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3.0. Corporate Governance Conflicts, mechanism, risks, and benefits -…
3.0. Corporate Governance
Conflicts, mechanism, risks, and benefits
Principal - agent conflict
Definition
The principal - agent conflict (or agency relationship) is created when one party (a principal) hires another party (an agent) to perform a task or service and can be present with or without a contract govening the relationship
Conflicts of interest between shareholders and managers/directors
Business risks
Insufficient effort
: Managers may be unable or unwilling to make investments, manage costs appropriately, or make hard decisions
Inappropriate risk appetite
: Getting
option grants
motivate excessive management risk-taking because options do not have any downside risk; but
compensated cash
may be
inadequately motivated to take risk
Empire building
: Management compesation and status are typically tied to business size
Entrenchment
- Cố thủ: Directors and managers want to retain their jobs, so copying competitors and peers, avoiding risks, and pursuing complicated transactions and restructurings that they are uniquely suited to manage
Self-dealing
- tự giao dịch để làm ảo kết quả tài chính: exploit firm resources to maximize personal benefits (excessive perquisites) or defraud investors by misappropriating assets
Information asymmetry
Managers and directors have
more and better information
about the functioning and strtegic direction of the firm than shareholders -> manager may make strategic decisions that are not necessarily in the best interest of shareholders
=> weaken the ability of shareholders to exercise control
Agency cost:
which can be direct, such as the costs of hiring monitoring agents (BOD) or indirect, like the forgone profits and economic benefits of lost opportunities
Conflicts between groups of sharehodlers
Definition
Dispersed ownership
: involves many sharehodlers, none of whom can exercise control over the corporation
Concentrated ownership
: involves controlling and non-controlling sharehoders
Conflict of interest
Controlling shareholders: can exercise control over the corporation
a long-term shareholder with a multi-year or multi-decade perspective
Non-controlling/Minority shareholders
focus on maximizing shareholder value, seek quick gains from cost cutting, selling assets, or share repurchases
Action
Takeover transaction
: Controlling shareholders may be in a position to get better terms for themselves relative to the terms forced on minority shareholders
Related - party transaction
: Controlling shareholder arranges a deal between the company and a third-party supplier owned by the shareholder's spouse whereby the supplier provides the company with inventory at above-market prices
=> benefit the controlling shareholder and the spouse's interests
=> harm the profitability of the company and the interest of minority sharehoders
Voting structure
Single-class structure with straight voting
One vote for each share owned
Controlling shareholders is the ones who have more shares of the firm
Dual - class structure
One clase carries one or less than
one vote per share
, and the other (founders, insiders...) have
several votes per share
Controlling shareholders is the ones who have the superior voting power, not the ones who have more shares
Conflict between shareholders and creditors
A divergence (phân kỳ) in
risk tolerance
regarding the company's investments between shareholders and creditors
Shareholders would likely prefer
riskier
projects with a strong likelihood of higher return potential
Creditors would like prefer
stable
performance and
lower-risk
activities
If the distribution of excessive dividends to shareholders impairs the company's ability to pay interest and principal -> conflict with creditors' interest
Corporate governance mechanisms
(1) Corporate reporting and transparency
Mechanism
Investors have access to a
public company's
financial and non-financial information through annual reports, proxy statements, company disclosures, investor relation resources, and other sources. Required annual FS
must be audited
Private companies
disclose information to the public only to the extent required by regulations or voluntarily, may disclose to their investors with negotiation form, not standardized form.
