Corp Guide.docx

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Department
Finance
Course
MFIN 1127
Professor
Jerome Taillard
Semester
Fall

Description
MF127EXAM 2 NOTESLECTURE 13I MANARIAL COMPENSATIONMichael C Jensen Corporate Budgeting Is Broken Lets Fix ItoHarvard Business Review p 94 101 November 2001Premise Performance assessmentCompensationboth based on targetsoEx bonus if more than 1000 units sold next yr stock options inthemoney if stock pricestrike price at maturityPayforperformance profile of each employee and manager is not smooth anymoreKinks in Compensation1Smooth2KinksKinksjumps and other discontinuitiesCreate incentives to lie and cheatoEx you are asked by management for your best guess of your BMW Series 5 Car sales next year Suppose 1You get a bonus if you sell more cars than your target2Target is based on your forecast willing to give unbiased forecast to your management Biggest perverse effect of kinksOther perverse effect of kinks Financial reportingCase 1 No shifting of revenues between the two yearsCase 2 Shifting of revenues between the two yearsoMisreporting incentive Move the recognition of 200 units sold in 2010 to 2011Straightline Linear compensation and financial reportingAssignmentoSuppose compensation scheme in 20102011linear function of annual sales with base salary of 100K of 120K if 1000 units are sold 140K if 2000 units are sold etcoConvince yourself prove that the manager has no financial incentives to misreport its sales numbers to headquarters by shifting forward or backward revenues over the two yearsMAJOR CONCLUSION Ideal linear relationship btwn compensationperformanceII CORPORATE GOVERNANCE AROUND THE WORLDAdvantages of better governance1Better access to capital markets2Cheaper cost of capitalCountry where firm resides matters1Affects costs of acquiring good performanceoEx costlier to credibly commit to proper financial reporting if the accounting governing body is corrupt2Affects benefits of having good governanceoEx Why acquire good governance if markets of your country are not developed enough to raise sufficient funds anywayGovernance structure of firms will be countryspecificWhat are the incentives to have good corporate governance in a country that has poor rule of law and undeveloped financial marketsOne alternative Crosslistings ADRsYou can bond yourself to governance of the US by crosslistingControlling vs Minority shareholdersIntroducing a new type of conflictoMuch more typical in developing countries than USTypical base Familyrun businessesoDesire to remain in control but Not enough funds to buy majority of sharesSolutions1Dual class shares2Pyramidal structure of ownershipMore than half of all East Asian firms resort to these structuresoIndonesia and Thailand in particularMinority shareholders become secondclass shareholdersA Dual class sharesVery common in developing countries Much less common in USoHightech firms mostly Google Zynga Facebook etcoAlso traditional economy firms Berkshire Hathaway Ford etc In all cases founders want to keep controlThere are other ways to control the firmoEx Dell IncMichael Dell CEO Chair of Board owns 12 of firm Dells LBO Not to the advantage of minority shareholdersTypical ExampleFirm issues 5 million common shares with two classesoControlling shareholders will hold the Class B sharesA4 million Class A shares one shareone voteo80 4M5M of the cash flow dividend rights4 million votesB1 million Class B one share10 voteso20 1M5M of the cash flow dividend rights10 million votesThe owners of the class B shares have1Only 20 of the CF rights2But 71 10104 of the voting rightsDual class share Google exampleJan 11 201113074 stockholders of record of Class A common stockoHeld by brokers and other institutions on behalf of stockholdersMany more individual investorsoTraded on NASDAQ288 stockholder of record of Class B common stockoHeld by insiders not tradedErik Schmidt CEO 93M shares 95 voting rightsLarry Page coFounder 285M shares 29 voting rightsSergey Brin coFounder 29M 295 voting rightsClass B shareholders control more than 75 of all voting rightsYet they hold only 303 of CF rightsDual class shares The GoodHarder for parties to take over or influence the firm1GoogleAllows management to follow a longterm innovationbased growth strategy2Media firm eg The New York TimesAllows management to follow longterm interest in serious news coverage despite fluctuations in quarterly resultsDual class shares The Bad
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