Corporate governance


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Corporate governance

  1. 1. CORPORATE GOVERNANCE• Corporate governance is defined as the set of rules and procedures that ensure that managers do indeed employ the principles of value-based management.• Corporate governance involves the manner in which shareholders’ objectives are implemented• It is reflected in a company’s policies and actions
  2. 2. • TWO models of Corporate Governance: – Shareholder model – Stockholder model• In its narrowest sense (shareholder model), corporate governance often describes the formal system of accountability of senior management to shareholders.• In its widest sense (stakeholder model), corporate governance can be used to describe the network of formal and informal relations involving the corporation.
  3. 3. • According to the shareholder model the objective of the firm is to maximize shareholder wealth through allocative, productive and dynamic efficiency i.e. the objective of the firm is to maximize profits.• The criteria by which performance is judged in this model can simply be taken as the market value (i.e. shareholder value) of the firm.
  4. 4. • The stakeholder model takes a broader view of the firm.• According to the traditional stakeholder model, the corporation is responsible to a wider constituency of stakeholders other than shareholders.• According to this model performance is judged by a wider constituency interested in employment, market share, and growth in trading relations with suppliers and purchasers, as well as financial performance.
  5. 5. • TWO primary mechanisms used in corporate governance: – Sticks : threat of removal of a poorly performing management – Carrots : type of plan used to compensate executives and managers• Corporate governance is closely connected with shareholders’ welfare maximization
  6. 6. • Poorly performing managers can be removed either by a takeover or by the company’s own BOD• Provisions in the corporate charter affect the difficulty of a successful takeover• The composition of BOD affects the likelihood of a manager being removed by the board
  7. 7. MANAGERIAL ENTRENCHMENT• Managerial entrenchment is most likely when a company has a weak BOD coupled with strong anti-takeover provisions in its corporate charter• In cases of managerial entrenchment, the likelihood that badly performing senior managers will be fired is low
  8. 8. NONPECUNIARY BENEFITS• Nonpecuniary benefits are noncash perks such as lavish offices, memberships at country clubs, etc.• Some of these expenditures may be cost effective, but others are wasteful and simply reduce profits.• Such fat is almost always cut after a hostile takeover.
  9. 9. • Targeted share repurchases, also known as greenmail, occur when a company buys back stock from a potential acquirer at a higher- than-fair-market price.• In return, the potential raider agrees not to attempt to take over the company.• Shareholder rights provisions, also known as poison pills, allow existing shareholders to purchase additional shares of a stock at a lower than market value if a potential acquirer purchases a controlling stake in the company.
  10. 10. • Restricted voting rights provision automatically deprives a shareholder of voting rights if the shareholder owns more than a specified amount of stock.• Interlocking BOD occur when the CEO of Company A sits on the board of Company B, and B’s CEO sits on A’s board.
  11. 11. • Stock option provides for the purchase of a share of stock at a fixed price, called the exercise price, no matter what the actual price of the stock is.• Stock options have an expiration date, after which they cannot be exercised.• An Employee Stock Ownership Plan (ESOP), is a plan that facilitates employees’ ownership of stock in the company for which they work.
  12. 12. Corporate Governance for Corporate Performance and Growth• It is useful to have a framework with which to understand how corporate governance can affect firm behavior and economic performance.• An effective corporate governance framework can minimize the agency costs and hold-up problems associated with the separation of ownership and control.• There are a number of potential channels of influence through which governance can affect performance.
  13. 13. • The principle-agent model suggests that managers are less likely to engage in strictly profit maximizing behavior in the absence of strict monitoring by shareholders.• Therefore, if owner-controlled firms are more profitable than manager-controlled firms, it would seem that insider systems have an advantage in that they provide better monitoring which leads to better performance.
  14. 14. • large shareholders are active monitors in companies, and that direct shareholder monitoring helps boost the overall profitability of firms.• This result is also borne out by studies of managerial turnover.• However, there are many cases where manager-controlled firms significantly outperform owner-controlled firms in terms of profitability, but that owner-controlled firms had higher growth rates.
  15. 15. • We must also keep in mind that corporate governance structures are not static but dynamic in nature.• Different owners will have different objectives, and it is highly likely that the identity of owners will matter for firm performance.• For example, managers of corporations under governmental or quasi-governmental control are likely to have different incentives and will, therefore, behave differently to managers of corporations in the private sector.• For this reason, ownership concentration and the identity of owners should be viewed as variables that exert a simultaneous, but different, influence on firm performance.
  16. 16. • The finding that owner-controlled firms are more profitable than manager-controlled firms is also consistent with the life-cycle model of the firm.• As firms grow and mature, this provides greater incentives for the increasingly unmonitored management to expropriate rents. The dilution and dispersion of equity stakes in this case, implies that as firms mature effective corporate governance mechanisms become increasingly important in assuring firm performance.• Managerial incentives, market control and other such factors of corporate governance also influences a firm’s performance and growth.