Corporate Governance
A global perspective
By Marc Goergen
Table of contents
Part 1 – Introduction to corporate governance......................................................................................1
Chapter 1 – Defining corporate governance and key theoretical models...........................................2
Chapter 2 – Corporate control across the world................................................................................6
Chapter 3 – Control versus ownership rights......................................................................................7
Part 2 – Macro corporate governance..................................................................................................10
Chapter 4 – Taxonomies of corporate governance systems.............................................................10
Chapter 5 – Corporate governance, types of financial systems and economic growth....................13
Chapter 6 – Corporate governance regulation in an international context......................................15
Part 3 – Improving corporate governance............................................................................................17
Chapter 7 – Board of directors.........................................................................................................17
Chapter 8 – Incentivizing managers and disciplining of badly performing managers.......................19
Chapter 9 – Corporate governance in emerging markets.................................................................22
Chapter 10 – Contractual corporate governance.............................................................................24
Chapter 11 – Corporate governance in initial public offerings.........................................................27
Chapter 12 – Behavioral biases and corporate governance.............................................................30
Part 4 – Corporate governance and stakeholders................................................................................33
Chapter 13 – Corporate social responsibility and socially responsible investment..........................33
Chapter 14 – Debtholders.................................................................................................................34
Chapter 15 – Employee rights and voice across corporate governance systems..............................36
Chapter 16 – The role of gatekeepers in corporate governance......................................................38
Part 1 – Introduction to corporate governance
,Chapter 1 – Defining corporate governance and key
theoretical models
Stocks/charges
Certificates of ownership and they also frequently have control rights (voting rights), which enable
their holders (shareholders) to vote at the annual general shareholders’ meeting (AGM)
Rights of voting shares
1. Appoint the members of the board of directors
Board of directors
Ultimate governing body within the corporation
Look after the interests of all the shareholders as well as those of stakeholders
Roles of non-executives
1. Monitor the firm’s top management
2. Provide advice
Corporate governance
The ways in which suppliers of finance to corporations assure themselves of getting a return on their
investment
OR
A corporate governance system is the combination of mechanisms which ensures that the manager
(the agent) runs the firm for the benefit of one or several stakeholders (principals). Such stakeholders
may cover shareholders, creditors, supplier, clients, employees and other parties with whom the firm
conducts its business
This definition differs on the kind of view of the firm, which interest are they seeking to
maximize
o Anglo-American firms maximize shareholder value (Shareholder primacy)
o Firms in other countries maximize all of the firm’s stakeholder interests
The definition we use in the book is; The latter deals with conflicts of interests, and their prevention
of mitigation
Conflicts of interests
Shareholders – Managers
Shareholder – Debtholders
Shareholders – Non-financial stakeholders
Different types of shareholders (Mainly the Large shareholder – Minority shareholder)
Definition of corporate governance following the Cadbury Report; the system by which companies
are directed and controlled
Principal – agent theory
2
,The agent has been asked by the principal to carry out a specific duty, the agent may not act in the
best interest of the principal once the contract between the two parties has been signed and may
prefer to pursue his own interest.
Problem of moral hazard
The fact that once the contract has been signed it may be in the interests of the agent to behave
badly or at least less responsibly, in ways that may harm the principal while clearly serving the
interest of the agent.
Complete contracts
Contract which specify exactly what:
The managers must od in each future contingency of the world
What the distribution of profits will be in each contingency
Potential way to mitigate/avoid principal – agents problems
Such contracts will never exist, as;
- It is impossible to predict all future contingencies of the world
- Such contracts would be too complex to write
- They would be difficult or even impossible to monitor and reinforce by outsiders such as a
court of law
Asymmetric information
Situations where one party, the one that agrees to carry out a certain duty or agrees to behave in a
certain way (the agent), has more information than the other party (the principal).
