Lecture 1 Corporate Governance and Social Responsibility(MN 21 Feb 11)

8/7/2019 Lecture 1 Corporate Governance and Social Responsibility(MN 21 Feb 11)

http://slidepdf.com/reader/full/lecture-1-corporate-governance-and-social-responsibilitymn-21-feb-11 1/43

Murali Neelamegam



Murali NeelamegamMurali Neelamegam

` Email [email protected]

Consultation Times are:Consultation Times are:` times by appointment



AssessmentsAssessments WeightingWeighting

%%Submission DateSubmission Date

IndividualIndividual -- EssayEssay 20002000

wordword essayessay

20% Lecture Week 7Lecture Week 7

44thth AprilApril

GroupGroup -- CaseCase studystudy(Written Report and Oral(Written Report and OralPresentation Case ReportPresentation Case Report--handhand--in 2000 word reportin 2000 word report

30%

Hand in Written

work in OralPres. in weeks 8,to 11

FinalFinal ExamExam

All material presentedand discussed in lecturesand tutorials

50%During ACUExam weeks

TOTAL 100%



` You select?

` I select?

` We select?

` Random?



Lecture 1Lecture 1-- Intr oductionIntr oduction

Murali NeelamegamMurali Neelamegam

5



` Defining Corporate Governance (legal, cultural,religion, traditions, political, economic)

` What is Corporate Governance? (rules based /

comply or explain)

` Why is it so important? (Enr on, global capital)` Agency theory (narr ow view, Mgrs & S/holders)

` Transaction cost theory (Internalise costs,

opportunistic)

` Stakeholder theory (br oad view, Co lge impactsociety, economies etc)



` A system of checks and balances, bothsystem of checks and balances, bothinternalinternal andand externalexternal to companies,to companies,

which ensures that companieswhich ensures that companies

discharge their accountability to alldischarge their accountability to alltheir stakeholders and act in atheir stakeholders and act in a sociallysocially

responsible wayresponsible way in all areas of their in all areas of their

business.business.

7

Corporate governance definitionCorporate governance definition



Internal governance mechanisms

` Ownership concentration

` Board of directors` Executive compensation

` Multi-divisional structure

External governance mechanism

` Market f or corporate contr ol

8

Corporate governance

mechanisms



Executive compensation

` The use of salary, bonuses, and long-term

incentives to align managers¶ interests withshareholders¶ interests

Multi-divisional structure

` The creation of individual business divisions to

closely monitor top-level managers¶ strategicdecisions

9

Internal governance

mechanisms (cont¶d)



Market for corporate control

`

The purchase of a firm that is underperf ormingrelative to industry rivals in order to impr ove

its strategic competitiveness

10

External governance

mechanism



`̀ Historically, firms were managed by the f ounder Historically, firms were managed by the f ounder--owners and their descendents. The managerialowners and their descendents. The managerialrevolution led to a separation of ownership andrevolution led to a separation of ownership andcontr ol, which is the basis of the modern publiccontr ol, which is the basis of the modern publiccorporationcorporation

`̀ In the modern corporation:In the modern corporation:

Shareholders and managers becomeShareholders and managers becomespecializedspecialized

Shareholders purchase shares, which entitlesShareholders purchase shares, which entitles

them to incomethem to income ±± residual returnsresidual returns ± fr om thefr om theoperations of the firm after expenses have beenoperations of the firm after expenses have beenpaidpaid

11

Separation of ownership andSeparation of ownership andmanagerial controlmanagerial control



`̀ Three perspectivesThree perspectives1.1. The agency TheoryThe agency Theory fr om Financefr om Finance

and economicsand economics

2.2. Transaction Cost TheoryTransaction Cost Theory fr omfr omSocial OrientedSocial Oriented

3.3. Stakeholder TheoryStakeholder Theory fr omfr om

Economics and organizationalEconomics and organizationaltheorytheory

12



13

Figure 10.1Figure 10.1



`̀ A mechanism established to allow differentA mechanism established to allow differentpartiesparties to contribute capital, expertise andto contribute capital, expertise andlabour, f or the maximum benefit of all of them.labour, f or the maximum benefit of all of them.

`̀ Shareholders limited liability and limitedShareholders limited liability and limited

involvementinvolvement`̀ Management runs the company withoutManagement runs the company without

responsibility of pr oviding funds.responsibility of pr oviding funds.

