Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
Lecture 01 – introduction and definitions
Some questions for this course
What is management?
What does the management of a firm?
Why does management do the things they do?
Who manages the manager?
Why doesn’t it work the way it is supposed to work?
Manage and supervise: separation of ownership and control (Fama and Jensen, 1983)
1. Initiation: generation of proposals for resource utilization and structuring contracts
2. Ratification: choice of the decision initiatives to be implemented
3. Implementation: execution of ratified decisions
4. Monitoring: measurement of the performance of the decision agent and
implementation of rewards
‘it is usually in the interest of everybody that the firm continues to exist as an entity’
Responsible corporate governance is aimed at securing firm continuity
Responsible corporate governance is aimed at securing firm continuity, because:
shareholders get their share of the profit
Customers get their products or services
Suppliers have their customers
Employees keep their job
Management receives their bonuses
Society receives taxes
Corporate governance objective: realizing long-term shareholder value, whilst considering
the interests of other stakeholders
i.e. corporate governance objective is: finding the position in the feasibility space that is
acceptable to all stakeholders
The feasible region is shown as being relatively small
By definition, the feasible region is almost relatively small because, if the feasible region
increases, the groups/stakeholders will adjust their demands in such a way that it becomes
small again
Example of shrinking feasible region: if a company’s profits are high, and shareholders
require a fixed dividend amount, the feasible region increases. As a reaction, shareholders
may want a higher dividend pay-out, or customers want lower product prices as competition
will probably increase in a profitable market. Then the feasible region shrinks again
1
,Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
Afbeelding 1: the feasibility space, X1 = a set of activities acceptable both to shareholders and employees, but not
acceptable to customers or the government (e.g. high prices). X2 = a set of activities acceptable to all but shareholders (e.g.
high wage, low price, etc.; XF = only feasible set of activities satisfying all stakeholders
Transparency and integrity are the backbone of good corporate governance
Transparency requires a sophisticated system of accounting
A sophisticated system of accounting should:
Allow investors to assess the magnitude and timing of future cash flows to be
generated by the business
Encourage efficient operations and maximization of results
Provide an early warning of problems in meeting firm objectives
Lead to quick corrective actions whenever things go wrong
Integrity requires ‘doing the right things’
A ‘check in the box’ approach to good corporate governance will not inspire a true sense of
ethical obligation. It could merely lead to an array of inhibiting ‘politically correct dictates’ –
William H. Donaldson (Former SEC Chairman)
Gatekeepers and watchdogs: supervisors, oversight bodies, auditors, analysts, investment
bankers, credit rating agencies, remuneration advisors, lawyers, the press (e.g. AFM, KPMG,
Wall Street Journal, Moody’s, Goldman Sachs, etc.)
Most importantly, every member of the chain must commit to collaborating with all others.
The chain is only as strong as its weakest link
Corporate governance deals with the way in which suppliers of finance to corporations
assure themselves of getting a return on their investment – Shleifer and Vishy, 1997
Corporate governance is the process used to manage the business affairs of the company
towards enhancing business prosperity and corporate accountability with the objective of
realizing long term shareholder value, while taking into account the interests of the other
stakeholders – Cabinet office, 2007
2
,Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
The definition of corporate finance from 1997 does not mention the ‘continuity of the firm’,
nor the ‘return on investment’ for ‘the suppliers of finance’. Apart from these investors, it
does not refer to any other stakeholder in the corporation
Today’s challenges to corporate governance:
long-term vs. short-term value
stakeholder value vs. shareholder value
Stakeholders that should be taken into account:
Shareholders: institutional shareholders, hedge funds, private shareholders
Society: tax authorities, regulators, stock markets, general public opinion
External auditors
Employees: internal audit, workers council, union members
Executive directors: CEO, CFO
Non-executive directors: audit committee, remuneration committee, nomination
committee
Credits
Suppliers
Customers
No firm can exist without its customers
The formal influence of customers may be limited, customer’s informal influence is big,
especially when exercising their opinion not to buy from a firm
In literature on corporate governance, this group (i.e. customers) is less visible than several
of the other groups of stakeholders
Shareholders of listed companies have taken the chance to participate in the profits of a firm
without taking responsibility for the operations
Shareholders have limited liability and therefore limited involvement in the company’s
affairs
The involvement of shareholders includes:
The right to elect directors
The fiduciary obligation of directors and management to protect their interests
The group of shareholders range from private persons that have only a few shares in a
corporation, to institutions (e.g. pensions funds) that own a significant portion of the shares
Apart from the difference in size, the goal of each shareholder for owning the shares can be
very diverse
3
, Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
Shareholders value:
The shareholder has the exclusive control of the stock itself
As a condition for the shareholders’ limited liability, the shareholder gives up the
right to control the use of the corporate property by others
o That right is delegated to the corporation’s management
It is one of the benefits of the corporate organization to the investor
o The investor can entrust his money to people who have expertise and time
the investor does not have
Shareholders have voting, information, and approval rights
The theory is that corporations are managed by officers, under a system of checks
and balances provided by the board of directs and the shareholders
Employees are often referred to as ‘the most important asset of our company’ by senior
management
Employees are compensated for the time and skills they devote to the firm.
