Chapter 29 BM - Chapter 29: Corporate Governance Corporate...

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Chapter 29: Corporate Governance Corporate Governance and Agency costs Corporate governance: system of controls, regulations and incentives designed to prevent fraud - Different stakeholders in a firm all have their own interest and when those interest diverge, there may be agency conflicts - Conflict of interest between managers and investors derives from separation of ownership and control in a corporation - Investors are able to diversify and costlessly reduce their risk exposure, managers are more risk averse - Role of corporate governance system is to mitigate conflict of interest, tries to align interests by providing incentives for taking right action and punishment for taking wrong action - Incentives come from owning stock and from compensation that is sensitive to performance - Punishment comes from firing a manager Monitoring the Board of Directors - solution to conflict: monitoring managers closely - Solution ignores costs of monitoring - Shareholders as a group elect the board of directors to monitor managers which is still costly - Different countries put different emphasis on importance and duties of different stakeholders Types of directors: Inside directors: employees, former employees, family members of employees Gray directors: people who are not as directly connected to firm as inside directors, but who have existing or potential business relationships with the firm (e.g. bankers, lawyers, consultants) Outside (independent) directors: most likely to make decisions solely in interests of shareholders Board Independence Boards with majority of outside directors are better monitors of managerial effort and actions Independent boards make fewer value-destroying acquisitions and are more likely to act in shareholders’ interests if targeted in an acquisition 1
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But many other factors affect firm performance that effect of independent board is difficult to detect AND outside investors have less incentive to monitor the board closely because their wealth is less sensitive to performance Board is captured when duties have been compromised by connections or perceived loyalties to management Board size and performance Smaller boards are associated with greater firm value and performance
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Chapter 29 BM - Chapter 29: Corporate Governance Corporate...

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