`̀ Other stakeholders: customers, creditors,Other stakeholders: customers, creditors,

suppliers, employees, community andsuppliers, employees, community andgovernmentgovernment

14



Four Characteristics:Four Characteristics:

1.1. Limited liability f or investors;Limited liability f or investors;2.2. Free transferability of investors interests;Free transferability of investors interests;

3.3.L

egal personalityL

egal personality (entity(entity--attributable, lifeattributable, lifespan, purpose)span, purpose)4.4. Centralized managementCentralized management

(Robert Clark of Har vard Law School)(Robert Clark of Har vard Law School)

15



` Principal and agent (Mgrs) have differentinterests, and the separation of ownership andcontr ol pr ovides potential f or divergent interests

to surface` Shareholders lack direct contr ol of large,

publicly traded corporations

` Pr oblems arise when the agent makes

decisions that result in the pursuit of goals thatconflict with those of the principal

16

Problems of the agencyProblems of the agency

relationshiprelationship



` The principal establishes governance andcontr ol mechanisms. It remains difficult or expensive f or the principal to verify that theagent has behaved appr opriately

` The agent sometimes exercises managerialopportunism, which is the seeking of self-interest with guile

` Managerial opportunism prevents themaximization of shareholder wealth

17

Problems of the agency

relationship (cont¶d)



Increased size and diversification of the firm

` Managers acting opportunistically may fail to maximize

the firm¶s perf ormance and shareholder returns simply

because:

Gr owth in the size of the firm leads to an

increase in compensation f or managers

Diversification of the firm reduces the

employment risk f or top managers

18

Examples of the agency

problem



Use of free cash flows

` These are resources generated after investment

in all pr ojects` Managers prefer to invest the funds in additional

pr oduct diversification

` Shareholders prefer the funds as dividends so

they contr ol how the funds are invested

19

Examples of the agency

problem (cont¶d)



Definition

` Agency costs are the sum of incentive costs,

monitoring costs, enf orcement costs andindividual financial losses incurred by principals

because it is impossible to use governance

mechanisms to guarantee total compliance by the

agent

20

Agency costs



` Boards of directors have a fiduciary duty to

shareholders to monitor management However, boards of directors are often accused

of being lax in perf orming this function

21

Agency costs and

governance mechanisms



22


� Large block shareholders have astrong incentive to monitormanagement closely:

± Owning at least 5% of theshares means it is worthwhile

spending time, effort andexpense on monitoring

± They may also obtain boardseats which enhances theirability to monitor effectively

� Financial institutions are legallyforbidden from directly holdingboard seats

OwnershipOwnership

concentration (a)concentration (a)



23

� The increasing influence of institutional owners (stock mutualfunds and pension funds):

± Have the size (proxy votingpower) and incentive (demandfor returns to funds) todiscipline ineffective top-levelmanagers

± Can influence the firm¶s choiceof strategies

OwnershipOwnership

concentration (b)concentration (b)


(cont¶d)



24

� Shareholder activism:

± Shareholders can convene todiscuss the corporation¶s

direction± If a consensus exists,

shareholders can vote as ablock to elect their candidatesto the board. Institutionalactivism should create apremium on companies withgood corporate governance

± Managerial share ownershipmay align their interests withshareholders, but it also

increases managers¶ power


(cont¶d)

OwnershipOwnership

concentration (b)concentration (b)



25

� Board of directors:

± Group of elected individualswhose primary responsibility isto act in the owners¶ interestsby formally monitoring andcontrolling the corporation¶stop-level executives

� Board has the power to:

± Direct the affairs of the

organization± Punish and reward managers

± Protect the rights and interestsof shareholders

OwnershipOwnership

concentrationconcentration

Board of directorsBoard of directors

(a)(a)

Internal governance mechanisms(cont¶d)



26

� Composition of boards:

± Insiders: the firm¶s CEO andother top-level managers

± Related outsiders: individualsnot involved with the firm¶sday-to-day operations, but whohave a relationship with thefirm

± Outsiders: individuals who areindependent of the firm¶s day-

to-day operations and otherrelationships

OwnershipOwnership



(b)(b)




27

� Criticisms of boards of directors:

± They are not fulfilling theirprimary fiduciary duty toprotect shareholders

± Too readily approve managers¶ self-serving initiatives

± Are exploited by insiders withpersonal ties to boardmembers

± Are not vigilant enough inmonitoring CEO behaviour

± Lack of agreement about thenumber and appropriate role of outside directors

OwnershipOwnership



(c)(c)




28

� Enhancing the effectiveness of boards and directors:

± More diversity in thebackgrounds of board members

± Stronger internal managementand accounting control systems

± More formal processes toevaluate the board¶sperformance

± More collaborative working andopen debate

± Appointing a reasonablenumber of outsiders

± Directors have an ownershipstake through share holdings

OwnershipOwnership



(d)(d)




29

� Forms of compensation:

± Salary, bonuses, andperformance-based long-termincentive compensation such asshare options

� Factors complicating executivecompensation:

± Strategic decisions by top-levelmanagers are complex, non-routine and affect the firm overan extended period

