Corporate Governance Dr Yifan Zhou Corporate Governance • What is the Corporate Governance? • Compensation Mechanisms • Board of Director Mechanisms Corporate Governance • All companies operate in a complex ecosystem compose d of interested stakeholder groups that are dependent on the company as well as each other for economic success. • Key stakeholder groups (company’s capital providers): ➢ Debt and equity holders. • Other interested parties. Corporate Governance What is the Corporate Governance? ➢ To ensure the returns of your investment: • To maximize long-term value for shareholders • Generate sufficient profitability to meet debt obligations, debtholders Shareholder value Good governance for shareholder? To maximize long-term value for shareholders The closing price for Microsoft (MSFT) in 1995 was $3.41, on December 29, 1995. The latest price is $329.86. Corporate Governance What is the Corporate Governance? Benefit of an effective corporate governance structure • enable adequate scrutiny and control over operations • improvement of operating performance • reduce investors’ perceived credit risk Stakeholder groups Shareholders and creditors: provide the capital and financial resources to finance the company’s activities. Stakeholder groups Board of directors : serves as the steward of the company Monitoring and advice Stakeholder groups Managers: execute the strategy set by the board and run day-to-day operations; Stakeholder groups Employees: provide the human capital for the company’s day-to-day operations; Corporate Governance Shareholders (Equity holders): ➢ Own shares of stock, or equity, in a corporation. ➢ Residual claim holders: • if company bankrupt, shareholders receive proceeds, only after all other claims are paid. Corporate Governance Shareholders (Equity holders): ➢ interests are typically focused on growth in profitability. ➢ maximizes the value of the company’s share price and dividends. Corporate Governance Creditors/Debtholders: Banks and Private Lenders ➢ Have direct access to company management ➢ Have non-public information about the company, reduces information asymmetries that exist between the company and these groups. Corporate Governance Creditors/Debtholders: Banks and Private Lenders ➢ has a degree of influence on the company. ➢ can decide to relax debt restrictions or extend more credit, or it can refuse to do either of these, which is typically more difficult in the case of public debt investors. Corporate Governance Creditors/Debtholders: Banks and Private Lenders ➢ wide variation in risk appetite ➢ Less financial leverage, asset value, cash flows…. Corporate Governance Creditors/Debtholders: Public Debtholders (or bondholders) ➢ rely on public information and credit rating. ➢ Unlike shareholders, debtholders do not hold voting power, limited influence over a company’s day-to-day operations. Corporate Governance Creditors/Debtholders: Public Debtholders (or bondholders) ➢ Seek for minimize downside risk, which is financial risk associated with losses. ➢ preferring stability in company operations and performance, which contrasts with the interests of shareholders. Corporate Governance Shareholder vs. Creditor (Debtholder) Interests: The conflict between shareholders and debtholders, reflects ➢ different positions in the capital structure ➢ different structure of risks ➢ different returns Corporate Governance Shareholder vs. Creditor (Debtholder) Interests: Debtholders favor decisions that reduce a company’s leverage and financial risk ➢ prior claim to cash flows and firm assets over shareholders ➢ return or upside is prescribed and limited Corporate Governance Shareholder vs. Creditor (Debtholder) Interests: Shareholders typically have more downside risk but much higher upside return potential. ➢ Higher risk, higher return for shareholders ➢ increase its borrowings, increase returns and default risk Corporate Governance Shareholder vs. Creditor (Debtholder) Interests: The debt/equity conflict is greater in the case of long-term rather than sh ort-term: Short term: higher risk higher return 1year same return Long term: higher risk 10 years higher risk shareholder debtholder shareholder easy to selling shares increase default risk debtholder Corporate Governance Principal–agent relationship: ➢ is created when principal hires an agent to perform a particular task or service. Principal–agent relationship Shareholders (the principal) elect directors (an agent) who are expect ed to protect their interests by appointing senior managers (another agent) to run the company. Corporate Governance Principal–agent relationship: Asymmetric information Managers have more information about a company’s performance and prospects (including future investment opportunities) than is available to outsiders, such as owners and creditors. Corporate Governance Principal–agent relationship: Asymmetric information ➢ decreases the ability of shareholders to assess the true performance of manager and directors. ➢ weaken shareholders ability to vote out poor