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 control
family ownership and control may provide better
incentives for the firm to focus on long-run performance
may also minimize the conflicts between owners and
professional managers
may 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 OWNERSHIP
state-owned enterprises (SOEs) suffer from an incentive
problem and often perform poorly
in 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” property
SOEs are de facto owned and controlled by government
agencies far removed from ordinary citizens and employees
there is little motivation for SOE managers and
employees to improve performance, which they can hardly
benefit 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 agents
do not completely overlap, there will inherently be
principal agent conflicts
agency costs - result of principal-agent conflicts:
principals’ costs of monitoring and controlling agents
agents’ costs of bonding signaling that they are
trustworthy
information 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 controlling
shareholders at the expense of minority shareholders
tunneling - form of corporate theft that occurs when
managers from the controlling family divert resources
from 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 shares
threat of takeovers does limit managers’ divergence
from shareholder wealth maximization
private 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
GOVERNANCE
VRIO framework
ability to successfully list on a high profile exchange
such as the NYSE and LSE is valuable, rare, and hardto-imitate
managerial human capital - these resources, such as
the social networks of executives, are unique and likely to
add value
top 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-thefittest” process by which firms will be forced to
adopt globally best practices.
Critics contend that governance practices will
continue to diverge throughout the world.