3/13/2017

IBU5GW

Governance
in a Globalising World

Week 3
Mechanisms of governance

This week

Understanding CG models and mechanisms

Cases:
Conrad Black
ISS

Shareholders vote

Individual assignment workshop

A unitary board with committees

the board

audit and risk social responsibility occ. health and safety

non-executive
director
executive director nominations remuneration

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Combining Chairman and

Managing Director Roles
Not recommended because:-
Chairman manages Board, MD manages the
business;
Difficult to be objective about management
performance;
Role to be played in Boardroom?
Too much power in one person;
Two minds better than one;
Under pressure, management demands take
precedence over governance;
Too much work for one person.

Ch.3 Mechanisms of Corporate

Governance
Thomsen, S., Conyon, M., 2012,
Corporate Governance;
Mechanisms and Systems,
McGraw Hill.

Introduction
Corporate governance mechanisms aims to:
Ensure that managers work in the best interest
of the shareholders (as a collective)
Minimise agency problems/costs
Set frameworks for contractual relationships
In the end, construct a sound economy

There exist a wide variety of governance

mechanisms, externally and internally

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Governance mechanisms

Informal governance Ownership

Social norms Blockholders
Reputation/trust Shareholder activism (monitoring)
Codes Takeovers

Regulation Stakeholder pressure

Corporate law Monitoring by creditors
Auditors
Boards Analysts
Competition
Incentive schemes

Social norms
Social norms: not being the Economic Man
acting in the best interests of the
shareholders

Stewardship: solves governance problems

to the extent that shareholders agree with
your moral actions
Do we have an agency problem in firms where
the manager behaves well, if the shareholders
prefers an immoral behaviour?

Trust and reputation

Reputation
Managerial work market: good reputation crucial
for the professionalised managers chances of
being employed
And to advance a career, i.e. be offered
managerial positions in larger/more valuable
firms
Importance of reputation diminishes with
internationalization as your actions are more
anonymous when taken in foreign markets

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Trust and reputation

PLAYER 2
The stakeholder
Cooperation Opportunisms

Cooperation Joint optimum Player 2 wins at

PLAYER 1 Both players win player 1s expense
The
manager Opportunism Players 1 wins at Worst case
player 2s expense Both players lose

Company law
Property rights
Contractual law
Crime law
Fraud
Corruption
Etc
Corporate law
Shareholder rights investor protection
Transparency requirements
Auditing requirements
Etc
Institutional elements, courts etc.

A legal world map

Civil law
Common law
Customary law
Religious law
Common and civil law
Unknown

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Common Law vs. Civil Law

Common Law Civil Law

Based on judicial opinions Based on codes and
principles rooted in the
Interpretations considered Roman empire
more are a guide Updates of legal codes only
Laws might be altered over through legislation
a single ruling Codes = literally followed
Judges rule based on
Laws are acquired over
previous interpretations of law
time
Stable, but reluctant and slow-
Flexible and rich (every moving (same solution for
case has its solution) every case)

Controlling owners
Higher incentives to monitor management
Often larger ability to monitor management
No free rider problems
Owner-management aligns the interest of
principals and agents
Solves moral hazard problems
Risks of controlling investors
May have other incentives than profit maximizing
Extraction of private benefits
More risk averse

Worlds Largest Family Firms and % of Family

Control
Sales Rank Company Percentage of family control
1 Wal-Mart Walton family owns 41%
2 Toyota Motor Corp Toyota family owns 2%
3 Ford Motor Co. Ford family owns approximately 40% of voting shares

4 Koch Industries Koch family owns 84% of Americas largest private company

5 Samsung Lee family controls 22%

Mittal family owns approximately 50% of the worlds largest steel

6 ArcelorMittal
company

7 Banco Santander Botin family owns 2.5%

8 PSA Peugeot Citroen Peugeot family holds 42% of voting shares

9 Cargill Cargill and MacMillan families own 85% of the 104 year old firm

10 SK Group Chey family controls 71 affiliated firms

Source: Pearl and Kristies (2009, spring)

