CORPORATE FINANCE: A SUSTAINABILITY PERSPECTIVE
Content of the course
>this course aims to develop a framework that will help you to understand firms’ financial
decisions, emphasizing sustainability consideration
It combines most common corporate finance theories with analysis of the most suitable
approach in practical situations
Corporate governance
Capital structure
Payout policies
Valuation Models
Short-term and long-term financing Sustainable finance
Corporate governance
The shareholder model
The stakeholder model
>The normal, sustainable operation of a firm requires balancing the interest of different
groups that are affected directly or indirectly
Corporate governance = is a system of controls, regulations and incentives that make
possible the normal operation of a firm
The size of a company influences the complexity of managing it because it’s important for
more people. Like shareholders, customers, employees, or even society. stakeholder
model
Most of literature on corporate governance is concerned with ensuring that firms operate in
the interest of shareholders
Friedman doctrine : there is one and only one social responsibility of business, to use its
resources and engage in activities designed to increase its profits for so long as it engages in
open and free competition without deception or fraud.
>all in complete free market
If the businessman also has a social responsibility, it must mean that he is to act in some
way that is not in the interest of his employers
According to Friedman, in a competitive economy with complete markets
- Shareholders should choose by themselves
- Firms cannot usurp democratic processes that shape laws and regulations
- Supporting a social cause in detriment of profit is equivalent to raise a tax
- The firm should do what it knows best
- Competition helps keeping the firm on check
>But are markets complete and competitive?
The shareholder model
Shareholders use a mixture of incentives and threats of dismissal to align the interest of the
parties
-in the united states : conflicts between managers and shareholders and prevention of fraud
-in Europe and in emerging economies: conflicts between controlling and minority
shareholders
Conflicts of interest on the shareholder model
Managers and shareholders
- Separation of ownership and control
- Agent (manager) and principal (shareholders) problem
- Incentives are not necessarily aligned
- Information availability is incomplete and asymmetric
,Fiduciary Duty =“ A fiduciary is someone who manages money or property for someone else.
When you are named a fiduciary, you are required by law to manage the person’s money
and property for their benefit, not yours” (CFBP, 2016)
>The fiduciary accepts legal responsibility for duties of care, loyalty, good faith,
confidentiality, and prudence.
The directors of a firm have a fiduciary responsibility to the corporation and the business's
Shareholders
Successful corporate governance requires balancing the costs and benefits of reducing the
agency problem
Actions:
>Monitoring : board of directors, shareholders and/external actors
>Implementing suitable compensation policies
>Facilitate direct intervention by shareholders
>Guaranteeing a balance of power among managers and shareholder
Director board (exist of inside members, outside members and grey members)
-supervises the CEO
-monitoring
-decision making
advising
The outside members
When the board has been captured, monitoring duties by the board may have been
compromised by connections or perceived loyalties to management
How does a board become captured by a CEO? : nomination process, conflicts of interest,
changes in behavior of the board members.
Why separating ownership and management in the first place?
-greater managerial ownership leads to fewer value-reducing actions by the managers
-but is makes managers harder to fire if their performance is not optimal = management
entrenchment
How can we align the interest of managers and shareholders?
How to make sure that the Board is independent?
- Smaller boards are associated with greater firm value and performance
- The longer the CEO serves, the more likely the board is to become captured
- Trade-off between expertise and independence
Compensations policies
>salary in line with competitors (base salary)
>productivity bonus (based on short term financial performance)
>severance pay and golden parachutes
,>provide ownership to executives
- give a direct incentive to increase the stock price
X incentive to manipulate the release of financial forecasts
X many executives have engaged in blackdating their option grants
Does it work?
