2 Corporate governance and financial strategy: contents Learning objectivesIllustrative stages in the ownership life cycleChanging role of corporate governance over the ownership life cycleIndicative attributes of lack of independence in a directorProblems with performance measures in executive payEPS growth as a target in different growth scenariosControl enhancement mechanisms (CEMs)Structures of control: the PyramidStructures of control: Indirect controlCase study 6.3: Hollinger control structureCorporate governance mechanisms and the minority shareholderCorporate governance mechanisms and the lenderCorporate responsibility and the drivers of value
3 Learning objectivesApply a model to determine which aspects of corporate governance are most relevant at different stages of a company’s life cycle.Recognize the limitations of different types of executive remuneration plan, and evaluate how their performance measures link to the creation of value.Understand and explain how differences in corporate governance regimes can affect the financing strategies of companies in those jurisdictions.Contrast the different mechanisms by which block-holders can control a company, and explain the impact, positive and negative, that this can have.Explain why stakeholders merit consideration in a discussion of financial strategy.
4 Illustrative stages in the ownership life cycle Sole traderPartnershipLtd company owned by managementLtd company owned with close associatesLtd company with private equity investorsLtd company owned by the publicAgency problems and accountabilities increase lower down the pyramid
5 Changing role of corporate governance over the ownership lifecycle Sole traderPartnershipLtd company owned by mgtLtd company owned by associatesLtd company with private equity investmentLtd company with wide ownershipAgency problemsNoneNone until organization size requires delegationSomeManyInternal control & reportingManage the moneyManage employeesRegular accountsDivision of duties and formalised internal controls.Sophisticated reporting systems.Reporting to outside shareholders.(All increase as the business develops)External reportingNot requiredMay need to file accountsReporting to investorsReporting to investors, and possibly to regulatorsExtensive reportingExternal auditNo needOptionalCompulsory in some regimesGenerally required by investorsGenerally compulsory / demanded by investorsCompulsoryManagement and directionSelfPartnersDirectorsManagement and investorsManagement, with input from PE investorsProfessional mgrs & NEDsManagement remnTo suit self and business needsTo suit partners and business needsTo suit owners and business needsAgree with external investorsAgree with investors; will include equity as incentive to grow capital and exitAgree with external investors and governance regulations
6 Indicative attributes of lack of independence in a director Has been an employee or executive of the company or a related company in the past X years.Is a close family member of a director of the company or a related company.Has had a significant business relationship with the company in the past Y years.Is a professional adviser to the company, or has some other business relationship.Represents a block shareholder or a major lender to the company, or has significant business transactions with same.Holds cross-directorships with other members of the company’s board.Participates in the company’s pension scheme or share option scheme.Has served on the board continuously for more than Z years
7 Problems with performance measures in executive pay Profit, earnings per share, and eps growthAccounting policies can be chosen selectivelyUse of debt distorts epsInvestment requirements can distort figuresRisk is not taken into accountDividend policy vs. share buybacks can distortDoes profit clearly relate to shareholder value?Return on Capital EmployedAll issues as per eps, etc.Distorted over project lifeAffected by company’s growth rateEffects of inflation can distortNot comparable to ‘cost of capital’Total shareholder return (TSR)Is the share price a good measure for exec performance?Complex for execs to understandTreadmill of expectationsNon-financial measuresQuality of information? (not audited)Subjective?Perception of ‘soft’ measures
8 EPS growth as a target in different growth scenarios eps growth of RPI+X% is a commonly used base measureeps growth does not necessarily lead to shareholder value!P0Share priceHigh plcLow plcNowTimeT1P1P2
9 Control enhancement mechanisms (CEMs) CEMs which work by giving block-holders enhanced voting rightsShares with multiple voting rightsNon-voting sharesPyramid structuresCEMS which lock in controlPriority shares with veto rights over certain decisionsVoting rights ceilings (which limit voting power regardless of how many shares are owned)Ownership ceilings (which prevent transfer of shares to owners if they would take the holding above a certain percentage)Golden shares (often used by governments in sensitive privatized companies)Source: Report on the Proportionality Principle in the European Union Available viaAt the time of writing, the EU is considering giving additional voting rights and dividends to investors holding shares for a period of years, with the aim of encouraging long-term investment.
10 Control enhancement mechanisms (CEMs) CEMs which work by giving block-holders enhanced voting rightsCEMS which lock in controlShares with multiple voting rightsNon-voting sharesPyramid structuresPriority shares with veto rights over certain decisionsVoting rights ceilings (which limit voting power regardless of how many shares are owned)Ownership ceilings (which prevent transfer of shares to owners if they would take the holding above a certain percentage)Golden shares (often used by Governments in sensitive privatized companies)Source: Report on the Proportionality Principle in the European Union Available via
11 Structures of control: the Pyramid Controlling shareholderHolding 2Holding 1Target51%Control is obtained through ownership of 13.3% of the shares
12 Structures of control: Indirect control Controlling shareholderHoldingTarget90%15%36%Control is obtained through ownership of 47.4% of the shares
13 Case study 6.4: Hollinger control structure Black and Radler together control 79.2% of Ravelston, which in turn owned 78.2% of HLG, so their combined indirect ownership interest in HLG was approximately 62%. In turn, HLG owned a 30.3% interest in Hollinger. Through HLG, Black and Radler’s indirect ownership interest in Hollinger was approximately 19%. Thus, every $100 transferred out of Hollinger and into HLG ‘cost’ Black and Radler $19 but gave them $62, thereby tripling their funds at the direct expense of the Hollinger common stockholders other than HLG.Extract and diagram are from page 8 of the Report of the Special Committee of Hollinger
14 Corporate governance mechanisms and the minority shareholder Reducing risk for minority shareholdersIncreasing risk for minority shareholdersAbility to vote on all resolutions, including voting directors onto or off the boardEase of votingLegal mechanisms for minority shareholders to take action against oppression by the majority or against expropriations by managementLaws or codes protecting the minority during a takeoverLaws protecting against insider tradingRequirement for independent non-executive directors on the boardRequirement for high levels of relevant financial and non-financial disclosures, for example details of transactions with related partiesControl enhancement mechanisms (CEMs) such as certain shares carrying multiple votes, or no votes, or ceilings on voting rights, or vetoes in certain situations
15 Corporate governance mechanisms and the lender Reducing risk for lendersIncreasing risk for lendersEase of ability of a lender to enforce their security to repossess assets if loan terms are breachedStrong legal protection over property rights, including intellectual property rights (so that the company’s assets cannot be expropriated)Bankruptcy laws that leave the existing executives in control of the company rather than letting creditors put in their own managementBankruptcy laws that enable management to protect the company against creditor claimsPriority of social or government claims over the rights of secured lenders
16 Corporate responsibility and the drivers of value Driver of valueSome examples of driving performance through sustainabilityGrow sales fasterInnovative products to meet sustainability needs.Attract customers by corporate responsibility stance.Increase operating profit marginBetter workforce efficiency by treating people better: attract better people, more training, less absenteeism, lower staff turnover.Efficiencies due to energy and waste management.Reduce cash tax ratePossibly take advantage of incentives.Fewer fixed assetsImproved efficiencies.Less working capitalReduced waste leading to reduced inventory.Better supply chain practices as companies work in coordination.Increase the period for which the organisation has a competitive advantageIncreased brand equity in the sustainable company.Compliance leads to legitimacy which extends the ‘licence to operate’.Lower cost of capitalInvestors perceive lower risk in companies that are compliant with ‘best practice’ governance regulations.