4/16/20131Business EconomicsLecturer: MA. Nguyen Xuan HuongChapter 1: IntroductionOverview of the subjectCredit: 3 credits (15 lectures)Textbook: Business Economics andManagerial Decision Making (Trefor Jones, JohnWiley & Sons Ltd. 2004)Assessment:Class participation and in-class activities: 10 %Presentation and assignment: 20%Mid-course test: 20 %Exam: 50 %Total: 100 %
4/16/20132Overview of the subject (cont)Lecture times and venuesFrom 15/4-9/6/2013- Monday (7-9): A605- Wednesday (10-12): A604Chapter Objectives• Study objectives of Business Economics• Overview of company• Distinguish ownership/shareholderrights andcontrol, owner and managerial controlled firm• Patterns of shareholding ownership• Inside and outside system of corporate control• External and internal factors constrainingmanagers’ discretionKey concepts• Ownership, corporate control, shareholders,shareholdings, shareholder-owned company• Dispersed ownership, owner-controlledmanagerial-controlled company.• Outsider and Insider system of corporate control,external and internal constrains• Managerialdiscretion• Corporategovernance, CG code• Firm, company, corporate, enterprise
4/16/20133What is Business Economics?Spencer and Siegelman (1969) “integration ofeconomic theory with business practice for the purpose offacilitating decision making and forward planning bymanagement.”Main contents: Business Economics focus on answeringthe following questions:• Why firms establish or exit market• Why firms expand? Horizontally or vertically?• Roles of entrepreneurs and firms• Roles of corporate structure• Relationship between firms and employees, shareholders,customers, suppliers, governments, as well the environmentOverview of company1. Definition of company- French Civil code: “Company is a contractthrough which 2 or more individuals agree to usetheir assets or capabilities into a commonactivities in order to share profits or otherbenefits from such common activitiesIn some cases under the law, company can beestablished by one individual.Members of the company commit to share loss”(Article 1832)Overview of Company (cont.)According to the Enterprise Law of Vietnam (2005)Enterprise means an economic organization thathas its own name, assets, stable office and is dulyconstituted for the purpose of conducting business(Article 4.1)
4/16/20134Common characteristics of firmsFirms are different in term of size, ownershiptypes, products, but have things in common:Owners - shareholders: set objectives, gain profit andbear the risk from firm operatingManagers: make day-to-day decisionObjectives: aimed at by owners, may not coincide thosepursued by managers in case the ownership isdispersedResources: capital, labor, technology, land,…Performance assessment: thorough certain criteria byowners, managers and other stakeholders2. Classifying companiesa. According to size of companies (Number ofemployees)Size of company Vietnam WBSuper small <10 <10Small <200 <50Medium 200 - 300 50 - 300Large >300 >300b. According to Enterprise law 2005Joint stock company (shareholdingcompany)Limited liability company with more than 1 memberLimited liability company with 1 memberPartnershipSole proprietorship (private company)
4/16/20135b1. Joint Stock companyCharter capital is divided into equal portions known as shares.Shareholder can be organization or individual; the minimum numberof shareholders will be three and there is no restriction on themaximum number of shareholders.Shareholders are liable for debts and other liabilities of the companywithin amount of capital that they contributed.Shareholders are free to transfer their shares, except for restriction withfounding shareholders and voting-preferred shareholders;A shareholding company will be given a legal status from the issuingdate of the certificate of business registration.A shareholding company is entitled to issue securities for the purposeof capital mobilizationAdvantages Disadvantages-Less risky for shareholders aseach will responsible up to thecontributed capital-Capital structure is flexible: manypeople can participate-Scope of business: very large-Can mobilize capital more easilyby issuing securities-Capital/ ownership are easilytransferred-Complicated -> difficult to control-Must follow strict regulations:suchas management and financeand accounting regulation,b2. Limited liability company with more than1 membersMembers can be organisation or individual; the minimum number ofmembers will be 2 and the maximum number of members will be 50.Members are liable for debts and other liabilities of the company withinamount of capital that they contributed.Members are able to transfer their contributed capital.A Limited liability company will be given a legal status from the issuingdate of the certificate of business registration.A Limited liability company is NOT entitled to issue securities for thepurpose of capital mobilization
4/16/20136Advantages Disadvantages-Less risky for members aseach will responsible up tothe contributed capital-Number of members limited-> easier in controlling-Share transfer is regulatedstrictly -> can controlmembers easily-Can not mobilize capital byissuing security-Follow strict regulationsrather than private companyor partnershipDiscussion questions:Compare and contrast the advantages anddisadvantages of shareholding company and liabilitylimited company?What do you understand by the terms “divorcebetween ownership and control”CHAPTER 1 TEN PRINCIPLES OFECONOMICSStructure patterns of shareholder-owned companyIf ownership is dispersed, the control of the firmmay not belong shareholders but senior managers:Board of Chief Executive or Directors- Monistic: firm serves for one interest group –shareholders;commonly in US and UK- Dualistic: for two interest groups: shareholderand employees; in France and Germany- Pluralistic: for not only interest of groups ofshareholders,employee but stakeholders such assuppliers; in Japan.