If this would not occur, NO moral hazard
These problems start to occur when the separation of ownership and control happens
Control the managers who run the day-to-day operations
Ownership shareholders
Agency costs
Sum of monitoring expenses + bonding costs + residual loss
Monitoring
The principal observing the agent and keeping a record of latter’s behavior and intervening in various
ways to constrain the agent’s behavior and to avoid unwanted actions
Bonding costs
Cost incurred by the agent in order to signal credibly to the principal that they will act in the interests
of the latter
Principal invests in the latter’s firm
Residual loss
The loss incurred by the principal due to the fact that the agent may still make some decisions that
do not maximize the value of the firm for the former and which are not prevented by monitoring and
bonding
Agency problems (between managers and shareholders)
3
, Perquisites (perks / fringe benefits)
On the job consumption by the firm’s managers
Benefits for managers and costs for shareholders
EXAMPLE: expensive offices, private use of corporate jets, CEO mansions, giving jobs to family
Empire building (Free Cash Flow problem)
The management pursuing growth rather than shareholder value maximization
Growth does not necessarily maximize shareholder value (and vice versa)
Also investing in negative NPV projects
One should only invest in positive NPV projects (projects whose future expected cash flow exceed
their initial investment outlay), any cash that remains is called the free cash flow. Investing in
negative NPV projects would destroy the shareholder value, because their expected cash flows are
lower than the initial investment outlay.
EXAMPLE: acquiring other firms
Refusal of the company’s management to pay out the free cash flow when there are no
positive NPV projects available
This problem occurs because managers derive benefits from increasing the size of their firm.
Managers derive benefits from engaging in growth strategies, whereas the costs are borne
by the shareholders.
Managerial entrenchment
Managers shield themselves from hostile takeovers and internal disciplinary actions, which may also
be a consequence of the principal-agent problem or from the presence of family control (positions
are transferred to following generations rather than to the best suited candidate)
‘quiet life’ / managerial shirking
Managers avoid cognitively difficult actions they underinvest, avoid closing down unprofitable
projects and stay clear of other improvements in firm efficiency
Managerial risk aversion
Managers are reluctant to invest in risky, but shareholder value enhancing projects.
This problem occurs because managers are heavily exposed to firm-specific risk as all their human
capital is invested in the firm, while that of the shareholders is diversified
Shareholders tend to have diversified portfolios, while managers hold undiversified portfolios
MITIGATING agency problems;
Monitoring
Bonding
Managerial incentive setting
Agency problems (related to debt and equity)
4
A global perspective
By Marc Goergen
Table of contents
Part 1 – Introduction to corporate governance......................................................................................1
Chapter 1 – Defining corporate governance and key theoretical models...........................................2
Chapter 2 – Corporate control across the world................................................................................6
Chapter 3 – Control versus ownership rights......................................................................................7
Part 2 – Macro corporate governance..................................................................................................10
Chapter 4 – Taxonomies of corporate governance systems.............................................................10
Chapter 5 – Corporate governance, types of financial systems and economic growth....................13
Chapter 6 – Corporate governance regulation in an international context......................................15
Part 3 – Improving corporate governance............................................................................................17
Chapter 7 – Board of directors.........................................................................................................17
Chapter 8 – Incentivizing managers and disciplining of badly performing managers.......................19
Chapter 9 – Corporate governance in emerging markets.................................................................22
Chapter 10 – Contractual corporate governance.............................................................................24
Chapter 11 – Corporate governance in initial public offerings.........................................................27
Chapter 12 – Behavioral biases and corporate governance.............................................................30
Part 4 – Corporate governance and stakeholders................................................................................33
Chapter 13 – Corporate social responsibility and socially responsible investment..........................33
Chapter 14 – Debtholders.................................................................................................................34
Chapter 15 – Employee rights and voice across corporate governance systems..............................36
Chapter 16 – The role of gatekeepers in corporate governance......................................................38
Part 1 – Introduction to corporate governance
,Chapter 1 – Defining corporate governance and key
theoretical models
Stocks/charges
Certificates of ownership and they also frequently have control rights (voting rights), which enable
their holders (shareholders) to vote at the annual general shareholders’ meeting (AGM)
Rights of voting shares
1. Appoint the members of the board of directors
Board of directors
Ultimate governing body within the corporation
Look after the interests of all the shareholders as well as those of stakeholders
Roles of non-executives
1. Monitor the firm’s top management
2. Provide advice
Corporate governance
The ways in which suppliers of finance to corporations assure themselves of getting a return on their
investment
OR
A corporate governance system is the combination of mechanisms which ensures that the manager
(the agent) runs the firm for the benefit of one or several stakeholders (principals). Such stakeholders
may cover shareholders, creditors, supplier, clients, employees and other parties with whom the firm
conducts its business
This definition differs on the kind of view of the firm, which interest are they seeking to
maximize
o Anglo-American firms maximize shareholder value (Shareholder primacy)
o Firms in other countries maximize all of the firm’s stakeholder interests
The definition we use in the book is; The latter deals with conflicts of interests, and their prevention
of mitigation
Conflicts of interests
Shareholders – Managers
Shareholder – Debtholders
Shareholders – Non-financial stakeholders
Different types of shareholders (Mainly the Large shareholder – Minority shareholder)
Definition of corporate governance following the Cadbury Report; the system by which companies
are directed and controlled
Principal – agent theory
2
,The agent has been asked by the principal to carry out a specific duty, the agent may not act in the
best interest of the principal once the contract between the two parties has been signed and may
prefer to pursue his own interest.
