WPC 480 Corporate Governance week 11
The public stock company: Hierarchy of authority
1. Shareholders (owners of the company)
Transferability of ownership through trading of shares of stock on exchanges,
Legal personality: has legal rights and obligations
Separation of legal ownership and management control
2. Board of Directors
3. Management
4. Employees
Agents- management and employees.
Have more information about the company than the shareholders do.
Agency theory- A theory that views the firm as a nexus of legal contracts
So conflicts that arise should be resolved legally
The firm needs to design work tasks, incentives, and employment contracts to minimize
opportunism by agents.
Two main agency problems – cause by information asymmetry between principals and agents
Adverse selection- Increases the likelihood of selecting inferior alternatives
Bad recruiting of CEO
Moral Hazard- Increases the incentive of agents to take undue risks or shirk other
responsibilities
The costs rolled over to the other party (Principals)
Board of Directors
Attempts to address the principal-agent problem
To provide mechanisms to:
Direct and control an enterprise
Ensure that it pursues strategic goals successfully and legally
To offer checks and balances
To ask the tough questions when needed
The centerpiece of corporate governance
Usually consist of inside and outside directors
Inside directors are: COO, CEO, CFO
Outside directors: Senior execs from other firms
Elected by shareholders
Board of Director tasks
Selecting, evaluating, and compensating the CEO
oThe board may fire him
oOverseeing the company’s CEO succession plan
oProviding guidance for executive compensation
General Strategic oversight and guidance
oReviewing strategic initiatives
oRisk assessment & mitigation
Corporate Governance Mechanisms to Align Incentives between Principles and Agents
Executive compensation
oStock options as a part of compensation
oSometimes stock options lead to short-term and myopic decisions (bad for long
term growth)
The market for corporate control
oAn external corporate-governance mechanism
oConsists of activist investors who seek to gain control of an underperforming
corporation and buy shares of its stock in the open market (Wall Street Movie)
Financial statement, auditors, government regulators, and industry analysts
oServe as addition external-governance mechanisms
oFinancial statements must be audited by CPA’s
oIndustry analyst make, buy, hold, or sell recommendations
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