INTERNATIONAL CORPORATE GOVERNANCE. Wintersemester Christian Harm

Transcription

1 INTERNATIONAL CORPORATE GOVERNANCE Wintersemester Christian Harm 1

2 In whose interest does the corporation work Corporate Governance centers on the issue of management accountability, but accountability to whom? Parties affected by top management decision Shareholders Banks Bondholders Suppliers Customers Employees / Workers Government as Taxation Authority Government as Regulator (Environment, Antitrust, Prudential) They all have an interest in controlling top management decisions! Does it matter, who sets the managerial agenda? 2

3 A note of caution from optimization theory Let X and Y be two variables important to two different constituencies A and B, respectively. If A sets the managerial agenda, and B constrains management by contract, the optimization problem will be: Max X, s.t. Y >=Y * This may yield an optimal value of X * If B would demand to set the managerial agenda, then A would constrain management via contract to yield at least X *, and the optimization problem will be: Max Y, s.t. X >= X * Then, for a large class of optimization problems, the optimum value for Y = Y * Then, it is a matter of indifference who sets the managerial agenda! Conversely, the governance problem is a lot more subtle than we may think! 3

4 The incentive model and agency theory What is the agency problem? Hidden action Agent Principal Contentious Action Doctor Patient Professional Care Polluter Society Emissions Output Causer of Accident Victim Care Fire Insuree Fire Insurer Fire Safety Hidden information Agent Principal Contentious Information Employee Employer Employee Productivity Car Seller Car Buyer Car Quality Insuree Insurer Risk Characteristics Borrower Lender Risk Characteristics 4

5 Agency Theory Reference Point: Risk-sharing 2 agents receive random income x Q: Can they define a sharing rule such that both are better off? One agent gets s(x), the other 2x - s(x) A: Yes, if their degrees of risk aversion are different. The Agency Problem: Two individuals, principal and agent Principal hires agent to do some work for him Principal is affected by agent s action (agent in part determines outcome x ) Principal can t observe agent s action Principal only observes noisy output: can t infer agent s action Agent s interests are not aligned with interests of principal Agent will not act in principal s best interest, but does what is best for himself 5

6 Agency Theory (ctd.) The solution: Principal designs incentive structure such that agent acts more in principal s interest One can show that the optimal sharing rule between principal and agent - Rewards agent overproportionately after good outcomes - Penalizes agent overproportionately after bad outcomes Risk-sharing plus incentives! Characteristics of the solution: Always second-best, i.e. worse than in a complete information world Also improvements due to monitoring, signaling, reputation, or incentive compatible contracts remain second-best Market failure remains a possibility 6

7 Jensen / Meckling: The Basics Agency conflict: A manager does not necessarily act in the interest of shareholders Why not? - An owner-manager is interested in monetary as well as non-monetary income. - Shareholders are interested only in monetary income. - With more shares sold to outsiders, the manager overconsumes fringe benefits. - Outside shareholders know this, and the firm is worth less. (Figure 1) 7

8 Jensen / Meckling: Agency Costs of Equity Consequences: - A growing firm will expand more without outside shares. (Figure 2) - This is a social (welfare) loss, as society produces less than it could. - This welfare loss represents the costs of agency. - If the manager can be monitored, both shareholders and the manager gain (Figure 3). - Then, monitoring reduces the social loss, or agency costs (Figure 4). 8

9 Jensen / Meckling: Agency Costs of Debt Not only outside equity carries agency costs, also outside debt. - Shareholder do not care about bankruptcy costs, creditors do. - Shareholders prefer more risk, since they do not care if they are "a little bit bankrupt, or a lot bankrupt". This is called the call option feature of equity: due to the convexity of the evaluation function, equity values increase with increasing risk, all other things equal. At the same time, the value of debt decreases by the same amount. - Creditors want to prevent owners from appropriating wealth through risk shifts, and agency costs of debt will increase with increasing leverage. - Hence: An optimal capital structure balances the agency costs of debt and equity (Figure 5). 9

