Summary all theory - Corporate Governane & Social Responsibility
64 views 1 purchase
Course
Corporate Governance and Social Responsibility
Institution
Tilburg University (UVT)
Summary of all the theory of the course Corporate Governance & Social Responsibility of Part 1(J.Gider) and Part 2 (M.A. Rola-Janicka) 2022/2023. Mandatory papers not included, see other summary.
L1 Introduction – Agency problems
• Agency problems arises when an agent acts on behalf of a principal.
- Moral hazard: after the signing of a contract, the agent has incentives to misbehave
o Examples: Insufficient effort, Entrenchment, Self-dealing, Lack of transparency &
Accounting manipulations
o Can only exist due to asymmetric information
- Adverse selection: when a principal can’t distinguish between the “good and bad” guy.
➔ Mitigate agency problems -> complete contracts, but not possible in practice:
o Impossible to predict all future contingencies, too complex, impossible to monitor
• Three components of agency costs are:
1. Monitoring costs: Costs of observing the agent and keeping a record of his behaviour and
avoid unwanted actions.
2. Bonding costs: cost in order to signal credibly to the principal
3. Residual loss: agent may not make decisions that maximize firm value
• Two forms of agency problems:
1. Perquisites: Consumption by the management (private jet)
2. Empire building: Free cash flow problem, management pursuing growth rather than
shareholder maximization
• Other agency problems:
- Insufficient effort: target was not carefully chosen, no proper due diligence and price
negotiations
- Lack of transparency: advantages of deal not properly explained
- Self-dealing: personal interest in buying the target
• Expropriation of minority shareholders by large shareholders:
- Tunnelling; Firm A sells to firm B at too low price
o Requires existence of minority shareholders who share the losses while they have
little control
o Create pyramidal structures
o 100% ownership aligns a thereby mitigate this problem, same goes for buying
back ownership from minority shareholders.
- Transfer-pricing: firm B overcharge for service/products to firm a
- Nepotism: Appointing family members to the top management positions
o Bad because: limiting possible candidates, poor candidates and infighting
- Infighting: Fight among the large shareholders, typically between family members
L2 Executive Compensation
• Manager vs shareholder:
- Manager: human capital is tied to firm, cannot diversify, earns a rent for her service
- Shareholder (risk bearer): hold residual claim to firm assets, has the right to sell her stake
in the firm, can diversify
• Executive compensation:
- Base salary
- Bonus (short term incentive, usually cash)
o Problem: backward looking -> easy to manipulate. Stock price is harder to
manipulate and forward looking. But not only reflect managerial effort, stock prices
changes also due to the economy, and it induce managers to take more risk.
- Long-term incentive plan (equity-based compensation)
o Stock & restricted options
- Retirement plan
- Insurance
• Two components to incentive the manger:
- The stick; manager gets fired when the firm doesn’t perform good. Bad stock price
performance is usually associated with executive turnover
- The carrot; pay for performance. Optimal contract for managers according to principal-
agent models
o Reward effort and rely on performance as a signal.
2
, • Compensation committee (outside directors) sets executive pay. But directors often unwilling to
challenge CEO due to:
- Friendship ties
- Value connections
- Avoid creating bad atmosphere
- The director who disagrees with majority is usually asked to resign
• Measuring the sensitivity of executive pay to performance, main idea – estimate:
β= average pay-performance sensitivity
Problem: need to control for many potentially
confounding factors
• From lecture:
High executive compensation is justified • High executive compensation is not justified
Market outcome Fairness/inequality
Scare talent Challenge the isolate performance (non-financial
performance)
Compensation for effort provision Disconnect performance and pay
Responsibility Market for CEO pay does not work well
Lack of downside responsibility
L3,4,5,6 Board of Directors
• The board of directors is responsible for 2 main objectives:
1. Give managers good incentives
- Design propriate executive compensation contracts
2. Monitor the managers
- Ensure that managers get punished if they misbehave
Examples of tasks are:
- Hiring and firing managers
- Defining/approving major business decisions
- Overseeing executive compensation and risk management
• Board structure:
- US: One-tier (standard) board
- Germany: Two-tier board; Management board & Supervisory board: Employees and Non-
executive shareholder representatives
• Duality: chairman and the CEO are the same person
Advantage Duality Disadvantage Duality
Strong leadership Reduce board independence (less people to monitor the
CEO)
No rivalry between CEA and Charman Increasing CEO entrenchment
Single spokesperson problem Overwhelming: monitoring directors and leading the task
management
• Conventional independence: neither financial nor familial ties to the CEO or to the firm
- Social ties: friends, military service, regional origin, academic or industry background
- Paper results:
o Conventional independence: negative insignificant to Salary + Bonus and positive
insignificant Total compensation
o Independence including social ties: negative significant to Salary + Bonus and
Total compensation
o 87% of 100 boards are conventionally independent, only 62% are also socially
independent
o Weaker pay-performance and turnover performance sensitivity for CEOs facing
socially-connected directors
➔ Board that are more independent (including social ties) pays their executive less (negative ß)
• Independent/dependent -> can both be a benefit, not always bad. When you have social ties with a
person, then you have private information about his skills and character.
3
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller juliareuvers. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $8.59. You're not tied to anything after your purchase.
