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The Corporate Governance of Listed Companies A Manual for by liwenting


									The Corporate Governance of Listed
A Manual for Investors

      By Dr. Kyle Wong, CFA and FRM
    What is Corporate Governance?

 Corporate governance refers to the firm’s internal
   controls and the procedures by which the firm is
 Defines rights and responsibilities of management,
   the board, and shareholders
 Good corporate governance ensures that shareholder
   interests are protected
Why Corporate Governance?
Corporate Governance System

“The system of principles, policies, procedures, and
clearly defined responsibilities and accountabilities
used by stakeholders to overcome conflicts of
interest inherent in the corporate form.”

   Eliminate or reduce conflicts of interest
   Use company assets in best interests of investors and
    other stakeholders
Core Attributes of Effective System
   Define shareholder rights
   Define oversight responsibilities
   Provide fair and equitable treatment
   Provide transparency/accuracy in disclosures
      Business Forms and Conflicts of Interest

   Sole proprietorships – owned and operated by a single
      Conflicts of interest: Typically involve creditors and

   Partnerships – two or more owners/managers
      Conflicts of interest: Typically involve creditors and
    Business Forms and Conflicts of Interest

   Corporations – distinct legal entity
   Point: Conflicts of interest between shareholders
     1) Management
     2) Board of directors
      Created by lack of owner control of day-to-day
       operations (separation of ownership and control)
      Agency Relationships
   Defined: One individual called the “agent,” acts on behalf
    of another called the “principal”
   Principal-agent problem – agent acts for his own benefit
    rather than principal’s benefit
   Areas of primary concern:
       Managers vs. shareholders

       Directors vs. shareholders
       Agency Relationship Conflicts

Manager (Agent) vs. Shareholder (Principal)
 Using funds to expand size of firm (motive for mergers)

 Granting excessive compensation, perquisites

 Investing in risky ventures with negative NPV

 Not taking enough risk (passing up positive NPV projects) if
  wealth is tied up in company stock; firm undiversified
     Agency Relationship Conflicts
Director (Agent) vs. Shareholder (Principal)
 Lack of independence (managers on BOD)
 Board members have personal relationship with
 Board members have consulting or other business
  agreements with the firm
 Interlinked boards
 Directors are overcompensated
 Point: BOD aligned with management, not shareholders
The Stakeholders
   Factors Affecting Corporate Governance

 Board of directors – independent directors,
   qualifications of directors, terms, committee structure
 Management – Code of Ethics, board oversight,
   compensation, alignment of interests
 Shareholder rights – voting rights        (e.g., cumulative),
   proxy voting, actions requiring shareholder approval
    What Makes a Good Board?
 Acts in the best interest of shareholders
   Independent majority
   Sometimes meets without managers present
 Ability to hire outside consultants with specialized
  knowledge (e.g., risk management, technology, legal)
 Annual terms give shareholders more control than
  longer, possibly staggered, terms
 Negative factors: CEO (or past CEO) is chair,
  members are closely related to customers or suppliers
      Independent Board Members

 Board members that do not have material relationships
   with management or significant shareholders
 No compensation from firm for other than board service
   (e.g., no consulting or finders fees)
 Works to protect shareholders’ long-term interest
       What Makes a Good Board Member?

 Qualifications and experience
       Can they make informed decisions?
       Do they understand the business?
       Are they ethical?
       Have they had legal or regulatory problems?
       Have they had other board experience?
       Do they attend meetings?
     Code of Ethics

 Strong Code of Ethics needed
 Policies should prevent personal use of corporate assets
    Board members should not serve as consultants
    Board members should not receive finders fees for
     M&A or sales opportunities
    Provisions of a Code of Ethics

   Congruent with local laws
   Prohibit advantages to firm insiders
   Conditions for waivers (and frequency of use)
   Require timely information to board
   Periodic audits/reviews of Code

    Weak code allows related-party transactions and
            personal use of company assets
        Board Committees

 Audit: Ensures quality of financial reporting
       Proper procedures (e.g., GAAP)
       Controls auditors
   Compensation: Sets executive compensation
       Links compensation to LT performance
       Need independence from management
 Nominations: Nominates/recruits new members
       Shareholders and Proxy Voting Rules

Easy proxy voting = better shareholder rights
       Limits on proxy voting
       Meetings timed inconveniently
       Require attendance
       Allows “share blocking”
        Cumulative voting with large minority
        shareholder group (e.g., founding family)
     Shareholder Sponsored Action

           Greater ability to influence board =
             greater shareholder protection

   Board nominations
   Resolutions/proposals
   Issues:
     When can they be made?
     Can board member be removed?
     Simple majority vs. supermajority?
      Different Classes of Stock
 Classes separate voting rights and economic value
 Potential acquirers may only deal with one class of
 Generally, separation of voting rights works to the
   impairment of at least one set of shareholders
 Different classes lead to trouble raising equity capital
  Takeover Defense and Share Value

Takeover defenses reduce shareholder value
 Golden parachutes
 Poison pills
 Greenmail

Is shareholder approval required to implement?
Past acquisition interest?
Government intervention in acquisition likely?
Corporate Governance
    Board of Directors Responsibilities

   Institute corporate values
   Create long-term strategic objectives
   Determine management’s responsibilities
   Ensure complete and accurate information
   Meet regularly
   Ensure board members are adequately trained
       Board of Directors
       Assessing Attributes and Best Practices

   Composition of board; 75% of directors independent
   Independent chairman on board (not CEO)
   Qualifications of directors
   How board elected (annual elections)
   Board self-assessment practices
   Frequency of separate sessions for independent directors
       Board of Directors
       Attributes and Best Practices cont.

