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Social Science
SOSC 4043
Sonya Scott

SOSC 4043 – FALL TERM BOOK NOTES September 25 , 2013 Theoretical Aspects of Corporate Governance (By: Christine Mallin) Introduction - The development of corporate governance is a global occurrence, and as such is a complex area including as it does legal, cultural, ownership, and other structural differences - Evolution of the economy, corporate structure, or ownership groups may all affect how corporate governance will develop and be accommodated within its own country setting - An important aspect is whether the company itself operates within a shareholder framework, focusing primarily on the maintenance or enhancement of shareholder value as its main objective, or whether it takes a broader stakeholder approach, emphasizing interests of diverse groups such as employees, providers of credit, suppliers, customers, and the local community Theories Associated with the Development of Corporate Governance Agency Theory - Identifies the agency relationship where one party, the principal, delegates work to another party, the agent - This relationship can have a number of disadvantages relating to the opportunism or self- interest of the agenet o E.g. the agent not taking appropriate risks in pursuance of the principal’s interests because he and the principal have different attitudes to risk, or the agent misusing his power o Also problem of information asymmetry, whereby principle and agent have access to different levels of information - Board of directors is an essential monitoring device to try to ensure that any problems brought about from this relationship are minimized - Any cost used to prevent issues and monitor are called “agency costs” Separation of Ownership and Control  Smith: “Directors of such companies however being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance”  Berle and Means: as countries industrialized and developed their markets, ownership and control of corporations became separated  Common law countries rely on independent judges and juries and legal principles supplemented by precendent-setting case law, which results in greater flexibility, whilst in civil law countries, judges often are life-long civil servants who administer legal codes packed with specific rules, which hobbles them in their ability to cope with change  In countries with a civil law system, there is more codification but weaker protection of rights, hence less encouragement to invest  The relationship between ownership and control outlined by Berle and Means largely applicable to US and UK, but not many other countries  Last few years there has been increasing pressure on shareholders to act more as owners and not just as holders of share, mostly due to numerous instances of corporate excesses and abuses  This will allow boards to be more accountable for their actions Transaction Cost Economics - Views the firm as governance structure whereas agency theory views the firm as a nexus of contracts o The latter means there is a connected group of contracts amongst various players, arising because it is impossible to have a contract which perfectly aligns interests of principle and agent in corporate control situation - Coase (speaking on the rationale for firms’ existence in the context of a framework of the efficiencies of internal as opposed to external contracting): “the operation of a market costs something and by forming an organisation and allowing some authority to direct the resources, certain marketing costs are saved” o There are certain economic benefits to the firm itself to undertake transactions internally o The firm becomes larger the more transactions it undertakes and will expand up to the point where it becomes cheaper or more efficient for the transactions to be undertaken externally o Coase therefore assumes that firms may become less efficient he larger they become - Hart: “in a world of incomplete contracts, governance structure does have a role. Governance structure can be seen as a mechanism for making decisions that have not been specified in the initial contract.” - TCE and agency are concerned with managerial discretion, both assuming managers are given to opportunism and moral hazard, and that mangers operate under bounded rationality, and that both theories regard board of directors as an instrument of control Stakeholder Theory - Takes account of a wider group of constituents rather than focusing on shareholders - A consequence of focusing on shareholders is that the maintenance or enhancements of shareholder value is paramount, whereas when a wider stakeholder group such as employees, providers of credit, etc is taken into account, the overriding focus on shareholder value becomes less self-evident - One rationale for effectively privileging shareholders over other stakeholders is that they are the recipients of the residual free cash flow o Means shareholders have a vested interest in trying to ensure that resources are used to maximum effect, which in turn should be to the benefit of society as a whole - You can compare Anglo-American model to German model whereby certain stakeholder groups such as employees, have a right enshrined in law for their representatives to sit on the supervisory board alongside the directors - Jensen advocates “enlightened value maximization”, which utilizes much of the structure of the stakeholder theory but accepts maximization of the long run value of the firm as the criterion for making the requisite tradeoffs among its stakeholders, and therefore solves the problems that arise from multiple objectives that accompany traditional stakeholder theory The Role of the Corporation (By: Thomas W. Joo) - In Butler and McChesney’s view, the corporation is a “contract”, or a voluntary economic relationship, between shareholders and management o This contract constitutes the parties’ negotiated solution to the agency cost problem - Competing view of corporation holds that the large public corporation is more than a relationship between shareholders and managers o Large corporations have profound influence on multiple constituencies in addition to shareholders o The law’s focus on shareholder interests is a political choice rather than an inevitability - Williams points out that corporations should focus on shareholder wealth, but only within bounds of laws enacted to protect other priorities, such as the environment or wor
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