case 3: cross and pyramid holdings tata motor s …adamodar/podcasts/cfugspr16/...case 3: cross and...

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Case3:CrossandPyramidHoldingsTataMotor’stopstockholdersin2013

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Case4:LegalrightsandCorporateStructures:Baidu¨  TheBoard:Thecompanyhassixdirectors,oneofwhomisRobinLi,

whoisthefounder/CEOofBaidu.Mr.LialsoownsamajoritystakeofClassBshares,whichhavetenNmesthevoNngrightsofClassAshares,granNnghimeffecNvecontrolofthecompany.

¨  Thestructure:BaiduisaChinesecompany,butitisincorporatedintheCaymanIslands,itsprimarystocklisNngisontheNASDAQandthelistedcompanyisstructuredasashellcompany,togetaroundChinesegovernmentrestricNonsofforeigninvestorsholdingsharesinChinesecorporaNons.

¨  Thelegalsystem:Baidu’soperaNngcounterpartinChinaisstructuredasaVariableInterestEnNty(VIE),anditisunclearhowmuchlegalpowertheshareholdersintheshellcompanyhavetoenforcechangesattheVIE.

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Thingschange..Disney’stopstockholdersin2009

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II.Stockholders'objecNvesvs.Bondholders'objecNves

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¨  Intheory:thereisnoconflictofinterestsbetweenstockholdersandbondholders.

¨  Inprac3ce:StockholderandbondholdershavedifferentobjecNves.Bondholdersareconcernedmostaboutsafetyandensuringthattheygetpaidtheirclaims.StockholdersaremorelikelytothinkaboutupsidepotenNal

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Examplesoftheconflict..

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¨  Adividend/buybacksurge:Whenfirmspaycashoutasdividends,lenderstothefirmarehurtandstockholdersmaybehelped.Thisisbecausethefirmbecomesriskierwithoutthecash.

¨  Riskshi^ing:Whenafirmtakesriskierprojectsthanthoseagreedtoattheoutset,lendersarehurt.LendersbaseinterestratesontheirpercepNonsofhowriskyafirm’sinvestmentsare.Ifstockholdersthentakeonriskierinvestments,lenderswillbehurt.

¨  Borrowingmoreonthesameassets:Iflendersdonotprotectthemselves,afirmcanborrowmoremoneyandmakeallexisNnglendersworseoff.

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AnExtremeExample:UnprotectedLenders?

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III.FirmsandFinancialMarkets

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¨  Intheory:Financialmarketsareefficient.ManagersconveyinformaNonhonestlyandandinaNmelymannertofinancialmarkets,andfinancialmarketsmakereasonedjudgmentsoftheeffectsofthisinformaNonon'truevalue'.Asaconsequence-¤  Acompanythatinvestsingoodlongtermprojectswillberewarded.

¤  ShorttermaccounNnggimmickswillnotleadtoincreasesinmarketvalue.

¤  Stockpriceperformanceisagoodmeasureofcompanyperformance.

¨  InpracNce:Therearesomeholesinthe'EfficientMarkets'assumpNon.

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ManagerscontrolthereleaseofinformaNontothegeneralpublic

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¨  InformaNonmanagement(Nmingandspin):InformaNon(especiallynegaNve)issomeNmessuppressedordelayedbymanagersseekingabeeerNmetoreleaseit.WhentheinformaNonisreleased,firmsfindwaysto“spin”or“frame”ittoputthemselvesinthebestpossiblelight.

¨  Outrightfraud:Insomecases,firmsreleaseintenNonallymisleadinginformaNonabouttheircurrentcondiNonsandfutureprospectstofinancialmarkets.

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Evidencethatmanagersdelaybadnews?

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DO MANAGERS DELAY BAD NEWS?: EPS and DPS Changes- byWeekday

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

Monday Tuesday Wednesday Thursday F r i d a y

% Chg(EPS) % Chg(DPS)

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SomecriNquesofmarketefficiency..

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¨  InvestorirraNonality:ThebaseargumentisthatinvestorsareirraNonalandpriceso^enmovefornotreasonatall.Asaconsequence,pricesaremuchmorevolaNlethanjusNfiedbytheunderlyingfundamentals.EarningsanddividendsaremuchlessvolaNlethanstockprices.

¨  ManifestaNonsofirraNonality¨  ReacNontonews:Somebelievethatinvestorsoverreactto

news,bothgoodandbad.OthersbelievethatinvestorssomeNmesunderreacttobignewsstories.

