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Behavioral Finance. Economics 437. Corp Governance. What is it? Control of a company with a board of directors Company can be public or private Board represents “shareholders” (or “stakeholders” Stakeholder concept is meaningless in general
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Behavioral Finance Economics 437
Corp Governance • What is it? • Control of a company with a board of directors • Company can be public or private • Board represents “shareholders” (or “stakeholders” • Stakeholder concept is meaningless in general • Shareholder concept can be plagued by principle/agent problems: e.g. pension funds, university endowments, foundations
Board of Directors Senior Management Business
Why is there a problem? • Individual directors may have their own agenda • Which might be: remaining as a director • Compensation and/or perquisites of office • Selection process inevitably flawed • Political appointments (University, Retirement Boards) • Management effectively appoints corporate boards • Boards are self perpetuating: Madison House, Paramont Theatre, etc. • Practical problems • Board members have other things to do • Have limited information, controlled by management
How Can You Tell That Corporate Board’s Are Not Up to the Task? • Management Compensation • Mergers and Acquisitions • “Insurance” Actions: Share offerings at below book prices
Reforms? • Sarbanes-Oxley – a response to Worldcom and Enron • Makes the auditor the policeman • Massive amount of paperwork, which reduces the effectiveness of boards • Mostly “checking the box” • Dodd-Frank • Aimed mainly at financial institutions • “Say on pay” provision (subject to principle/agent problems • “Pay for performance” • But how is performance measured and how controls the measurement? • Is management actually responsible for the performance that is measures or do outside forces control performance that management has no control over?
Shleifer and Vishny (1997) • Key question: “How do the suppliers of finance get managers to return some of the profits to them? • What if there are no rules? • Several methods of Corp Governance • US & England: legal: “duty of loyalty” “fiduciary” • Germany: large shareholder • Japan: large creditors • What really works: LBOs • Four countries are successful: US, UK, Germany, Japan….everyone else is problematic
Potential US Reforms • One term directors • Paid in deferred stock • Stock sales prohibited by directors during their terms as directors • Sales permited only after a period (say two years) has elapsed after they are no longer board members.