± Other variables affect the firm¶sperformance over time such asunpredictable economic, socialor legal changes

OwnershipOwnership



ExecutiveExecutive

compensation (a)compensation (a)




30

� Limits on the effectiveness of executive compensation:

± Unintended consequences of share options

± Managers who own more than1% of the firm¶s shares are lesslikely to be removed

± Some executives benefit frombig increases in the overallvalue of their shares even

though the firm¶s sharesunderperformed the market

OwnershipOwnership



ExecutiveExecutive

compensation (b)compensation (b)




31

� The corporate office, along withthe firm¶s board of directors,closely monitor performance of the business units or divisions

� When used as a singlegovernance mechanism, the M-form structure may actuallyfacilitate over-diversification andinappropriately high

compensation for corporateexecutives

OwnershipOwnership



ExecutiveExecutive

compensationcompensation

MultiMulti--divisionaldivisional

structurestructure




32


� Individuals and firms buy or takeover undervalued corporations

± Ineffective managers areusually replaced in such

takeovers

� The threat of takeover may leadfirm to operate more efficiently

� Changes in regulations havemade hostile takeovers difficult

Market for Market for

corporate control (a)corporate control (a)



33

� Managerial defence tacticsincrease the costs of mounting atakeover. These tactics mayinvolve:

± Asset restructuring throughdivestments

± Changes in the financialstructure of the firm such asrepurchasing shares

± Mobilising shareholders to notapprove takeover

� Market for corporate control lacksthe precision possible withinternal governance mechanisms

Market for Market for

corporate control (b)corporate control (b)


(cont¶d)



Legislation` Trade Practices Act 1974 (TPA)

Pr omotes competition and fair trading and

pr ovision f or consumer pr otection` Prices Surveillance Act 1983 (PSA)

Ser ves three functions:1 Vet pr oposed price rises in organisation under

sur veillance2 Hold inquiries into pricing practices and report

findings to a Commonwealth minister 3 Monitor prices, costs and pr ofits of an industry or

business and report findings to a minister

34

Corporate governance in

Australia



The Australian Competition and Consumer Commission (ACCC)

` Formed in 1995 by merger of the Trade Practices

Commission and theP

rices Sur veillance Authority` Deals with competition matters and enf orcement of the TPA

` The Act covers anticompetitive and unfair marketpractices, mergers or acquisitions of companies,pr oduct safety/liability, and third-party access to

facilities of national significance

35


Australia (cont¶d)



The Australian Securities and InvestmentsCommission (ASIC)

` Established in 1991 to administer the Corporations

Law` ASIC is the single national regulator of Australia¶s

1.2 million companies

Australian Stock Exchange Listing Rules (ASX)

` The Australian Stock Exchange imposes a series of important regulatory guidelines f or all listedcompanies in Australia

36


Australia (cont¶d)



Standards Australia

` Has published a set of corporate governance

standards which complement the ASX BestPractice Recommendations and target small

and medium size enterprises and the not-f or-

pr ofit sector

37


Australia (cont¶d)



Shareholder activists` Shareholder activism refers to the extent to which

individual shareholders (albeit as a gr oup) arewilling (or even perhaps able) to influence acorporation¶s board of directors

` The Australian Shareholders Association (ASA) now has policies on: Poor perf ormance, executive remuneration,

accounting policies, conflict of interest,

disclosure, share ownership limits

38


Australia (cont¶d)



The financial media

` In the small Australian marketplace, the media are

a powerful element of the governance system.

Print news media, such as the Australian Financial Review and Business Review Weekly , along with

television¶s Business Sunday , freely report

Australian corporate activities

39



` It is important to ser ve the interests of the firm¶s

multiple stakeholder gr oups:

Capital market stakeholders

x Shareholders in this gr oup are viewed as the most

important

x The f ocus of governance mechanisms is to contr ol

managerial decisions to assure shareholder

interests

x Interests of shareholders is ser ved by the board of

directors

40

Governance mechanisms

and ethical behaviour



Product market stakeholdersx Customers, suppliers and host communities may

withdraw their support of the firm if their needs arenot met, at least minimally

Organisational stakeholdersx Managers and non-managerial employees

similarly may withdraw support, reduce their workeff ort or even quit

` Effective governance pr oduces ethical behaviour inthe f ormulation and implementation of strategies

41

Governance mechanisms and

ethical behaviour (cont¶d)



` Group work.

Q«.Which theoretical framework discussed in

this chapter do you believe presents the mostappropriate explicit framework for corporate

governance, and why?

PRESENT FINDINGS««

Lecture 1 Corporate Governance and Social Responsibility(MN 21 Feb 11)

Documents

Transcript of Lecture 1 Corporate Governance and Social Responsibility(MN 21 Feb 11)