Transcript Corporate governance

Corporate governance
Week 9
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Outline
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Separation of ownership & managerial control
Ownership concentration
Boards of directors
Executive compensation
Multi-divisional structure
International corporate governance
Governance mechanisms and ethical behaviour
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Corporate Governance
 The relationship among stakeholders that is
used to determine and control the strategic
direction and performance of the organisation
 Concerned with identifying ways to ensure that
strategic decisions are made effectively
 Used in corporations to establish order between
the firm’s owners and its top-level managers
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Shareholders
 The right to share in residual income means that
shareholders must accept the risk that no residual profits
will remain if the firm’s expenses exceed its income.
 Reduce risk efficiently by holding diversified portfolios
 In small firms, managers and owners are often one in the
same, so there is no separation of ownership and
control.
 As firms grow larger, individual owners generally do not
have access to sufficient capital to fund the growth of the
business and seek other investors with which to share
residual profits (and risk).
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Separation of Ownership & Managerial Control
 Shareholders
 Purchase stock, becoming Residual Claimants
 Reduce risk efficiently by holding diversified portfolios
 Professional managers contract to provide
decision-making
 Leads to efficient specialisation of tasks, such
as:
 Risk bearing by shareholders
 Strategy development and decision-making by
managers
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Agency Theory
An agency relationship exists when:
Agency Relationship
Shareholders
Risk Bearing Specialist
(Principals)
Firm Owners
Hire
Managers
(Agents)
Decision
Makers
(Principal)
Managerial DecisionMaking Specialist
(Agent)
which creates
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Agency Theory
 An agency problem occurs when the desires or
goals of the principal and agent conflict, and it is
difficult or expensive for the principal to verify
that the agent has behaved appropriately
 Example: Over-diversification that occurs
because increased product diversification leads
to lower employment risk for managers and
greater compensation
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Risk
Manager & Shareholder Risk & Diversification
Shareholder
(Business)
Risk Profile
Dominant
Business
Managerial
(Employment)
Risk Profile
Related
Related
Constrained Linked
Level of Diversification
Unrelated
Businesses
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Agency Theory
The Solution:
 Incentive-based performance contracts
 Monitoring mechanisms such as the board of
directors
 Enforcement mechanisms such as the
managerial labour market
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Agency Theory
 Principals may engage in monitoring behaviour
to assess the activities and decisions of
managers
 However, dispersed shareholding makes it
difficult and inefficient to monitor management’s
behaviour
 Boards of directors have a fiduciary duty to their
shareholders to monitor management
 However, boards of directors are often accused
of being lax in performing this function
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Agency Costs
 The sum of incentive, monitoring, and
enforcement costs as well as any residual losses
incurred by principals because it is not possible
for principals to guarantee 100% compliance
through monitoring arrangements.
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Corporate Governance Mechanisms
 Prevent problems emanating from the
separation of ownership and control by positively
influencing managerial behaviour
 Direct top level managers actions towards
preferred shareholder aims is dependent on
correct mechanisms
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Governance Mechanisms
 Internal
 Ownership Concentration
 Boards of Directors
 Executive Compensation
 Multidivisional Organisational Structure
 External
 Market for Corporate Control
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Internal Governance Mechanisms
Ownership concentration
 Relative amounts of stock owned by individual
shareholders & institutional investors
 Defined by the number of large block
shareholders and the total % they own
 Large block typically have at least 5%
 Large block shareholders have a strong
incentive to monitor management closely
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Internal Governance Mechanisms
Ownership concentration
 Their large stakes make it worthwhile for them to
spend time, effort and expense to monitor
closely
 They can obtain board seats. This enhances
their ability to monitor effectively (although
financial institutions are legally forbidden to hold
board seats directly)
 Diffuse Ownership
 Produces weak monitoring of managerial
decisions
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Internal Governance Mechanisms
 Diffuse Ownership (cont.)
 Makes it difficult for owners to coordinate their
actions effectively
 May result in levels of diversification that are
beyond the optimum level desired by
shareholders (especially when this condition
is combined with weak monitoring)
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Internal Governance Mechanisms
Board of Directors
 Responsible for representing the firms owners
by monitoring strategic decisions of top level
managers
 Consists of insiders, related outsiders and
outsiders
 Review and ratify important decisions
 Set compensation for the CEO and decide when
to replace the CEO
 Usually lack contact with day-to-day operations
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Internal Governance Mechanisms
Board of Directors
 Must deal with Managerial Opportunism
 Seeking of self-interest with guile where
opportunism is represented by an attitude or
inclination and a set of behaviors (self-interest
seeking with guile).
