1. 11-1© 2006 by Nelson, a division of Thomson Canada Limited. Corporate Governance Chapter Eleven

2. 11-2© 2006 by Nelson, a division of Thomson Canada Limited. Agency Relationship Risk Bearing Specialist (Principal) Managers (Agents) Decision Makers which creates Managerial Decision- Making Specialist (Agent) Hire An agency relationship exists when: Shareholder s (Principals) Firm Owners Agency Theory

3. 11-3© 2006 by Nelson, a division of Thomson Canada Limited. Governance Mechanisms Ownership Concentration - Large block shareholders have a strong incentive to monitor management closely. In Canada such shareholders account for 65% to 70% of publicly traded stocks (59% in the U.S.) - Their large stakes make it worth their while to spend time, effort & expense to monitor closely. - Institutional owners are financial institutions such as stock mutual funds and pension funds that control large- block shareholder positions.

4. 11-4© 2006 by Nelson, a division of Thomson Canada Limited. Insiders Outsiders Boards of Directors - Set compensation of CEO & decide when to replace the CEO. - Formally monitor & control the firm’s top- level executives. - May lack contact with day to day operations. A firm’s CEO & other top-level managers Related Outsiders Individuals not involved with a firm’s day-to- day operations, but who have a relationship with the company Individuals independent of a firm’s day-to- day operations and other relationships Governance Mechanisms

5. 11-5© 2006 by Nelson, a division of Thomson Canada Limited. Executive Compensation Executive compensation: A governance mechanism aligning the interests of managers & owners through salaries, bonuses and long term incentives such as stock options. Stock options: A mechanism which links the executive’s performance to the performance of the company.

6. 11-6© 2006 by Nelson, a division of Thomson Canada Limited. Market for Corporate Control An external governance mechanism that becomes active when a firms internal controls fail which is triggered by a firm’s poor performance, relative to industry competition.