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Summary - Class notes - Corporate Governance
1539208800 Lecture 1 - part 1
Fama & Jensen (1983) - Manage & Supervise
InitiationGeneration of proposals for resource utilitzation and structuring contracts
RatificationChoice of the decision initiatives to be implemented
ImplementationExecution of ratified decisions
MonitoringMeasurement of the performance of decision agent and implementation of rewards
Responsible Corporate Governance is aimed at securing the continuity of the firm. Why?
- Shareholders get their share of the profit
- Customers get products or services
- Suppliers have their customers
- Employees keep their job
- Management receives their bonuses
- Society receives taxes
What is the objective of Corporate Governance?The objective is realising long term shareholder value whilst taking into account interests of other stakeholders. In other words: finding the position in the feasibility space that is acceptable to all stakeholders.
What is the feasibility space?The feasibility space represents a situation which is satisfying for all stakeholders (e.g. employees, shareholders, society and customers). Refer to picture in the slides.
What can you tell about the size of the feasibility space?The feasible region is shown as being relatively small. This is amost by definition the case: if the feasible region increases, the groups will adjust their demands in usch a way that is relatively small again.
What are examples of gatekeepers and watchdogs?
- Oversight bodies
- Analists/investment bankers
- Credit rating agencies
- Remuneration advisors
Most importantly, every member of the chain must commit to collaboration with all others. This chain is only as strong as its weakest link.
What are the backbones of good Corporate Governance?
Transparency form a backbone of good corporate governance and requires a sophisticated system of accounting. Such system should:
- Allow investors to assess the magnitude and timing of future cash flows to be generated by a business
- Encourage efficient operations and maximization of results
- Provide an early warning of problems in meeting objectives of the firm
- Lead to quick corrective action whenever things go bad
IntegrityIntegrity forms the backbone of good corporate governance and requires "doing the right things". A "check in the box" approach to good corporate governance wil not inspire a true sense of ethical obligation. It could merely lead to an array of inhibiting "politically correct" dictates.
What's the difference in the vision on CG in the past and nowadays?In the past, it focused on Return on Assets for the suppliers of finance. It did not include any other stakeholders or mentions the continuity of the firm. Nowadays it is called "the process used to manage the business affairs of the company towards enhancing business prosperity and corporate accountability when the objective of realizing long term shareholder value, while taking into account the interest of the other stakeholders".
What are today's challenges of CG?
- Long-term value vs short-term value
- Stakeholder value vs shareholder value
What is the role of customers in CG?No firm can exist without its customers. Their formal influece may be limited, their informal influence (especially when exercising their option not to buy from the firm) is big. In the literature on CG, this group is less visible than several of the other groups of stakeholders.
What are stakeholders that should be taken into account? (Schedule)Refer to schedule
What is the role of shareholders in CG?- Shareholders of listed corporations have taken the chance to participate in the profits of the firm without taking responsibility for the operations. They have limited liability and therefore limited involvement in the company's affairs.
- Their involvement includes the right to elect directors and the fiduciary obligation of directors and management to protect their interests.
- The group of shareholders ranges from private persons that have only a few shares in a corporation, to institutions such as pension funds that own a significant portion of the shares. Apart from the difference is size, the goal of each shareholder for owning the shares can be very diverse.
What is the separation of ownership and control in combination with shareholder value?
The shareholder has the exclusive control of the stock itself, but as a condition for the shareholder's limited liability, the shareholder gives up the right to control the use of the corporate's property by others. That right is delegated to the management of the corporation. One of the benefits is that the investor can entrust his money to people who have the time and the expertise, which he does not have. Additionally he has voting, information and approval rights.
The theory is that corporations are managed by officers, under a system of checks and balances provided by the board of directors and the shareholders.
What is the role of employees in CG?Employees are often referred to by senior management as "the most important asset of our company". They are compensated for the time and skills they devote to the firm. They have various faces: they can be organized in a union, they can have a significant amount of shares, and in several countries they are represented in the Board of Directors as well.
SocietyThe group that we refer to as the Society is composed of a large amount of sub-groups that include the government (which sets formal rules and regulations) and organizations such as the local variant of the SEC (who can be very specific on the requirements with respect to disclosure for listed companies)
SuppliersSuppliers and other creditors have an interest in (1) that their current invoices are being paid and (2) that they can deliver to and invest in the firm in the future as well.
