Fiche du cours corporate governance

1. Corporate governance :
Chapter 1 :
What is corporate governance ?
The way to avoidmalpractice inthe financial industryistoseta corporate governance.Thislater deals
withthe waysin whichsuppliersof finance (capital) tocorporations (managers) assure themselvesof
gettinga returnon theirinvestment.
Stakeholders:Individuals/institutionwhoseinterestsare stronglytiedtothe successof the company.
Everyone thathas a stake inthe company.
 Shareholders:Holdsharesinthe companyandhave votingrights
 Creditors:Fundthe firmwithdebt(banks;shadow banks;bondholders;…) don’tvote butcan
impose covenants.
 Why doessocietycaresaboutthe company?Because if the companyissuccessful,they’re
gonnapay highertaxestothe state that is goingto be distributedamongdifferentpartsof
society.
Managers: Knowthe problems/threatsandhow the firmisactuallymanagedand make the decisions.
Have the informationandpowerbutnotthe incentive torunthe companyina responsible way.
To make sure that managersact inthe bestinterestof stakeholders,we needmonitors.
Why are good corporate governance practicesextremelyimportantinthe case of firmswithlargely
dispersedminorityshareholders?
 Minorityshareholdersare toosmall to directlyinfluence the decisionsof the company.(don’t
evenhave the incentive).

2. Board of directors:Needstobe independentand have tocome up with/evaluate policies and
procedures andapprove strategicdecisions tomake sure there’sagoodcorporate governance.They
take responsibilityforthe corporate governance of the firm.Overseethe management, are electedby
the shareholders (1share = 1 vote) andare supposedtorepresent theirinterest.
Three typesof directorsinthe board:
 Executive directors:Directorsthatare simultaneouslyservingasmembersof the company.
Bothdirectorsand managers(CEO,CFO..)
 Non-executive directors: Boardmemberswhoare notpart of the company’sexecutive team but
still connectedtothe company (previous employeesorfamilyties conflictof interests)
 Independentdirectors: Nomaterial relationwiththe company(management/owners) workfor
a competingcompany. Are goingto be objective while makingdecisions.
 Do not receive anyothercompensationfrom the companyinadditionthe boardfees
 Must have not beenemployedbythe companyinthe recentpast
 Have no otherclose linkstothe management
 Have no actual or potential conflictof interestwiththe company
The role of the board:
A boardof directorsshouldmeetatleastquarterly,withadditional meetingsdeterminedbyspecific
circumstances.( Forlargercompanies x 2). There isno maximumlengthof tenure howeverboards
withlongeronestendtobe more alignedwithmanagement
Theymake sure that:
 Minorityshareholderrightsare formalizedandprotected
 Dividendpoliciesare precise
 High-qualityannual reportispublished
 Financial/non-financialinformationisdisclosed

3. How should managers behave?BusinessEthicsand Social Responsibility
Ethic normsare notmandatoryeventhoughtheymaybecome law intime.Inthe short term, ethical
behaviormayprove costly.Butmay be rewardinginthe longrun.
Laws change overtime,asthe perceptionof right&wrong.
In corporate governance,the mainstreamapproachisthe neoclassical one inwhichethicsplaylittle role
➤ The most usedframeworkisthe Principal-Agentframework(alsoknownasmoral hazard).
Real businessethicdecision:
Afterceasingoperationsandsatisfyinglegal financial obligations,the companyshould
 distribute all the remainingproceedsasdividendtoits
 devote half of the balance toits workers,inproportiontotheirservice
 A decisionmustbe more ethical than the other.
Conflictof interests:
Definition:A situationinwhichapersonisinvolvedinmultipleinterestsandservingone couldinvolve
workingagainstanother Occupyingtwosocial rolessimultaneouslywhichgenerate opposing
benefitsorloyalties.
Most commonforms are:Self-dealing;outside employment;nepotism (actinthe bestinterestof their
relatives);gifts(corruption) ;pumpanddump (pumpa stock that islosingvalue beforesellingit)…
The value of governance over time:
The more a companygrows,the more its corporate governance becomesimportant.

