Corporate Governance Introduction More general thing than financial contracting –Shleifer and Vishny: “corporate governance deals with the ways in which.

Slides:



Advertisements
Similar presentations
FINANCIAL MANAGEMENT I and II
Advertisements

FINANCIAL MANAGEMENT I AND II
How can firms raise money despite the agency problem? The prime aim: make you acquainted with a few principal corporate governance mechanisms (variants.
Panduan Pendanaan Perusahaan How do we want to finance our firm’s assets?  2002, Prentice Hall, Inc.
EVOLUTION OF DISCLOSURE REGULATION RATIONALES: PRELUDE TO A NEW THEORY.
FINANCING UNDER ASYMMETRIC INFORMATION 3th set of transparencies for ToCF.
Chapter 12. Determining the Financing Mix n Operating Leverage n Financial Leverage n Capital Structure.
LOGO Financial Contracting OLIVER HART Presented by: Xulei Ruan.
Dividend Policy and Retained Earnings (Chapter 18) Optimal Dividend Policy Conflicting Theories Other Dividend Policy Issues Residual Dividend Theory Stable.
Financial Management I
INDIA.
Interactions of Tax and Nontax Costs n Uncertainty u Symmetric uncertainty u Strategic uncertainty (information asymmetry) F Hidden action (moral hazard)
Competing For Advantage Part IV – Monitoring and Creating Entrepreneurial Opportunities Chapter 11 – Corporate Governance.
1 Chapter 1: Goal and Functions of Finance Objective of the Firm – the primary goal of the firm is to maximize stockholder wealth Wealth Maximization versus.
Introduction to Corporate Finance Financial Policy and Planning.
11-1© 2006 by Nelson, a division of Thomson Canada Limited. Corporate Governance Chapter Eleven.
11-1© 2006 by Nelson, a division of Thomson Canada Limited. Corporate Governance Chapter Eleven.
Business Organization and Financial markets Some basic concepts Financial management: Lecture 2.
Lecture 5 Contracting and Other Economic Determinants of Financial Reporting.
Drake DRAKE UNIVERSITY MBA Finance 200 Financial Management Drake University Summer 2005.
© 2005 McGraw-Hill Ryerson Limited © 2003 The McGraw-Hill Companies, Inc. All rights reserved.
The prime aim Make you acquainted to the contractual approach to agency problems.
DECISION RIGHTS AND CORPORATE CONTROL 5th set of transparencies for ToCF.
Introduction to Financial Management
The standard view of CG (“The Shareholder Value Model”): Deals with the ways in which suppliers of finance to corporations assure themselves of getting.
TOPICS 1. FINANCIAL DECISIONS, INVESTMENT DECISIONS AND DIVIDEND DECISIONS 2. FINANCIAL MANAGEMENT PROCESS 3.PROFIT MAXIMIZATION AND WEALTH MAXIMIZATION.
Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure Jensen and Meckling, JFE, 1976 About 3400 citations.
Transparency 10-1 Used in corporations to establish order between the firm’s owners and its top-level managers Corporate Governance is a relationship among.
Fundamentals of Corporate Finance
The Capital Structure Puzzle: Another Look at the Evidence
Copyright © 2011 Pearson Prentice Hall. All rights reserved. Getting Started: Principles of Finance Chapter 1.
Chapter 9 Capital Structure © 2005 Thomson/South-Western.
Tam Lai Ying Law Tsz Yeung Au Man Hung
Function of Financial Management and Financial Accounting in the Health and Fitness Sector.
The Role of Financial Management
Corporate Governance and the new Financial Regulation: Complements or Substitutes? ECGI Brussels 25 October 2010 Is Bank Governance Different? Patrick.
Principles of Managerial Finance 9th Edition Chapter 1 Overview of Managerial Finance.
EBIT/EPS Analysis The tax benefit of debt Trade-off theory Practical considerations in the determination of capital structure CAPITAL STRUCTURE Lecture.
CHAPTER 10 CORPORATE GOVERNANCE AND ETHICS
Definition and Basic concepts. Definition of Finance Finance is the art and science of managing money which is concerned with the process, institutions,
0 Corporate Finance Ross  Westerfield  Jaffe Seventh Edition 1 Chapter One Introduction to Corporate Finance.
Introduction to Corporate Finance MB 29. Meaning of Corporate Finance  Corporate finance can be defined as a body of knowledge that deals with the following.
Boards and Shareholders. Boards of Directors Corporate governance: The processes, policies, and laws that govern an organization (often corporations)
Essentials of Managerial Finance by S. Besley & E. Brigham Slide 1 of 23 Chapter 1 An Overview of Managerial Finance.
Planning the Financing Mix
Goals and Governance of the Firm
Economic Consequences and Positive Accounting Theory
Nature of Financial Management
Financial Management (An Introduction). Contents of the Chapter Meaning of Finance Meaning of Financial Management Three Major Decisions of Financial.
CHAPTER 10 CORPORATE GOVERNANCE AND ETHICS
Chapter One Overview of Managerial Finance Principles of Managerial Finance.
1-1 Introduction to Finance Lecture Goals and Governance of the Corporation This chapter introduces the corporation, its goals, and the roles of.
Chapter 16 - Planning the Firm’s Financing Mix. Balance Sheet Balance Sheet Current Current Current Current Assets Liabilities Assets Liabilities Debt.
 Finance is concerned with resource allocation as well as resource management, acquisition and investment. Simply, finance deals with matters related.
The Scope Of Corporate Finance Professor XXXXX Course Name / Number.
MLI28C060 - Corporate Finance Seminar 8. Question 1. Describe the key features of Agency Theory in terms of how it views the firm. Adopts a focus on shareholder.
Milgrom and Roberts (1992): Chapter 6 Economics, Organization & Management Chapter 6: Moral Hazard and Performance Incentives Examples of Moral Hazard:
MGMT 452 Corporate Social Responsibility
Chapter 1 Introduction to Corporate Finance.
Chapter 8 Lecture - Firms, the Stock Market, and Corporate Governance
Chapter 1 Learning Objectives
Introduction to Corporate Finance
Chapter 1 Learning Objectives
STRATEGY IMPLEMENTATION
Chapter 1 Introduction.
What is corporate governance?
Who Controls Our Business?
©2003 South-Western Publishing Company
Introduction to Corporate Finance
CHAPTER 10 Corporate Governance
Presentation transcript:

