Corporate Governance

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Corporate Governance

• Kenneth Kim
• John Nofsinger
• 2th Edition
• Pearson Prentice Hall

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Chapter 1

• Corporations and Corporate Governance

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Chapter overview

• Forms of Business Ownership
• Separation of Ownership and Control
• Can Investors Influence Managers?
• An Integrated System of Governance
• International Monitoring

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Forms of Business Ownership

• Three general types of business ownership

• Sole proprietorship
• Partnership
• Corporation

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Comparison of three forms
Sole proprietorship Partnership Corporation
Business owner Single owner Partners Shareholders
Owners liability Unlimited Unlimited Limited
Easy access to capital market? No No Yes
Is management and ownership separate? No No Yes
Are business owners exposed to double taxation? No No Yes
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Pros and Cons of Corporations

• Pros

• 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.

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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

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Principal-agent problem

• Principalshareholders
• Agentmanagers
• 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 firms assets for their own
  ends, all at the expense of shareholders.

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Solutions to Principal-agent problem

• Incentivesaligning executive incentives with
  shareholder desires.
• e.g. stock, restricted stock, and stock
  options.
• Monitoringsetting up mechanisms for monitoring
  the behavior of managers.

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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.

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Monitors

• Monitors are called for because managers may not
  act in the shareholders 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

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Figure 1.1
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Inside monitors-Board of directors

• Oversee management and are supposed to represent
  shareholders interests.
• Evaluates management and design compensation
  contracts to tie managements salaries to the
  firms performance.

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Outside monitors

• Interact with the firm and monitor manager
  activities
• Auditors
• Analysts
• Bankers
• Credit agencies
• Attorneys

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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

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Other monitors

• Market forces
• Stakeholders
• Creditors
• Employees
• Society

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An Integrated System of Governance
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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

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Summary

• The corporations, probably the most important
  business form, generate approximately 90 percent
  of the countrys 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.