4. Economic Concept:
Asymmetricinformation:Occurs whenone party to an economictransactionpossessesgreatermaterial
knowledge thanthe otherparty. Forexample,shareholderscannotobserve the actionsof the managers.
Two types:
- Moral Hazard: Anysituationinwhich aneconomicactor has an incentive toincrease its
exposure to riskbecause itdoesnotbearthe full costsof that risk.
- Adverse Selection:A partywhohas all the informationusesittoitsadvantage.
Chapter 2: Assetmanagementand institutional investors:
Institutional shareholders:
The influenceof institutional investors:
Can communicate theiropinionstomanagersand boards,seektohave directorsappointedorremoved,
vote againstproposal sponsoredbymanagement,andexpresstheirdissatisfactionbysellingtheir
shares“votingwiththeirfeet”.
Shareholders’objectives:
Differentshareholdersmightalsobe inconflictwitheachother:Have differentinvestmenthorizon
(holdingshares).
 Passive investors: (indexfunds) Seektoreplicateascloselyaspossiblethe performance of a
specificmarketindex.Mightbe lessattentivetofirm-specificmatters
 Active investors:Care aboutindividual firmoutcomes butmighttryto influencecorporate
affairs(lobbyingtohave boardmembersremoved,voicingconcernsaboutcompensation,
advancingpolicymeasures)Try to influence governance-relatedmatters.
Heterogeneityof shareholdergroupscreatesacoordinationproblem: Becomes more difficultbecause
of the free rider problem (shareholdersactionsare costlybutthe benefitsare enjoyedbythemall)
Block holders:
Are investorswithasignificantownershippositioninacompany’sstock(between1% and5% at least).
Theycan be an executive,adirector,acorporation,oran institutional investor. Theyhave significant
votingrights, andtheycan get boardrepresentation.
Schedule13D is an SEC filing thatmustbe submitted withing 10 daysby anyonewho acquiresownership
of more than 5% of any class of publicly traded securities in a public company.
Proxy Voting:Publiclytradedcorporationsare requiredtoholdanannual meetingof shareholdersto
electthe boardof directorsandtransact otherbusinessthatrequiresshareholders’approval.
Shareholdersare providedadvance notice of the annual meetingthroughawritten proxystatement.
Institutionalinvestorsvote inlinewithmanagementrecommendationsabout
 95% whenvote “for”
 56% whenvote “against”
Exit vs Voice:
Newtheoriesview blockholders asinformedtraderswhocontrol managementthroughexit
 sellingafirm’sstockbasedonprivate information.

5. Thisexitexertsdownwardpressure onthe stockprice,whichhurtsmanagementthroughitsequity
interestinthe firm.
Indexing:Referstostrategiesintendedtoreplicate the performance of benchmarkindexes. The main
advantagesare lowcosts,broad diversification,andtax efficiency.
Difference betweenpassivefundsandETFs: AnETF islike a security
Risk of IndexFunds:
 SyntheticETFs:ETFs that are notreallyowningthe securitiesforthe index they’re replicatingin
theirbasket.Theyhold verydifferentsecuritiesanduse derivativesto geta returnthat isas
close as possible tothe one of the benchmark. If theydefault,the fundneedstobe
liquidated;andpeople whoinvestedinETFswill receive the moneythatisleft,andsince the
assetsare muchmore illiquid,they’regonnabe more difficulttosell andinvestorswillgetless
money.
 Impact onvolatility:Everytime ETFsare created,assetmanagershave tobuythe securities that
are part of ETFs. WhenETF iscloseddown,theywill have tosell those securitieswhichcreates
additional tradingvolume thatwill have animpactonvolatility.
 Commonownership:mostcompanieshave the same institutional investors (competition↗).If
so,the beststrategywouldbe notto compete aggressively.
 Agencyproblems(cross-trading):Consequence of the factthatmost of thisbig institution
investorsofferhundredsof fundstotheirclients You’ll alwayshave thatsome fundsare
more importantfroma strategicperspective.Fundconglomeratesuse cross-tradestoreallocate
performance fromcheapfundstoexpensive ones. Crosstradesare tradesina black market
amongfundsaffiliatedwiththe same group.
How to designan indexfund:
Active fundsmaximize Sharpe Ratio,passive fundsminimize trackingerrors (differencebetweenthe
returnof the portfolioof passive fundandthe returnof the benchmark)
Activist investors:
Use a varietyof mechanismstoinfluence corporate policy.Theysponsorproposalsonthe proxy,
pressure thoughthe media,orengage directly.
Under SECRule 14a-8 a shareholderowningatleast$2000 or 1% inmarketvalue of a companyforat
leastone yearcan submita shareholderproposal.