10 Financial contracting and corporate governance Jensen and Meckling were the first to address the agency problem in a context of financial contracting. They revolutionized corporate finance by suggesting that agency problems are responsible for the existence of an optimal capital structure. Still, they worked with an assumption of perfect investor rationality. If we depart from that assumption (what if x is not uniquely measurable or divisible), financial contracts become more incomplete, and various institutional structures are created to safeguard investors interests. Then, all governance institutions can be viewed as elements of (financial) contract design! This course studies these institutions as they have evolved in different national settings. 10

11 Tirole article Important issues raised: Managerial Incentives and Agency Control vs. Contract or Law Securities Design Why different financial securities? Control for whom? Shareholder vs. Stakeholder 11

12 Incentives and Pledgeable Income Managers face perverse incentives between income and perks (like Jensen and Meckling) If investors write contracts, which leave too little income with managers, managers will choose perks over income. Monitoring and Control increase income pledgeable to investors. Few insights above agency or Jensen and Meckling 12

13 Securities Design Why multiple securities with different cash flow and control characteristics? a) Investor Demands / Clientele Effects b) Liquidity favors Debt (LBO s): needs control element! c) Multi-task Monitoring: unintuitive? E.G.: conflicting monitoring objectives d) Control rights: Differential disciplining environments Can renegotiation eliminate security differences? My hypothesis: it takes a combination of a) or b) and c) or d) Most likely: Investor Demands plus Control Rights 13

14 Shareholders and Stakeholders Customers, employees, communities, banks all make some kind of investment in their relationship with the firm. All want to enjoy the benefits of their relationship with the firm All may want some contract with the firm safeguarding their investment Are multiple control rights possible? If not, who should get them? 14

15 Shareholders and Stakeholders First important element to award control: contracting options are limited / incomplete. Second element to award control: the relevant stakeholders have potentially a lot to lose. (Tirole: face externalities). Trade-off: unambiguous objective function vs. externalities. Many stakeholders = ambivalent managerial objectives = unaccountable management. 15

16 Systems view International Corporate Governance In different economic systems, different mechanism and institutions of management supervision have emerged. A systems view tries to discover the internal logic of a set of corporate governance mechanisms and institutions - how well do the components fit together? Sometimes, the effectiveness of individual mechanisms or institutional structures can be assessed (e.g.: should German managers receive more incentive-related pay?) Sometimes, the appropriateness of an entire system can be analyzed (e.g.: should Eastern European transition economies adopt a market or a bank-based financial sector?) 16

17 International Corporate Governance Systems view on corporate governance regimes: The international focus allows us to learn from the differences, and draw more fundamental conclusions about the more abstract concept, in this case corporate governance. Being based on thoughts of financial contract design, this course will pay special attention to the interrelation between corporate governance institutions and financial sector architecture. In the end, we shall learn that good governance strengthens the financial sector, which in turn contributes to economic growth. 17

18 Course Design The course splits into three components: 1) Theory: what is a firm, what is management, what is governance? 2) A detailed study of the relative merits of the various governance institutions for equity and debt investors in different countries. 3) A systems view of the different governance structures found around the world. In the second part, we will examine the following governance mechanisms and institutions: Shareholder activism / proxy voting Board structures / Non-executive directors Performance-based management remuneration Takeover markets Leveraged buy-outs Bankruptcy laws Creditor-led work-outs of firms in financial distress Bank regulation 18

19 Syllabus 1 st Segment: Introduction, theory of the firm, governance and finance Class General Introduction, Agency Theory Class Theories of the Firm and Management Class Governance and Finance 2 nd Segment: Equity Governance Class Shareholder Voting and Disclosure Class Boards of Directors Class Management compensation schemes Class Takeover markets 19

20 Syllabus (ctd.) 3 rd Segment: Debt governance Class Bankruptcy: Theory and International Evidence Class Work-outs: International Evidence Class Bank Regulation Class Bank Governance and the current financial crisis 4 th Segment: The Systemic View this section is still under review! Class Debt Economies Class The USA as a managerialist system Class Law, Finance, and Growth TBA? Political determinants of governance structures Examination :15 17:45 20