¨  Aninsiderconspiracy:Financialmarketsaremanipulatedbyinsiders;PricesdonothaveanyrelaNonshiptovalue.

¨  Shorttermism:Investorsareshort-sighted,anddonotconsiderthelong-termimplicaNonsofacNonstakenbythefirm

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Aremarketsshortsightedandtoofocusedonthenearterm?Whatdoyouthink?

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¨  Focusingonmarketpriceswillleadcompaniestowardsshorttermdecisionsattheexpenseoflongtermvalue.a. Iagreewiththestatementb. Idonotagreewiththisstatement

¨  Allowingmanagerstomakedecisionswithouthavingtoworryabouttheeffectonmarketpriceswillleadtobeeerlongtermdecisions.a.  Iagreewiththisstatementb.  Idonotagreewiththisstatement

¨  Neithermanagersnormarketsaretrustworthy.RegulaNons/lawsshouldbewrieenthatforcefirmstomakelongtermdecisions.a.  Iagreewiththisstatementb.  Idonotagreewiththisstatement

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Aremarketsshortterm?Someevidencethattheyarenot..

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¨  Valueofyoungfirms:Therearehundredsofstart-upandsmallfirms,withnoearningsexpectedinthenearfuture,thatraisemoneyonfinancialmarkets.Whywouldamyopicmarketthatcaresonlyaboutshorttermearningsaeachhighpricestothesefirms?

¨  CurrentearningsvsFuturegrowth:Iftheevidencesuggestsanything,itisthatmarketsdonotvaluecurrentearningsandcashflowsenoughandvaluefutureearningsandcashflowstoomuch.A^erall,studiessuggestthatlowPEstocksareunderpricedrelaNvetohighPEstocks

¨  MarketreacNontoinvestments:ThemarketresponsetoresearchanddevelopmentandinvestmentexpendituresisgenerallyposiNve.

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Ifmarketsaresoshortterm,whydotheyreacttobiginvestments(thatpotenNallylowershorttermearnings)soposiNvely?

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Butwhataboutmarketcrises?

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¨  Marketsaretheproblem:ManycriNcsofmarketspointtomarketbubblesandcrisesasevidencethatmarketsdonotwork.Forinstance,themarketturmoilbetweenSeptemberandDecember2008ispointedtoasbackingforthestatementthatfreemarketsarethesourceoftheproblemandnotthesoluNon.

¨  Thecounter:Therearetwocounterargumentsthatcanbeoffered:¤  Theeventsofthelastquarterof2008illustratethatwearemore

dependentonfuncNoning,liquidmarkets,withrisktakinginvestors,thaneverbeforeinhistory.Aswesaw,nogovernmentorotherenNty(bank,Buffee)isbigenoughtostepinandsavetheday.

¤  Thefirmsthatcausedthemarketcollapse(banks,investmentbanks)wereamongthemostregulatedbusinessesinthemarketplace.Ifanything,theirfailurescanbetracedtotheiraeemptstotakeadvantageofregulatoryloopholes(badlydesignedinsuranceprograms…capitalmeasurementsthatmissriskyassets,especiallyderivaNves)

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IV.FirmsandSociety

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¨  Intheory:Allcostsandbenefitsassociatedwithafirm’sdecisionscanbetracedbacktothefirm.

¨  InpracNce:Financialdecisionscancreatesocialcostsandbenefits.¤  Asocialcostorbenefitisacostorbenefitthataccruestosocietyasawholeandnottothefirmmakingthedecision.n  Environmentalcosts(polluNon,healthcosts,etc..)n QualityofLife'costs(traffic,housing,safety,etc.)

¤  Examplesofsocialbenefitsinclude:n  creaNngemploymentinareaswithhighunemploymentn  supporNngdevelopmentininnerciNesn  creaNngaccesstogoodsinareaswheresuchaccessdoesnotexist

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SocialCostsandBenefitsaredifficulttoquanNfybecause..

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¨  Cannotknowtheunknown:TheymightnotbeknownattheNmeofthedecision.Inotherwords,afirmmaythinkthatitisdeliveringaproductthatenhancessociety,attheNmeitdeliverstheproductbutdiscovera^erwardsthatthereareverylargecosts.(Asbestoswasawonderfulproduct,whenitwasdevised,lightandeasytoworkwith…Itisonlya^erdecadesthatthehealthconsequencescametolight)

¨  Eyesofthebeholder:Theyare‘person-specific’,sincedifferentdecisionmakerscanlookatthesamesocialcostandweightthemverydifferently.

