made in either cash or shares. Dividends
payments as a form of discipline
What are type II agency costs?
Majority shareholder makes one of her firms trade on attractive terms with another of her
firms. Known as a Related Party Transaction.
A majority shareholder can force the company
to declare a large dividend because he needs
the cash.
Who are the firm’s stakeholders?
give some examples
A stakeholder is someone, other than a shareholder, who has an interest in the firm and potentially has a claim on the cash flows of the firm.
ex:clients, shareholders, employees, environment, regional government, consumers, suppliers, local employment
What is common law?
Common Law •Law develops following judge’s decisions, court rulings •Flexible and can adjust quickly to events
What is civil law?
site another type of law
Civil Law •Law is developed through regulation and code of laws •Judges interpret the law •Based on code of principles
ex: religious law
How to countries protect investors?
What are the two separate issues to consider when investing?
-by law enforcement
• Many countries have strong regulations but
very weak enforcement
- So, two separate issues to consider:
- The Efficiency of the Judicial System
- Is the Rule of Law and Order followed? To what extentdoes a government enforce its laws?
What are the two ownership structures? describe
Widely Held Firms (no majority shareholder)
•Separation between ownership and control
•Agency Issues Type I between managers and shareholders
•Short term horizon (short‐termism)
Closely Held Firms (Family, banks, governments)
•Manager and shareholder incentives aligned
•Agency Issues Type II between controlling (majority) and non‐ controlling (minority) shareholders
•Longer term horizon
Describe a bank based system
•Banks are central to the process of moving funds between demanders and suppliers of capital •More active monitoring •Germany and Japan are examples
Measures: • Bank Liquid Liabilities/GDP • Bank Assets/GDP • Domestic Bank Deposits/GDP
Describe a market based system
•Securities markets are as important as banks and can be significantly more important •External market discipline •US and UK are examples
Measures: • Market Capitalisation/GDP • Total Trading Volume/GDP
