Chapters 1, 14, and 33

An Introduction to Corporate Governance

The goals of a corporation

What should be the goals of a corporation?
Many stakeholders

Focus on stockholders?
Maximize profit?

Figure 1.3: Whose Company Is It?

** Survey of 378 managers from 5 countries

Japan Germany France United Kingdom United States

0

3 17 22 71 76 40 60 80

97 83 78 29 24 20

100

120

The Shareholders All Stakeholders

% of responses

Figure 1.3: Labor as stakeholder

** Survey of 399 managers from 5 countries. Which is more important...jobs or paying dividends? 3 Japan 97

Germany France United Kingdom United States

0
Dividends Job Security

40 41

60 59 89 89

11 11 20 40 60 80

100

120

% of responses

Creditors as stakeholders
Figure 33.1: The value of the financial claims on firms in 2007 as a percentage of GDP.
200 180 160 140 120 100 80 60 40 20 0
US UK Europe Japan Non-Japan Asia

Percent

Bank Loans

Stock Market

Private Bond Market

Banks as Stakeholders in Japan: Cross-holding of shares

1.9%

Sumitomo Corporation

4.4%

Sumitomo Bank

2.2%

Sumitomo Trust

1.8%

2.2%

4.3%

Our focus
US, UK, and HK: to focus on stockholders
Maximize the total value of the companys common stock
will then max each stockholders wealth

Create value by
smart capital budgeting (What to be maximized? Net profit?) suitable financial policy such as capital structure

Topics of Corporate Finance

Capital budgeting: What long-term investments (real assets) or projects should the firm take?
Chapters 2-5 have been covered in FINA2010. We will briefly review basic capital budgeting (Chapter 6), and will discuss advanced capital budgeting (e.g., decision trees and real options)

Working capital management

How do we manage the day-to-day finances of the firm? Already covered in FINA2010 or accounting

Capital structure
Should we use more debt or more equity to finance our assets? Related to the costs of capital Related to options Dif between US and HK

Dividends
How much? Different types of dividends? Dif between US and HK.

Figure 1.1: Flow of Cash between

Financial Markets and Firm's Operations
(2) Firm's operations (1)

Financial
manager (4a)

Financial
markets

(3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors

(4b)

Focus on stockholders
A typical US corporations stock ownership structure? How about HK? Will ownership structure affect the running of the corporation?

A US corporations equity is often widely held (Figure 14.4: 2008 statistics)

Rest of World 11.7 Other 1.9 Households 35.7

Mutual Funds, etc. 23.9 Insurance Companies 7.5

Pension Funds 19.2

Percent of Holdings

Asian Closely-held Firms

Table 33.1: The ownership of firms in Asia is held by a small number of very wealthy families

Hong Kong Indonesia Japan Korea Malaysia Philippines Singapore Taiwan Thailand

Number of Firms in Smaple 330 178 1240 345 238 120 221 141 167

Family 66.7 71.5 9.7 48.4 67.2 44.6 55.4 48.2 61.6

State 1.4 8.2 0.8 1.6 13.4 2.1 23.5 2.8 8

Widely Held 7 5.1 79.8 43.2 10.3 19.2 5.4 26.2 6.6

Percent of Assets controlled by top 10 families 32.1 57.7 2.4 36.8 24.8 52.5 26.6 18.4 46.2

Figure 33.6 ABB: one of Swedens largest companies

Shares 23.4% Shares 27.1% Shares 24.3%

Votes 41.2%
Wallenberg Family Investor

Votes 35.7%
Incentive

Votes 32.8%
ABB

Shares 5.7% Votes 7.4%

Differences between voting rights and cash-flow rights

Pyramids of shareholding Dual-class shares

Agency Problems
Agency relationship
Principal hires an agent to represent his/her interest Stockholders and managers Its impossible that all the stockholders can actively monitor the managers
The board of directors is supposed to represent the stockholders interests.

Agency problem: conflict of interest between principal and agent

Do US and HK corporations have similar agency problems?

Agency Problems
US: usually between the professional managers and stockholders
E.g., see dividend policy

HK: usually between the major stockholder

(who is also the manager; a principal as well as the agent for

and other stockholders Agency problem can be more severe in HK than in US Agency problem also exists between creditors (principal) and stockholders (agent): see capital
other stockholders)
structure

Agency Problems & Corporate Governance

Legal and Regulatory Requirements
E.g., SEC in US (SFC in HK) sets accounting and reporting standards as well as law protecting minority shareholders from exploitation

Compensation plans
Bonus, incentive pay such as stock options

Board of Directors
Sarbanes-Oxley Act (SOX): more than half of all directors are independent. Institutional shareholders nominate directors

Agency Problems & Corporate Governance

Monitoring by
analysts lenders

Shareholder pressure
Elect new directors or/& fire CEO Sell shares

Hostile takeovers