- Increase agency problems
Increase overconfidence and risk-taking behavior
Inefficiency in payout policies
- Contributes to inequality
The case of pension funds in US
Independency
Negotiating skills
Availability
Expertise
Contributed to inequality
- The case of pension funds in US
Shareholders direct action
Shareholders’ approval/voice : shareholders must approve many major actions taken by the
board (e.g. merger agreements)
Proxy contests : disgruntled shareholders can hold a proxy contest and introduce a rival slate
of directors for election to the board
If everything else fails, shareholders could consider to mount a hostile takeover = sell their
shares to others
An active takeover market is part of the system through which the threat of dismissal is
maintained
Takeover are more likely in the United States then in other countries
Regulation
Should the government intervene to prevent corporate fraud
>some massive failures have impact on the public beyond shareholders
They undermine the public confidence on financial markets, making funding scarce and
expensive
, Some examples : Sarbanes-Oxley Act, Dodd-Frank Act
Sox attempted to achieve goals by:
- Strengthening auditing processes, stiffening penalties for providing false information,
improving internal financial control processes
New measures designed to strengthen corporate governance :
- Independent compensation committee
- Nominating directors
- Vote on executive pay and golden parachutes
- Claw back provisions
- Pay disclosure
Controlling vs minority shareholders
In emerging economies, firms often belong to big economic groups/conglomerates
How to make sure that minority shareholders interests are protected?
Emerging economies: greater ownership concentration and business groups
Why? Weaker shareholders, less transparent accounting standards, banking system is not
well developed in large inefficient, political influence compensates for a lack of formal
property rights protection
Conglomerates are big and diverse allowing for: vertical integration, internal capital markets,
relational contracting
State ownership
Remains high in emerging economies
>it can be both a product and a contribution factor to a weak institutional environment
Cross holdings : families can maximize control over a corporation without owning more than
50 % of equity
Dual class shares : when one class of a firm’s share has superior voting rights over the other
class
Tunneling : controlling shareholders can move profits (and hence dividends) ‘up the pyramid’
Summary lecture 1 :
Managers are not the shareholders
Its all about what the shareholders want
>monitoring role of the board of directors
>compensation align interest with equity compensation
>participation proxy voting
>dismissed/takeover if everything else fails , also the availability of the possibility of
takeover has an influence on the behavior
Content of the course
>this course aims to develop a framework that will help you to understand firms’ financial
decisions, emphasizing sustainability consideration
It combines most common corporate finance theories with analysis of the most suitable
approach in practical situations
Corporate governance
Capital structure
Payout policies
Valuation Models
Short-term and long-term financing Sustainable finance
Corporate governance
The shareholder model
The stakeholder model
>The normal, sustainable operation of a firm requires balancing the interest of different
groups that are affected directly or indirectly
Corporate governance = is a system of controls, regulations and incentives that make
possible the normal operation of a firm
The size of a company influences the complexity of managing it because it’s important for
more people. Like shareholders, customers, employees, or even society. stakeholder
model
Most of literature on corporate governance is concerned with ensuring that firms operate in
the interest of shareholders
Friedman doctrine : there is one and only one social responsibility of business, to use its
resources and engage in activities designed to increase its profits for so long as it engages in
open and free competition without deception or fraud.
>all in complete free market
If the businessman also has a social responsibility, it must mean that he is to act in some
way that is not in the interest of his employers
According to Friedman, in a competitive economy with complete markets
- Shareholders should choose by themselves
- Firms cannot usurp democratic processes that shape laws and regulations
- Supporting a social cause in detriment of profit is equivalent to raise a tax
- The firm should do what it knows best
- Competition helps keeping the firm on check
>But are markets complete and competitive?
The shareholder model
Shareholders use a mixture of incentives and threats of dismissal to align the interest of the
parties
-in the united states : conflicts between managers and shareholders and prevention of fraud
-in Europe and in emerging economies: conflicts between controlling and minority
shareholders
Conflicts of interest on the shareholder model
Managers and shareholders
- Separation of ownership and control
- Agent (manager) and principal (shareholders) problem
- Incentives are not necessarily aligned
- Information availability is incomplete and asymmetric
,Fiduciary Duty =“ A fiduciary is someone who manages money or property for someone else.
