Prof. Igor Filatotchev Session 2

Transcription

1 Corporate Governance: The Role of Boards and Institutional Investors Prof. Igor Filatotchev Session 2 1

2 Aims and Objectives To introduce main concepts of the agency framework To outline basic elements of various corporate governance practices To link this discussion to the topics of subsequent sessions and case analyses 2

3 Incomplete Contracting some issues that parties may face are not predictable at the contracting date; even if all issues could be foreseen, there may be too many issues to write into the contract; monitoring the behaviour of others may be costly; enforcing the contracts may involve considerable legal costs; it is difficult to make a full account of different factors linked to human behaviour 3

4 Principal-Agent Relationship and the Firm Berle, A.A. & Means, G. C. (1932) The Modern Corporation and Private Property. NY: Macmillan The Principal (shareholders) delegates to the Agent (managers) the responsibility for selecting and implementing an action (production of goods and services). The Agent is compensated by the Principal, with the Principal being the residual claimant to the outcome of the Agent s act (profits). 4

5 Agency Problem The bulk of the profits goes to the outside shareholders All major decisions are taken by the corporate officers (CEOs) The outside shareholders are unable to control the corporate officers The interests of CEOs and shareholders may diverge widely. Senior managers are in a position to enrich themselves at the expense of the shareholders 5

6 Basic Problems of Information Asymmetry The essence of the Agency Theory is that the Principal has inferior information to the Agent. Moral Hazard: the principal and agent share the same information up to the point at which the agent takes an action, but thereafter the principal is only able to observe the outcomes. Adverse Selection: the principal does not know some information which is relevant to the action, whereas the agent can make use of this information to his own advantage. 6

7 Agency Costs and the Firm CEOs may derive non-pecuniary benefits from their actions: - managers perquisites - maximisation of growth versus profits - mergers and acquisitions Different risk attitudes: - shareholders maintain a diversified portfolio of assets - manager s wealth is tied to a particular firm - managers may be more risk-averse and, for example, under-invest in R&D and innovation 7

8 The directors of companies, being managers of other people s money than their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own Adam Smith, The Wealth of Nations,

9 Case example: Free Cash Flow and big oil companies in the USA in the 1980s Free Cash Flow: Liquid financial assets for which investments in current businesses are no longer economically viable 9

10 Corporate Governance and Control Corporate Governance is the process by which society exerts some control on the corporation and corporate managers through markets or regulatory system. Regulatory system (insider trading, ban on anticompetitive activities, etc.) Product and factors markets The internal control system (Corporate Boards, managerial hierarchy, etc.) The external control systems (take-overs, board participation by banks, etc.) 10

11 Shareholder Activism and the Role of Boards Shareholder activism - shareholders take an active role in the firm s operations and attempt to secure drastic changes in the organisation when performance declined. Annual General Meeting of Shareholders Board of Directors that include the representatives of the owners and has the responsibility to oversee the direction of the organisation chosen by the CEOs Internal control is the process by which the Board oversees the management of a corporation Incentive clauses in managers contracts (ESOs; LTIPs) 11

12 Principles of Good Corporate Governance Separate the roles of Chairman and Chief Executive Officer. Not less than one half of the Board should be Non Executive (Independent) Directors, and their independence and effectiveness should be strengthened. Establish committee dominated by Non Executive Directors and independent of management (e.g., nomination, audit and remuneration committees). Short-term contracts for executive directors, etc. 12

13 Board Committees Nomination committee is responsible for recruitment of executive and non-executive board members. Should be independent from the executives. Remuneration committee determines director s remuneration packages, including bonuses, ESOs and LTIPS Audit committee oversees internal audit processes and relationships with external auditors. 13

14 Board Independence CEO duality is when the roles of CEO and Board Chairman are combined Non-executive (UK) or independent (USA) directors board members who are not employed by the firm in any executive position, do not have business links with the firm and not involved in any long-term relationships with the executives (friends, family, etc.) Senior Independent Director (SID) oversees the relationships with main shareholders. 14

15 Corporate Governance and Market for Corporate Control Corporate governance through exit : shareholders can sell their shares in the company to someone else. accumulation of shares by a core investor corporate take-over is initiated when the managers of one firm, the raider, make an offer for another firm, the target, that is resisted by the management of the target leveraged buy-out (LBO) occurs when investors acquire a relatively large proportion of the outstanding stock of a firm using debt. 15

16 Does it Really Work? The effectiveness of shareholder activism is generally reduced by a free rider problem: AGM attracts a very small fraction of shareholders (vote by proxy); Gathering of information is expensive and time consuming Why to bother if you can benefit from the result in any case? 16

17 Managerial Incentives The salary a potential manager can command is assumed to reflect performance to date, but: Lack of complete information about the manager s abilities Management is a team work, recognising the influence of a single manager may be difficult. Performance-related pay and misrepresentation. There may be other personal utility-creating activities which seem to the manager superior to seeking performance improvements in the firm. 17

18 Market for Corporate Control Most managers fear take-overs because of the implied or direct thereat to their jobs, but: Anti-take-over strategy: - poison pill - golden parachutes - greenmail, etc. Market for Corporate Control is an expensive and ethically controversial mechanism of governance. 18

19 New Perspectives on Corporate Boards Monitoring and control Resource and legitimacy Strategy/Service Access to resources Strategic leadership Strategic restructuring expertise Corporate venturing 19

20 Corporate Governance and Entrepreneurial Leadership Wealth protection and wealth creation roles of corporate governance Resource and strategy roles of corporate boards Boards as a knowledge pool The new roles of non-executive directors Individual entrepreneurship, corporate venturing and innovation 20

21 From Board Structure to Board Processes Are structural characteristics (% of independent directors, CEO/Chairman, etc) really important? Conflicting evidence Emphasis on board processes (engagement, involvement, support and advise) What should a Chairman do? Strategic roles of internal and external audit 21

22 Learning Outcomes Corporate Governance theory is underpinned by agency framework which is focused on potential costs of the principal-agent problem Information asymmetries and managerial opportunism may destroy shareholders values, and corporate governance is there to protect shareholders interests However, there are other roles of corporate governance that may include resource, strategy and knowledge aspects. 22

23 Reading Filatotchev & Wright (2005) various Monks, R.G. and Minow, N. (2004) various Cadbury, A Corporate Governance and Chairmanship: a Personal View. Oxford: OUP. Shleifer, A. and Vishny, R A Survey of Corporate Governance, Journal of Finance, Vol 52, No 2, June. 23

24 Questions? 24