Please enable JavaScript.
Coggle requires JavaScript to display documents.
Corporate Governance Around the World, Advantages, Disadvantages, (i)…
Corporate Governance
Around the World
Law and Corporate Governance
English common law
Has considerable power to interpret law based on the unique circumstances of each individual case, including other business and commercial dispute situations
Follow the practice and legal precedent set by national courts.
Affects decision-making in extraordinary cases
Outcome cannot be determined based on applicable statutes or written rules of law
French civil law
Derived from the legal system of France and the laws of some continental European countries
French law is the most important and has great influence on the laws of other countries
Based on concepts, categories, and rules derived from Roman law, with some canonical influence, sometimes supplemented or modified largely according to local custom or culture
Civil law describe law concerning people and things and the relationships that develop between them
Comprehensive system of rules and principles that are usually organised by rule and easily accessible to citizens and jurists
Favours cooperation, order, and predictability
Based on a logical and dynamic taxonomy developed from Roman law and reflected in the structure of the codes
Avoid excessive detail, and contains general provisions that allow adaptation to change
Primarily legislative, but still leaves room for the judiciary to adapt the rules to social change and new needs
Corporate Governance Reform
Political Dynamics
It is not easy to change historical legacies
parties
vested interests
resist any attempt to change the status
should
understand the political dynamics surrounding
governance issues
seek help
the media
public opinion
nongovernmental organisations (NGOs)
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002
help protect investors
fraudulent financial statements by companies
required strict reform of existing securities regulations
introduced tough new penalties
who broke the law
address
financial scandals in the early 2000s involving publicly traded companies
The primary goal
to protect investors
improving the accuracy
reliability of corporate disclosures
restoring public confidence
1 more item...
Accounting Regulations
The establishment
overseeing the audit public companies
limit the consulting services
Audit committee
The company
appoint independent
“financial experts”
to its audit committee
Evaluation of Internal Controls:
Public companies
evaluate the effectiveness
preventing fraud
Take the main responsibility
The CEO and finance officials (CEO and CFO)
sign
quarterly
annual financial reports.
The Cadbury Code of Best Practice
The British government
appointed
the Cadbury Commission in 1991
addressing corporate governance
The Cadbury Rules
'Code of Best Practice'
The UK's Cadbury
financial reporting
auditing
recommends
at least three (non-consecutive) external directors.
CEO and COB
two different individuals.
The Dodd-Frank Act
called the Dodd-Frank Wall Street Reform and Consumer Protection Act
regulations
the financial industry
created programs
stop mortgage companies
lenders from taking advantage
Volker rule
Deposit-taking banks
be banned
proprietary trading
from owning
more than a small fraction
2 more items...
Resolution authority
Government
seize
dismantle a large bank
orderly manner
Objectives of Reform
strengthening the independence
enhancing the transparency
disclosure standard
energising the regulatory
monitoring functions of the SEC
stock exchanges.
More than these companies’
failed
auditors
regulators
banks
institutional investors
will damage investor
confidence
stunt the development of capital markets
raise the cost
of capital
distort capital allocation
shake confidence in
capitalism itself
Cadbury Code
The board of directors
meet regularly
retain complete
effective control over the company
oversee management
The head of the company
clearly accepted division
responsibility
The board of directors
include non-executive directors
considerable size
number so that their views carry considerable weight in board decisions.
Consequense of Law
Protection of investors’ rights has major economic consequences
Pattern of corporate ownership and valuation
Component
Capital Markets and Valuation
Investor protection promotes the development of external capital markets
Strong investor protection will be conducive to large capital markets
Well-developed financial markets may stimulate economic growth by making funds readily available for investment at low cost
Enhances savings
Channels savings toward real investments in productive capacities, thereby fostering the capital accumulation
Enhances efficiency of investment allocation through monitoring and signaling functions of capital markets
Weak investor protection can be a factor in sharp market declines
Accelerated expropriation can induce sharp declines in security prices
Private Benefits of Control
Not shared by other shareholders on a pro-rata basis
The voting premium
The total vote value as a proportion of the firm’s equity market value
Dominant shareholders extract substantial private benefits
of control
Block premium
Difference between the price per share paid for the control block and the exchange price after
the announcement of the control transaction, divided by the exchange price after the control transaction
Large shareholders tend to extract significant private benefits of control in those countries
Ownership and Control Pattern
Large shareholders can control and monitor managers effectively and solve the agency problem
No conflicts between large shareholders and small shareholders
Dominant investors may acquire control through various schemes
Shares with superior voting rights
Accumulating superior voting shares, investors can acquire control rights exceeding cash flow rights
Pyramidal ownership structure
Control a holding company that owns a controlling block of another company
Interfirm cross-holdings
Concentrate and leverage voting rights to acquire control
Development of capital markets
Economic growth
The Agency Problem
Shareholders
Shareholders allocate decision-making
authority to the managers
Residual control rights refer to the right to make discretionary decisions under those contingencies that are not specifically covered by a contract
Managers
May allow themselves to consumer exorbitant perquisites
E.g., private jets worth tens of millions of dollars
may also steal investors’ funds
E.g., transfer pricing scheme
Self-interested managers may also waste funds by undertaking
unprofitable projects that benefit themselves but not investors
Managers may also adopt antitakeover measures to ensure personal job security
Managers can exercise substantial discretion over the disposition and allocation of investors’ capital
Investors are no longer assured of receiving fair returns on their funds
Remedies for the Agency Problem
1. Independent board of directors
Definition
An independent director is a member of the board of directors who
(1) do not have a material relationship with the company,
(2) is not part of the company’s executive team, and
(3) is not involved with the day-to-day operations of the company.
