lecture_corpgov_521_2011

lecture_corpgov_521_2011 - Corporate Governance Making sure...

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Corporate Governance Making sure firms don’t waste money on value destroying (negative NPV) projects Invest in NPV < 0 project Share price falls “Good corporate governance” is equivalent to “keeping the share price up”
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Example of Agency Problems Obvious agency problems Unnecessarily lavish perks Palatial office buildings Top heavy layers of management Entrenched bureaucracy Hidden agency problems Cronyism, nepotism, racism, etc. Committees to avoid decision-making Using corporate assets to push political agenda
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Other People’s Money Company is worth $1 B Proposal to buy $100 M Lear jet fleet CEO cites “time”, “airfare”, etc. saved Firm’s cost-benefit analysis Cost to firm $100M PV of savings $20M Net value to shareholders -$80M CEO’s cost benefit analysis CEO owns 0.01% of firm’s stock Cost to CEO (0.01% of $100M) $10K PV of CEO’s enjoyment $1M Net value to CEO +$990K
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Lear Jet
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Good Corporate Governance: The Prevention and Cure of Agency Problems
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US Corporate Governance Situation: Most big US firms are ‘widely- held” – that is, their shareholders are thousands of individuals (as well as pension plans, mutual funds, and other institutions) Problem: The CEOs and other top executives may spend the firm’s money on things they want, not necessarily on things with positive NPVs
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Factors that Mitigate Governance Problems
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Potential Ways to Improve Corporate Governance 1. Shareholder lawsuits / public scrutiny 2. Hostile takeovers 3. Stock Compensation 4. Proxy Fights 5. Large Shareholders 6. Independent Board 7. Leverage
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1. Shareholder Lawsuits Shareholders sue top executives on behalf of “the corporation” But Frivolous lawsuits Bias towards low risk policies Risk averse people stay out of corporate management
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2. Hostile Takeovers Badly run firms taken over But Takeovers driven by egos, etc., not economics
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3. Make Top Executives Own Stock Pay them in stock options, not cash But Public Outrage Executives scamming the system Leads to executive “entrenchment”?
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Other People’s Money Agency problems should be worst where managers own the least stock q = 1 0% managerial stock ownership 100% Predicted firm value q ratio CEO pays little of Lear jet cost CEO pays most of Lear jet cost Predicted relationship is not observed
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Old CEOs Sometimes Die on the Job stock price CEO death announced time
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Entrenched Management Agency problems should be worst where managers own lots of stock q = 1 0% managerial stock ownership 100% Predicted firm value q ratio Firm is easy to take over Firm is hard to take over Predicted relationship is not observed
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Managerial Stock Ownership This is observed q = 1 0% managerial stock ownership 100% Observed firm value q ratio Managerial stake is too low causing divergence of interests problems Managerial stake is too high causing managerial entrenchment
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This note was uploaded on 01/02/2012 for the course FINANCE 347 taught by Professor Bayou during the Fall '11 term at NYU.

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lecture_corpgov_521_2011 - Corporate Governance Making sure...

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