A Survey of Corporate Governance.
The fundamental problem of corporate governance?
How to assure financiers that they get a return on their financial investment?
▪ CG mechanisms are economic and legal institutions (i.e. rules) that can be adjusted by the political process.
A Survey of Corporate Governance.
What is the agency problem in the context of CG?
Financiers face the difficulty in assuring that their funds are not expropriated or wasted on unattractive projects.
▪ Ideally, a financier would sign a contract with a manager that specifies division of
profits and manager’s actions in all states of the world
A Survey of Corporate Governance.
What are some of the bad things that the management can do?
Expropriation can happen via direct absconsion with the money as well as more subtle ways - transfer pricing, empire building, pursuing pet projects or entrenching in the position.
A Survey of Corporate Governance.
What is the evidence for agency costs/ PBOC?
If the stock price falls when managers announce a particular action, this action must serve the interest of managers rather than shareholders.
Manager’s resistance to the value-enhancing takeover or adoption of Poison Pills signals the existence of PBOC.
Large blocks of shares carry more control and thus trade at a large premium.
A Survey of Corporate Governance.
Why investors invest at all (having all agency problems)?
- Legal protection (Vote on important matters, Duty of loyalty, creditors have covenants)
- Large investors (CF rights and control rights of large shareholders are better aligned, hostile takeover). Costs: lack of diversification, expropriation of small shareholders, scare-away general public investment, low motivation of employees.
A Survey of Corporate Governance.
What were the conclusions?
Successful corporate governance systems combine significant legal protection (exert pressure
through votes and collateral collection) of at least some investors with an important role for large investors (force managers to distribute profits).
Private Benefits of Control: An International Comparison.
What are private benefits of control?
Benefits that are not shared among all shareholders in
proportion of the shares owned, but are exclusively enjoyed by parties in control: “psychic” value, outright theft, transfer pricing, using insider info for personal gain
Private Benefits of Control: An International Comparison.
What are the two main ways of measuring PBOC ?
1.Control premium - the difference between the price per share of the control block and the market price per share.
Drawbacks:
Sales of control blocks are rather rare; delay in incorporating public information to the market price.
2. Price difference between shares in a dual-class system. Extra voting rights as a proxy for corporate control.
Drawback:
dual class shares are not allowed in every country.
Private Benefits of Control: An International Comparison.
What affects the size of PBOC premium?
The size of block traded.
Sellers bargaining power (distress, buyer is a foreigner).
Private Benefits of Control: An International Comparison.
How PBOC affects financial development?
- Entrepreneurs are reluctant to make their companies public; equity markets are underdeveloped.
- Less widely held companies.
- To maximize profit, governments should sell companies privately rather than in public offerings.
Private Benefits of Control: An International Comparison.
What lessens PBOC (according to the study)?
- The legal environment (Anti-director rights).
- Disclosure standards.
- Enforcement.
Extra-Legal institutions: - Product market competition.
- Public opinion pressure.
- Government as a monitor through tax enforcement.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
What are the two activities that institutional
investors conduct when they are unhappy with company’s performance?
- Voice – engaging with management to try to initiate changes.
- Exit – leave the firm by selling shares.
▪ Threat of exit can also serve as a disciplinary action.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
What are the determinants of voice intensity?
- Higher liquidity of shares held encourages investors not to bother with activism and liquidate.
- Investment horizon - long-term orientation provides more incentives to monitor and intervene.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
Exit and threat - Substitutes or complements?
The paper finds robust positive correlation between the two variables, suggesting that they are complements.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
When are exit threats effective?
- threat by other investors for the same reason.
- presence of multiple informed shareholders.
- If managers own equity in the company - more convincing.
- size of the equity stake should be significant for the threat to be effective.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
What discourages shareholder activism?
- The “free rider” problem – they would personally incur costs of activism while the benefits would be shared among all shareholders.
- Inadequate legal rules do affect activism.
- Conflicts of interest: Investors might be concerned that aggressive engagement might affect their future relations with firms (private costs).
- Managers of funds are not sufficiently rewarded for activism.
Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.
What encourages shareholder activism?
▪ Fraud
▪ Inadequate corporate governance and excessive compensation.
▪ Disagreement with a firm’s strategy, specifically large mergers and
acquisitions.
▪ Contributions to politicians
Active Ownership.
What are examples of social and governance (ESG) concerns?
▪ Environmental engagements typically concern climate change, water issues.
▪ Social concerns - human rights, public health and labor standards.
▪ Governance - audit and control, executive compensation.
Active Ownership.
Theoretical Effects of Corporate Social Responsibility?
- Based on long-term strategy, consistent with the interests of institutional investors (e.g. pension
funds). Firm value should increase! - A channel to express personal values on behalf of their stakeholders. Delegated philanthropy saves time
and information costs of doing charity on one’s own. Firm value should increase! - CSR activities are management-initiated, opposed by shareholders, thus revealing agency problems. Firm value should decrease!
Active Ownership.
Channels of the ESG value enhancement?
- Consumers: Socially conscious consumers have a greater customer loyalty and are willing to pay premium for ESG-induced product differentiation.
- Employees: Firms with higher employee satisfaction.
- Morals: More “virtuous” companies attract broader clientele than “sinful” companies.
- Progressiveness: Successful ESG interventions signal similarly successful future interventions as well as firm’s openness to improvements in other areas.
Active Ownership.
Determinants of successful ESG engagement?
- Large and mature firms.
- Institutional ownership. Other socially conscious investors increase the chances of collaboration.
- Underperforming firms. Potential room for improvement.
- Consumer industries. Consumer-facing and brand-driven firms aremore likely succumb to reputational concerns (e.g. Nike).
Active Ownership.
Market responses to ESG activism?
- ESG engagement generates 2.3% abnormal return of firm stock value over the one year (!)
- There is no market reaction after Unsuccessful engagement (!)
- Compared to CG, ES (environmental and social) activism results in higher sales and employee efficiency – consistent with the argument of higher customer base and employee loyalty.
Active Ownership.
Why firms might not voluntarily pursue ESG strategies?
▪ Targeted firms have poorer corporate governance hindering the initiation of ESG policies.
▪ In the absence of active owners, companies might fail to identify ESG opportunities.
The Agency Problems of Institutional Investors.
What are Stewardship activities?
They are engagement with public companies to promote corporate governance practices that are consistent with encouraging longterm value creation for shareholders in the company (e.g. voting in shareholder meetings, monitoring corporate managers)
Require substantial costs from the funds.
