Please enable JavaScript.

Coggle requires JavaScript to display documents.

Introduction (4 & 5) Aligning incentive, Incomplete contract (Role of…

- - - - Employment Contracts and Incentives
        •Level of effort depends on marginal benefit and not level of pay
        •Firm can increase the commission rate and lower the base pay to increase profits
        •Optimum base pay can even be negative (as in the case of franchises)
        •Performance-based pay allows the employee to exploit his/her private information
        –Firm knows little about individual customers but sales staff do.
        –Without incentives, saleperson has no incentive to move on to more likely buyers
        –With incentives, sales person will focus effort on most likely buyers.
  - - - Factors Affecting High Powered incentives
        •Favours HIGH powered incentives because‘better value’for principal.
        –Low risk-aversion > low premium for risk
        –Low effort aversion > low premium for effort
        –High marginal contribution of effort > big payoff for extra work because of incentive payment
        –Relatively noise free incentives > does not impose excessive risk >Variance of performance measures is low
        •Opposites favour low powered incentives
    - - Selecting Performance Measures
        •A good measure
        –Should not have a huge random component
        –Should encourage desirable activities
        –Should discourage undesirable activities
        •Measures could be
        –Absolute measures
        –Relative measures
        •Relative measures reduce risk due to common effects
        •Relative measures may also encourage sabotage
- - - - Stakeholder Theory Perspective
        •Some versions of stakeholder theory include the environment, animal species and future generations as stakeholders.
        • Accounting rules require impact on stakeholders of corporate decisions to be explained.
        –e.g. The Corporate Report (ASSC,1975) and OFR
        •However, companies have a legal obligation to actin the interests of their clients, assumed to be narrow economic interests.
        •“Instrumental ethics”–Solomon(2007)
        •One may ask, is there a ‘business’ case in relation to stakeholder theory?
  - - - Jensen (2001)
        •if managers take stakeholder goals into account then what objectives must be satisfied and how do we measure them? •There will also be trade-offs between goals. How do we trade-off between goals of various participants?
        –The lack of a single objective may cloud the best way to efficiently run the company.
        •And if managers are balancing stakeholder goals with shareholder goals then how do we make them accountable? •Instead Jensen suggests the goal should be ‘enlightened value maximisation’ where the goal of the company is Long Run Value Maximisation and all short term stakeholder trade-offs should be made using this criterion.
      - Stakeholder Models •Germany
        –Boards of 20+.
        –Bankers on boards (3 or 4).
        –Employee representation on the board (can’t be removed by shareholders).
        –Sense of ‘duty’ to the community (Charkham, 2007).
        –Cooperation. –Lower cost of capital?
      - •Japan
        –Obligation, Family, Consensus.
        •Whose company is it anyway?
        –Corporate social responsibility
        •Don’t like to downsize
        •Profit isn’t everything
        •Lifetime employment (weakening)
        –Keiretsu
        •Cross-shareholdings, stability, mutual support
        –Lower cost of capital?
      - Sir Adrian Cadbury (1999)
        •“Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals….the aim is to align as nearly as possible the interests of individuals, corporations, and society”.
- - - - Two methods of control
        If they don't like they can leave/exit
        raise Voice
- - - - •Efficient contracts (make sure contract is doing what is suppose to do if not action should be taken against it.)
        •Incentives contracts (i.e. guide employees to the objective of the principle to create the wealth but how would you measure the performance)
        –Executive compensation
        •Boards of Directors (BOD represent the shareholders (principal) and control the action of the management (agents). but the problem is that BOD are made up of the executive director and non-executive director in which executive director are requrit from the company management)
        •Executive Dismissals
        •Debt
        •Accounting and Auditing
        •Disclosure
    - - • Markets (stock market pricing and pressure, turnover and market for the corporate control, product markets, capital markets, management labour market)
        • Regulation (accounitng and auditing rules, legal system and corporate law, corporate governance code, takeover codes,
        • Investors(Shareholder and shareholder democray, blockholders (holding big chunk), family ownership, institutional investors, debtholders,)
- - - - -Different objectives between owners and managers
        -Managers have most of the control rights
        -Owners have most of the cash flow rights
        -The managers (agents) may not act for the interest of the shareholders (principals)
        Governance is about achieving goal congruence, efficient contracts and incentive compatibility to reduce the impact of the separation of ownership from control
    - - Agency theory perspective
        •Dominant academic view?
        •Dispersion of share ownership and separation of ownership and control (Berle and Means,1932).
        •Seen unambiguously as a problem in today’s agency theory
        •“Principal”and“Agent”(Jensen and Meckling, 1976) •Agents do not necessarily make decisions in the best interests of the principal–there is a conflict.
        •Information asymmetry
        •Focus on short terms
        
        Agency Theory Perspective
        •Assumes shareholders interested in pursuit of narrow economic goals
        •Agency costs-monitoring by the shareholder is expensive
        •In finance theory,the objective of business is of ten assumed to be the maximisation of shareholder wealth
        •This perspective is the predominant view in the US and UK, the result of cultural and historical factors (in particular, emphas is given to the market system).
        •It is important to remember that in different countries, with different forms of ownership, different perspectives and objectives are prevalent.
      - The Principal/Agent Framework
        •How does a firm make its employees work to advance the firm’s strategy?
        •The principal/agent framework is useful in addressing this question
        •Framework: Principal hires the agent to take actions that affect the pay off to the principal
        •Principal gets value created by agent’s action minus payment to agent
        •Agent looks at his/her payment less the cost of his/her effort •Conflict arises if there is no mechanism to align the interests of the two parties :check:
        
        How does the Principal (the shareholders) make sure that the Agents (the CEO and senior managers) do what the Principal wants
        when: –perfect information is not available (observability prevents measurement of performance)
        –monitoringis costly (time, money, effort)
        –moral hazard is a problem (agents may act in ways which are not in the interest of the principal)
        •Solutions:
        –Voice -Monitoring and Activism
        –Contracts -efficient contracts, incentive contracts
        –Markets –MCC, managerial labour markets, dismissals
        –Exit –Not happy then sell :check:
        
        Agency Costs
        •Monitoring costs (incurred by Principal) –These methods include auditing, formal control systems, budget restrictions, the establishment of incentive compensation systems which serve to identify the manager’s interests more closely with those of the outside equity holders
        •Bonding costs (incurred by Agent) –such forms as contractual guarantees to have the financial accounts audited by a public accountant, explicit bonding against malfeasance on the part of the manager, and contractual limitations on the manager’s decision-making power –guarantee to the outside equity holders that limit activities
        •Residual loss
        the different between budgeted profit and actual porfit.
        Monitoring costs + bonding costs + Residual costs** :check:**