Chapter 1 -The corporation: 1.2 Ownership versus control of corporations

ethics and incentives within corporations - corporate bankruptcy: who are the two sets of investors who claim cash flows?

- debt holders - equity holders

the corporate management team: the board of directors makes rules on what?

-> how the corporation should be run (including how the top managers in the corporation are compensated) -> sets policy -> monitors the performance of the company

ethics and incentives within corporations - corporate bankruptcy: to prevent such seizure of assets what might a firm do?

-> renegotiate with the debt holders -> file for bankruptcy protection in a court

Global financial crisis - The Dodd-Frank Act: the Dodd-frank act aims to do what things?

1) promote US financial stability by improving accountability and transparency in the financial system 2) put an end to the notion of too big to fail 3) protect the American taxpayer by ending bailouts 4) protect consumers from abusive financial services practices

Global financial crisis - the Dodd-Frank Act on corporate compensation and governance: To limit senior corporate executives' influence over their own compensation and prevent excessive compensation, the Act directs the SEC to adopt rules that do what? (5)

1. Mandate the independence of a firm's compensation committee 2. provide shareholders the opportunity to approve - in a non-binding, advisory vote - the compensation of executive officers at least once every 3 years (referred to as a 'say on pay' vote) 3. require firm disclosure and shareholder approval of large bonus payments (so-called 'golden parachutes') to ousted senior executives as the result of a takeover 4. Require disclosure of the relationship of executive pay to the company's performance, as well as the ratio between the CEO's total compensation and that of the median employee 5. create 'clawback' provisions that allow firms to recoup compensation paid based on erroneous financial results

explain the organisational chart of a typical corporation

1. The board of directors, representing stock holders, controls the corporation and hires the chief executive office 2. the CEO is responsible for running the corporation. The Chief financial officer oversees the financial operations of the firm -> the controller manages both tax and accounting functions -> the treasurer is responsible for capital budgeting, risk management and credit management activities

Goldman sachs example: what were the main arguments against going public?

1. as a private partnership they could generate enough capital internally and in the private placement markets to fund growth 2. take a longer term view of returns on investments with less focus on earnings volatility which is not valued in public companies 3. retain voting control and alignment of the partners and the firm

the financial manager: within the corporation, financial managers are responsible for what 3 main tasks?

1. making investment decisions 2. making financial decisions 3. managing the firm's cash flows

Goldman sachs example: what were the main arguments for going public? (5)

1. needed greater financial and strategic flexibility to achieve aggressive growth and market leadership goals 2. have a more stable equity base to support growth and disperse risk 3. increased access to large public debt markets 4. increased access to publically traded securities with which to undertake acquisitions and reward and motivate employees 5. a simpler and more transparent structure with which to increase scale and global reach

Goldman sachs example: what was the driving force behind the conversion?

1. to secure permanent capital to grow 2. to be able to use publicly traded securities to finance strategic acquisitions 3. to enhance the culture of ownership and gain compensation flexibility

the corporate management team: who is the most senior financial manager?

Chief financial officer

define 'board of directors

a group of people who have the ultimate decision making authority in the corporation

ethics and incentives within corporations -the CEO's performance: what is a hostile takeover?

an individual or organisation - sometimes known as corporate raider - can purchase a large fraction of the equity and acquire enough votes to replace the board of directors and CEO - with a new superior management the shares are likely to increase in price and a profit is provided

ethics and incentives within corporations - corporate bankruptcy: corporate bankruptcy is best though of as what?

as a change in ownership of the corporation, and not necessarily as a failure of the underlying business

Goldman sachs example: did the conversion achieve its goals?

as a public company they have a simpler, bigger and more permanent capital base; including enhanced long-term borrowing capacity in the public debt markets -> they have drawn on substantial capital resources to serve clients, take advantage of new business opportunities and better control the path through changing economic and business conditions -> been able to use stock to finance key acquisitions and support large strategic and financial investments -> going capital positioned them to compete effectively through the cycle -> the growing size and scope of the business has provided the most challenges

The firm and society: explain why the 2008 financial crisis highlighted decisions that are costly for society

banks took on excessive risk which benefited shareholders but the resulting crisis harmed the broader economy

The goal of the firm: why are the interests of shareholders often aligned with important decisions?

because regardless of their own personal financial position and stage in life, all the shareholders will agree that they are better off if management makes decisions that increase the value of their shares.

why is it often not feasible for the owners of a corporation to have direct control of the firm?

because there are sometimes many owners, each of whom can freely trade his or her shares

ethics and incentives within corporations - agency problems: why do many claim that managers have little incentive to work in the interests of shareholders?

because there is a separation of ownership and control

rather than the owners who possess direct control of the corporation?

board of directors chief executive officer

Global financial crisis - The Dodd-Frank Act: what did this act bring into place?

brought change to financial regulation in response to widespread calls for financial regulatory system reform after a near collapse

the corporate management team: how do shareholders of a corporation exercise their control?

by electing a board of directors

ethics and incentives within corporations - agency problems: how is the agency problem commonly addressed?

by minimizing the number of decisions managers must make for which their own self-interest substantially differs from the interests of shareholders e.g. managers' compensation contracts are designed to ensure that most decisions in the shareholders' interest are also in the managers' interests; shareholders often tie the compensation of top managers to the corporation's profits or share price.