Corporate Governance Introduction More general thing than financial contracting –Shleifer and Vishny: “corporate governance deals with the ways in which the suppliers of finance to corporations assure themselves on getting a return on their investment” –Tirole: interests of stakeholders other than investors should also be taken into account –Most generally (Zingales): CG is a set of mechanisms that shape relationships between all parties to a firm. Ideally, this set should provide the parties with incentives to do ex-ante efficient investments (not necessarily monetary) and ensure efficient bargaining ex-post

Pledgeable income and efficiency From the “traditional” (Shleifer and Vishny) perspective the goal of corporate governance is to maximize “pledgeable income” (at the lowest cost) “Pledgeable income”: how much (in expected terms) the manager can credibly promise to return to investors. The greater it is the more confident investors are in getting their money back, hence, the more willing they are to invest in positive NPV projects

Basic framework Assume (p+Δp)X H – I > 0, but pX H – I < 0 Incentive scheme: E gets w if success, 0 if failure. Incentive compatibility (no private benefit extraction): Δpw ≥ B Setting w at B/ Δp, we get that the maximum (gross) return the investors can get, given IC holds: (p+Δp)(X H – (B/Δp)) Financing stage Project costs I. Entrepreneur has A<I; borrows at least I-A Moral hazard stage Choice of probability of success: p+Δp (no private benefit) or p (private benefit B) Outcome stage Verifiable profit: X  {0, X H }; Pr[X=X H ] = either p+Δp or p

The basic idea of “corporate governance” can be viewed as increasing pledgeable income through the reduction of private benefits It should be done in the least costly way (optimal combination of the corporate governance mechanisms) Hence, financing is feasible iff (p+Δp)(X H – (B/Δp)) ≥ I – A i.e. pledgeable income exceeds the investors’ outlay

Mechanisms Executive compensation –Rationale: aligning managers’ objectives with the shareholders’ interests  need for compensation based on stock price and other measures of performance (shares, stock-options, bonuses) –Has risen in the US since 1970, especially due to a rise in the use of stock options in 90’s  high pay- performance sensitivity (in the US equity based compensation is on average 50-60% of the total compensation) –But is it an outcome of optimal contracting? Evidence suggests that maybe not, managers can pay themselves too much because they capture the process of setting compensation –Stock-based compensation involves costs: e.g. short termism, excessive risk (stock options), insufficient effort (stock options), earnings manipulation…

Mechanisms (cont-d) Board of directors –Supposed to protect shareholders and oversee management –In reality is often captured by the management or controlling shareholders –Hence, in theory, need for “independent” directors –But overall empirical evidence yields very ambiguous conclusions about the effects board composition on firm value

Mechanisms (cont-d) Large investors: monitoring and control –Reduce (discourage) managerial opportunism (self-dealing) –But involve costs Lack of diversification Lack of liquidity Excessive monitoring Pursuing own goals at the expense of other investors

Mechanisms (cont-d) Takeovers –Ex-ante effect: managerial discipline –Ex-post: efficient allocation of assets Value increasing takeovers should succeed Value decreasing takeovers should fail –Failure of both goals may occur in reality

Mechanisms (cont-d) “Gatekeepers” –Auditors –Financial Analysts –Credit Rating Agencies Should warn investors if things go wrong In reality sometimes fail –Conflicts of interest –Lack of incentives (lack of competition)

Mechanisms (cont-d) Minority shareholder actions –Proxy Fights (vote for removal of current management) –Shareholder Activism (all kinds of pressure by a shareholder (often an institution) on management: shareholder proposals, “focus list” of poor performers, articles in media, etc.) –Shareholder litigation Overall, minority shareholder actions are rare outside US and UK, empirically have rather limited effect Russia: Hermitage case (see Dyck, Volchkova and Zingales (2005))

Other mechanisms Adopting US GAAP, IFRS (IAS) Hiring an independent auditor Cross listing (listing abroad) Sound dividend policy … We will consider Large Shareholders and Takeovers in more detail now…