performers. Corporate Governance Principal–agent relationship: Asymmetric information ➢ decreases the ability of shareholders to assess the true performance of manager and directors. ➢ weaken shareholders ability to vote out poor performers. Corporate Governance Principal–agent relationship: Compensation Mechanisms ➢ grants of shares and options to purchase shares in the company) ➢ motivate managers to work hard to maximize shareholder value. Corporate Governance Principal–agent relationship: Conflicts between the principal and agent ➢ In practice, compensation is the main tool used to create alignment of interests between management and shareholders Corporate Governance Principal–agent relationship: Entrenchment ➢ overall level of board director or manager compensation, or tenure, is excessive. ➢ risk motivated by a vested interest in keeping one’s position. Corporate Governance Principal–agent relationship: Empire building ➢ When director and management compensation are high and tied to the size of the business, “growth for growth’s sake” ➢ managers are motivated to pursue tasks that might not increase shareholder value. Corporate Governance Principal–agent relationship: Excessive risk taking ➢ compensation relying on stock grants and options ➢ can motivate risk-taking behavior by management, participate only in upside share price moves. Corporate Governance Board of Director Mechanisms: ➢ The board is a central component of a company’s governance structure. ➢ has the responsibility to review any proposals for corporate transactions capital acquisitions, mergers, and acquisition…. Corporate Governance Board of Director Mechanisms: Board Committees ➢ boards establish committees to which they delegate specific functions within their areas of specialization. ➢ provide recommendations/reporting to the board regularly. Board of Director Mechanisms Common Board Committees and Key Oversight Functions Corporate Governance Board of Director Mechanisms: Audit Committee ➢ overseeing the audit and control systems at the company and ensuring their effectiveness. ➢ Best practice for audit committee composition is for all members to be independent. Corporate Governance Board of Director Mechanisms: Audit Committee ➢ recommending the appointment of a competent and independ ent external auditor and proposing its remuneration. Corporate Governance Board of Director Mechanisms: Audit Committee ➢ monitoring the financial reporting process ➢ supervising the internal audit function, annual audit plan, and annual review. Corporate Governance Board of Director Mechanisms: Governance Committee ➢ to ensure company adopts good corporate governance structures and practices. Corporate Governance Board of Director Mechanisms: Governance Committee ➢ to ensure company adopts good corporate governance structures and practices. Corporate Governance Board of Director Mechanisms: Governance Committee ➢ oversees the development of the governance policies 1. corporate governance code, 2. charter of the board and its committees, 3. code of ethics, and conflict of interest policy, among others. Corporate Governance Board of Director Mechanisms: Remuneration or Compensation Committee ➢ developing director and executive remuneration policies, ➢ overseeing performance policy management and evaluation ➢ setting policies relating to employee compensation. Corporate Governance Board of Director Mechanisms: Remuneration or Compensation Committee Remuneration packages that are designed to prevent managers chasing short-term profits are likely to be most effective and aligned with long-term shareholder interests. Remuneration or Compensation Committee HSBC Holdings plc Annual Report and Accounts 2022 Remuneration or Compensation Committee HSBC Holdings plc Annual Report and Accounts 2022 Corporate Governance Board of Director Mechanisms: Remuneration or Compensation Committee Remuneration packages that are designed to prevent managers chasing short-term profits are likely to be most effective and aligned with long-term shareholder interests. Corporate Governance Board of Director Mechanisms: Nomination Committee ➢ nomination of directors to the board and election process ➢ overseeing performance policy management and evaluation ➢ identifying senior leadership candidates ➢ maintaining board composition and independence Corporate Governance Board of Director Mechanisms: Risk Committee ➢ determining company risk profile ➢ appropriate enterprise risk management ➢ aligning corporate activities with risk appetite Corporate Governance Board of Director Mechanisms: Investment Committee ➢ assessing of major investment opportunities ➢ evaluating board investment recommendations Corporate Governance Board of Director Mechanisms: Investment Committee ➢ assessing of major investment opportunities ➢ evaluating board investment recommendations Corporate Governance • What is the Corporate Governance? • Shareholder vs. Creditor (Debtholder) Interests • Principal–agent relationship • Compensation Mechanisms • Board of Director Mechanisms
