CH 12: Corporate Governance and Business Ethics

What is the hierarchy for authority for the Public Stock Companies?

State charter
Shareholders
Board of directors
Management
Employees

How does the hierarchy of authority of public stock companies work?
State grants:
Shareholders appoint:
Board oversees:

State grants charter of incorporation to shareholders
Shareholders appoint a board to govern firm
Board oversees firm management

What are the benefits of public stock companies? (4)

Limited liability for investors
Transferability of ownership
Legal personality
Separation of legal ownership and management control

Public companies are only liable for:

amount invested

ownership of public company is transferred through:

trading of shares of stock on exchanges

If the company creates an incentive by paying for something instead of out of your pocket

agency theory

Public companies have legal personality meaning it has:

legal rights and obligations and can continue beyond founders death

Because public companies have separation of legal ownership and management control, it allows:

skilled managers to run company

“The social responsibility of business is to increase its profits” quote from ___

Milton Friedman

Michael Porter believed managers should have a dual focus on:

Shareholder value creation
Value creation for society

When you watch over another’s money, you do not do so with the same level of “anxious vigilance” as they would is the idea of the ___ by ___

Invisible hand by Adam Smith

What is the issue with public companies

principal agent problem

due to the separation of ownership and control, the interests of owners and agents diverge

agency theory

what are the problems with the principal agent theory

adverse selection
moral hazard

When information asymmetry increases the likelihood of selecting inferior alternatives (Ex: agent misrepresents ability to do job)

Adverse selection

information asymmetry increases the incentive of one party to take undue risks or shirk other responsibilities because the costs incur to the other party

Moral hazard

What is an example of moral hazard for individuals

Car insurance is good- you have less incentive to take care of your car

system by which companies are directed and controlled

corporate governance

Corporate governance provides mechanisms to: (2)

offer checks and balances
attempts to address the principal agent problem

Some argue that the global financial crisis of 2008 was worsened because large Fortune 500 companies did not practice effective ___

corporate governance

What are the two parts of corporate governance mechanisms

External (Usually from BOD)
Internal (CEO making firm decisions)

The board of directors are considered the:

centerpiece of corporate governance

Have a fiduciary responsibility or a legal duty to act solely in another party’s interests

Board of directors

a legal duty to act solely in another party’s interests

fiduciary responsibility

What are the responsibilities of the Board of Directors?

General strategic oversight and guidance
Selecting, evaluating, and compensating the CEO
Revieing, monitoring , and approving strategic initiatives
Risk assessment and management

What are the two types of people on the board

Inside directors (Top Management teams)
Outside directors (to create board independence)

most powerful member of the board of directors; ensures duties to shareholders being fulfilled and acts as a link between board and top management

chairperson

occurs when the CEO is also board chairman

duality

About ___ of S&P 500 CEOs have duality

half

Why is duality controversial?

lack of oversight vs unity of command

board member diversity reduces:

group think

goal of __ is to tie incentives with firm performance therefore making executives work in favor of these shareholder interests

executive compensation

Executive compensation often uses ___ to align compensation with shareholder interests

stock options

An external corporate-governance mechanism
Often pursued when a company is underperforming

Help increase the incentive of to buy the firm (try to take control of the company)

Activist investors

Activist investors:

Seek to gain control of an underperforming corporation
Buy shares of its stock in the open market

To avoid misrepresentation of financial results Public Companies must:

have financial statements following GAAP
Have financial Statements that are audited

Provide financial recommendations (Buy, hold, sell) and provide oversight to the public; increases or decreases stock price because of their information given to the public

industry analysts

What is the example of the governance fail? And why did they fail

Silicone Valley Banking (only CEO was internal BOD, only 1 outside director had banking experience meaning they didn’t know what performance was/meant)

What we might consider “the most internal of corporate governance mechanisms”. But is not formally recognized as a governance mechanism

ethics

A lot of studies show that there is little scientific support for

agency theory

Agreed upon code of conduct in business, based on societal norms

business ethics

Counter theory to agency theory

stewardship theory

Lay the foundation and provide training for: “behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society”

business ethics

Universal norms include:

Fairness
Honesty
Reciprocity

What is the ethics scandal example
Within last 10 years company had:

– Tax evasion

– Rogue trader (lost $2.3 billion)

– LIBOR manipulation

– Exchange rate manipulation

UBS

__ and ethics are NOT interchangable

legal

Hiked an out-of-patent drug that had no generic alternative

from $13.50/pill to $750/pill

• Did nothing illegal

• Was subpoenaed by Congress

• Busted on securities fraud and is serving 7 years

Person who shows ethical and legal are not interchangable

Martin Scorelli (Pharma Bro)

What is important to create an ethical climate within an organization?

strategic ethical leaders

Ethics are defined by

code of conduct
profession at large