When you are named a fiduciary, you are required by law to manage the person’s money
and property for their benefit, not yours” (CFBP, 2016)
>The fiduciary accepts legal responsibility for duties of care, loyalty, good faith,
confidentiality, and prudence.
The directors of a firm have a fiduciary responsibility to the corporation and the business's
Shareholders
Successful corporate governance requires balancing the costs and benefits of reducing the
agency problem
Actions:
>Monitoring : board of directors, shareholders and/external actors
>Implementing suitable compensation policies
>Facilitate direct intervention by shareholders
>Guaranteeing a balance of power among managers and shareholder
Director board (exist of inside members, outside members and grey members)
-supervises the CEO
-monitoring
-decision making
advising
The outside members
When the board has been captured, monitoring duties by the board may have been
compromised by connections or perceived loyalties to management
How does a board become captured by a CEO? : nomination process, conflicts of interest,
changes in behavior of the board members.
Why separating ownership and management in the first place?
-greater managerial ownership leads to fewer value-reducing actions by the managers
-but is makes managers harder to fire if their performance is not optimal = management
entrenchment
How can we align the interest of managers and shareholders?
How to make sure that the Board is independent?
- Smaller boards are associated with greater firm value and performance
- The longer the CEO serves, the more likely the board is to become captured
- Trade-off between expertise and independence
Compensations policies
>salary in line with competitors (base salary)
>productivity bonus (based on short term financial performance)
>severance pay and golden parachutes
,>provide ownership to executives
- give a direct incentive to increase the stock price
X incentive to manipulate the release of financial forecasts
X many executives have engaged in blackdating their option grants
Does it work?
- Increase agency problems
Increase overconfidence and risk-taking behavior
Inefficiency in payout policies
- Contributes to inequality
The case of pension funds in US
Independency
Negotiating skills
Availability
Expertise
Contributed to inequality
- The case of pension funds in US
Shareholders direct action
Shareholders’ approval/voice : shareholders must approve many major actions taken by the
board (e.g. merger agreements)
Proxy contests : disgruntled shareholders can hold a proxy contest and introduce a rival slate
of directors for election to the board
If everything else fails, shareholders could consider to mount a hostile takeover = sell their
shares to others
An active takeover market is part of the system through which the threat of dismissal is
maintained
Takeover are more likely in the United States then in other countries
Regulation
Should the government intervene to prevent corporate fraud
>some massive failures have impact on the public beyond shareholders
They undermine the public confidence on financial markets, making funding scarce and
expensive
, Some examples : Sarbanes-Oxley Act, Dodd-Frank Act
Sox attempted to achieve goals by:
- Strengthening auditing processes, stiffening penalties for providing false information,
improving internal financial control processes
New measures designed to strengthen corporate governance :
- Independent compensation committee
- Nominating directors
- Vote on executive pay and golden parachutes
- Claw back provisions
- Pay disclosure
Controlling vs minority shareholders
In emerging economies, firms often belong to big economic groups/conglomerates
How to make sure that minority shareholders interests are protected?
Emerging economies: greater ownership concentration and business groups
Why? Weaker shareholders, less transparent accounting standards, banking system is not
well developed in large inefficient, political influence compensates for a lack of formal
property rights protection
Conglomerates are big and diverse allowing for: vertical integration, internal capital markets,
relational contracting
State ownership
Remains high in emerging economies
>it can be both a product and a contribution factor to a weak institutional environment
Cross holdings : families can maximize control over a corporation without owning more than
50 % of equity
Dual class shares : when one class of a firm’s share has superior voting rights over the other
class
Tunneling : controlling shareholders can move profits (and hence dividends) ‘up the pyramid’
Summary lecture 1 :
Managers are not the shareholders
Its all about what the shareholders want
>monitoring role of the board of directors
>compensation align interest with equity compensation
>participation proxy voting
>dismissed/takeover if everything else fails , also the availability of the possibility of
takeover has an influence on the behavior