Employees have various faces, not only literally:
They can be organized in a union
They can have a significant amount of shares
In several countries they are represented in the board of directors as well
The group that we refer to as ‘society’ is composed of a large amount of sub-groups that
include:
The government which sets formal rules and regulations
Organizations such as the local variant of the SEC who can be very specific on
requirements with respect to disclosure for listed companies
Suppliers and other creditors have an interest in that their current invoices are being paid,
and that they can deliver to and invest in the firm in the future as well
Creditors play an important role in a number of governance systems and can serve as
external monitors over corporate performance
Directors of a firm face the challenging task of balancing the wishes of each of the
stakeholder groups
Officially, directors act on behalf of the shareholders
Directors won’t just do what shareholders want because:
Keeping stock is a different profession than managing a business
It is not always easy to determine what the best interest for shareholders is
It is not always easy to determine what the best interest for shareholders is
4
Lecture 01 – introduction and definitions
Some questions for this course
What is management?
What does the management of a firm?
Why does management do the things they do?
Who manages the manager?
Why doesn’t it work the way it is supposed to work?
Manage and supervise: separation of ownership and control (Fama and Jensen, 1983)
1. Initiation: generation of proposals for resource utilization and structuring contracts
2. Ratification: choice of the decision initiatives to be implemented
3. Implementation: execution of ratified decisions
4. Monitoring: measurement of the performance of the decision agent and
implementation of rewards
‘it is usually in the interest of everybody that the firm continues to exist as an entity’
Responsible corporate governance is aimed at securing firm continuity
Responsible corporate governance is aimed at securing firm continuity, because:
shareholders get their share of the profit
Customers get their products or services
Suppliers have their customers
Employees keep their job
Management receives their bonuses
Society receives taxes
Corporate governance objective: realizing long-term shareholder value, whilst considering
the interests of other stakeholders
i.e. corporate governance objective is: finding the position in the feasibility space that is
acceptable to all stakeholders
The feasible region is shown as being relatively small
By definition, the feasible region is almost relatively small because, if the feasible region
increases, the groups/stakeholders will adjust their demands in such a way that it becomes
small again
Example of shrinking feasible region: if a company’s profits are high, and shareholders
require a fixed dividend amount, the feasible region increases. As a reaction, shareholders
may want a higher dividend pay-out, or customers want lower product prices as competition
will probably increase in a profitable market. Then the feasible region shrinks again
1
,Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
Afbeelding 1: the feasibility space, X1 = a set of activities acceptable both to shareholders and employees, but not
acceptable to customers or the government (e.g. high prices). X2 = a set of activities acceptable to all but shareholders (e.g.