CreditorsCreditors play an important role in a number of governance systems and can serve as external monitors over corporate performance.
DirectorsThe Directors of the firms face the challenging task of balancing the wishes of each of the groups mentioned before. The officially act on behalf of the shareholders.
Why won't Directors just do what the shareholders want?
1. Keeping stock is a different profession than managing a business
2. It is not always easy to determine what the "best interest" for the shareholders is. E.g. If the executive directors do not listen well enough to the firm's employees (e.g. lower wages and more dividend), an unmotivated workforce may endager the shareholder value.
What is the main task of directors?The task of the directors may be viewed as maintaining the activities of the organization within the feasible region determined by the intersecting acceptable sets of the stakeholders.
What kind of Directors do exist?
- Non-executive Directors - in many countries they form the supervisory board
- Executive Directors
One-tier systemThe Executive Board and the Supervisory Board form together really one Board.
Two-tier systemThe Executive Board and the Supervisory Board are separated.
In essence, the supervisory board has to ensure that two conditions are fulfilled:
1. They should be certain that the executive directors are really acting in the interest of the shareholders. This is not easy to accomplish because "in the interest of" cannot be straightforwardly translated into actions.
2. They should be certain that the executive directors are capable in running the company. They do so by the mechanism of hiring and firing. Finding a new CEO is a long and tedious process, but in many respects the most important task they have
(3. Supervisor should also regularly ask how things are going.)
According to the Dutch Corporate Governance Code (Dutch CG Code 2009) the Executive Board and the Supervisory Board have to serve the interests of the company and are accountable for this to the general meeting of shareholders. The shareholders are, in principle, free to put their own interests first.
Draw the Governance Paradigm of Vaassenx
What are the four important characteristics of the Governance Paradigm?
1. Information and the information system is key to governing a system
2. There is a continuous interaction between the environment and the system
3. The subjective choice of the system boundaries determines what information is considered external and internal
4. There is a control system (e.g. manager) that attempts to control the behaviour of a controlled system (e.g. subordinate) on the basis of often imperfect information.
What are the two generic modes of reaction?
- Feedforward mechanisms
- Feedback mechanisms
Note that for External Governance, the Control System itself is the Controlled System.
Why are governance and control two stongly related concepts? - Simple vision
To put it simply: by means of governing a business, the executive directors attempt to control it.
Why are governance and control two strongly related concepts? - Traditional and narrow perspective
From a rather traditional and narrow perspective:
- Governance and control entails giving task assignmetns and holding workers accountable for fulfilments of their task
- The processes that take place are delegation and accoutnability. If power and responsibilities are delegated, the need for control arises
Why are governance and control two strongly related concepts? - Broader senseControl encompasses all those activities aimed at having organization members cooperate to reach the organizational goals.
Corporate Governance consists of External Governance and Internal Governance.
External GovernanceEverything above the executive board - e.g. shareholders, supervisory board, other stakeholders
Internal GovernanceEverything under the executive board - e.g. staff, business units
The principle-agent problemSeparation of ownership and the management of the company leads to issues. Due to a lack of direct control by the owners, other mechanisms of control are required.
PrincipleThose who have 'principle' interest in the business - owner
AgentThose who act on behalf of another - a representative of an instrument
Codes of Conducts have been developed to improve governance
Why are codes of conducts developed?Due to scandals, new laws are created to obligate companies to follow code of conducts, to make executives held personally accountable for their actions. There is a tendency to demand for more regorous supervision, regulations and requirements on IC.
Legislation for Corporate Governance
NL: Dutch CG Code
USA: Sarbanes-Oxley Act
UK: Code on Corporate Governance
Degree of trust and transparancy:
Asia: High trust, low transparancy - Trust me
EU: Medium trust, medium transparancy - Tell me
USA: low trust, high transparancy - Show me
Dutch CG codeThe Dutch CG code contains principles and best practice definitions for CG and it recommends the legislator to embed the principle of "apply or explain" in the law legislation of Book 2 BW. It applies to organizations with a statutory seeds in NL, quoted on a stock exchange recognized by the governant (this can be foreign)
The code represents, in five chapters, the basics and best practices for:
Ch I: Compliance with and enforcement of the code
Ch II: The Management Board
Ch III: The Supervisory Board
Ch IV: The shareholders and GM
Ch V: The audit of financial reporting and position of internal audit and the external auditor.
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