1 / 21

Topic 5: Corporate Governance

Topic 5: Corporate Governance. Owners or Investors. Berle and Means (1932) – Large firms → separation of ownership and control Most shareholders act like passive investors Principal – agent problem Solutions Incentives Monitoring. Need a score card?. Stakeholders. Monitors.

lara
Download Presentation

Topic 5: Corporate Governance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Topic 5: Corporate Governance

  2. Owners or Investors • Berle and Means (1932) – Large firms → separation of ownership and control • Most shareholders act like passive investors • Principal – agent problem • Solutions • Incentives • Monitoring

  3. Need a score card? Stakeholders Monitors Controllers Within Firm Stockholder Board of Dir. Outside Firm Auditors Analysts Bankers Credit Agency Attorneys Creditor Managers Employee Government SEC IRS Society

  4. Problems with Controllers • Shirking • Hiring friends • Consuming excess perks • Building empires • Avoid risks to secure job • Manage to the “short-run” • Performance standards for CEO don’t exist

  5. Carrots • CEO pay usually seems excessive price • Incentives to align manager and stakeholder interests • Base salary and bonus • Stock options • Restricted stock • Performance shares • Perks – Not just country club membership • Do they work? • Not really – Jensen and Murphy (1990) • Larry Ellison has $475 M worth of options

  6. Carrots • The mechanics of options • Stock @ $50 – CEO gets 1M, 5year, $50 options • 5 years later, shares trading @75 • CEO buys shares for $50, sells for $75, and pockets $25M • Say he is a bad CEO and the stock went nowhere for five years • Options expire worthless, but at worst CEO only loses his job • But even management can give options value

  7. Carrots • Why do firms use them? • Doesn’t cost any cash or value today • Firm has 100 M shares w/ $1 EPS and 10M executive options. Exercise options → 110 M shares w/ $0.91 EPS • Only since July 2005 firms required to expense options

  8. What else is wrong with options? • May incent CEO to forego dividends = Buffett’s RE argument • May incent CEO to take on “too” risky projects • No incentive effect if “underwater” • Manipulate earnings to time grants and exercise • “Rising tide lifts all boats” • Nothing is universally bad

  9. Sticks • All of the players need to take some responsibility • Auditors and Accountants • Board of Directors • Investment Banks and Securities Analysts • Creditors and Credit Rating Agencies • Shareholders • Government • Other corporations (M&A)

  10. Auditors and Accountants • Internal Auditors/compliance officer • External auditors – conflict w/ consulting • FASB establish GAAP • May be under firm pressure to • Manage earnings • Meet internal targets • Meet external targets • Window dress • Smooth earnings

  11. Board of Directors • Hire, evaluate, and/or fire top management • Vote on major operating proposals • Vote on major financial decisions • Offer expert advice to management • Make sure firm’s activities and financial health accurately reported to shareholders • Committees – Audit, compensation, nomination, executive, finance, community relations, corporate governance, …

  12. Board of Directors • Have to have good relations with mngt., but Buffett warns of being too close • Shareholders can hold them responsible, but firm buys D&O policy • Why would anybody be a director? • A plum for a good friend • Median compensation - $56,000 • 150 hours of work and 8 meetings a year • Travel, stock, options,… • 95% are retired execs, 82% are execs from another firm

  13. So what makes a good Board of Directors? • Finance has done a lot of digging • Independent • Problem: It is a small universe to be independent • Small board • Problem: Free-rider (moral hazard in teams) • Joint CEO/Chairman of Board • Problem: Is CEO the one to monitor top management and set the agenda? • Have a vested interest or offer a level of expertise • Problem: Disney outsiders own no stock and OJ Simpson on audit committee of Infinity Broadcasting

  14. Investment Banks and Securities Analysts • IPO process and helping with new issues • Going to sell to customers. Reputation • Need to maximize value for client. Info • Less than 1% of firms that want to issue IPO do so. Investment banker decides. • During tech bubble demand forced lower standards • Facilitate M&A

  15. Investment Banks and Securities Analysts • Analysts evaluate securities and make earnings forecasts • Expert on firm and industry – Reg FD undercuts a little • Forecast earnings - underestimate • Make buy/sell recommendation - maybe • Set target price • Like banking side, need to be friend of firm to maintain relationship – “Chinese” wall may not exist

  16. Investment Banks and Securities Analysts • Summer 2002 regs. Analysts: • Not supervised by investment banking operations • No compensation tied to banking business • Can’t promise favorable rating to get deal • Disclose compensation source • Disclose relationship with firm (officer or board) • Disclose firm relationship to bank

  17. Creditors and Credit Rating Agencies • Just another investor?? • Risky project vs. “really risky” project • Corporate debt creates three monitors • Debt itself can be disciplinary • Miss a payment → lender sue for control • Covenants • Institutional lenders monitor • Banks and other institutions • Credit agencies monitor and rate debt • Same “consulting” problem as analysts

  18. Shareholders • Why don’t they watch their own investments? • Diverse ownership by individuals • Most shareholder proposals are “cranks” • Large shareholders do • Kerkorian at Chrysler, now GM or Ichann at Imclone • Buffett owns so many can do what he wants • Institutionals can • Public pensions are active • Mutual funds hold 25% of all US stock

  19. Government • Depression of 1930s → SEC acts of 1933, 1934, 1940 • Internet bubble → Sarbanes-Oxley 2002 • Create board to oversee public accountants • Auditor independence • Corporate responsibility – CEO signs off • Enhanced disclosure • SEC underfunded • Can’t retain good help – wages 40% < other federal peers = no consistency • Under staffed – since ’93 work load doubled and staffing unchanged

  20. Other corporations (M&A) • I’ve talked about hubris, overconfidence, nonexistent synergies, overpaying…. • Some firms really are being run poorly • The market system does work. (Darwin was right) • Takeover defenses can thwart this mechanism • Poison pill • Golden parachute • Staggered board

  21. Where does Buffett stand? • Attitude is partnership • Most directors have significant investment • Verify intent vs. outcome • Shareholder oriented $1 premise • Honesty • don’t need Reg FD • Give owners tools needed to evaluate • Options may encourage wrong behavior • Next time review for exam

More Related