Chapter 16

Governing the Corporation

LEARNING OBJECTIVES

After studying this chapter, you should be able to:

1. Differentiate various ownership patterns around the world

2. Articulate the role of managers in both principal-agent and principal-principal conflicts

3. Explain the role of the board of directors

4. Identify voice- and exit-based governance mechanisms and their combination as a package

5. Acquire a global perspective on how governance mechanisms vary around the world

6. Articulate how institutions and resources affect corporate governance

7. Participate in two leading debates on corporate governance

8. Draw implications

OWNERSHIP AND CONTROL

concentrated ownership and control - founders start up firms and completely own and control them on an individual or family basis

diffused ownership - publicly traded corporations owned by numerous small shareholders but none with a dominant level of control

separation of ownership and control - dispersal of ownership among many small shareholders, in which control is largely concentrated in the hands of salaried, professional managers who own little (or no) equity

FAMILY OWNERSHIP

vast majority of large firms throughout continental Europe, Asia, Latin America, and Africa feature concentrated family ownership and controlfamily ownership and control may provide better incentives for the firm to focus on long-run performancemay also minimize the conflicts between owners and professional managersmay lead to the selection of less qualified managers (who happen to be the sons, daughters, and relatives of founders), the destruction of value because of family conflicts, and the expropriation of minority shareholders

STATE OWNERSHIPstate-owned enterprises (SOEs) suffer from an incentive problem and often perform poorlyin theory, all citizens (including employees) are owners, in practice, they have neither rights to enjoy dividends generated by SOEs (as shareholders would) nor rights to transfer or sell “their” propertySOEs are de facto owned and controlled by government agencies far removed from ordinary citizens and employeesthere is little motivation for SOE managers and employees to improve performance, which they can hardlybenefit from personally

PRINCIPAL - AGENT CONFLICTS

top management team (TMT) - group, led by the chief executive officer (CEO), that represents another crucial leg of the corporate governance tripod

agency relationship - relationship between shareholders (principals) and professional managers (agents)

principals - persons (such as owners) delegating authority

agents - persons (such as managers) to whom authority is delegated

PRINCIPAL - AGENT CONFLICTS

agency theory - simple yet profound proposition:to the extent that the interests of principals and agentsdo not completely overlap, there will inherently be principal agent conflictsagency costs - result of principal-agent conflicts:principals’ costs of monitoring and controlling agentsagents’ costs of bonding signaling that they are trustworthyinformation asymmetries - dynamic between principals and agents; agents such as managers almost always know more about the property they manage than principals do

PRINCIPAL-PRINCIPAL CONFLICTS

principal-principal conflicts - conflicts between two classes of principals: controlling shareholders and minority shareholders

expropriation - activities that enrich controllingshareholders at the expense of minority shareholders

tunneling - form of corporate theft that occurs when managers from the controlling family divert resourcesfrom the firm for personal or family use

related transactions - legal means whereby controlling owners sell firm assets to another firm they own at below market prices or spin off the most profitable part of a public firm and merge it with another private firm of theirs

BOARD OF DIRECTORS

inside directors - top executives of a firm

outside directors - nonmanagement members of

the board

CEO duality – when CEO serves as board chair

interlocking directorate - one person affiliated with one firm sits on the board of another firm

ROLE OF BOARD OF DIRECTORS

control - effectively control managers

service - advising the CEO

resource - acquisition functions

Boards’ effectiveness in serving the control function stems from their independence, deterrence, and norms

GOVERNANCE MECHANISMS

voice-based mechanisms - willingness of shareholders’ to work with managers, usually through the board, by “voicing” their concerns pay-for-performance link in executive compensation is usually not very strong

boards may have to dismiss underperforming CEOs

GOVERNANCE MECHANISMS

exit-based mechanisms - means by which corporate control is gained from external sources when shareholders no longer have patience and are willing to “exit” by selling their sharesthreat of takeovers does limit managers’ divergence from shareholder wealth maximizationprivate equity - acquisition of a significant portion or a majority control in a more mature firm leveraged buyouts (LBOs) - means by which private investors, often in partnership with incumbent managers, issue bonds and use the cash raised to buy the firm’s stock

INSTITUTIONS AND CORPORATE GOVERNANCE

given reasonable investor protection, founding families may over time feel comfortable becoming minority shareholders of the firms they founded

when formal legal and regulatory institutions are dysfunctional, founding families must run their firms directly

absent investor protection, bestowing management rights to outside professional managers may invite abuse and theft

corporate governance ultimately is a choice about political governance

RESOURCES AND CORPORATE GOVERNANCEVRIO framework

ability to successfully list on a high profile exchange such as the NYSE and LSE is valuable, rare, and hard-to-imitatemanagerial human capital - these resources, such as the social networks of executives, are unique and likely to add valuetop managerial talents are hard to imitate - unless they are hired away by competitor firms.within an organizational setting (in TMTs and boards) that managers and directors at the top of an organization can make a world of difference

OPPORTUNISTIC AGENTS vs.MANAGERIAL STEWARDS

Agency theory assumes managers are agents who may engage in self-serving, opportunistic activities if left to their own devices. However, critics contend that most managers are likely to be honest and trustworthy.Stewardship theorists agree that agency theory is useful when describing a certain portion of managers and under certain circumstances. If all principals view all managers as selfserving agents with control mechanisms to put managers on a “tight leash,” some managers, who initially view themselves as stewards, may become so frustrated that they end up engaging in the very self-serving behavior agency theory seeks to minimize.

GLOBAL CONVERGENCE vs. DIVERGENCE

Is corporate governance converging or diverging globally?Convergence advocates argue that globalization unleashes a “survival-of-the-fittest” process by which firms will be forced to adopt globally best practices.Critics contend that governance practices will continue to diverge throughout the world.