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Lecture 15

CANS 406 Lecture 15: 15 - Corporate governance and Organization structure and controls
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Department
Canadian Studies
Course Code
CANS 406
Professor
Desmond Morton

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Corporate governance and Organization structure and controls
March 20th
Corporate governance:
Set if the mechanisms used to manage relationships among stakeholders and to determine and
control the strategic direction and performance of organizations
o Can also apply to non-profits and foundations
o Board links the organization to its external environment, to secure critical resources and to
build prestige and legitimacy (Roche, 2008)
Concerned with identifying ways to ensure that strategic decisions are made more effectively
Used in corporations to establish harmony between the firm's owners and its top-level managers,
whose interest may be in conflict
o Board's 3 key functions:
Monitoring the managers' actions on behalf of shareholders
Advising the managers on strategic direction and key strategic decisions
Interfacing with stakeholders/institutions in external environment to help provide
legitimacy, expertise and access to critical resources
Agency
Agency theory
o Berle & Means (1932)
Separation of ownership and control
Delegation of management control to a small group within the company
In practice: shareholders/owners of capital end up losing function of
management and effective rights to exercise control/modify terms of initial
delegation arrangements
Due to scattered ownership shares among numerous shareholders
Shareholder interests vs managerial interests
o Opportunistic behaviour by managers:
Empire-building vs returning profits to shareholders
Maagerial disretio aagerial "perks": orporate jets, …
Agency relationship
o
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Agency relationship exists when shareholders hire managers and pay them
Can also refers to relationship between clients (principals) and consultants (agents)
o Problems:
Principal and agent have divergent interests and goals
Shareholders lack direct control of large, publicly trade corporations
Agent makes decisions that result in pursuit of goals that conflict with those of the
principal
It's difficult/expensive for the principal to verify that the agent has behaved
appropriately
Agent falls prey to managerial opportunism
Managerial opportunism: seeking of self-interest with guile (cunning or deceit)
(ruse, astuce)
Agency costs and governance mechanisms
o Agency costs: sum of incentive costs, monitoring costs, enforcement costs, and individual
financial losses incurred by principals
Governance mechanisms cannot guarantee total compliance by the agent
o Principals may engage in monitoring behavior to assess the activities and decisions of
managers
However: dispersed shareholding makes it difficult and inefficient to monitor
management's behavior
o Boards of directors have a fiduciary duty to shareholders to monitor management
But boards of directors are often accused of being lax in performing this function
Managerial opportunism
o Seeking of self-interest with guile
o It's an attitude (inclination) and set of behaviors (specific acts of self-interest)
o Prevents the maximization of shareholder wealth (primary goals of owner/principals)
o Response to managerial opportunism
Principals do not know beforehand which agents will or won't act that way
Thus, principals establish governance and control mechanisms to prevent managerial
opportunism
Ways of addressing problems, arising from separation of ownership and managerial control (first 3
are internal, last one is external)
o Ownership concentration
Relative amounts of stock owned by individual shareholders and institutional
investors
o Board of directors
Individuals responsible for representing the firm's owners by monitoring top-level
managers' strategic decisions
o Executive compensation
Use of salary, bonuses, and long-term incentives to align managers' interests with
shareholders' interests
o Market for corporate control
Purchase of a firm that is underperforming relative to industry rivals in order to
improve its strategic competitiveness
Ownership concentration
o Large block shareholders (5% share) have a strong incentive to monitor management closely
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Their large stakes make it worth their time, effort and expense
May obtain board seats, which enhances their ability to monitor effectively
o Financial institutions are legally forbidden from directly holding board seats
o Increase influence of institutional owners (stock mutual funds and pension funds):
Have the size (proxy voting power) and incentive (demand for returns to fund) to
discipline ineffective top-level managers
Can affect firm's choice of strategies
o Shareholder activism
Shareholders can convene to discuss corporation's direction
If a consensus exists, shareholders can vote as a block to elect their candidates to the
board
Proxy fights
There are limits on shareholder activism available to institutional owners in
responding to activists' tactics
Board of directors
o Group of elected individuals that acts the owners' interest to formally monitor and control
firm's top level executives
o Board has the power to:
Direct the affairs of the organization
Punish and reward managers
Protect owners from managerial opportunism
o Basic roles and tasks of the Board (Hitt)
Monitor
Stay on top of developments inside and outside the corporation
Evaluate and influence
Evaluate management's proposals, decisions, actions
Offer advice, suggestions, alternatives
Initiate and determine
Involvement in setting corporation's mission and specifying strategic options
(more rarely, intensive involvement)
o Composition of Boards (not specific rule as to how many people)
Insiders: firm's CEO and other top-level managers
Related outsiders: individuals uninvolved in day-to-day operations, but who have a
relationship with the firm
Affiliated diretors suppliers, aks, legal, aoutig series…
Ex-officers/ex-CEO
Family members
Outsiders: individuals who are independent of firm's day-to-day operations and other
relationships
Pressure from institutional investors to designate one of independent outsider
directors as lead, or president director
o Sarbanes Oxley Act of 2002
What did it do?