4/16/20137Patterns of share ownership: United KingdomThe percentage of individual shareholding in totaldecline sharply over 1963-2001 period, from 54 %to 14.8 %.In contrast, during similar period that of financialinstitutions increases dramatically from 30.3% to60.2 %, decreased to 50 % in 2001. But this groupreplaced the individual as the largest shareholdingForeign ownership also has risen markedly from 7% to a stable point of 31.9 % over 40 years.Patterns of share ownership: other EuropeanThe share of financial institution is lower but thatof non-financialcompanies is higher as comparedto UKIndividual ownership is more significant than thatof institution in Italy and Spain, but less in FranceForeign ownership is more important in France,Spain but less in Germany and ItalyPatterns of enterprises’ ownership : Vietnam• 100 % state- owned enterprise (SOEs) wasdominanttype before the decade 1990s.The shareof these firms in total firms’ capital has beendecreasing to about 20 %. A number of equitizatedmember companies of these corporations, groupshas been increasing.• Wholly foreign-owned, joint-venture with state-owned firms, joint-venture with private fastestincreasedduring 90s decade. Those participate tostock exchange are increasing.
4/16/20138Patterns of ownershipstructure: Vietnam (cont.)• The proportionof private-ownedfirms has beengrowingfast, especially since 2000. But shareholderowned/join-stock company (with state-ownedcapitalor not), still make up a small percentage.• The share of financial institution is not significant inthe join-stock firms but tend to increase since 2000followingthe operationof the stock exchange, rapidestablishmentof numerousbanks and stockcompanies.Is firm owner- or manager- controlled?Control of firm is defined as directing the firm toowners’ objectivesDispersion control from ownership in shareholder firm:The owners still bear the risk of operating firm but theyare not manager (or not only chief managers) thus maynot control the firm or lead the firm to goals set bythem. This is because managers who are appointed byowners but still have ends relatively separate from theowners.Is firm owner- or manager- controlled? (cont.)The easy classifying cutting-off point :- An individual share owners holds > 50 % of the equitycan outvote the remaining and control company(assume: one voter held one share)- If that < 50 % of the stock, they can win the vote if itgain the sufficient support of the others to outvote. Orvice versa.
4/16/20139Is a firm owner- or manager- controlled? (cont.)The other cut-off points to distinguish:- Berle & Means (1932): owning 20 % of stock issufficient for owner-controlled, < 20 % for managerialcontrolled- Radice (1971): 15 % for owner-controlled and 5 % formanagerial-controlledCut-off points is the simplistic classification:- Nyman & Silberston (1978): strongly criticized thatmethod, stress one factor which does not emerge fromcrude data but affects substantially to voting.Is firm owner- or manager- controlled? (cont.)That is coalitions of interests, especially of families.- Cubin & Leech (1983): create a probabilistic votingmodel, defining:+ Control is arbitrary 95 % chance of winning a vote. Thedegree of control is probability the controlling groupsecuring majority support in a contested vote.+ In their samples: 10 % is essential (73 companies) and 5% (in 37 companies)Variables of control of a companyThe size of the largest holdingThe size and distribution of the remaining sharesThe willingness of other shareholders to form a votingunited frontThe willingness of other shareholders to vote for thelargestholding group.