¨  Decisionparalysis:Theycanbeparalyzingifcarriedtoextremes.

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Atestofyoursocialconsciousness:Putyourmoneywhereyoumouthis…

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¨  AssumethatyouworkforDisneyandthatyouhaveanopportunitytoopenastoreinaninner-cityneighborhood.Thestoreisexpectedtoloseaboutamilliondollarsayear,butitwillcreatemuch-neededemploymentinthearea,andmayhelprevitalizeit.

¨  Wouldyouopenthestore?¤  Yes¤  No

¨  Ifyes,wouldyoutellyourstockholdersandletthemvoteontheissue?¤  Yes¤  No

¨  Ifno,howwouldyourespondtoastockholderqueryonwhyyouwerenotlivinguptoyoursocialresponsibiliNes?

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Sothisiswhatcangowrong...

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STOCKHOLDERS

Managers puttheir interestsabove stockholders

Have little controlover managers

BONDHOLDERSLend Money

Bondholders canget ripped off

FINANCIAL MARKETS

SOCIETYManagers

Delay badnews or provide misleadinginformation

Markets makemistakes andcan over react

Significant Social Costs

Some costs cannot betraced to firm

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TradiNonalcorporatefinancialtheorybreaksdownwhen...

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¨  Managerialself-interest:Theinterests/objecNvesofthedecisionmakersinthefirmconflictwiththeinterestsofstockholders.

¨  Unprotecteddebtholders:Bondholders(Lenders)arenotprotectedagainstexpropriaNonbystockholders.

¨  Inefficientmarkets:Financialmarketsdonotoperateefficiently,andstockpricesdonotreflecttheunderlyingvalueofthefirm.

¨  Largesocialsidecosts:Significantsocialcostscanbecreatedasaby-productofstockpricemaximizaNon.

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WhentradiNonalcorporatefinancialtheorybreaksdown,thesoluNonis:

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¨  Anon-stockholderbasedgovernancesystem:Tochooseadifferentmechanismforcorporategovernance,i.e,assigntheresponsibilityformonitoringmanagerstosomeoneotherthanstockholders.

¨  AbeeerobjecNvethanmaximizingstockprices?TochooseadifferentobjecNveforthefirm.

¨  Maximizestockpricesbutminimizesidecosts:Tomaximizestockprice,butreducethepotenNalforconflictandbreakdown:¤  Makingmanagers(decisionmakers)andemployeesintostockholders¤  ProtectlendersfromexpropriaNon¤  ByprovidinginformaNonhonestlyandpromptlytofinancialmarkets¤  Minimizesocialcosts

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I.AnAlternaNveCorporateGovernanceSystem

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¨  GermanyandJapandevelopedadifferentmechanismforcorporategovernance,baseduponcorporatecrossholdings.¤  InGermany,thebanksformthecoreofthissystem.¤  InJapan,itisthekeiretsus¤  OtherAsiancountrieshavemodeledtheirsystema^erJapan,withfamily

companiesformingthecoreofthenewcorporatefamilies¨  Attheirbest,themostefficientfirmsinthegroupworkatbringing

thelessefficientfirmsuptopar.Theyprovideacorporatewelfaresystemthatmakesforamorestablecorporatestructure

¨  Attheirworst,theleastefficientandpoorlyrunfirmsinthegrouppulldownthemostefficientandbestrunfirmsdown.Thenatureofthecrossholdingsmakesitsverydifficultforoutsiders(includinginvestorsinthesefirms)tofigureouthowwellorbadlythegroupisdoing.

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II.ChooseaDifferentObjecNveFuncNon

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¨  FirmscanalwaysfocusonadifferentobjecNvefuncNon.Exampleswouldinclude¤  maximizingearnings¤  maximizingrevenues¤  maximizingfirmsize¤  maximizingmarketshare¤  maximizingEVA

¨  ThekeythingtorememberisthattheseareintermediateobjecNvefuncNons.¤  Tothedegreethattheyarecorrelatedwiththelongtermhealthandvalueofthecompany,theyworkwell.

¤  Tothedegreethattheydonot,thefirmcanendupwithadisaster

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III.MaximizeStockPrice,subjectto..