Global financial crisis - the Dodd-Frank Act on corporate compensation and governance: what is one of the most important conflicts of interest between corporate executives and shareholders?

compensation

the financial manager - investment decisions: the financial manager must weigh up what?

costs and benefits of all investments and projects and decide which of them qualify as good uses of the money shareholders have invested in the firm.

in a corporation what two things are separate?

direct control ownership

ethics and incentives within corporations -the CEO's performance: what is one way in which shareholders can encourage managers to work in the interests of shareholders?

discipline them; shareholders can in principle pressure a board to oust a CEO

ethics and incentives within corporations -the CEO's performance: why is the threat of takeover a positive force?

disciplines bad managers and motivates boards of directors to make difficult decisions a market for corporate control exists which encourages managers and boards of directors to act in the interests of shareholders

ethics and incentives within corporations -the CEO's performance: directors and top executives are rarely replaced through grassroots shareholder uprising. How are they?

dissatisfied investors choose to sell their shares -> might require offering shares at a low price

ethics and incentives within corporations - corporate bankruptcy: when a firm fails to repay its debts, the end result is a change in ownership of the firm, with control passing from .......... to ..................

equity holders to debt holders

ethics and incentives within corporations -the CEO's performance: how is share price viewed as a barometer?

gives leaders feedback about their shareholder's opinion of their performance

the corporate management team: the CEO is charged with running the corporation by doing what?

instituting the rules and policies set by the board of directors

Goldman sachs example: what prompted Goldman Sachs to become a bank holding company in Fall 2008?

it became clear that the market viewed oversight by the federal reserve and the ability to source insured bank deposits as offering a greater degree of safety and soundness by changing their status they gained all the benefits available to their commercial banking peers, including access to permanent liquidity and funding, without affecting their ability to operate or own any of their current businesses or investments

Goldman sachs example: what was a big perceived advantage of the private partnership?

its sense of 'distinctiveness and mystique, which reinforced the culture of teamwork and excellence and helped differentiate from competitors'

ethics and incentives within corporations - corporate bankruptcy: bankruptcy need not result in a ............ of the firm

liquidation

the corporate management team: the board of directors delegates most decisions that involve day-to-day running of the corporation to who?

management

ethics and incentives within corporations - agency problems: if compensation contracts reduce managers' risk by rewarding good performance but limiting the penalty associated with poor performance, what might be the result?

managers may have an incentive to take excessive risk

the corporate management team: in most corporations, each share of stock gives the shareholder what?

one vote in the election of board of directors

ethics and incentives within corporations - corporate bankruptcy: even if control of the firm passes to debt holders, it is in the debt holders' interest to do what?

run the firm in the most profitable way possible

ethics and incentives within corporations - agency problems: why is it argued that managers have little incentive to work in the interests of the shareholders when this means working against their own self interest?

separation of ownership and control in a corporation

Global financial crisis - The Dodd-Frank Act: in response to the 2008 financial crisis, the US federal government revaluated its role in the control and management of financial institutions and private corporations. What did they sign into law on July 21 2010?

the Dodd-Frank Wall Street Reform and Consumer Protection Act

Global financial crisis - The Dodd-Frank Act: in the wake of the 1929 Stock market crash and subsequent depression congress passed what act?

the Glass-Steagall Act -> establishing the federal deposit insurance corporation and instituted significant bank reforms to regulate transactions between commercial banks and securities firms.

ethics and incentives within corporations - corporate bankruptcy: when a corporation borrows money, who becomes investors in the corporation?

the holders of the firm's debt

ethics and incentives within corporations - agency problems: what is the issue with tying compensation too closely to performance?

the shareholders asking managers to take on more risk - managers may not make decisions that the shareholders want them to or might be hard to find talented managers willing to accept the job

ethics and incentives within corporations - agency problems: what is the limitation of tying compensation too closely to performance?

the shareholders might be asking managers to take on more risk than they are comfortable taking

the corporate management team: when 1 or 2 shareholders own a very large proportion of the outstanding stock what usually happens?

they are either on the board of directors or they have the right to appoint a number of directors

the financial manager - cash for treasury management: the financial manager must ensure that the firm has enough cash on hand to meet its day-to-day obligations. what is the financial manager's job?

to make sure that access to cash does not hinder the firm's success. a company will typically spend a significant amount of cash developing a new product before its sales generate income.

ethics and incentives within corporations - corporate bankruptcy: if a corporation fails to repay debts, debt holders are entitled to what?

to size the assets of the corporation in compensation for the default

ethics and incentives within corporations - agency problems: what is the agency problem?

when managers, despite being hired as the agents of shareholders, put their own self interest ahead of the interest of shareholders

ethics and incentives within corporations - agency problems: further potential for conflicts of interest and ethical considerations arise from what?

when some stakeholders in the corporation benefit and others lose from a decision

the financial manager - financing decisions: Once the financial manager has decided which investments to make, they decide how to pay for them. Large investments may require the corporation to raise additional money. A financial manager must decide what?

whether to raise more money from new and existing owners by selling more shares (equity) or borrow the money (bonds or other debt)