Corporate Governance

1. Corporate Governance Kenneth Kim & John Nofsinger 2th Edition Pearson Prentice Hall

2. Chapter 1 Corporations and Corporate Governance

3. Chapter overview: • Forms of Business Ownership • Separation of Ownership and Control • Can Investors Influence Managers? • An Integrated System of Governance • International Monitoring

4. Forms of Business Ownership • Three general types of business ownership: • Sole proprietorship • Partnership • Corporation

5. Comparison of three forms

6. Pros and Cons of Corporations • Pros: • Easy access to capital markets • Infinite life unless go bankrupt or merged by others • Owners have limited liability • Liquid corporate ownership • Cons: • Shareholders are exposed to double taxation • Costs of running a corporation is relatively high • Corporations suffer from potentially serious governance problems.

7. Separation of Ownership and Control • The thousands, or more, investors who own public firms could not collectively make the daily decisions needed to operate a business. Therefore: • The shareholders are owners of the firm • The officers (or executives) control the firm

8. Principal-agent problem • Principal—shareholders • Agent—managers • Principal-agent problem represents the conflict of interest between management and owners. For example if shareholders cannot effectively monitor the managers’ behavior, then managers may be tempted to use the firm’s assets for their own ends, all at the expense of shareholders.

9. Solutions to Principal-agent problem • Incentives—aligning executive incentives with shareholder desires. e.g. stock, restricted stock, and stock options. • Monitoring—setting up mechanisms for monitoring the behavior of managers.

10. Can Investors Influence Managers? • Some inactive shareholders will go along with whatever management wants. • Some active shareholders have tried to influence management, but they are often met with defeat.

11. Monitors • Monitors are called for because managers may not act in the shareholder’s best interest. • Figure 1.1 shows that monitors exist: • inside the corporate structure • Board of directors • outside the structure • Auditors, analysts, bankers, credit agencies, and attorneys • in government • SEC, and IRS

12. Figure 1.1

13. Inside monitors-Board of directors • Oversee management and are supposed to represent shareholders’ interests. • Evaluates management and design compensation contracts to tie management’s salaries to the firm’s performance.

14. Outside monitors • Interact with the firm and monitor manager activities • Auditors • Analysts • Bankers • Credit agencies • Attorneys

15. Government monitors • The SEC regulates public firms for the protection of public investors • The SEC also makes policy and prosecutes violators in civil courts. • The IRS enforces the tax rules to ensure corporations pay taxes. • The Sarbanes-Oxley Act of 2002

16. Other monitors • Market forces • Stakeholders • Creditors • Employees • Society

17. An Integrated System of Governance

18. International Monitoring • Important differences occur between the types of monitoring and incentive used in other capitalist countries and the U.S. due to: • Different compensation contracts • Different accounting standards • Different institutional investing environment • Bank-oriented or capital markets-oriented • Different legal environment

19. Summary • The corporations, probably the most important business form, generate approximately 90 percent of the country’s revenue. • Separation of ownership and control causes the agency problem. • Possible solutions to Principal-agent problem are incentives and monitoring. • The corporate system has interrelated incentives.