Advantages
Is the key to good corporate governance
An independent board with a majority would be better suited to oversee the Chief Executive Officer (CEO) rather than a board consisting of dependent directors
Appointing more independent directors often brings more third-party advice and expertise
Disadvantages
The risk of information asymmetry as independent directors are generally less informed about the company than the management team
In addition, they may not have the requisite skills and knowledge to be an effective board member
2. Incentive contracts
The contract types that is an owner to make an additional compensation to a contractor based on the contractor’s execution performance of cost, schedule, quality, and safety,..
3. Concentrated ownership
The case where majority of shares are held by few owners.
Disadvantages
Advantages
Concentrated ownership is an effective way to reduce the agency problem
Thereby reducing the situation of mistakes or frauds in management and administration
They will favor decisions that enhance long-term performance over decisions with short-term benefits.
When the executives are large shareholders or have large voting rights, they can use their power to influence the decisions of the Board of Directors for personal gain
4. Accounting transparency
The financial reporting process of accounting where companies report their financials to the public.
Advantages
To achieve greater transparency.
Disadvantage
The scandal about accounting transparency
"the collapse of Enron"
Creating products whose sole purpose was to help companies transform their debt into capital or revenue through the use of accounting loopholes, special purpose entities, and poor financial reporting.
5. Debt
A dividend to pay to shareholders
Disadvantages
In turbulent economic conditions, managers do not have such flexibility and the company’s survival can be threatened
The risk-averse managers to forgo profitable but risky investment projects, causing an underinvestment problem
Debt may not be such a desirable governance mechanism for young companies with few cash reserves or tangible assets
Borrowing and the subsequent obligation to make interest payments on time
Debt can be a stronger mechanism than stocks for credibly bonding managers to release cash flows to investors
6. Shareholder activism
"Activist investors”
Who invest in stocks of a company for the explicit purpose of influencing the company’s management, started to play an important role in promoting shareholders’ interests.
Activist shareholders also pursue their social and political agenda
The companies to make commitments to corporate social responsibilities
Get involved in target firms’ strategic, operational, and financial decisions, these firms experience significant share price appreciations
Increase gender and ethnic diversity on the board of directors
7. Overseas stock listings
Companies based in countries with weak investor protection regimes, such as Italy, South Korea, and Russia
They may choose another way to provide better investor protection by listing their shares in countries with strong investor protection regimes, such as the United States and the United Kingdom.
The Eun and Huang study
B-shares and H-shares, is subject to much more stringent disclosure and listing standards.
Institutional investors, may provide more rigorous monitoring of the management.
"Ceteris paribus"
Foreign companies with weak governance may choose to outsource a potential existing corporate governance arrangement in the United States through
cross-listing
.
8. Market for corporate control
A company that is constantly underperforming and all its internal governance mechanisms can't fix the problem.
Another company or investor makes a takeover bid.
The bidder typically makes a tender offer to the target shareholders at a price substantially exceeding the prevailing share price.
Advantages
Offered managers incentive contracts
such as shares and stock options
to reduce arbitrage and better align their interests managers with the interests of investors.
managers can be motivated to run the company in a way that enhances shareholder wealth as well as their own
Disadvantages
Losses to the company if supervisory shareholders are not careful
managers can artificially manipulating accounting numbers
sometimes with the involvement of auditors, or by changing investment policies
they can reap great profits in terms of personal interests
(i) Countries to reform the accounting rules
(ii) Companies to have an active and qualified audit committee.
