BUSI 4940 Chapter 10 (Lecture)
Questions and Correct Answers.
Corporate governance is - Answer -the set of mechanisms used to manage relationships
among stakeholders and to determine and control the strategic direction and performance of
organizations
-concerned with identifying ways to ensure that strategic decisions are made more effectively
(more of an academic than practitioner issue)
-used in corporations to establish harmony between the firm's owners and its top-level
managers whose interests may be in conflict
Separation of Ownership and Managerial Control - Answer •Basis of the modern corporation
-(Common) Shareholders purchase stock, becoming residual claimants (owners)
-Shareholders reduce risk by holding diversified portfolios
-Professional managers are contracted to provide decision making (Their risk is that a great
portion of their wealth is tied to the one company)
The structure of modern public corporations leads to efficient specialization of tasks
Risk bearing by shareholders
Strategy development and decision making by managers
Agency Relationship - Answer The goal of a principal is to gain Agency Efficiency-achieving
the best ratio of cost/benefit within the relationship
Shareholder = Bankruptcy risk, but can diversify investments
Managers = Most of their wealth is tied to one company
1. Shareholders (Principals/Owners) hire Managers
2. Managers (Agents/Decision makers)
creates
3. an agency relationship
-risk-bearing specialist (Principal) paying compensation to a managerial decision-making
specialist (agent)
Agency Relationship Problems - Answer •Principal and agent have divergent interests and
goals.
•Shareholders lack direct control of large, publicly traded corporations.
•An agent may make decisions that result in the pursuit of goals that conflict with those of the
principal.
, •It is difficult or expensive for the principal to verify that the agent has behaved appropriately.
•Agent falls prey to managerial opportunism.
Agency Costs and Governance Mechanisms - Answer •Agency Costs
-The sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses
incurred by principals, because governance mechanisms cannot guarantee total compliance by
the agent
•Principals may engage in monitoring behavior to assess the activities and decisions of
managers.
-However, dispersed shareholding makes it difficult and inefficient to monitor management's
behavior.
Ownership Concentration - Answer •Definition - The number of 'large-block' shareholders
and the total percentage of the firm's outstanding shares they own.
•"Large-Block Shareholder" - Typically own 5% or more of a company's issued shares
•"Institutional" Shareholders - Financial institutions, such as mutual funds and pension plans,
that control large-block shareholder positions
•Strong incentive and resources to monitor management
•In the U.S., financial institutions are not allowed to directly hold seats on the board
•Shareholder Activism
-Coordinating large-block shareholders to force changes to the board or strategic direction of
the company
-Atlantic Power Example
Board of Directors - Answer •Board of directors
-Group of elected individuals that acts in the owners' interests to formally monitor and control
the firm's top-level executives
•Board has the power to
-direct the affairs of the organization("nose in, hands out")
-punish and reward managers
-protect owners from managerial opportunism
Board of Directors - Composition of Boards - Answer -Insiders are the firm's CEO and other
top-level managers.
-Related Outsiders are individuals uninvolved with day-to-day operations, but who have a
relationship with the firm.
-Outsiders are individuals who are independent of the firm's day-to-day operations and other
relationships.
Questions and Correct Answers.
Corporate governance is - Answer -the set of mechanisms used to manage relationships
among stakeholders and to determine and control the strategic direction and performance of
organizations
-concerned with identifying ways to ensure that strategic decisions are made more effectively
(more of an academic than practitioner issue)
-used in corporations to establish harmony between the firm's owners and its top-level
managers whose interests may be in conflict
Separation of Ownership and Managerial Control - Answer •Basis of the modern corporation
-(Common) Shareholders purchase stock, becoming residual claimants (owners)
-Shareholders reduce risk by holding diversified portfolios
-Professional managers are contracted to provide decision making (Their risk is that a great
portion of their wealth is tied to the one company)
The structure of modern public corporations leads to efficient specialization of tasks
Risk bearing by shareholders
Strategy development and decision making by managers
Agency Relationship - Answer The goal of a principal is to gain Agency Efficiency-achieving
the best ratio of cost/benefit within the relationship
Shareholder = Bankruptcy risk, but can diversify investments
Managers = Most of their wealth is tied to one company
1. Shareholders (Principals/Owners) hire Managers
2. Managers (Agents/Decision makers)
creates
3. an agency relationship
-risk-bearing specialist (Principal) paying compensation to a managerial decision-making
specialist (agent)
Agency Relationship Problems - Answer •Principal and agent have divergent interests and
goals.
•Shareholders lack direct control of large, publicly traded corporations.
•An agent may make decisions that result in the pursuit of goals that conflict with those of the
principal.
, •It is difficult or expensive for the principal to verify that the agent has behaved appropriately.
•Agent falls prey to managerial opportunism.
Agency Costs and Governance Mechanisms - Answer •Agency Costs
-The sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses
incurred by principals, because governance mechanisms cannot guarantee total compliance by
the agent
•Principals may engage in monitoring behavior to assess the activities and decisions of
managers.
-However, dispersed shareholding makes it difficult and inefficient to monitor management's
behavior.
Ownership Concentration - Answer •Definition - The number of 'large-block' shareholders
and the total percentage of the firm's outstanding shares they own.
•"Large-Block Shareholder" - Typically own 5% or more of a company's issued shares
•"Institutional" Shareholders - Financial institutions, such as mutual funds and pension plans,
that control large-block shareholder positions
•Strong incentive and resources to monitor management
•In the U.S., financial institutions are not allowed to directly hold seats on the board
•Shareholder Activism
-Coordinating large-block shareholders to force changes to the board or strategic direction of
the company
-Atlantic Power Example
Board of Directors - Answer •Board of directors
-Group of elected individuals that acts in the owners' interests to formally monitor and control
the firm's top-level executives
•Board has the power to
-direct the affairs of the organization("nose in, hands out")
-punish and reward managers
-protect owners from managerial opportunism
Board of Directors - Composition of Boards - Answer -Insiders are the firm's CEO and other
top-level managers.
-Related Outsiders are individuals uninvolved with day-to-day operations, but who have a
relationship with the firm.
-Outsiders are individuals who are independent of the firm's day-to-day operations and other
relationships.
