Ch. 19. Corporate Governance and Performance
Corporate Governance Systems in US
US – Wide-spread ownership
Japan and Germany – concentrated ownership.
Reasons for wide spread ownership in US;
1. protection of small shareholder
2. restrictions on commercial banks and insurance companies
Benefits of wide spread ownership:
1. allows risk diversification
2. liquidity
3. limited liability of investors
Costs of wide spread ownership:
1. separation of ownership and control
2. monitoring expenditures
3. conflicts between different stakeholders: stock holders, bond
holders, employees, consumers
4. harder to deal with externalities (environment, research)
Solutions:
board of directors represents interests of various stakeholders;
ownership of management helps to align interests
Internal Control
Board of Directors
role: represent shareholders
board composition: outsiders and insiders, board size
compensation of directors: stock ownership, small
monetary reward, mainly reputation.
Ownership Concentration
incentives vs. entrenchment
ranges of managerial ownership
Relationship to
Tobin’s Q
Bond returns
0-5%
positive
negative
5-25%
negative
positive
>25%
slightly positive slightly negative
The table implicates that entrenchment effects are
stronger than the effects from improved incentives only
in the 5-25% range.
Executive Compensation
Jensen and Murphy (1990) found that sensitivity of
compensation to stock price performance is about 3%.
Incentives mostly come from option grants
Outside Control
Management Changes
Outside Ownership:
public pension funds, other large block holders. Pension
funds are usually not very active.
block holders improve firm performance. Evidence on
majority stock holders (owners of more than 50%) does not
support entrenchment hypothesis.
Companies usually employ multiple control mechanisms.
Empirically hard to tell the effect of each mechanism apart.
Failure of control mechanisms leads to proxy fights of takeovers
Proxy Contests
- stimulated by poor performance
- succeed if put at least 2 people on board
- implies significant leakage of information
- negative CARs are observed if proxy defeated by white
knight or buyout
- not clear if successful proxy fight improves
performance
M&A market for control
Comparison to Alternative Governance systems
Germany, Japan – better for large firms, but:
Banks do not necessarily get involved, since their attention is
wide-spread
Banks have governance problems too
Conflicts of interest for tied-up firms
Slow governance change