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SAMSUNGs Family Feuds Part

1

Whistle blow
Chairman
Saccarine
Byung Chul Lee (Founder) Smuggling

Maeng Hee Lee (1st Son) Chang Hee Lee (2nd Son) Kun Hee Lee (3rd Son)
Source: Reuters, http://www.reuters.com/article/2012/05/29/us -samsung-lawsuit-idUSBRE84S18V20120529

SAMSUNGs Family Feuds Part

2
Only Son
Lawsuit
Education
- BA in East Asian History at
Chairman Seoul National University
Kun Hee Lee - MBA in Keio University in Tokyo
Maeng Hee Lee
- Doctoral degree from
Harvard Business School

Training
- Many low-profile positions

Jae Yong Lee

- Recent promotion to COO
Jae Hyun Lee
(1st Son, COO Samsung Electronics) (1st Son, Chairman, CJ)
Source: http://w ww.businessweek.com/articles/2012-06-06/samsungs-family-feud#p2

Example

Parmalat SpA is a multinational Italian dairy and

food corporation.
Having become the leading global company in the
production of long-life milk using the ultra-high-
temperature (UHT) process
The company collapsed in 2003 with a 14 billion
($20bn) hole in its accounts in what remains
Europe's biggest bankruptcy

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Example
Parmalat Europes Enron
Run by charismatic Calisto Tanzi
Creates fictitious sales
e.g., double counts sales
e.g., fictitious subsidiaries
Has dubious loans treated as equity
Fake Bank of America account worth 5 billion
dollars by using forgery documents.
Why did Tanzi do this?
- To finance other loss-making business of his
family
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Shareholder activism
Monitoring
- activity at general meetings
- proxy voting
- private negotiations with management
- shareholder proposals
- open debates / public announcements
- exit
Interest alignment

Shareholder activism
Jana Partners and Ontario Teacher's Pension
Plan two minority shareholders met with
McGraw-Hill management and its board of
directors to discuss a plan to break the
company into four units.
"McGraw-Hill enjoys an open dialogue with
its many shareholders and often gets
insights from those discussions."

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Takeovers

Threat of being taken over is a powerful

governance mechanism
Severely damages the reputation of managers
However, seldom seen in practice as most
firms employ takeover defenses
Poison pills
Empirical evidence that takeovers improve
firm performance and that barriers to hostile
takeovers reduce it

The board
Elected by shareholders to perform monitoring
duties
Motivating managers (incentives)
Sanctions (risk of being fired)
Arguments that boards matter more in dispersed
firms
Critical point: the quality of boards depend on the
election process and shareholder competence to
elect the right directors

Incentive systems
Interest alignment
Stock options and grants (rewards for future
performance)
Motivation of managers
Bonuses (rewards for past performance)
Highly dependent on design
What can the managers control?
Stocks: risk that decision which would maximise profit in
the long run might not be taken as they harm the share
price in a shorter run

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Creditors and capital structure

If companies need to borrow, creditors can
exercise influence on the firm by making demands
on board composition, management, capital
structure etc as conditions for lending
Monitoring by creditors
Capital structure essential
High and low levels of debt are associated with higher
risks of bankruptcy, financial distress and creditor-
shareholder conflicts
Weight agency problems against risk of bankruptcy and
conflicts of interest between creditors and shareholders

Auditors
Auditors are elected by shareholders to audit the
firm on behalf of the investors. The aim is to:
Ensure correct information about the state of the firm
Not water-proof as auditors are dependent on
management for information
From a shareholder perspective: is more information
better? Annual reports have grown extensively over the
years, now often reaching 150 pages. Does this add
value?
Can auditors be considered a new layer in the agency
relationship model?

Analysts
Analysts aim to help outside investors understand
the firm
Particularly valuable to shareholders with limited
resources and/or competence
Risk: analysts issue too many recommendations to
buy, in order to stimulate market trade
Rating agencies have also been criticised for being
too optimistic in times of crisis
Analysts exist despite strong fundamentals since the
efficient market hypothesis indicates that all relevant
information is already available at the market

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Competition
Competition fundamentally corrects for
inefficiencies in the market-based system

Bad management will at one point lead to

higher costs, loss of competitiveness,
slower growth, bankruptcy etc.
Works well in the long run, however not enough
for shareholders who cannot accept
underperformance for substantial time periods
until the market has gotten it right

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