Corporate Governance and Performance Analysis Professor Sidney E. Harris Lecture 1

Corporate Governance Landscape Shareholders Board Management Employees Country/Company Ideology Courts-State/Federal SEC Security Analysts Stock Exchanges Institutional Investors Accountants/Auditors Law Firms

Historical Perspective 1814, Henry Cabot Lowell, founded the first public company in U.S. Within seven years investors had received a 100% return Is management focused on maximizing shareholder value?

Historical Perspective After 1929 stock market crash, congressional investigators uncovered widespread insider trading, stock price manipulation, and diversion of corporate funds for personal use The 1933 Securities Act imposed extensive disclosure requirements on corporations In 1934, Congress established the SEC to enforce the new regulations

Historical Perspective After the 34 Act, management became conservative and bureaucratic In the 1972, Jensen and Meckling proposed the Principal-Agent Problem-”one party employs another to do a job” By the early1980s, the shareholder value movement began to take shape LBOs were seen as a principal tool to extract value--”solve the principal-agent problem”

Historical Perspective Technology firms began to rely on stock options to compensate employees In the 1990s, widespread adoption of stock options In the late ‘90s, mega-options grants were introduced In 2006, stock options are treated as an expense

America’s Governance Model Role of Government Purpose of Business Capital Markets Customers Employees

America’s Rivals UK Germany France China Japan Korea

Transition Economy Governance Model Ownership-families, inter-locking companies (including suppliers), and banks Role of business-tied to national identity Banks and capital markets have a closer relationship with government “Rule of man” versus “rule of law” Crony capitalism and lack of opacity

Actions Needed Much greater independence between business and government Strong foreign presence Reduction in rules and regulation that favor who you know Free and investigative press Strong system of the rule of law

Cycle of Greed Institutional Investors focus on the short term growth in earnings Drives Share Price Alignment of CEO Incentives Pressure for auditors to allow accounting tricks Board Oversight