How can firms raise money despite the agency problem? The prime aim: make you acquainted with a few principal corporate governance mechanisms (variants of the shareholder (standard) model)

Three principal ways of organising investor control 1.The Anglo-Saxon system (the outsider system) with dispersed ownership and legal protection 2.The Continental system (the insider system) with large investors (often banks) and protection through concentrated ownership 3.Financing without governance with protection based on implicit contracts and trust relationships

Rights protected by law: Cash flow rights give shareholders the rights to receive dividends at the discretion of the board of directors Voting rights) give the shareholders right to 1) vote on corporate matters (mergers and liquidation) and 2) elect boards of directors Controlling rights creditors rights to 1) force a firm that is in default to liquidate assets, 2) enforce restrictions on the debtor’s behaviour, which are written into the debt contracts and 3) right to investigate the books of the firms.

Legal protection in practice In most OECD countries the courts enforce managers duty of loyalty to shareholders: the managers have a duty to act in the interests of the shareholders, but….. The business judgement rule reduces the possibilities for an outside court to enforce the contracts Legal restrictions on managements’ self-dealing: managements consult the board before making major decisions

Reforms of the boards of the companies Independent boards, which do not depend heavily on information they get from the management The size of the boards: the risk of dominant managements is less with large boards, while large boards lead to growing co-ordination costs According to EU company law supervision may be delegated to board committees (nomination committees, remuneration committees)

Protection of minority shareholders ‘Over-regulation’ thesis: regulatory impediments to concentration prevents shareholders to form voting blocks. ‘Under-regulation’ thesis: weak investor protection. Both types of ‘minority investor’ policies undermine the financing of firms Rights of minorities to approve transactions between subsidiaries and parent firms Equal price rules in takeovers Listing requirements that ensure that companies’ relationships with 30%+ voting blocks is at ‘arm’s length’

Large investors Large shareholders reduce agency costs: Higher turnovers of directors and both bank and non bank block holders improve corporate performance Improvements of performance up to a certain point. Beyond that point private benefits are generated that are not shared by minority shareholders

…….also negative effects of large investors Serious when power is based on superior voting rights or pyramid structure (departure from one share one vote). May use their control rights to pay themselves special dividends. Large creditors have incentive to give up good investment projects, because they bear some of the costs, while shareholders accrue the benefits. Small public equity markets (due to large investors) decrease the protection of minority investor rights.

Voting block: The sum of voting power acquired through a direct stake plus the voting power acquired through a variety of legal devices that can be used to detach votes from shares.

Hostile takeovers A bidder makes a tender offer to the dispersed shareholders of the target firm Rapid-fire mechanism for ownership concentration The target firms are mostly poorly performing firms and their managers are removed Takeovers typically increase the combined value of the target and acquiring firm Expensive, as bidders have to pay expected increase in profits.