6. Type of activist investors:Pensionfunds;social responsibilityandstakeholderfunds;hedge funds.
Hedge funds:
Investonly foraccreditedinvestors.
Wolf pack strategy:several fundspileupshares.
 Aggressive tactics:regularanddirectcommunicationwithboard/management/shareholdersto
seize control of the board
Designinganactivistcampaign:It’scomposedof:
Findingatarget ➤ increasingthe targetvalue ➤developanexitstrategy
Firststep:A targetcompanyneedsto be undervalued.Mosthedgerslookforacompanyin a profitable
industrybutthat has 2 or 3 problemsthatare compressingthe valuationof the company.The hedge
fundwill solve the problemsandthusincrease the value of the company. Hedge fundshave torelayon
othershareholdersbecausetheydon’thave strongrightsandpower sotheywill neverlookfora
companythat isownedbymore than50% by an individual. Theylookforinstitutionalinvestorsbecause
they’ll supportthe helpof the hedge funds.
 Proxyfight:anattemptto take control overthe board of directors.
Secondstep:Change capital structure,finddifference instrategiesof competitors,Enterprofitable
markets,close downnon-profitable business,change boardof directors,acquisition,refocusoncore
business…
➤ What’s the difference between ETFs andindex funds? ETFs canbe traded (bought and sold) during the day and index funds
can only be traded at the set price point at the end of the trading day.
➤ Whydo passive funds underperform their benchmarks?
➤ How can activist investors influence corporate policies?
➤ Whycan commonownershipbe badfor consumers?

7. Chapter 3: Mergersand Acquisitions:
Reasonsbehind Acquisitions:
 Synergies
 Diversification
 Change inownership
 Increasedmarketpower
 Acquisitionof newtechnology
The Market for Corporate Control: A change of control involvesnotonlyreplacingmanagementbutalso
makingsubstantial changestofirmstrategy,cost,andcapital structure.
The (threatof) takeoverworksasa discipliningdevice.
Good Change of control  Value createdbythe firm – transactioncosts> currentfirm’svalue
If this isthe case,the acquirer(bidder) will attempttopurchase the target.
Types ofacquisitions:
Friendly acquisition:The targetis opentoreceivinganofferfromthe acquiringfirm
Hostile takeover:The target resistsattemptstobe acquiredat anyreasonable price “BearHug”
The managementof the firmmightadoptdefense mechanismtoprotectitself “antitakeoverdefenses
Takeoveroffercanbe structuredinthree basicforms:
 A tenderoffer:Whenthe acquirermakesa publicoffertoacquire the sharesof the targetat a
statedprice.Theyare generallyhostile.
 The managementandthe board of directorsof the targetcompanyare entirelyleftoutsideof
the operation (Whethertheybelievethe price isfairornot).
 Whenantitakeoverdefensesare inplace,atenderofferiscombinedwitha proxy contest:The
acquirerasksthe targetto electa replaceable boardproposedbythe acquirer.(triestogeta
majorityof boarderdirectors)
 Merger:whentwocompanies directlynegotiate atakeover.Tendtobe friendly.
Proxyfight:The acquirergo aroundthe target boardand appeal directlytothe targetshareholdersand
convince themtounseatthe target’sboard byusingtheirproxyvotestosupportthe acquirer’s
candidatesforelection.
AcquisitionPremium:
Is paidby an acquirerina takeover the % difference betweenthe acquisitionprice andthe pre-
mergerprice of a targetfirm. The average is43%
Whena bid isannounced,the stockprice of the target usually increasesby15%
 Why doesn’titgoall the wayup to 43%? There is a riskthe acquisitionwill notgothrough.
Acquirershareholderssee anaverage gainof 1% buthalf receive aprice decrease.
 Because a large quantityof moneyisspentinofferingapremiumtothe targetand paying
investmentbanks.
Example:

