cg - edited

8/8/2019 CG - edited

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Agency Relationship Problems

Principal and agent have divergent interests and goals.

Shareholders lack direct control of large, publicly tradedcorporations.

Agent makes decisions that result in the pursuit of goals that conflict with those of the principal.

It is difficult or expensive for the principal to verify thatthe agent has behaved appropriately.


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Examples of the AgencyProblem

The Problem of Product Diversification Increased size, and the relationship of size to

managerial compensation Reduction of managerial employment risk

Use of Free Cash Flows

Managers prefer to invest these funds inadditional product diversification (see above). Shareholders prefer the funds as dividends so

they control how the funds are invested.


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9

Manager and Shareholder Riskand Diversification

R i s k R i s k

DiversificationDiversification

DominantDominantBusinessBusiness

UnrelatedUnrelatedBusinessesBusinesses

RelatedRelatedConstrainedConstrained

RelatedRelatedLinkedLinked

ManagerialManagerial(employment)(employment)

risk profilerisk profile

BB

Shareholder Shareholder (business)(business)risk profilerisk profileSS

AA

MM


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Agency Costs and GovernanceMechanisms

Agency Costs The sum of incentive costs, monitoring costs,

enforcement costs, and individual financiallosses incurred by principals, becausegovernance mechanisms cannot guarantee totalcompliance by the agent.

Principals may engage in monitoring behaviorto assess the activities and decisions of managers.

However, dispersed shareholding makes it difficultand inefficient to monitor managementsbehavior.


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Corporate Governance Mechanism nternal Governance Mechanisms

Ownership Concentration

Relative amounts of stock owned by individual shareholders and institutional investors Board of Directors

Individuals responsible for representing the firm s- owners by monitoring top level managers strategic

decisions Executive Compensation

, , -Use of salary bonuses and long term incentives to align managers interests with shareholders interests

xternal Governance Mechanism Market for Corporate Control

The purchase of a company that is underperforming relative to industry rivals in order to improve the

firm s strategic competitiveness


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OWNERSHIP CONCENTRATION O w n e rship C o n ce n tra tion is d e fin e d a s b o th th e n u m b e r o f

la rg e b lock share h o ld e rs an d th e to ta lp e rce n tag e o f share s

.th a t th e y o w n

It h a s re ce ive d con sid e rab le in te re st a s a g o ve rn an ce m ech an ism b e cau se la rg e b lock sh a re h o ld e rs a re in cre asin g ly active in th e ir d e m a n d s th a t co rp o ra tion s a d op t

e ffe ctive g ove rn an ce m e ch an ism s to con tro lm a n ag e ria l.d e cision s

D iffu se O w n e rsh ip,A la rg e n u m b e r o f sha re h o ld e rs w ith sm a llh o ld in g s a n d fe w

, .if an y la rg e b lock sha re h o ld e rs

.Prod u ces w e ak m o n ito rin g o f m an ag e rs d e cision s It m a ke s d ifficu lt fo r o w n e rs to e ffe ctive ly coo rd in a te th e ir.a ctio n s

Higher levels of monitoring could encourage managers to avoid


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2. Board of DirectorsBoard of directors

Group of elected individuals that acts in theowners interests to formally monitor andcontrol the firms top-level executives

Board has the power to: Direct the affairs of the organization Punish and reward managers Protect owners from managerial

opportunism


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Board of Directors ( Contd)

Composition of Boards: Insiders: the firms CEO and other top-levelmanagers

Related Outsiders: individuals uninvolved withday-to-day operations, but who have arelationship with the firm

Outsiders: individuals who are independent of the firms day-to-day operations and otherrelationships

Enhancing the effectiveness of boards and

directors: More diversity in the backgrounds of board

members


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3. Executive CompensationForms of compensation:

Salaries, bonuses, long-term performanceincentives, stock awards, stock options

Factors complicating executive compensation: Strategic decisions by top-level managers are

complex & non-routine Executives decision often affects firms financial

outcomes over an extended period Other variables affecting the firms performance

over time.


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4. Market for Corporate Control Individuals and firms buy or take over

undervalued corporations. Ineffective managers are usually replaced in such

takeovers. Threat of takeover may lead firm to operate

more efficiently. Changes in regulations have made hostile

takeovers difficult. Managerial defense tactics increase the costs of

mounting a takeover Defense tactics may require:

Asset restructuring Changes in the financial structure of the firm Shareholder approval


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Managerial Defense Tactics Poison Pill preferred stock in the merged firm

offered to shareholders at a highly attractive rate of exchange

Corporate charted ammendment- anammendment to stagger the elections of members tothe BOD of the attacked firm so that all are notelected during the same year ,which prevents abidder from installing a completely new board in thesame year.

Golden Parachute- Lump-sum payments of cash thatare distributed to a select group of senior executives.

Litigation- Lawsuits that help a target company stall


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Managerial Defense Tactics(Contd)

Greenmail The repurchase of shares of stock by theaggressor at a premium in exchange for anagreement that an aggressor will no longer target thecompany for takeover.

Standstill agreement Contract between the partiesin which the pursuer agrees not to acquire any morestock of the target firm for a specified period of timein exchange for the firm paying the pursuer a fee.

Capital structure change Dilution of stock, makingit more costly for a bidder to acquire , ESOPs,recapitalization, new depth, stock selling and share


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International CorporateGovernance

Understanding the international corporate

governance is required for assessing the

multinational firm in todays economy.

The stability associated with the German &

Japanese governance structures has been viewed

as an asset. The main aim is to develop a more global

governance system.


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Corporate Governance inGermany

The owner & manager may still be the same individual.

Concentration of ownership is an important means of

corporate governance.

Banks occupied the centre of German corporategovernance structure.

Firms with more than 2000 employees required to have

a two-tiered board structure.Corporate governance in Germany is changing due to

globalization of business.

C i J


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Corporate governance in Japan Attitudes in Japan are affected by the concepts of obligation,

family & consensus.

Obligation: to return a service for one rendered or derivedfrom a more general relationship.

Family: company family, individuals are members of a unit.

Consensus: energy used to win the hearts and minds of people whenever possible.

Japan has a bank-based financial & corporate governancestructure.

Foreign shareholders accounts for 28% of the overall

G M h i d


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Organizat ionalrganizat ionalStakeholderstakeholders

roduct Marketroduct MarketStakeholderstakeholders

Governance Mechanisms andEthical Behavior

It is im p o rta n t to se rve th e in te re sts o f th e firm s It is im p orta n t to se rve th e in te re sts o f th e firm s!m u ltip le sta ke h o ld e r g rou p s !m u ltip le sta ke h o ld e r g rou p s

(S h a reh o ld e rs in th e ca p ita lm a rke t(S h a reh o ld e rs in th e ca p ita lm a rke t)stakeh o ld e r g rou p are view ed as)stakeh o ld e r g ro u p are view ed as th e m ost im p ortan t stake h o ld e r th e m ost im p ortan t stake h o ld e r

.group .group Th e focus of g ove rn an ce Th e focus of g ove rn an ce

m e ch an ism s is on th e con tro lo f m e ch an ism s is on th e con tro lo f m an ag e ria ld ecision s to assure m an ag e ria ld ecision s to assure.sh a reh o ld e r in te re sts .sh a reh o ld e r in te re sts

In te re sts o f sh a reh o ld e rs is se rve d In te re sts o f sh a reh o ld e rs is se rve d.b y th e B o a rd o f D irecto rs .b y th e B o a rd o f D irecto rs

api ta l Marketapi ta l MarketStakeholderstakeholders

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