1. Chapter 11 Corporate governance

2. Businesses in the United States Number of businesses in the United States? Number of employers in the United States? Number of corporations in the United States? 1/5 of U.S. corporations account for 95 percent of the sales of all corporations (textbook) 22.7 mill. in 2003 (SBA) 5.66 mill. in 2001 (SBA) 4.5 in 1995 (usinfo.state.gov)

3. Corporate governance Relation between owners and managers –Owners Owners have the rights of ownership which means that they have a legal claim to the firm’s residual assets (those that remain after paying off creditors) Owners have limited liability for the actions of corporations. –Managers have a FIDUCIARY responsibility towards owners Managers face moral hazard: They are tempted to serve their own interests over their FIDUCIARY responsibility towards shareholders. –Legal problems: Salaries are too large, too many perks –Illegal problems: insider trading and misrepresentation of company information (after Sarbanes – Oxley Act) In the 1990s there was a major move towards paying managers with shares so as to place them closer to the needs of shareholders. This change misfired: Managers became very concerned with short term gains.

4. Corporate governance Two types of corporations: –Privately held: Owners maintain a higher level of control. There is private exchange of shares. Conditions are usually specified in the corporate charter –Publicly held The focus of our discussion. Exchange is public stock exchanges: NYSE, NASDAQ, regional. They have to follow strict information guidelines by the SEC.

5. Corporate Governance mechanisms and strategies Mechanisms: –The stock market –Annual meetings –Board of directors Strategies (Hirschman) –Exit –Voice

6. The stock market: Exit mechanism Conditions for the stock market to work properly –It is wide enough: There are enough number of companies so an unhappy investor can sell and buy shares in a different company. –It is deep enough: There is enough number of shares of one particular company so there is enough number of people willing to buy or sell one the investor wants to sell or buy. –Good information from company reporting, auditors, stock analysts, and credit rating agencies.

7. Changes in the market for corporate control mechanism Growth of institutional investors is changing the system from exit to voice. –Growth of pension and mutual funds Because of their size the market becomes more narrow and less deep. Hence they are forced to engage in “relationship investing”– becoming involve in management decisions. Growth of social investment (on the trillions of $).

8. Annual meeting: Voice mechanism Annual gathering of shareholders to discuss the firm’s performance and strategy They can be easily co-opted by management Proxies have been used by managers and shareholders to impose their positions. –Proxy: the vote that an absentee shareholder has transferred to someone. Most commonly a manager. –After the 1992 reforms it became easier for other shareholders to get proxies. This reform facilitated communication among shareholders.

9. Shareholder Activism Shareholders use of annual meetings to affect management through shareholder resolutions –serve a social cause –limit executive compensation and even force top management out.

10. Board of Directors: Voice mechanism Shareholders control corporations by picking the BOD. –Voting is proportionate to the # of shares owned. –Whoever controls over 50% of the shares gets to name the board of directors. Profile –Size –Insiders and outsiders –Close knit networks. Functions –Hiring and firing on top managers –Major strategic decisions –Fiduciary responsibility –Advisory responsibility

11. Shaping up the board Suits against negligent directors. Companies provide liability insurance to their boards but the threat of legal action should keep members on their toes.