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¨  ThestrengthofthestockpricemaximizaNonobjecNvefuncNonisitsinternalselfcorrecNonmechanism.Excessesonanyofthelinkageslead,ifunregulated,tocounteracNonswhichreduceoreliminatetheseexcesses

¨  Inthecontextofourdiscussion,¤  managerstakingadvantageofstockholdershasledtoamuchmore

acNvemarketforcorporatecontrol.¤  stockholderstakingadvantageofbondholdershasledtobondholders

protecNngthemselvesattheNmeoftheissue.¤  firmsrevealingincorrectordelayedinformaNontomarketshasledto

marketsbecomingmore“skepNcal”and“puniNve”¤  firmscreaNngsocialcostshasledtomoreregulaNons,aswellas

investorandcustomerbacklashes.

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TheStockholderBacklash

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¨  AcNvistInsNtuNonalinvestorshavebecomemuchmoreacNveinmonitoringcompaniesthattheyinvestinanddemandingchangesinthewayinwhichbusinessisdone.TheyhavebeenjoinedbyprivateequityfundslikeKKRandBlackstone.

¨  AcNvistindividualslikeCarlIcahnspecializeintakinglargeposiNonsincompanieswhichtheyfeelneedtochangetheirways(Blockbuster,TimeWarner,Motorola&Apple)andpushforchange.

¨  Vocalstockholders,armedwithmoreinformaNonandnewpowers:AtannualmeeNngs,stockholdershavetakentoexpressingtheirdispleasurewithincumbentmanagementbyvoNngagainsttheircompensaNoncontractsortheirboardofdirectors

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TheHosNleAcquisiNonThreat

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¨  ThetypicaltargetfirminahosNletakeoverhas¤  areturnonequityalmost5%lowerthanitspeergroup¤  hadastockthathassignificantlyunderperformedthepeergroupovertheprevious2years

¤  hasmanagerswhoholdlieleornostockinthefirm¨  Inotherwords,thebestdefenseagainstahosNletakeoveristorunyourfirmwellandearngoodreturnsforyourstockholders

¨  Conversely,whenyoudonotallowhosNletakeovers,thisisthefirmthatyouaremostlikelyprotecNng(andnotawellrunorwellmanagedfirm)

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Inresponse,boardsarebecomingmoreindependent…

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¨  BoardshavebecomesmalleroverNme.Themediansizeofaboardofdirectorshasdecreasedfrom16to20inthe1970stobetween9and11in1998.ThesmallerboardsarelessunwieldyandmoreeffecNvethanthelargerboards.

¨  Therearefewerinsidersontheboard.Incontrasttothe6ormoreinsidersthatmanyboardshadinthe1970s,onlytwodirectorsinmostboardsin1998wereinsiders.

¨  DirectorsareincreasinglycompensatedwithstockandopNonsinthecompany,insteadofcash.In1973,only4%ofdirectorsreceivedcompensaNonintheformofstockoropNons,whereas78%didsoin1998.

¨  MoredirectorsareidenNfiedandselectedbyanominaNngcommieeeratherthanbeingchosenbytheCEOofthefirm.In1998,75%ofboardshadnominaNngcommieees;thecomparablestaNsNcin1973was2%.

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Disney:Eisner’srise&fallfromgrace

¨  InhisearlyyearsatDisney,MichaelEisnerbroughtaboutlong-delayedchangesinthecompanyandputitonthepathtobeinganentertainmentgiantthatitistoday.HissuccessallowedhimtoconsolidatepowerandtheboardsthathecreatedwereincreasinglycapNveones(seethe1997board).

¨  In1996,EisnerspearheadedthepushtobuyABCandtheboardrubberstampedhisdecision,astheyhadwithothermajordecisions.Intheyearsfollowing,thecompanyranintoproblemsbothonitsABCacquisiNonandonitsotheroperaNonsandstockholdersstartedtogetresNve,especiallyasthestockpricehalvedbetween1998and2002.

¨  In2003,RoyDisneyandStanleyGoldresignedfromtheDisneyboard,arguingagainstEisner’sautocraNcstyle.

¨  Inearly2004,ComcastmadeahosNlebidforDisneyandlaterintheyear,43%ofDisneyshareholderswithheldtheirvotesforEisner’sreelecNontotheboardofdirectors.Followingthatvote,theboardofdirectorsatDisneyvotedunanimouslytoelectGeorgeMitchellastheChairoftheboard,replacingEisner,whovowedtostayonasCEO.

