1. Kenneth Kim & John Nofsinger 2th Edition Pearson Prentice Hall
Corporate Governance
Kenneth Kim
&
John Nofsinger
2th Edition
Pearson Prentice Hall

2. Chapter 1
Corporations and Corporate Governance

3. Chapter overview: Forms of Business Ownership
Separation of Ownership and Control
Can Investors Influence Managers?
An Integrated System of Governance
International Monitoring

4. Forms of Business Ownership
Three general types of business ownership:
Sole proprietorship
Partnership
Corporation

5. Comparison of three forms
Sole proprietorship
Partnership
Corporation
Business owner
Single owner
Partners
Shareholders
Owner’s liability
Unlimited
Limited
Easy access to capital market? No
Yes
Is management and ownership separate?
Are business owners exposed to double taxation?

6. Pros and Cons of Corporations
Easy access to capital markets
Infinite life unless go bankrupt or merged by others
Owners have limited liability
Liquid corporate ownership
Cons:
Shareholders are exposed to double taxation
Costs of running a corporation is relatively high
Corporations suffer from potentially serious governance problems.

7. Separation of Ownership and Control
The thousands, or more, investors who own public firms could not collectively make the daily decisions needed to operate a business. Therefore:
The shareholders are owners of the firm
The officers (or executives) control the firm

8. Principal-agent problem
Principal—shareholders
Agent—managers
Principal-agent problem represents the conflict of interest between management and owners. For example if shareholders cannot effectively monitor the managers’ behavior, then managers may be tempted to use the firm’s assets for their own ends, all at the expense of shareholders.

9. Solutions to Principal-agent problem
Incentives—aligning executive incentives with shareholder desires.
e.g. stock, restricted stock, and stock options.
Monitoring—setting up mechanisms for monitoring the behavior of managers.

10. Can Investors Influence Managers?
Some inactive shareholders will go along with whatever management wants.
Some active shareholders have tried to influence management, but they are often met with defeat.

11. Monitors
Monitors are called for because managers may not act in the shareholder’s best interest.
Figure 1.1 shows that monitors exist:
inside the corporate structure
Board of directors
outside the structure
Auditors, analysts, bankers, credit agencies, and attorneys
in government
SEC, and IRS

12. Figure 1.1

13. Inside monitors-Board of directors
Oversee management and are supposed to represent shareholders’ interests.
Evaluates management and design compensation contracts to tie management’s salaries to the firm’s performance.

14. Outside monitors Interact with the firm and monitor manager activities
Auditors
Analysts
Bankers
Credit agencies
Attorneys

15. Government monitors
The SEC regulates public firms for the protection of public investors
The SEC also makes policy and prosecutes violators in civil courts.
The IRS enforces the tax rules to ensure corporations pay taxes.
The Sarbanes-Oxley Act of 2002

16. Other monitors
Market forces
Stakeholders
Creditors
Employees
Society

17. An Integrated System of Governance

18. International Monitoring
Important differences occur between the types of monitoring and incentive used in other capitalist countries and the U.S. due to:
Different compensation contracts
Different accounting standards
Different institutional investing environment
Bank-oriented or capital markets-oriented
Different legal environment

19. Summary
The corporations, probably the most important business form, generate approximately 90 percent of the country’s revenue.
Separation of ownership and control causes the agency problem.
Possible solutions to Principal-agent problem are incentives and monitoring.
The corporate system has interrelated incentives.