22 Investors and Other Stakeholders

What is a principal-agent relationship?

When one party (principal) hires another (agent) to act on their behalf

Who are typical examples of principals and agents?

Shareholders (principal) and company management (agent).

What is asymmetric information in the principal-agent relationship?

The agent has more information than the principal

What causes shareholders to demand more from agents?

Asymmetric information increases agency risk.

What are agency conflicts?

Divergences between the interests of the principal and agent.

What are agency costs?

Costs incurred due to conflicts of interest between principal and agent.

What increases agency costs?

Less transparency and less institutional ownership.

What are direct agency costs?

Costs from measures like hiring monitors.

What are indirect agency costs?

Loss of profits due to poor decision-making.

What conflict exists between shareholders and debt holders?

Shareholders prefer more risk and leverage

What is an example of insufficient effort from management?

Political CEOs avoiding hard decisions or Tesla's leadership being distracted.

What is inappropriate risk appetite?

Agents taking excessive risk due to equity compensation or being too risk-averse due to fixed salaries.

What is empire building in agency issues?

Managers make too many acquisitions to increase company size and their compensation.

What is entrapment in agency issues?

Managers play it safe and copy competitors to avoid risk.

What is self-dealing in agency issues?

Managers exploit company resources without shareholder-aligned incentives.

What is the control vs. minority shareholder issue?

Conflicts arise when ownership is concentrated and decision-making favors controlling shareholders over minorities.

What is dispersed ownership?

Many shareholders with no absolute control.

What is concentrated ownership?

Control by an individual or group

What are voting schemes in corporate control?

Different classes of shares with varying voting rights.

Why is corporate reporting important for stakeholders?

External stakeholders rely on reports to assess performance and position; poor reporting increases risk.

What do public companies report?

Annual reports

What do private companies report?

Only share info when required or voluntarily.

What is an AGM (Annual General Meeting)?

A yearly meeting to discuss board elections

What is an EGM (Extraordinary General Meeting)?

A special meeting for major resolutions or urgent shareholder concerns.

What is shareholder activism?

Investor strategies to influence company direction

What is an example of shareholder activism?

Hedge funds pushing for operational or strategic changes.

What is shareholder litigation?

Lawsuits filed when directors are believed to have failed fiduciary duties.

What is a corporate takeover?

Action taken when shareholders believe directors have failed; includes proxy fights and tender offers.

What is a hostile takeover?

Acquiring a company without management’s consent.

What are anti-takeover measures?

Mechanisms like staggered board elections and poison pills to deter takeovers.

What is a poison pill strategy?

A shareholder rights plan that dilutes a takeover bidder’s shares by offering discounts to other shareholders.

What is a bond indenture?

A legal contract outlining company obligations and shareholder rights.

What is a creditor committee?

A group formed when a company files for bankruptcy to represent creditor interests.

What is the role of the board of directors?

Delegate functions to committees while retaining overall responsibility.

What does the audit committee do?

Monitors financial reporting

What does the governance committee do?

Oversees director/manager selection

What does the compensation committee do?

Develops remuneration policies and sets performance criteria.

What are employee mechanisms in governance?

Include labor laws

What are customer and supplier mechanisms?

Public sentiment and price specifications

What are government mechanisms in governance?

Laws and regulations such as contract law and intellectual property.

What are the benefits of governance in operations?

Risk mitigation

What are operational risks in governance?

Poor performance

What are legal

regulatory

What are legal/regulatory/reputation risks?

Government investigations

What are financial benefits of strong governance?

Higher valuation due to greater investor confidence.

What are financial risks of weak governance?

Management failures leading to default.