Problem of moral hazard
The fact that once the contract has been signed it may be in the interests of the agent to behave
badly or at least less responsibly, in ways that may harm the principal while clearly serving the
interest of the agent.
Complete contracts
Contract which specify exactly what:
The managers must od in each future contingency of the world
What the distribution of profits will be in each contingency
Potential way to mitigate/avoid principal – agents problems
Such contracts will never exist, as;
- It is impossible to predict all future contingencies of the world
- Such contracts would be too complex to write
- They would be difficult or even impossible to monitor and reinforce by outsiders such as a
court of law
Asymmetric information
Situations where one party, the one that agrees to carry out a certain duty or agrees to behave in a
certain way (the agent), has more information than the other party (the principal).
If this would not occur, NO moral hazard
These problems start to occur when the separation of ownership and control happens
Control the managers who run the day-to-day operations
Ownership shareholders
Agency costs
Sum of monitoring expenses + bonding costs + residual loss
Monitoring
The principal observing the agent and keeping a record of latter’s behavior and intervening in various
ways to constrain the agent’s behavior and to avoid unwanted actions
Bonding costs
Cost incurred by the agent in order to signal credibly to the principal that they will act in the interests
of the latter
Principal invests in the latter’s firm
Residual loss
The loss incurred by the principal due to the fact that the agent may still make some decisions that
do not maximize the value of the firm for the former and which are not prevented by monitoring and
bonding
Agency problems (between managers and shareholders)
3
, Perquisites (perks / fringe benefits)
On the job consumption by the firm’s managers
Benefits for managers and costs for shareholders
EXAMPLE: expensive offices, private use of corporate jets, CEO mansions, giving jobs to family
Empire building (Free Cash Flow problem)
The management pursuing growth rather than shareholder value maximization
Growth does not necessarily maximize shareholder value (and vice versa)
Also investing in negative NPV projects
One should only invest in positive NPV projects (projects whose future expected cash flow exceed
their initial investment outlay), any cash that remains is called the free cash flow. Investing in
negative NPV projects would destroy the shareholder value, because their expected cash flows are
lower than the initial investment outlay.
EXAMPLE: acquiring other firms
Refusal of the company’s management to pay out the free cash flow when there are no
positive NPV projects available
This problem occurs because managers derive benefits from increasing the size of their firm.
Managers derive benefits from engaging in growth strategies, whereas the costs are borne
by the shareholders.
Managerial entrenchment
Managers shield themselves from hostile takeovers and internal disciplinary actions, which may also
be a consequence of the principal-agent problem or from the presence of family control (positions
are transferred to following generations rather than to the best suited candidate)
‘quiet life’ / managerial shirking
Managers avoid cognitively difficult actions they underinvest, avoid closing down unprofitable
projects and stay clear of other improvements in firm efficiency
Managerial risk aversion
Managers are reluctant to invest in risky, but shareholder value enhancing projects.
This problem occurs because managers are heavily exposed to firm-specific risk as all their human
capital is invested in the firm, while that of the shareholders is diversified
Shareholders tend to have diversified portfolios, while managers hold undiversified portfolios
MITIGATING agency problems;
Monitoring
Bonding
Managerial incentive setting
Agency problems (related to debt and equity)
4