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Internal Governance Mechanisms
Executive Compensation
 Salary, bonuses, long-term incentive
compensation
 To align interests of managers with those of
shareholders
 Executive decisions are complex and nonroutine
 It is difficult to establish how managerial
decisions are directly responsible for outcomes
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Internal Governance Mechanisms
Executive compensation
 Incentive systems do not guarantee that
managers make the ‘right’ decisions, but do
increase the likelihood that managers will
perform the activities and achieve the results for
which they are rewarded
 Stock ownership (long-term incentive
compensation) makes managers more
susceptible to market changes that are partially
beyond their control
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Internal Governance Mechanisms
Multi-divisional structure
 Designed to control managerial opportunism
 Corporate office and board monitor businessunit managers’ strategic decisions
 Increased managerial interest in maximising
wealth
 Broadly diversified product lines make it difficult
for top-level managers to evaluate the strategic
decisions of divisional managers
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Internal Governance Mechanisms
Multi-divisional structure (cont.)
 It may not effectively govern actions taken by the
corporate office.
 Firms using the M-form structure are more likely
to continue diversification.
 The M-form facilitates further diversification.
 Continued diversification may create conditions
requiring division mangers to emphasize shortterm results.
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External Governance Mechanism
Market for corporate control
 The market for corporate control acts as an
important source of discipline over managerial
incompetence and waste
 Operates when firms face the risk of takeover
where they are operated inefficiently
 Changes in regulations have made hostile
takeovers difficult
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Board of Directors
Powers
 Directing the affairs of the organisation
 Punishing (disciplining) and rewarding
(compensating) managers
 Protecting the rights and interests of
shareholders (owners)
 As a result, if the board of directors is
appropriately structured and operates in an
effective manner, it can protect owners from
managerial opportunism.
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Board of Directors
Problems
 Insiders continue to dominate boards (by
controlling the flow of information to outside
directors)
 Outside directors are nominated for board
membership by insiders (primarily by the CEO)
and thus are indebted to insiders
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Board of Directors
Boards working collaboratively with management
 Make higher quality strategic decisions
 Make decisions faster
 Become more involved in decisions regarding
succession (rather than blindly supporting the
incumbent’s choice)
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Board of Directors
Recommendations for More Effective Board
Governance:
 Increase diversity of board members’
backgrounds (Australian boards obviously lack
diversity)
 Strengthen internal management and
accounting control systems
 Establish formal processes for evaluation of the
board’s performance
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Corporate Governance in Australia
 Importance of institutional shareholders
 A small market for corporate control compared to
the USA
 Boards are relatively small: 6-12 people,
very few females, many multiple board
memberships, 75% non-executive directors
 Australian landscape features an active financial
press, an active shareholders’ association and
an increasingly important role for government in
corporate governance
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Corporate Governance in Australia
 Major banks dominate large companies
 The top three shareholders of Amcor, BHP and
Brambles are the same:
 Westpac
 Chase Manhattan (a US bank)
 National Nominees (NAB)
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Corporate Governance in Australia
 There must be protection for all shareholders
(including those with a minority holding)
 Management must be held accountable to
shareholders regularly
 There must be transparency and full disclosure
by each Australian Stock Exchange-listed
company
 There must be an active, and independent,
board that oversees a corporation’s
management.
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Laws and Institutions in Australia
 Legislation:
 Corporations Law
 Trade Practices Act 1974
 Prices Surveillance Act 1983
 The Australian Competition and Consumer
Commission (ACCC);
 Australian Securities and Investments
Commission (ASIC);
 Australian Stock Exchange (ASX)
 Shareholder activists
 Financial media
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Corporate Governance in Germany
 Public firms often have a dominant shareholder
frequently a bank
 Medium-to-large firms have a two-tiered board:
 Vorstand monitors and controls managerial decisions
 Aufsichtsrat selects the Vorstand
 Employees, union members and shareholders
appoint members to the Aufsichtsrat
 There is usually less emphasis on shareholder
value than for Australian. firms, although this
may be changing
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Corporate Governance in Japan
 Obligation, ‘family’ and consensus are important factors
 Banks (especially ‘main bank’) are highly influential with
firm’s managers
 Keiretsus are strongly interrelated groups of firms tied
together by cross-shareholdings
 Powerful government intervention
 Close relationships between firms and government
sectors
 Passive and stable shareholders who exert little control
 Virtual absence of external market for corporate control
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Ethical Corporate Behaviour
 It is important to serve the interests of multiple
stakeholder groups
 Important stakeholder groups
 Shareholders are served by the board of directors
 Product market stakeholders (customers, suppliers
and host communities) and
 organisational stakeholders (managerial and nonmanagerial employees)
 There is a controversial belief that ethically responsible
firms should introduce governance mechanisms that
serve all stakeholders’ interests
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Australian Shareholders Association
 An active lobby group against corporate
governance misbehaviour
 Has policies about:
 Executive performance
 Conflict of interest
 Disclosure
 Poor firm performance
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