   Audit committee and audit oversight (only independent
   Nominating committee (only independent directors)
   Compensation committee and management compensation
    (mostly performance-based)
   Use of independent and expert legal counsel
      Board of Directors
      Attributes and Best Practices cont.

   Statement of governance policies
   Disclosure and transparency (more disclosure is better)
   Insider or related-party transactions (board approval for
    related-party transactions)
   Responsiveness to shareholder proxy votes
    Corporate Governance Policies

   Codes of ethics
   Directors’ oversight, monitoring
   Management’s responsibility to board
   Reports of director’s oversight
   Board self assessments
   Management performance assessments
   Director training
    Corporate Governance and Company

   Firms with strong/effective governance systems
       Higher measures of profitability

       Higher returns for shareholders

   Weak/ineffective governance system:
       Increased risk to investors

       Reduced value

       Extreme cases: bankruptcy
Considerations in M&A
     Attitude of Target Management

   Friendly merger offers
         Acquirer approaches management

          Negotiations and due diligence

           Definitive merger agreement

    Public announcement and shareholders vote
    Attitude of Target Management

Hostile merger offers
Acquirer submits proposal to board of directors

      Successful          Unsuccessful

                Tender offer    Proxy battle

Offer made to shareholders
                               Proxy solicitation
      Pre-offer Defense Mechanisms
   Poison pill: Shareholders given right to purchase more
    shares at a discount
     Flip-in pill: Buy target’s shares

     Flip-over pill: Buy acquirer’s shares

   Poison put: Bondholders can demand immediate
    repayment in case of a takeover
   States with restrictive takeover laws: Company can
    reincorporate in a state with anti-takeover laws (Ohio and
      Pre-offer Defense Mechanisms (cont.)
   Staggered board: Bidder can only win a minority of the
    board seats in one year
   Restricted voting rights: Equity ownership above threshold
    level causes loss of voting rights unless approved by the
   Supermajority voting provision for mergers: Corporate
    charter requires shareholder support in excess of simple
    majority (e.g., 75%)
      Pre-offer Defense Mechanisms (cont.)

   Fair price amendment: Requires a “fair” price to be offered
    to shareholders based on an independent appraisal
   Golden parachutes: Managers receive lucrative cash
    payouts if they leave the target company after a merger
     Post-offer Defense Mechanisms

   “Just say no” defense: Refuse takeover offer then
    convince shareholders to do the same
   Litigation: File a lawsuit against the acquirer to consume
    acquirer’s time and money
   Greenmail: Target repurchases shares from the acquirer at
    a premium
     Like a payoff to acquirer – think “blackmail”

     50% tax on greenmail profits
     Post-offer Defense Mechanisms (cont.)

   Share repurchase: Target submits a tender offer for its own
   Leveraged recapitalization: Target assumes a large amount
    of debt to repurchase shares
   Crown jewel defense: Target sells a major asset to a
    neutral third party
     Risk is that court could declare sale illegal

   Pac-man defense: Target makes a counteroffer to acquire
    the acquirer
    Post-offer Defense Mechanisms (cont.)

   White knight defense: Friendly third party makes offer to
    acquire target
     May start bidding war

   White squire defense: Friendly third party buys minority
    stake in target
     Block potential acquirer from gaining enough shares
      U.S. Antitrust Regulation
   1890: The Sherman Antitrust Act:
     Made monopolies illegal

     Deemed unenforceable – ambiguous wording

   1914: The Clayton Antitrust Act:
     Improve on Sherman Act, detailed specific business
       practices that were made illegal
     Federal Trade Commission created to work with U.S.
       Dept. of Justice
        U.S. Antitrust Regulation (cont.)
   1950: The Celler-Kefauver Act:
     Address weaknesses of Clayton Act

     Added new rules concerning vertical and conglomerate
   1976: The Hart-Scott-Rodino Antitrust Improvements Act of
     Required all potential mergers to be approved in
       advance by the FTC and DOJ
     Prior to 1976, merger had to be dissolved after the fact
Herfindahl-Hirschman Index

Herfindahl-Hirschman Index:
 Key measure of market power for determining anti-
   trust violations
           HHI   ( MS i  100 ) 2
                   i 1

   MSi = market share of firm i
   n = number of firms in the industry
   Herfindahl-Hirschman Index (cont.)

Post merger   Industry    Change      Antitrust
    HHI     Concentration in HHI       Action
                  Not         Any
  < 1000                              No action
              concentrated   amount
  Between                    100 or
               Moderate               Possible
1000 & 1800                   more

                             50 or    Virtually
  > 1800         High
                             more     certain

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