Corporate Financial Strategy
4th edition
Dr Ruth Bender
Chapter 6
Corporate governance and financial
strategy
Corporate Financial Strategy
Corporate governance and financial strategy: contents
 Learning objectives
 Illustrative stages in the ownership life cycle
 Changing role of corporate governance over the ownership life cycle
 Indicative attributes of lack of independence in a director
 Problems with performance measures in executive pay
 EPS growth as a target in different growth scenarios
 Control enhancement mechanisms (CEMs)
 Control enhancement mechanisms (CEMs)
 Structures of control: the Pyramid
 Structures of control: Indirect control
 Case study 6.3: Hollinger control structure
 Corporate governance mechanisms and the minority shareholder
 Corporate governance mechanisms and the lender
 Corporate responsibility and the drivers of value
Corporate Financial Strategy
2
Learning objectives
1. Apply a model to determine which aspects of corporate governance
are most relevant at different stages of a company’s life cycle.
2. Recognize the limitations of different types of executive remuneration
plan, and evaluate how their performance measures link to the
creation of value.
3. Understand and explain how differences in corporate governance
regimes can affect the financing strategies of companies in those
jurisdictions.
4. Contrast the different mechanisms by which block-holders can control
a company, and explain the impact, positive and negative, that this
can have.
5. Explain why stakeholders merit consideration in a discussion of
financial strategy.
Corporate Financial Strategy
3
Illustrative stages in the ownership life cycle
Agency problems
and
accountabilities
increase lower
down the pyramid
Sole trader
Partnership
Ltd company owned by management
Ltd company owned with close
associates
Ltd company with private equity
investors
Ltd company owned by the public
Corporate Financial Strategy
4
Changing role of corporate governance over the ownership
lifecycle
Sole trader
Agency
problems
None
Internal control
& reporting
Partnership
Ltd company
owned by mgt
None until organization size
requires delegation
Manage the money
Manage employees
Regular accounts
External
reporting
Not required
Ltd company owned
by associates
Ltd company
with private
equity
investment
Ltd company
with wide
ownership
Some
Some
Many
Division of duties and formalised internal controls.
Sophisticated reporting systems.
Reporting to outside shareholders.
(All increase as the business develops)
May need to file
accounts
Reporting to
investors
Reporting to
investors, and
possibly to
regulators
Extensive
reporting
External audit
No need
Optional
Compulsory in
some regimes
Generally required
by investors
Generally
compulsory /
demanded by
investors
Compulsory
Management
and direction
Self
Partners
Directors
Management and
investors
Management,
with input from
PE investors
Professional
mgrs & NEDs
Management
remn
To suit self
and
business
needs
To suit partners
and business
needs
To suit owners
and business
needs
Agree with external
investors
Agree with
investors; will
include equity
as incentive to
grow capital
and exit
Agree with
external
investors and
governance
regulations
Corporate Financial Strategy
5
Indicative attributes of lack of independence in a director
 Has been an employee or executive of the company or a related
company in the past X years.
 Is a close family member of a director of the company or a related
company.
 Has had a significant business relationship with the company in the past
Y years.
 Is a professional adviser to the company, or has some other business
relationship.
 Represents a block shareholder or a major lender to the company, or
has significant business transactions with same.
 Holds cross-directorships with other members of the company’s board.
 Participates in the company’s pension scheme or share option scheme.
 Has served on the board continuously for more than Z years
Corporate Financial Strategy
6
Problems with performance measures in executive pay
Profit, earnings per
share, and eps growth
Accounting policies can be chosen selectively
Use of debt distorts eps
Investment requirements can distort figures
Risk is not taken into account
Dividend policy vs. share buybacks can distort
Does profit clearly relate to shareholder value?
Return on Capital
Employed
All issues as per eps, etc.
Distorted over project life
Affected by company’s growth rate
Effects of inflation can distort
Not comparable to ‘cost of capital’
Total shareholder return
(TSR)
Is the share price a good measure for exec
performance?
Complex for execs to understand
Treadmill of expectations
Non-financial measures
Quality of information? (not audited)
Subjective?
Perception of ‘soft’ measures
Corporate Financial Strategy
7
EPS growth as a target in different growth scenarios
eps growth of RPI+X% is a
commonly used base measure
eps growth does not necessarily
lead to shareholder value!
