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.

The End