Chapter 13 Exam 3

How would you define corporate governance?

Derives from the Latin word Gubernare, which means to steer. A set of mechanisms used to manage the relationships (and conflicting interests) among stakeholders, and to determine and control the strategic direction and performance of organizations (aligning strategic decisions with company values).

What is the relationship between corporate governance and diversification?

Diversification can also help to insulate top managers. These top managers are less susceptible to losing their jobs when the demand in one of their businesses is reduced if there is a corresponding increase in demand in another part of the business.

Agency problem

A consequence of the separation of ownership (shareholders/principals) and control (managers/agents) in the corporation. Agency problems occur when the goals or principals differ from those of agents

Mission Statement

A formal declaration of a company's core values, business objectives, and ethical aspirations

Stock grant

A gift, or grant, of stock given to organizational members, primarily executives.

Board of Directors

A group of individuals who monitor the executive team of the corporation and ensure that those executives are acting in the best interests of the shareholders

Corporation

A legal structure for organizing where the organization is distinct and separate entity from its owners, also known as shareholders

Partnership

A legal structure for organizing where the owners of a business share ownership. The partnership is no separate from its owners

Individual Proprietorship

A legal structure for organizing where the same person owns and runs the business

Nexus of contracts

A model of the corporation suggesting that the firm is the sum total of its contracts with different stakeholders

Stakeholder

Any person or group that can affect or is affected by the activities of the corporation

Inside directors

Executives or managers working inside the company who also hold seats on the board of directors

What is the effect of concentrated ownership on the competitiveness of firms?

First we must address what constitutes concentrated ownership. Large block shareholders are those who hold more than 5% of the firm's outstanding stock. Firms that do not have concentrated ownership tend to not have a high degree of monitoring of managerial decision making. Ownership that is widely dispersed tends to prevent shareholders from banding together, communicating, and coordinating their actions. Research has shown that concentrated ownership tends to provide better monitoring of managerial decision making and prompts managerial decisions that maximize shareholder value.

How can a company's culture encourage members to engage in unethical behaviors? Ethical behaviors?

Good corporate governance encourages or forces managers to consider the ethical implications of the actions they take. Enron had a culture of making money no matter what the cost, which led to them lying on returns. There are 4 arguments about what is right or wrong: -A good society creates the greatest good for the greatest number of people. -The good society ensures a basic set of rights for its citizens. -The good society creates the most freedom for people to act as they please. -In a good society, individuals are for each other, exhibit empathy with others, and focus on meaningful relationships.

Ethical values

Values that define for an individual, group, or society things that are morally right or wrong

Pay for performance

Variable or contingent compensation that focuses managers on key variables, designed to align their interests with the management team

What is the meaning of Gubernare

To steer

What are two reasons to emphasize good corporate governance?

-Apparent failure of corporate governance mechanisms to adequately monitor and control top-level managers' decisions during recent times. -Evidence that a well-functioning corporate governance and control system can create a competitive advantage for an individual firm.

What are four ethical concerns managers must considers?

-Avoiding harm to individuals. -Fairness and honesty -Recognition of sacred/transcendent -Liberty and overcoming oppression

Where do we see agency relationships today?

-Between shareholders and top level managers. -Between managers and their employees. -Between paid consultants and their clients. -Between the insured and the insurer.

What issues can independent board experience?

-While independent directors do provide a high degree of monitoring of managers, these individuals are often too distant from the firm's operations to have substantive knowledge about the firm's operations. -Another issue associated with independent directors is that they do not possess the level of skill and knowledge that managers possess. Hence, independent directors may not be able to make informed decisions about the activities of company managers.

What steps can be taken to enhance board effectiveness?

1. Diversity: Increasing the percentage of ethnic minorities and women. Diverse backgrounds, such as public service. Greater diversity adds to more effective decision making, and this holds true in the board of director context as well. 2. Increase the effectiveness of boards by looking at the strength of the firm's internal account and managerial controls systems. 3. Formally evaluation firms own performance. 4. Firms are also creating lead director roles. 5. Change the way boards are compensated.

Why do agency conflicts occur in modern corporations?