8. 1- Aftertax profit= 50*(1-0.34) = $33
Yingcorp value=33*0.5 – 20*0.5 = $6.5
Yang corp value = 20*0.5 – 33*0.5 = $6.5
Ying-Yangcorp value = (50-20)*(1-0.34) = $19.9 > $13 (6.5+6.5)
In thiscase,the combinationof the twocompaniescreatesmore value
Two firms, Alpha,Inc.,and Omega Corporation.Both willeither make $20 million or lose$10 million
every year with equalprobability.Thefirms’profitsare perfectly positively correlated.That is, any year
Alpha,Inc.earns$20 million, Omega Corporation also makes$20 million, and the sameis true of a losing
year.Assumethatthe corporatetax rateis 34%
 Whatare the total expected after-tax profitsof both firmswhen they aretwo separate firms?
 Whatare the expected after-tax profitsif thetwo firmsare combined into one corporation called
Alpha-Omega Corporation butarerun astwo independentdivisions?
 They’ll receive lowerthanwhatthey’re goingtolose.The value of the combinedcompanieswill
be equal to the one incase of standalone companies noadditional valueiscreated(froma
tax purposes)
The LeveragedBuyout: LBO
Assume acompany’sraiderannouncesatenderofferforhalf the outstandingsharesof afirm.Instead
of usinghisowncash to payfor these shares,the raiderborrowsthe moneyand pledgesthe shares
themselvesascollateral on the loan.
 Since the onlytime the raiderwill need moneyiswhenthe tenderoffersucceeds.Inthiscase,the
bankwill be certainthat the raiderwill have control of the collateral.
The law allowsthe raidertoattach the loansdirectlytothe corporation(as if it’sthe companythat will
borrow).Atthe endof the process,the raiderstill ownshalf the shares,butthe corporationis
responsible forrepayingthe loan. The corporate raiderhasgottenhalf the shareswithoutpayingfor
them😊
Exercise:
AntitakeoverProtections:
Poisonpill:Givesthe target shareholdersthe righttobuysharesin eitherthe targetor an acquirerat a
deeplydiscountedprice. The acquisitionbecomeslessvaluableMakesthe takeoversoexpensivefor
the acquiringshareholdersthattheychoose topass onthe deal. Shiftsthe value fromthe acquirerto
the target shareholders.

9. StaggeredBoard: (Classifiedboard):A boardwhose three-yeartermsare staggeredsothatonlyone-
thirdof the directorsare up for electioneachyear.A bidder’scandidatewouldhave towinaproxyfight
twoyears ina row before the bidderhada majoritypresence onthe targetboard.
White Knight:The targetcompanylooksfor another,friendliercompanytoacquire it.
GoldenParachute:An extremelylucrativeseverance (indemnity) thatisguaranteedtoafirm’ssenior
managementinthe eventona takeover.
Supermajorityrules:Twi-thirds(even90%) of the shareholdershave toapprove ahand-overincontrol.
Dual-classshares: Differentclassesof shareswithdifferentvotingrights. Those withgenerousvoting
rightsare not publiclytraded.
A Governance Index:
Theydividedthe companiesinseveral portfoliosandsortingthemaccordingtothe numberof
antitakeoverprotections.
 The portfoliowiththe leastnumber (5) iscalleda“DemocracyPortfolio”:The companieswherethe
board membershave more orlessthe same right.
 The portfoliowith14 or more antitakeoverprotectionsiscalleda“DictatorshipPortfolio”:
Companieswhere the governance isthe poorest.

10. Chapter 4: Board of directors and executive pay:
Functionsof the board:
Four mainfunctions:Strategyformulation;Policymaking;Executivesupervision;Accountability.
- Strategyformulation:
In large companieswhere directorsare mostlyindependent,the strategyis drivenbyCEOandthe
managementteam.The directorselaboratethe LTplans.
- Policymaking:
The board oftendelegates (buymayalsodecide notto) policymakingtothe CEOand top executive
team.But everyboarshas a dutyto ensure thatappropriate policies are inplace.
- Executive Supervision:
Ensuringthe corporation’sfinancial integrityandthe considerationof legal andcomplianceissues.
Insurance of complete,accurate,reliable,relevant,andtimelyfinancial information.

11. - Accountability:
To whomare the boards accountable?Shareholdersorstakeholders?
Internal vs External directors:
 Internal:(alsoexecutivedirectors) are employedbythe companyandare typicallymembersof
the seniormanagement. Theyhave aconflictof interest
 External:(alsonon-executive directors) have noinvolvementindailyoperationandserve an
oversightrole. Theymaynot “care enough”or maybe toodependentonthe management
Gender(Im)balance:
Board Committees:
The board create subcommitteesto:
 Enable independentdirectorstomeetseparatelyfromthe board
 Delegate boardactivitiestoreduce theirburden
Chairman of the Board:
The chairman chairsmeetingsof the shareholdersandboardmeetings.He influences the size and
structure of the boarsand nominates the committee.Andrepresentsthe companypublicly.
Problem:Iselectedbythe board(notbythe shareholders)
Familyfirms:

