Corporate Governance

1
Corporate Governance

• Kenneth Dyson

2
The Corporate Form

• Artificial person
• Independent legal existence
• Assets liabilities separate from the owner
• Why do we need corporate governance?
• Advantages of corporate form necessitate
  separation of ownership control

3
Corporate Objectives

• Maximising shareholders wealth
• Hayek and Friedman
• Benefit shareholders and society at large
• Originates with Berle Means (1932)
• What about?
• Employees Creditors Customers Managers

4
What is Corporate Governance?

• Capitalist definition
• A set of methods to ensure that shareholders get
  maximum return on their funds
• Socialist (stakeholder) definition
• Maximise the welfare of all (potential)
  stakeholders (i.e. customers etc)
• Codes of best practise capitalist perspective
  Calper (US) Cadbury (UK)

5
An Overview of Corporate Governance Systems

• Two distinct cultural approaches
• Market orientated (US UK)
• Bank or relations based (Germany Japan)
• Bank based
• Long-term relationship with businesses
• Sit on board own a large block of shares
• Market based
• Dispersed ownership (individuals institutions)

6
Cultural Differences

• Europe
• Ownership highly concentrated
• Family ownership (Bosch, Muller etc)
• Hostile takeovers rare (Mannesman)
• Asia
• Long-term relationship with banks
• Bank holds debt equity

7
US UK Approach

• Principal/Agent relationship
• Principal (shareholder)
• Agents (directors)
• Moral hazard
• Adverse selection
• Directors
• A lot of discretion as to their actions
• Not clear how the primary objective is to be
  achieved

8
Agency Problem

• Incentive problem between the shareholders and
  the management
• Managers engage in activities detrimental to the
  core objective
• Perks entrenchment etc
• Risk taking beyond the norm for short-term gain
• Shareholders wary of investing further funds
• Equity more expensive than internal funds

9
Provision of Incentives to Minimise Agency
Problems

• Executive compensation
• Accounting performance based
• Equity options
• Promotion/dismissal
• All can be manipulated
• Information release controlled by management

10
Monitoring Control

• Two forms
• Passive
• Active
• Passive
• Better information reduces the agency problem
  i.e. signalling debt issues etc
• Active
• Control of management with a
• board of directors large shareholder creditor
  potential takeover

11
Information the Accounts (Passive)

• Annual financial accounts
• Audited
• Information to evaluate management performance
• Presented at the AGM
• AGM
• Remove directors
• Authorise certain activity i.e. remuneration

12
Board of Directors (Active)

• Responsibility
• Direct corporation to achieve shareholders core
  objective
• Set
• Policy
• Authorise decisions
• Appoint management
• Set remuneration

13
The Role of the Director

• Conceptually different from management
• Director directs corporation to achieve core
  objective
• Management then execute the directors strategy
  to achieve the core objective
• Often the two roles are combined
• Board dominated by management
• Encouraged non-executive directorships to develop
• Director should be a steward (i.e. watchdog for
  the shareholders)
• Independence (from management) is essential

14
Large Shareholders (Active)

• Concentration improves the control of management
• Small shareholders/debt holders may be sidelined
• May reduce the incentive for initiative
• May take excessive risks to satisfy short-term
  objectives i.e. max share price

15
Large Creditors (Active)

• Debt acts as a disciplining device
• Interest payments must be met
• Less scope for miss-appropriating earnings
• Free cash flow theory (Jensen, 1986)
• Reputation (Diamond, 1989)
• Liquidation/bankruptcy (Hart, 1995)

16
Market for Corporate Control Takeover (Active)

• Depends on the tendency for new owners to replace
  directors/management
• Problems as a controlling device
• Winners curse
• Blocked by politics i.e. public interest
• Typically poor performers

17
Summary

• Defined the corporate form
• Core objective
• Corporate Governance What why?
• Approaches
• UK US
• Agency problem
• Monitoring control

18
How Governance Might be Improved

• A more competitive market for corporate control
• Drop barriers i.e. public interest
• Reduce cost of shareholder activism
• How?
• Corporate objectives
• Votes
• Directors
• Disclosure audits
• Enforcement
• Critical information systems
• Institutional investors

19
Corporate Objective

• Companies could differentiate themselves from the
  competition
• Identify corporate objective(s) more precisely

20
Votes

• Extend scope and reduce cost of voting in
  corporate elections
• More meaningful
• Compulsory (institutional shareholders)
• Easier for shareholders to get resolutions on to
  the agendas of AGMs

21
Directors

• Identification and selection criteria more
  transparent
• Independence from management
• Non-executive
• Chairperson/CEO role split
• Reports
• Greenbury Cadbury Hampel

22
Disclosure Audits

• Interim/Quarterly reports
• Risk management reports
• Environmental Ethical audits
• Governance audit
• Extent to which a companies structures systems
  are achieving the desire core objective(s)

23
Critical Information Systems

• Good information systems
• Real-time
• Not historic
• Measure actual desirable performance

24
Institutional Investors

• Comprise the bulk of investors in the UK
• 60 to 70
• Preferential briefings (until recently)
• Cosy relationship
• More active involvement in governance
• Raise agenda items
• Vote
• Declare conflicts of interest i.e. pensions etc

25
At the end of the Day

• Whatever mechanisms are used, corporate
  governance is the responsibility of the
  shareholders
• Must be critically aware
• Take nothing at face value

26
Conclusions

• Corporate governance is an agency problem
• Minimise conflicts of interest
• Minimise opportunities for malfeasance
• Shareholders ultimately responsible for governance