high wage, low price, etc.; XF = only feasible set of activities satisfying all stakeholders
Transparency and integrity are the backbone of good corporate governance
Transparency requires a sophisticated system of accounting
A sophisticated system of accounting should:
Allow investors to assess the magnitude and timing of future cash flows to be
generated by the business
Encourage efficient operations and maximization of results
Provide an early warning of problems in meeting firm objectives
Lead to quick corrective actions whenever things go wrong
Integrity requires ‘doing the right things’
A ‘check in the box’ approach to good corporate governance will not inspire a true sense of
ethical obligation. It could merely lead to an array of inhibiting ‘politically correct dictates’ –
William H. Donaldson (Former SEC Chairman)
Gatekeepers and watchdogs: supervisors, oversight bodies, auditors, analysts, investment
bankers, credit rating agencies, remuneration advisors, lawyers, the press (e.g. AFM, KPMG,
Wall Street Journal, Moody’s, Goldman Sachs, etc.)
Most importantly, every member of the chain must commit to collaborating with all others.
The chain is only as strong as its weakest link
Corporate governance deals with the way in which suppliers of finance to corporations
assure themselves of getting a return on their investment – Shleifer and Vishy, 1997
Corporate governance is the process used to manage the business affairs of the company
towards enhancing business prosperity and corporate accountability with the objective of
realizing long term shareholder value, while taking into account the interests of the other
stakeholders – Cabinet office, 2007
2
,Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
The definition of corporate finance from 1997 does not mention the ‘continuity of the firm’,
nor the ‘return on investment’ for ‘the suppliers of finance’. Apart from these investors, it
does not refer to any other stakeholder in the corporation
Today’s challenges to corporate governance:
long-term vs. short-term value
stakeholder value vs. shareholder value
Stakeholders that should be taken into account:
Shareholders: institutional shareholders, hedge funds, private shareholders
Society: tax authorities, regulators, stock markets, general public opinion
External auditors
Employees: internal audit, workers council, union members
Executive directors: CEO, CFO
Non-executive directors: audit committee, remuneration committee, nomination
committee
Credits
Suppliers
Customers
No firm can exist without its customers
The formal influence of customers may be limited, customer’s informal influence is big,
especially when exercising their opinion not to buy from a firm
In literature on corporate governance, this group (i.e. customers) is less visible than several
of the other groups of stakeholders
Shareholders of listed companies have taken the chance to participate in the profits of a firm
without taking responsibility for the operations
Shareholders have limited liability and therefore limited involvement in the company’s
affairs
The involvement of shareholders includes:
The right to elect directors
The fiduciary obligation of directors and management to protect their interests
The group of shareholders range from private persons that have only a few shares in a
corporation, to institutions (e.g. pensions funds) that own a significant portion of the shares
Apart from the difference in size, the goal of each shareholder for owning the shares can be
very diverse
3
, Corporate Governance, Risk Management, and Control – Lecture Summary – March/ April
Shareholders value:
The shareholder has the exclusive control of the stock itself
As a condition for the shareholders’ limited liability, the shareholder gives up the
right to control the use of the corporate property by others
o That right is delegated to the corporation’s management
It is one of the benefits of the corporate organization to the investor
o The investor can entrust his money to people who have expertise and time
the investor does not have
Shareholders have voting, information, and approval rights
The theory is that corporations are managed by officers, under a system of checks
and balances provided by the board of directs and the shareholders
Employees are often referred to as ‘the most important asset of our company’ by senior
management
Employees are compensated for the time and skills they devote to the firm.
Employees have various faces, not only literally:
They can be organized in a union
They can have a significant amount of shares
In several countries they are represented in the board of directors as well
The group that we refer to as ‘society’ is composed of a large amount of sub-groups that
include:
The government which sets formal rules and regulations
Organizations such as the local variant of the SEC who can be very specific on
requirements with respect to disclosure for listed companies
Suppliers and other creditors have an interest in that their current invoices are being paid,
and that they can deliver to and invest in the firm in the future as well
Creditors play an important role in a number of governance systems and can serve as
external monitors over corporate performance
Directors of a firm face the challenging task of balancing the wishes of each of the
stakeholder groups
Officially, directors act on behalf of the shareholders
Directors won’t just do what shareholders want because:
Keeping stock is a different profession than managing a business
It is not always easy to determine what the best interest for shareholders is
It is not always easy to determine what the best interest for shareholders is
4