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Eisner’sconcession:Disney’sBoardin2003

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Board Members OccupationReveta Bowers Head of school for the Center for Early Education,John Bryson CEO and Chairman of Con EdisonRoy Disney Head of Disney AnimationMichael Eisner CEO of DisneyJudith Estrin CEO of Packet Design (an internet company)Stanley Gold CEO of Shamrock HoldingsRobert Iger Chief Operating Officer, DisneyMonica Lozano Chief Operation Officer, La Opinion (Spanish newspaper)George Mitchell Chairman of law firm (Verner, Liipfert, et al.)Thomas S. Murphy Ex-CEO, Capital Cities ABCLeo O’Donovan Professor of Theology, Georgetown UniversitySidney Poitier Actor, Writer and DirectorRobert A.M. Stern Senior Partner of Robert A.M. Stern Architects of New YorkAndrea L. Van de Kamp Chairman of Sotheby's West CoastRaymond L. Watson Chairman of Irvine Company (a real estate corporation)Gary L. Wilson Chairman of the board, Northwest Airlines.

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ChangesincorporategovernanceatDisney

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1.  RequiredatleasttwoexecuNvesessionsoftheboard,withouttheCEOorothermembersofmanagementpresent,eachyear.

2.  CreatedtheposiNonofnon-managementpresidingdirector,andappointedSenatorGeorgeMitchelltoleadthoseexecuNvesessionsandassistinsevngtheworkagendaoftheboard.

3.  AdoptedanewandmorerigorousdefiniNonofdirectorindependence.4.  RequiredthatasubstanNalmajorityoftheboardbecomprisedof

directorsmeeNngthenewindependencestandards.5.  ProvidedforareducNonincommieeesizeandtherotaNonof

commieeeandchairmanshipassignmentsamongindependentdirectors.

6.  AddednewprovisionsformanagementsuccessionplanningandevaluaNonsofbothmanagementandboardperformance

7.  ProvidedforenhancedconNnuingeducaNonandtrainingforboardmembers.

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Eisner’sexit…andanewagedawns?Disney’sboardin2008

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ButasaCEO’stenurelengthens,doescorporategovernancesuffer?1.  Whiletheboardsizehasstayedcompact(attwelvemembers),

therehasbeenonlyonechangesince2008,withSherylSandberg,COOofFacebook,replacingthedeceasedSteveJobs.

2.  TheboardvotedreinstateIgeraschairoftheboardin2011,reversingadecisionmadetoseparatetheCEOandChairposiNonsa^ertheEisneryears.

3.  In2011,IgerannouncedhisintenttostepdownasCEOin2015butDisney’sboardconvincedIgertostayonasCEOforanextrayear,forthe“thegoodofthecompany”.

4.  ThereweresignsofresNvenessamongDisney’sstockholders,especiallythoseinterestedincorporategovernance.AcNvistinvestors(CalSTRS)starNngmakingnoiseandInsNtuNonalShareholderServices(ISS),whichgaugescorporategovernanceatcompanies,raisedredflagsaboutcompensaNonandboardmonitoringatDisney.

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WhataboutlegislaNon?

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¨  EverycorporatescandalcreatesimpetusforalegislaNveresponse.ThescandalsatEnronandWorldComlaidthegroundworkforSarbanes-Oxley.

¨  Youcannotlegislategoodcorporategovernance.¤  ThecostsofmeeNnglegalrequirementso^enexceedthebenefits

¤  Lawsalwayshaveunintendedconsequences¤  Ingeneral,lawstendtobeblunderbussesthatpenalizegoodcompaniesmorethantheypunishthebadcompanies.

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Isthereapayofftobeeercorporategovernance?

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¨  Inthemostcomprehensivestudyoftheeffectofcorporategovernanceonvalue,agovernanceindexwascreatedforeachof1500firmsbasedupon24disNnctcorporategovernanceprovisions.¤  BuyingstocksthathadthestrongestinvestorprotecNonswhilesimultaneously

sellingshareswiththeweakestprotecNonsgeneratedanannualexcessreturnof8.5%.

¤  EveryonepointincreaseintheindextowardsfewerinvestorprotecNonsdecreasedmarketvalueby8.9%in1999

¤  FirmsthatscoredhighininvestorprotecNonsalsohadhigherprofits,highersalesgrowthandmadefeweracquisiNons.

¨  ThelinkbetweenthecomposiNonoftheboardofdirectorsandfirmvalueisweak.SmallerboardsdotendtobemoreeffecNve.

¨  Onapurelyanecdotalbasis,acommonthemeatproblemcompaniesandisanineffecNveboardthatfailstoasktoughquesNonsofanimperialCEO.