Chapter 4 - Corporate Governance Around the World Governance and the Public Corporation Agency Incentives Capital Markets and Valuation Promotion of Economic Growth Reform The Sarbanes-Oxley Act

Governance and the Public Corporation The public corporation, is jointly owned by many shareholders protected with limited liability; - this includes C, S, LLC, LLP It is an efficient risk sharing mechanism that allows corporations to raise large amounts of capital. A key weakness is the conflict of interest between managers and shareholders. In principle, shareholders elect a board of directors, who in turn hire and fire the managers who actually run the company. In reality, management-friendly insiders often dominate the board of directors, with relatively few outside directors who can independently monitor the management.

Governance and the Public Corporation In the case of Enron, Tyco, WorldCom and other dysfunctional corporations, the CEO and boards of directors grossly failed to safeguard shareholder and other stakeholders interests.

Agency Shareholders allocate decision-making authority to the managers. Many shareholders are not qualified to make complex business decisions. A shareholder with a diversified portfolio would not have the time to devote to making the numerous decisions at each of the many companies. Kohl, Belzberg, Pritzkers. Having the short-term control of the firm’s assets, managers might be tempted to act in the manager’s short-term best interest instead of the shareholder’s long-term best interest. Enron, Tyco and WorldCom.

Agency In the U.S., shareholders have the right to elect the board of directors. If the board remains independent of management, it can serve as an effective mechanism for curbing the agency problem. In Japan, most corporate boards are insider-dominated and primarily concerned with the welfare of the keiretsu to which the company belongs.

Incentives Incentives are designed as a compensation scheme that gives executives an incentive to work hard at increasing shareholder wealth. Executive stock options are an increasingly popular form of incentive compatible with increasing shareholder wealth. Executive Stock Options in essence, exist to align the interests of shareholders and managers.

Capital Markets and Valuation Investor protection promotes the development of external capital markets. When investors are assured of receiving fair returns on their funds, they will be willing to pay more for securities. Thus strong investor protection will be conducive to large capital markets. Weak investor protection can be a factor in sharp market declines during a financial crisis.

Promotion of Economic Growth The continuation of well-developed financial markets, promoted by strong investor protection, may stimulate economic growth by making funds readily available for investment at low cost. Financial development can contribute to economic growth in many ways, including: It enhances savings. It channels savings toward real investments in productive capacities. It enhances the efficiency of investment allocation.

Reform In recent years, Companies’ internal governance mechanisms, external auditors, regulators, banks, and institutional investors have all failed in their respective roles. If we now Fail to reform corporate governance, this will damage investor confidence, inhibit the development of capital markets, raise the cost of capital, alter capital allocation, and even destroy confidence in the capitalist system itself.

The Sarbanes-Oxley Act Accounting regulation Audit committee Internal control assessment Executive responsibility Will The Sarbanes-Oxley cure all greed and white color crime?

Financial Health Financial Ratios: 1. Liquidity 2. Profitability 3. Solvency

Stages of Int’l Corporate Finance Start-up Growth to Maturity Maturity Exit strategy

Liquidity Ratios Current ratio – Current assets/Current liabilities Quick ratio - Cash, receivables, s-t investments /Current liabilities Receivable turnover – Sales/Average receivables Inventory turnover – Cost of goods sold/Average inventory

Profitability Ratios Profit margin – Net income/Net sales Asset turnover – Net sales/Average assets Return on assets – Net income/Average total assets Return on equity (ROE) – Net income/ Average common stockholders equity

Profitability Ratios Earnings per share (EPS) – Net Income/Weighted and a measure of ROI average common shares outstanding Price-earnings ratio (P-E) – Market price per share/ also called multiples Earning per share Payout ratio – Cash dividends/Net income

Solvency Ratios Debt to equity ratio – Debt/Equity (use this ratio) Debt to total asset ratio – Total debt/Total assets Times interest earned – EBIT/Interest expense Free cash flow – Cash provided by operating activities – capital expenditures - Cash dividends

Financial Analysis of Int’l Corporation Corporation – 10K (insert) Balance Sheet Income Statement Statements of Cash flows

Starbucks Case Characteristics of : Start up phase Growth to maturity

Howard Schultz - Entrepreneur Nature Fathers influence

Market Pricing Approaches Market - based Cost - based

Strategies Cost Leadership Product differentiation

Developing Target Prices and Target Costs Develop a product that satisfies the needs of potential customers Choose a target price Derive a target cost per unit: Target Price per unit minus Target Operating Income per unit Perform cost analysis Perform engineering to achieve target cost

Cost – Plus Pricing The formula for setting a cost-based price is to add a markup component to the cost base: Cost base $ 1.00 Markup component – 30% .30 Prospective selling price $ 1.30 =====

Starbucks – Capital Raising Page 9 - $400,000, subsequently, $1.25 million Page 10 – Actual - $1.65 million, including $400,000 (ability to raise capital) Page 10 – Purchases Starbucks for $3.8 million Page 13 – Raises $13 million (why and how) Page 14 – IPO 1.5 million shares, $29 million (what does it take to do an IPO)?

Starbucks - Franchise Page 18 – Why not franchise at maturity? Brand equity and trademark. Page 2 – Alliances, why? Compare with Disney and Nike, benefits. Page 22 – Licensing with Kraft at maturity, why? Page 23 – Purchase of Seattle’s Best, why?

Starbucks - International Strategies 1. Differentiation 2. Cost leader 3. Technology 4. Where to expand and why?

Starbucks - Phases Start-up Growth to maturity Maturity