High plc
Share price
P2
Low plc
P1
P0
T1
Now
Corporate Financial Strategy
8
Time
Control enhancement mechanisms (CEMs)




CEMs which work by giving block-holders enhanced voting rights
Shares with multiple voting rights
Non-voting shares
Pyramid structures




CEMS which lock in control
Priority shares with veto rights over certain decisions
Voting rights ceilings (which limit voting power regardless of how many shares are owned)
Ownership ceilings (which prevent transfer of shares to owners if they would take the holding
above a certain percentage)
 Golden shares (often used by governments in sensitive privatized companies)
 Source: Report on the Proportionality Principle in the European Union Available via
 http://ec.europa.eu/internal_market/company/shareholders/indexb_en.htm
 At the time of writing, the EU is considering giving additional voting rights and dividends to
investors holding shares for a period of years, with the aim of encouraging long-term investment.
Corporate Financial Strategy
9
Control enhancement mechanisms (CEMs)
CEMs which work by giving
block-holders enhanced voting
rights
 Shares with multiple voting rights
 Non-voting shares
 Pyramid structures
Source: Report on the Proportionality
Principle in the European Union Available
via
http://ec.europa.eu/internal_market/compa
ny/shareholders/indexb_en.htm
Corporate Financial Strategy
CEMS which lock in control
 Priority shares with veto rights over
certain decisions
 Voting rights ceilings (which limit
voting power regardless of how many
shares are owned)
 Ownership ceilings (which prevent
transfer of shares to owners if they
would take the holding above a
certain percentage)
 Golden shares (often used by
Governments in sensitive privatized
companies)
10
Structures of control: the Pyramid
Controlling
shareholder
51%
Holding 2
51%
Holding 1
51%
Target
Control is obtained through
ownership of 13.3% of the
shares
Corporate Financial Strategy
11
Structures of control: Indirect control
90%
Controlling
shareholder
Holding
15%
36%
Target
Control is obtained through
ownership of 47.4% of the
shares
Corporate Financial Strategy
12
Case study 6.4: Hollinger control structure
Black and Radler together
control 79.2% of Ravelston,
which in turn owned 78.2% of
HLG, so their combined indirect
ownership interest in HLG was
approximately 62%. In turn, HLG
owned a 30.3% interest in
Hollinger. Through HLG, Black
and Radler’s indirect ownership
interest in Hollinger was
approximately 19%. Thus, every
$100 transferred out of Hollinger
and into HLG ‘cost’ Black and
Radler $19 but gave them $62,
thereby tripling their funds at the
direct expense of the Hollinger
common stockholders other than
HLG.
Extract and diagram are from page 8 of the
Report of the Special Committee of Hollinger
http://www.sec.gov/Archives/edgar/data/868512/
000095012304010413/y01437exv99w2.htm
Corporate Financial Strategy
13
Corporate governance mechanisms and the minority shareholder
Reducing risk for minority
shareholders
Increasing risk for minority
shareholders
 Ability to vote on all resolutions, including  Control enhancement mechanisms
voting directors onto or off the board
(CEMs) such as certain shares carrying
multiple votes, or no votes, or ceilings on
 Ease of voting
voting rights, or vetoes in certain
 Legal mechanisms for minority
situations
shareholders to take action against
oppression by the majority or against
expropriations by management
 Laws or codes protecting the minority
during a takeover
 Laws protecting against insider trading
 Requirement for independent nonexecutive directors on the board
 Requirement for high levels of relevant
financial and non-financial disclosures, for
example details of transactions with
related parties
Corporate Financial Strategy
14
Corporate governance mechanisms and the lender
Reducing risk for lenders
Increasing risk for lenders
 Ease of ability of a lender to enforce
 Bankruptcy laws that leave the existing
their security to repossess assets if loan
executives in control of the company
terms are breached
rather than letting creditors put in their
own management
 Strong legal protection over property
rights, including intellectual property
 Bankruptcy laws that enable
rights (so that the company’s assets
management to protect the company
cannot be expropriated)
against creditor claims
 Priority of social or government claims
over the rights of secured lenders
Corporate Financial Strategy
15
Corporate responsibility and the drivers of value
Driver of value
Some examples of driving performance through
sustainability
Grow sales faster
Innovative products to meet sustainability needs.
Attract customers by corporate responsibility stance.
Better workforce efficiency by treating people better: attract
better people, more training, less absenteeism, lower staff
Increase operating profit margin
turnover.
Efficiencies due to energy and waste management.
Reduce cash tax rate
Fewer fixed assets
Less working capital
Possibly take advantage of incentives.
Improved efficiencies.
Reduced waste leading to reduced inventory.
Better supply chain practices as companies work in
coordination.
Increase the period for which
the organisation has a
competitive advantage
Increased brand equity in the sustainable company.
Compliance leads to legitimacy which extends the ‘licence to
operate’.
Lower cost of capital
Investors perceive lower risk in companies that are
compliant with ‘best practice’ governance regulations.
Corporate Financial Strategy
16