12. InsiderTrading:
 Tradingby individualswithaccesstononpublicinformationaboutthe company.
 Tradingby specificinsiderssuchasemployees ispermittedaslongasit doesn’trelyoninfothatare
not inthe publicdomain.
VolckerRule:
Prohibitabank or institutionthatownsabankfrom engaginginproprietarytrading,andfromowningor
investinginahedge fundorprivate equityfund,andalsotolimitthe liabilitiesthatthe largestbanks
couldhold.
The proposal of the VolckerRule ledtoanexodusof topproprietarytradersfromlarge banksto form
theirownhedge fundsorjoinexistinghedge funds.
Executives:
Developthe corporate strategyandbusinessmodel andoverseethe dailymanagementof the firm.
CEOs are hiredbythe board.Most newlyappointedCEOsare internal executives.Andtendtohold
stocksof the firmtheyworkin,whichis positivelyassociatedwithfirmperformance.
The componentsof typical executive compensationpackage:
Salary;annual bonus;variousbenefits,stockoptions,otherLTincentives.
Base salary andBonus:
 The base salary:determinedthroughthe benchmarkingmethod
 Cash bonuses:Computedbasedonthe performance of the firmoverthe pastyear.
Bonusesaren’tusuallybasedonabsolute performance measure butmeasuredrelativetoa
standard.
What isthe problemwithinternalstandard?
Stock Options:
Executive stockoptions:the mostcommonform:longpositioninacall option.
The stock optionsgive the executiveof the firmthe incentivetomanage the firmmaximizingvalue.
Thus,theyalignmanagers’goalswithshareholders’goals.
Chapter 6: Trading governance indexes
Whydo we needindexes? MostETFs and passive fundsare basedonindexes.Evenlarge partof active
funds(mutual funds) have benchmarks. Investmentcompaniesrequire indexestodesigninvestment
products.
What’san index?Aninvestmentrule thatexplainshow tostructure a portfolioof assets.Itmight
require purchasingassets(longonly) orpurchase andsell assets( long-short).
Anythingthatallowstogive a score and rank companiesaccordingtoitcan be made intoa tradeable
index.

13. Greenwashingisconsideredanunsubstantiatedclaimtodeceiveconsumersintobelievingthata
company'sproductsare environmentallyfriendly.
What’sa Factor? Measurable characteristic/elementinwhichthe change canaffectthe value of an
asset.
An assetthathas higherreturnsthanits marketbetarequires maybe mispricedorexposedtoanother
underlyingrisk.
Portfolioconstruction long/short stockthat score high / low on the underlyingriskdimension.
Most popularfactors:SMB; HML; Momentum;BAB(bettingagainstbeta)…
How to constructa tradeable index basedonnepotism:
Give a rating to US publiccompaniesbasedonkinshiptiesamongtopexecutives
Constructa tradingstrategy(whichstockstobuy/sell)
Measure the alphaof the tradingstrategy
Motivations:Nepotismiswidespread:
➤ One-fifthof Americanmenendupworkingforthe same employerastheirfathers(Censusestimates)
➤ JPMorgan hiredchildrenof Chinese governmentofficialstowinbusinessinChina
➤ FrancoisFillonpaidhiswife andchildrenhundredsof thousandsof eurosfromthe publicpayroll for
little ornowork
The motivationisthatthere isno publiclyavailable measure of nepotismandwe don’tknow whetherit
ispricedby the market.
What we do:
Compulsorydisclosure inthe proxystatementsof USpublicfirmsof familyconnections. Examine more
than 50,000 proxystatements,all U.S.publicfirms,17yearsof data. Use textual analysistoextract
kinshiprelationships.
Jointtestof whetherkinshiptiesare i) detrimental tofirmvalue andii) fullyvaluedbythe market.
➤ If kinshiptiesare fullypriced,we shouldobserve noreturnpredictability
➤ If marketsoverlookkinshiptiesandnepotismiscostly,we shouldfindthathigh-nepotismstocks
under-perform.
NepotismvsFamilyfirms:
“family”firmsoutperformnon-familyfirmsintermsof profitability.Familyfirmsdefinedasfirmsheld
for 20% of more by a single familyorindividual.
 Around35% of publicfirmsinthe U.S. employrelativesintopjobs.A portfoliothatbuyslow-
nepotismstocksandsellsshorthigh-nepotismstocksyields7.4% annually.
MeasuringKinshipties We countthe numberof ties,e.g.,3wives+ 2 sons + 1 cousin(…) ➤ KIN:
numberof ties/ numberof employees ➤HighestKIN inoursample:CablevisionSystemsCorp.