SAN DIEGO STATE UNIVERSITY COLLEGE OF BUSINESS ADMINISTRATION The Latest Research in Corporate Governance: Finance Nikhil P. Varaiya Professor of Finance

Top-Tier Finance Journals Journal of Finance Journal of Financial Economics Journal of Financial and Quantitative Analysis Review of Financial Studies Journal of Business American Economic Review Journal of Applied Corporate Finance

Topics 1.Corporate Governance and Corporate Performance: Review of Current Finance Research 2.Corporate Governance and Corporate Performance: Implications 3. Shareholder Value Creation Drivers 4. Key Tasks of Management and Board 5. Summary

1. Corporate Governance and Corporate Performance: Review of Current Finance Research Bhagat and Bolton (2008) examine the relationship between seven Corporate Governance (CG) metrics and two Corporate Performance (CP) metrics. CG metrics Gompers-Ishii-Metrick (GIM) index; Bebchuk-Cohen- Ferrell (BCF) Index; Brown-Caylor (BC) Index; The Corporate Library (TCL) Index; Board Ownership; CEO- Board Chair Separation; and Board Independence; GIM, BCF are constructed from IRRC data; BC constructed from ISS data CP metrics Operating Rate of Return and Risk-adjusted Share- holder Return

Summary of Bhagat & Bolton Results GIM; BCF, Board Ownership, and CEO-BOD Chair Separation improves contemporaneous and subsequent operating performance. Board Independence is not associated with better contemporaneous or subsequent operating performance. None of the governance metrics is associated with stock market performance. Given poor firm performance, the likelihood of disciplinary management turnover increases with Board Ownership and with Board Independence.

Corporate Governance and Corporate Performance: Review of Current Finance Research (cont.) Wruck (2008) surveys literature on private equity to infer key operating tasks and likely success factors Operating Tasks  Which assets to keep and which to divest? Organization Design Issues  Who makes what decisions?  How is success defined?  What is the performance measurement and reward system? High leverage ensures that post-buyout shareholder equity is highly concentrated Highlights disciplining role of recent regulatory developments coupled with active market for corporate control on corporate governance and performance of public corporations

Corporate Governance and Corporate Performance: Review of Current Finance Research (cont.) Jonathan Macey (2008) Effective corporate governance is about ensuring that firms meet investor expectations of maximizing shareholder value; the role of corporate governance is to minimize ‘corporate deviance’ from meeting shareholder expectations Boards, shareholder voting, outside accountants, credit-rating agencies, and stock market analysts have not been very effective in meeting shareholder expectations Market for corporate control, hedge funds, private equity funds, dissident directors have been more effective in meeting shareholder expectations

Corporate Governance and Corporate Performance: Review of Current Finance Research (cont.) Ralph Walkling (2008) reports on discussion with Robert Monks and Michael Jensen on the current state of corporate governance Robert Monks:  “I see governance as concerned primarily with internal processes and accountability rather than performance.”  “What does the board of an American corporation actually do and what is it supposed to be doing… In America a board does pretty much what the CEO wants it to do.” Michael Jensen: “The function of a board member in the U.S. is basically to counsel and support the CEO.” Both have stressed that the boards get active only when there is a crisis of corporate performance.

Corporate Governance and Corporate Performance: Review of Current Finance Research (cont.) Conundrum: The benefits of private equity—concentrated share ownership and significant board involvement—serve to align shareholder and management interests. However, private equity needs an active public market for equity, so the public corporation must endure as an organization form.

2. Corporate Governance and Corporate Performance: Implications Corporate Governance is a complex combination of: contract, law, and societal norms and customs. Measurement of this complex combination and its link to Corporate Performance is problematic Yet, effective Corporate Governance requires that the Board embrace the following linkage: Corporate GovernanceCorporate StrategyCorporate Performance

3. Drivers of Shareholder Value Creation: Profitability & Growth MBV = 0.166x[Profitability] x[Growth]; Adj. R 2 = 71%

The Growth-Profitability Imperative AlliedSignal Corp. Larry Bossidy, CEO, sets rugged growth targets and provides the resources to get there but requires that [business] units earn their cost of capital. FORTUNE, August 21, 1995 Microsoft Corp. “It’s a very large company, and it almost can’t grow at the rates it was growing.” WALL STREET JOURNAL, January 28, 2003 Intel Corp. “I have been chartered with growing the earnings of this company. Figuring out where the opportunities are over the next five years and refining our bets. President & COO, Paul Otellini Intel Beyond 2003, Stanford B-School Case, 2003 Emerson Electric Chuck Knight, CEO, Emerson Electric wants to push revenue growth to as high as 10% per year, from under 5% in recent years, while keeping profit margins and return on equity steady. FORBES, August 1, 1994 Qualcomm “The company can return some of its cash to shareholders without impacting future revenue and earnings growth or restricting strategic opportunities.” Chairman & CEO Irwin Jacobs. SAN DIEGO UNION TRIBUNE, Feb. 12, 2003

Key Tasks of Management and Board Participation & Operating Strategy Financing Strategy Implementation Strategy 1.Which Markets Should We Serve? 2.Determine Our Competitive Position: Cost-Offering-Price in served markets 1.Estimate Financing Needs to Sustain Our Growth Strategy. 2.Determine Sources and Composition of Financing. 1.Select the Organizational Design: People, Architecture, Routines and Culture to Best Identify & Implement the Strategies Above.

Key Tasks of Management and Board Strategy – People – Architecture – Routines – Culture Right Strategy  Right Markets  Right Competitive Positions in Served Markets  Right Financing Mix Right Implementation  Right People  Right Organization Architecture  Right Communication Routines  Right Corporate Culture

5. Summary The impact of corporate governance on corporate performance is complex and poses measurement challenges. Studies have shown that effective corporate governance (board ownership, CEO-Chair separation) can enhance firm performance. The board will be effective in its governance role when it is knowledgeable about: (i) the firm’s markets and competitive positions, and (ii) decision-making drivers within the firm.

SAN DIEGO STATE UNIVERSITY COLLEGE OF BUSINESS ADMINISTRATION The Latest Research in Corporate Governance: Finance

SAN DIEGO STATE UNIVERSITY COLLEGE OF BUSINESS ADMINISTRATION The Latest Research in Corporate Governance: Finance Nikhil P. Varaiya Professor of Finance