Lecture 4a: Corporate governance
What is corp gov? -> steer a coy properly. In narrow view, relation between shareholder and
director. Control of coy making it acceptable. Ensuring ppl get ROI
Aims and objectives
1) By the end of this lecture and the relevant readings, you should be able to:
a) Understand the foundations of Corporate Governance;
b) Discuss and evaluate different corporate theories;
c) Illustrate the application of different corporate theories in Company Law.
Corporate theory
2) What are companies?
3) Why do we have companies?
4) What does Company law do?
5) Needed because unincorp coys became less common in history, more and more coys
became incorporated. Owners were traditionally directors too
6) Now coys had ability to take on investment and infrastructure could facilitate this
a) Investment by members of public not owners of the coys
b) Ownership separate from control
7) Over course of 20th century, became main actor in most maj economies
8) 2 impt propositions
a) Shareholders are so numerous and dispersed that no one shareholder had any
interest in controlling the management
b) Concern that not only were managers not accountable to shareholders, but
because they control biz enterprise, they had enormous social impact.
9) Institutional investors tended to prefer market mechanisms to promote interests
a) Hostile takeovers
b) Executive pay
10) In some places (stakeholder constituencies) is where public have stakeholder role
, 11) So now corp governance can be
a) II
b) RI
c) Gen public
Empty concept, a legal construct
12) What is a Company?
a) Invented by lawyers
b) Why?: history answers to large extent, but coy is response to channelling
investment necessary for expansion of coys and their infrastructure
c) Industrial revolution needed huge infrastructure; trains, canals, factories etc
d) Where would the money come from?
Success of companies
13) Background. Why has this form (corporate form) has become successful
14) In scale and scope: alfred chandler explained the nature of success in big business
a) … the modern industrial enterprise has rarely continued to grow or maintain its
competitive position over an extended period of time unless the addition of new
units (and … elimination of older ones) has … permitted its managerial
hierarchy to reduce costs [and] to improve functional efficiency in
[production], marketing and purchasing…
i) Efficient resource allocation
b) Reductions in costs and efficient resource utilization have resulted… from the
exploitation of economies of scale in production and distribution, from
[economies of scope], or from reduction in the costs of transactions
involved.
i) Efficient production strategies
15) Firm is a solution to the uncertainties of market. Eg: in ctt enforcement, doing the R&D
etc
Model 1: Contractual model
16) Individual persons decide the objects and the clauses of the contract
17) However the company has ‘Personality’
18) Can be sued and sue
19) Unlimited time (perpetuity)
20) The property is owned by the company-NOT the shareholders
, a) Coy itself has prop rights
21) Nexus of ctt approach. When funds, coy law enables coy ot own its assets, and because
of this, provides for asset partitioning
Contractual model: agency problems
22) Contractarian theory concentrates upon relationships between key players in the firm.
These relationships are seen as akin to contracts, being ‘vehicle[s] for exchange’
(Jensen and Meckling).
a) In adopting the nexus of ctt model, recognise that manager of firm knows more
than principals. In order for principals to effectively ensure manager is making
decisions in an effective manner, they incur sunk costs : AGENCY COSTS
b) To deal with this, things like Director duties, shareholder rights, etc.
23) Easterbrook and Fischel believe a company serves as a nexus of contracts: a single
contracting party that coordinates the activities of suppliers of inputs and of consumers.
a) That there is a single ctting party, that coordinating activities of suppliers of input:
shareholders
24) The legal problem is to ensure that one party to the contract does not unfairly exploit the
other.
25) A type of contract arises as between shareholders and managers.
26) Shareholders invest their money in the company; but they appoint directors/managers to
oversee the business.
a) Shareholders are principals
b) Managers are agents
27) Managers might prefer their own position and rent seek; alternatively, they might fail to
perform to the expected level of competence/diligence (‘shirking’). [can see how DD try
to minimise agency problems]
28) The principal finds it difficult to monitor the agent [hence disclosure and transparency]
and to determine whether these problems exist; yet shareholders’ position should be
protected as residual risk-bearers (in the sense that their returns are not fixed/at-risk:
see Moore and Petrin). [but the law steps in and market to ensure that agency problem
is somewhat mitigated]
29) Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations (1776)
thought joint-stock companies might be inefficient; hired managers would not bring the
same anxious vigilance to their firms’ interests as owner-managers.
30)
31) Berle and Means, The Modern Corporation and Private Property (1932), undertook an
empirical study and found that shareholding was becoming dispersed; control had been
ceded by shareholders to specialised managers – the directors:
a) The position of the owner has been reduced to that of having a set of legal and
factual interests in the enterprise while [managers] are in the position of having
legal and factual powers over it…
, b) If we are to assume that the desire for personal profit is the prime force
motivating [managers], we must conclude that the interests of control are …
often radically opposed to those of ownership… In the operation of the
corporation, the controlling group even if they own a large block of stock, can
serve their own pockets better by profiting at the expense of the company than
by making profits for it…
32) The Modern Corporation and Private Property (1932) written by berle and Means
a) [H]ave we any justification for assuming that those in the control of the modern
corporation will also choose to operate it in the interests of the owners? Th[is]
will depend on the degree to which the self- interest of those in control may run
parallel to the interests of ownership and, insofar as they differ, on the checks
on the use of power which may be established by political, economic or social
conditions.
i) How ensure self interest aligns to interests of shareholders? : one way is
remuneration and incentives (share options)
ii) Where they different, but enforce checks and balances by various
methods
33) The Modern Corporation and Private Property (1932)
34) One response to the agency problem is directors’ duties. These ‘fill gaps’ in contracts
between principals and agents; they dissuade managers from acting in their own
interests.
35) Berle and means noted
a) We have the picture of a group of owners, necessarily delegating certain powers
of management, protected in their property rights by a series of fixed rules under
which the management had a relatively limited play. The management of the
corporation indeed was thought of as a set of agents running a business for a
set of owners; and while they could and did have wider powers than most
agents, they were strictly accountable and were in a position to be governed in
all matters of general policy by their owners.
b) The owners would have ability to exercise powers through the general meeting –
electing/dismissing the directors by way of special resolution. But Berle and
Means noted that even this control was diminished by the ability to vote by proxy
(can be devolved by the giving of a proxy)…
36) Alternative strategies for dealing with the agency problem:
37) Economic answer Under the efficient capital markets hypothesis,(other ways to deal
with the agency problem) capital markets are said to incorporate publicly available
information into the price of company shares. (if coy not being managed properly, then
demand for shares decrease. Subsequently, depressed share price makes them ripe for
takeovers, PEs. better managed coys or more active shareholders have steps in place to
ensure that neg/ inefficient directors are removed. Coys that dont do this are targets for