Not required
audited annual FS
Implications
Investors rely on corporate reports and information to:
Assess company performance and that of its directors and managers
Vote on key corporate matters or changes
Ensure compliance with legal commitments in debt contracts
Make valuation and investment decisions
(2) Shareholder mechanism
Shareholder meetings
a. Annual general meetings (AGMs)
Held once a year, enable shareholders to
participate in discussion
and to
vote
on major corporate matters and transactions that are not delegated to the BOD
b. Extraodinary general meetings (EGMs)
Called when other resolutions requiring shareholder approval are proposed, or when requested by a specified minimum number of calling shareholders
Shareholders unable to attend a meeting in person usually authorize another party to vote on their behalf in a
proxy voting
process
Voting
Proxy voting
When shareholders are unable to attend a meeting -> they can authorize their voting rights to another one
Cumulative voting (>< straight voting)
Shareholders have the ability to
accumulate and vote all their shares
for a single candidate in an election involving more than one director
Implications
Shareholders can better monitor the company through a direct exchange of information
Mitigating agency problems and their associated risks
Shareholder activism
Mechanism
Shareholder activism
involves investor strategies to
compel a company to act in a desired manner
Activists often pressure management using tactics such as initiating proxy fight, proposing shareholder resolution, and publicizing issues of contention
Hedge funds are among the most predominant shareholder activist
Implication
The primary motivation of activist shareholders is to
increase shareholder value
Direct corporate engagement and stewardship (sự quản lý) to
promote positive corporate action
Shareholders Litigation
Shareholder activists may pursue additional tactics, such as litigation or lawsuits
In many countries, laws restrict shareholders from pursuing legal action by either imposing minimum sharehoder interest threholds for such lawsuits or prohibiting them altogether
Corporate takeovers
Mechanism
Proxy fight/ contest
A group seeking a controlling position on a company's BOD attemps to persuade shareholders to vote for the group
Tender offer
Offer involves an invitation to shareholders to sell their interests directly to a group seeking to gain control
Hostile takeover
Acquire a company without the consent of company management
Implication
Senior managers & BOD have an incentive to focus on
shareholder wealth maximization
to preserve their position status
Negative implications
for a company's corporate governance practices if the company choose to adopt
anit-takeover measures: straggered board, Poison pill
- Low-price additional share offerings to current share holders
(3) Creditor mechanism
Mechanism
Bond indenture
Covenants: are the terms and conditions of lending agreements within the indenture, require the company to take certain actions or restrict it from taking certain actions
Collaterals: Offering of assets or financial guarantees against which the bondholders will have a claim if the company defaults
Creditor commitees
Ad hoc committee: A group of bond investors form when a company is struggling to meet its obligations to approach the company with potential options to restructure their bonds
(4) Board and management mechanism
Board structure
One-tier board
singe BOD that includes: internal (excutive) and external (non-executive) directors
2-tier board
Supervisory board
Management board (made up of executive directors)
Staggered board
BOD divided into 3 classes that are elected separately in consecutive yrs - one class every yr:
Negative aspect
: need several yrs to replace a full board
=> limit their ability to effect a major change of control at the companhy
Positive aspect
: provides continuous implementation of strategy and oversight without constantly being reassessed by new board members thereby bringing short-termism into company stratergy
Mechanism
BOD
Duty of the board member is elected by shareholders to
act in their interests:
Engage in the company's day-to-day activities, which are delegated to
management
Ensure the effectiveness of the company's
audit and control system
Ensure the company has an appropriate enterprise
risk management system
BOD gồm 3 ban nhỏ
(1) Audit committee
Monitoring the financial reporting process
Supervising the internal audit function, annual audit plan
Appointing and interacting with an external auditor
(2) Governance / Nominations Committee
Governance
Developing, monitoring corporate governance policies, practices
Ensuring organizational compliance and remediation with applicable laws and regulations
Aligning organizational structure with governance principles
Nominations
Overseeing the director nomination and board election process
Identifying senior leadership candidates
Maintaining board composition and independence
(3) Compensation/ Remuneration Committee
Developing director and executive remuneration policies
Overseeing performance policy management and evaluation
Setting human resources (HR) policies relating to employee compensation
(4) Other
Risk/ Investment Committee
Risk
Determining company risk profile
Ensuring appropriate enterprise risk management
Aligning corporate activities with risk appetite
Investment
Assessing of major investment opportunities
Evaluating board investment recommendation
(5) Employee Mechanism
Mechanism
(3) Employment contrasts: for the individual and outline the employee's rights and responsibilities; they are not all encompassing, leaving some discretion within the relationship
(4) Other items such as the code of ethisc and HR documents are intended to outline the relationship in order to manage and mitigate any legal or reputational risks
(2) Union: advocate on behalf of members to influence certain matters affecting employees, such as compensation and working conditions
(5) Employee stock ownership plan (ESOP) to help retain employees and align their interest with company
(1) Labor law: define the standards for employees' rights and responsibilites and cover such matter as work hours, post-employment, health care and other benefit coverage, and paid leave
Implication
Employers and employees can determine clearly about their rights and resposibilities:
A company seeks to comply with employees' rights and
mitigate legal or reputational risks
in violation of these rights
Ensure that employees are fulfilling their responsibilities toward the company and are qualified and motivated to act in the company's best interest
(6) Customer and supplier mechanism
Mechanism
Specify the products and services underlying the relationship, the prices or fees and the payment terms, the rights and responsibilites of each party, the after-sale relationship, and any guarantees
Specify actions to be taken and recourse available if either party breaches the terms of the contract
Implication
Mitigate legal risks and reputational risks in violation of these rights and responsibilities
Ensure the customers and suppliers to comply with their responsibilites toward the company
(7) Government
Mechanism
The gov and regulators seek to protect the public through developing laws and monitoring compliance. Regulations vary by industry and increase with the level of risk that the public is exposed to
In some countries, regulators develop
corporate governance codes
that companies must either adopt or explain why they have not done so
In some countries, corporate governance regulations are specified by stock exchanges as part of their listing requirement
Implication
Companies normally seek to
adopt internal governance
and
compliance procedures
and
adhere to the relevant financial reporting
and
transparency requirements
imposed by regulators
Corporate governance risks and benefits
P.16-17 vở
Operational risks and benefits
Legal, regulatory, reputational risks and benefits
Financial risks and benefits