4/16/201310Discussion questions• Companies A, B and C have the following share ownership structure:– Firm A: the largest shareholder is an individual owning 10% of theequity, a further five members of the family own 25%, with theremaining shares owned by financial institutions and with no oneinstitution owning more than 3%. The board of directors does notinclude the largest shareholder but does control 10% of the equity.– Firm B: the largest shareholder is an institution owning 3% of theequity. The remaining shares are owned by 20,000 individual andinstitutionalshare-holders.– Firm C: the largest shareholder is an individual owning 40% of theequity. A single bank owns 20% and three companies the remaining40%.• Classify each firm according to whether it is owner or manageriallycontrolled and whether it is likely to be part of an insider or outsidersystem of corporate governanceSystems of corporate control: InsiderConcentrated ownership: large-holding, dominance ofinstitution/corporateshareholderShares are not frequently sold, but large blockFirm mergers rarely thorough merger, but agreementOwners and other stakeholders are represented on the boardof companies; active participation in controlling companyCountries applying: Europe (typically Germany) and JapanSystems of corporate control: OutsiderDispersed ownership: dominated by non-bank institution andprivate individuals.Owners and other stakeholders are not represented on theboards of companies; passive investor, rarely question theoperation of company.Share is easily traded not for investment purposeManagerial control; changing management and policies is veryslow; may be via takeover.Countries: US, UK
4/16/201311Constrains on managerial discretion:External factorsLarge shareholders: use their voting power to change theirpolicies or management if they are dissatisfiedAcquirers of share blocks sold by existing unhappyshareholdersBidders who state to buy all the voting shares if the companyundergoes takeover processDebtors/s investors secure their interest, especially infinancially difficult timeConstrains on managerial discretion: External factors(cont.)External regulators: company law, and independent auditors,lodging company’s account to regulatorIn outsider system: these external factors mostly affects viastock market, following movements in the share price.In insider system: the external constrains exercise throughthe voting powers since selling share is not simple.Constrains on managerial discretion: Internal factorsNon-executivedirectors(UK)or supervisory board (Germany):theirduty is to constrain executivedirectors.But they areappointed by executive managers,outvoted by executive directorsthus may not be independent.In Germany the board membersareselectedmore widelyOwners/shareholders:controlby:a) using the voting power at meetings of firm or informal withmanagers:Vote against re-election of ED or their decisions;b) Organizing coalitions to influence management informallyand force voting at the general.(in UK)
4/16/201312Constrains on managerial discretion: Internal factors(cont.)Stakeholder within the company: customers, suppliers, lendersand local community.Their constrain actions being undertakenin two ways:+ Direct criticism or comments to the executives+ Indirect information,affecting to shareholders, medias,outside expertsConstrains on managerial discretion: aligning the interestsof managers and shareholdersDevising incentive mechanism to align interest of managersand shareholders:Profit-related bonus + share options based on successfulperformanceof managers in term of owners objectives.Difficulties: Manager’s non-monetary motivation.A survey of around 300 companiesin UK in the 1980s –early90s:weak correlation between rewarding system and firmperformance.Constrains on managerial discretion: improving corporategovernanceCorporate governance concepts:• In broader term, CG cover not only management’sresponsibility to shareholders but also to stakeholders as wellas wide community.• From government point of view : CG is “ensuringaccountabilityin the exercise of power and financialresponsibility,while not discouraging firm from beingenterprising and risk taking.” (Jones, 2004)
4/16/201313Constrains on managerial discretion: improving corporategovernance (cont.)The main instrument of CG over the world and in OECD iscodes of practice to ensure two mentioned aspects of goodcorporate practice.In UK, Combined Code 1998, requires each corporate:+ A non-executive chairman bearing responsibility clearlydistinguished from chief executive+Three non-executive directors of managementConstrains on managerial discretion: improving corporategovernance (cont.)+A remuneration committee of at least three non-executivedirectors to decide the reward for directors+A nomination committee composed 100% non-executivedirectors to appoint new directors.+Annual report to shareholders should contain:a)A narrative account of how the broad principles wasapplied, explain any departures from Codeb) Payment to chief executive and highest paid directorConstrains on managerial discretion: improving corporategovernance (cont.)+ Directors should receive appropriate training to completeduty well+The company need to justify if chairman and chief executiveare the same.+ Directors who retire before the end of term should explain
4/16/201314Constrains on managerial discretion: limitations forimproving corporate governanceo In practice the Code doest not completely prevent badconduct of a part of executiveso The compliance with the Code doest not guaranty theprofitabilityof companyo Non-executive directors are the directors of the other, notensuring their independent scrutinyo Non-executive limited ability to carry out their expected dutyDiscussion questionCompare and contrast the constraint ofCEO working for a firm of insider systemand of outsider system?