Corporation
a mechanism established to allow different parties to contribute capital, expertise and labor for their mutual benefit.
Types of Corporations
-Sole proprietorship
-Partnership
-Corporations (public vs private)
Characteristics of public corp
-limited liability for investors- less risks
-Transferability of investor ownership: shares & stocks
-Legal personality: rights and obligations
-Separation of legal ownership and management control
Issues small firm faces with little separation bet. ownership & mgt control
-lack of skills to grow the firm will need outsiders to improve it
-give up some ownership for capital
investors owns corp but can’t make daily decisions, what do they do
-The shareholders elect directors to acts as agents to supervise.
-The directors appoint officers/ execs to run the firm daily
Principal and Agent
Principal- hires agent
Agent- performs work
Fiduciary duty
this is when agents owe a duty to act in best interest of their principal
Meaning of Agency Problem
When there is separation of ownership and management in a corp., self-
interested execs can benefit themselves at the expense of the shareholders and stakeholders
Principal - agent problem
-conflict of interest
-lack of trust
-diff. objectives
-agency costs
How severe are agency costs
-stock value falls
-loss of retirement funds
-lawsuits
-Bankruptcy
-Reputational damage
-Financial restatements
-Violation of foreign corrupt practice act
-Massaging earnings
Ponzi scheme
type of fraud where returns to earlier
investors are paid using money from new investors, rather than from actual profits
Mitigation strategies- how to prevent cooking the books?
Independent Audit Committee on Board of Directors
Mitigation strategies- how to prevent fraudulent representing coy value
SOX (Sarbanes-Oxley Act): External Auditors Cannot Consult for
Corporation
Mitigation strategies- how to prevent execs from stealing coy money
Independent External Auditor
Corporate governance
the collection of control mechanisms that
an organization adopts to prevent or dissuade potentially self-interested managers from engaging in activities detrimental to the
welfare of shareholders and stakeholders
Spheres of Corporate Governance
Stakeholders
-Officers: managing the corp
-Directors: monitoring & advising the corp
Shareholders: own shares in the coy
Who appoints who?
Shareholders- elect directors
Directors: appoints CEO/officers
Money flow of Corporate Governance
-Officers- make $ by managing corp.
-Directors- can issue div. based on % of profits to shareholders
-Shareholders- receive didvidends
How can we prevent executives from shirking
(not putting in effort)?
Compensate with bonuses - compensation committee
How can we prevent executives from taking
excessive risks?
compensate with shares
How can we prevent executives from taking
too little of risks?
compensate with options
How to prevent executives from hiring& promoting friends& family? from awarding contracts to friends? from hiring friends& fam to BOD
Nomination committee
info about these committees in US & Canada
-US - All 3 must be independent
-Canada- Audit must be independent, doesn’t need to be compensation & nominating committee