Establishes Public Company Accounting Oversight Board
Audit committees of corporations must consist of independent directors, with
no links to firm
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Description
Corporate governance and Organization structure and controls March 20 th Corporate governance: Set if the mechanisms used to manage relationships among stakeholders and to determine and control the strategic direction and performance of organizations o Can also apply to non-profits and foundations o Board links the organization to its external environment, to secure critical resources and to build prestige and legitimacy (Roche, 2008) Concerned with identifying ways to ensure that strategic decisions are made more effectively Used in corporations to establish harmony between the firm's owners and its top-level managers, whose interest may be in conflict o Board's 3 key functions: Monitoring the managers' actions on behalf of shareholders Advising the managers on strategic direction and key strategic decisions Interfacing with stakeholders/institutions in external environment to help provide legitimacy, expertise and access to critical resources Agency Agency theory o Berle & Means (1932) Separation of ownership and control Delegation of management control to a small group within the company In practice: shareholders/owners of capital end up losing function of management and effective rights to exercise control/modify terms of initial delegation arrangements Due to scattered ownership shares among numerous shareholders Shareholder interests vs managerial interests o Opportunistic behaviour by managers: Empire-building vs returning profits to shareholders Managerial discretion (managerial "perks": corporate jets, ) Agency relationship o Agency relationship exists when shareholders hire managers and pay them Can also refers to relationship between clients (principals) and consultants (agents) o Problems: Principal and agent have divergent interests and goals Shareholders lack direct control of large, publicly trade corporations Agent makes decisions that result in pursuit of goals that conflict with those of the principal It's difficult/expensive for the principal to verify that the agent has behaved appropriately Agent falls prey to managerial opportunism Managerial opportunism: seeking of self-interest with guile (cunning or deceit) (ruse, astuce) Agency costs and governance mechanisms o Agency costs: sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals Governance mechanisms cannot guarantee total compliance by the agent o Principals may engage in monitoring behavior to assess the activities and decisions of managers However: dispersed shareholding makes it difficult and inefficient to monitor management's behavior o Boards of directors have a fiduciary duty to shareholders to monitor management But boards of directors are often accused of being lax in performing this function Managerial opportunism o Seeking of self-interest with guile o It's an attitude (inclination) and set of behaviors (specific acts of self-interest) o Prevents the maximization of shareholder wealth (primary goals of owner/principals) o Response to managerial opportunism Principals do not know beforehand which agents will or won't act that way Thus, principals establish governance and control mechanisms to prevent managerial opportunism Ways of addressing problems, arising from separation of ownership and managerial control (first 3 are internal, last one is external) o Ownership concentration Relative amounts of stock owned by individual shareholders and institutional investors o Board of directors Individuals responsible for representing the firm's owners by monitoring top-level managers' strategic decisions o Executive compensation Use of salary, bonuses, and long-term incentives to align managers' interests with shareholders' interests o Market for corporate control Purchase of a firm that is underperforming relative to industry rivals in order to improve its strategic competitiveness Ownership concentration o Large block shareholders (5% share) have a strong incentive to monitor management closely Their large stakes make it worth their time, effort and expense May obtain board seats, which enhances their ability to monitor effectively o Financial institutions are legally forbidden from directly holding board seats o Increase influence of institutional owners (stock mutual funds and pension funds): Have the size (proxy voting power) and incentive (demand for returns to fund) to discipline ineffective top-level managers Can affect firm's choice of strategies o Shareholder activism Shareholders can convene to discuss corporation's direction If a consensus exists, shareholders can vote as a block to elect their candidates to the board Proxy fights There are limits on shareholder activism available to institutional owners in responding to activists' tactics Board of directors o Group of elected individuals that acts the owners' interest to formally monitor and control firm's top level executives o Board has the power to: Direct the affairs of the organization Punish and reward managers Protect owners from managerial opportunism o Basic roles and tasks of the Board (Hitt) Monitor Stay on top of developments inside and outside the corporation Evaluate and influence Evaluate management's proposals, decisions, actions Offer advice, suggestions, alternatives Initiate and determine Involvement in setting corporation's mission and specifying strategic options (more rarely, intensive involvement) o Composition of Boards (not specific rule as to how many people) Insiders: firm's CEO and other top-level managers Related outsiders: individuals uninvolved in day-to-day operations, but who have a relationship with the firm Affiliated directors (suppliers, banks, legal, accounting services) Ex-officers/ex-CEO Family members Outsiders: individuals who are independent of firm's day-to-day operations and other relationships Pressure from institutional investors to designate one of independent outsider directors as lead, or president director o Sarbanes Oxley Act of 2002 What did it do? Establishes Public Company Accounting Oversight Board Audit committees of corporations must consist of independent directors, with no links to firm
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