1. Like all individuals, managers are self interested. Their interests inherently lie int heir own well being, their survivial, and their individual success. Agency conflicts occur when managers engage in activities that support their own interests and in those activities that o not maximize the profit maximization expectations of principals (shareholders). 2. Shareholders are distant from overseeing the day to day activities of managers. Distance and the self interest of managers help to prompt managers to engage in activities that are against the profit maximization goals of shareholders.

Tender offer

An offer by those hoping to control the corporation to purchase shares of dissatisfied investors

Cultural

A pattern of behavioral assumptions that are considered appropriate and correct for organizational members

Bonuses

Additional compensation paid to executives, managers, and employees when they meet certain performance objectives

What are agency relationships?

Agency relationships occur between principals (owners of firm) and agents (managers). when one party (principals) relinquishes decision making responsibility to agents (managers) for compensation.

Proxy fight

An attempt by dissatisfied investors or stakeholders to gain seats on the board of directors, or influence corporate policy

In what three ways can we classify board members?

Board Insiders: executives that currently work within the company. These individuals are elected to the board because they bring some unique skill or knowledge or competency that enhance the board's decision making ability. Related Outsiders: Board members that are not employed by the firm. However, these individuals have some type of relationship (family, business) that compromises their ability to make independent strategic judgments. Independent Directors: Individuals that do not have some type of business or family relationship with the firm, nor do these individuals work for the firm. Independent directors are relied upon to help provide boards with independent advice and counsel.

Historically, who manages firms in the US? How is this different today?

Historically, firms have been managed by their founders. However, through the 19th and earlier 20th century, firm size began to grow and adopt the corporate form of organization. Today, the corporate form of organization is the predominant form that most companies take. Today, the managers of the modern corporations are not the founders of the firm.

Agents

Individuals or groups hired to administer the property or resources of principals. The managers of a corporation are considered to be agents of the shareholders

What distinguishes inside form outside directors?

Inside directors: executives or managers, bring their skills and working knowledge of the firm's operations and stategies to the board. Outside Directors: People not employed by the corporation in any other role, should bring deep knowledge and a fresh perspective, both of which ensure that the firm's strategy will serve the financial interests of the shareholders.

Other constituency laws

Laws that allow the board of directors to freely consider the needs of stakeholders other than shareholders when making critical strategic decisions for the firm

Outside directors

Members of the board of directors not employed by the corporation in any other role

What is the agency problem? What are some solutions to it?

Owned by Principals, Managed by Agents. Interests may differ, hurting principles. Solution: Monitor the agents, align incentives. One solution: The BOD- appointed by principles, two fiduciary duties (loyalty & care). 2nd solution: Incentives- Agents will act like principals if they have the same interests. Pay for performance, compensation at risk (bonuses, stock options, stock grants)

What mechanisms can companies use to align incentives of managers and owners?

Pay for performance or variable compensation. -Bonuses -Stock options -Stock grants

Stock based compensation

Payment to organizational members in the form of shares in the corporation.

What is the difference between a principal and an agent?

Principals are owners of firms. Agents are managers of firms.

Ethical behavior

That which promotes human freedom of expression and development.

Stakeholder Model

The belief that a corporation should be run for the benefit of its entire stakeholder set, with no group enjoying primacy in decision making

Fiduciary Duty

The legal obligation of an agent, a fiduciary, to act in the best interests of the principal, or owner. Fiduciary duties include the duty of loyalty, to work for the optimal good of the owner, and the duty of care, to not take undue risk that would jeopardize the principal

Principals

The owners of a resource or piece of property. In the corporation, shareholders are considered principles

Corporate Governance

The processes and structures that provide the ultimate decision-making authority for the firm

Stock option

The right to buy a certain number of the corporation's shares at a specified future date of a specified price.

Property Rights

The rights of owners to: (1) claim the residual earnings of the corporation, or profits after all other stakeholders have been paid, and/or (2) monitor the management team to make sure that the team works in their best interest

What is the relationship between diversification and the size and scope of a firm?

This added size and scope leads to a higher level of complexity that mangers often demand to be compensated for.

What is the board's primary job?

To act int he best interests of the corporation's owners (fiduciary duty)

What is the role of the board of directors in running a public company?

To monitor the executive team of the corporation and ensure that those executives are acting int he best interest of the shareholders.

Shareholder primacy

the belief that a corporation should be run, primarily or exclusively, for the benefit of its shareholders