Describe corporate governance

Corporate governance: internal control and systems for managing company, framework that define
rights, roles and responsibilities of various group within organization
 Shareholder theory:
o focus on interest of company owners (maximize market value of firm common equity)
o concerned with the conflict of interest between the firm’s managers and its owners
 stakeholder theory: focus on managing conflict among interest of stakeholder group
Describe a company’s stakeholder groups and compare interests of stakeholder groups
1-Shareholders:
1. Residual interest in the corporation-provide it with capital
2. Little involvement in company
3. Voting rights for the election of the board of directors
4. Voting rights for other important corporate matters, which gives them effective control of the firm and its
management.
5. Interest on the ongoing profitability and growth of the firm that increase value of ownership shares
2-board of directors
1. protect the interests of shareholders
2. to hire, fire, and set the compensation of the firm’s senior managers
3. to set the strategic direction of the firm
4. To monitor financial performance and other aspects of the firm’s ongoing activities.
3-Senior managers
1. Receive compensation (remuneration) made up of a salary, a bonus
2. Interest include continued employment
3. Interest in maximizing the total value of their compensation.
4. Executive bonuses are typically tied to some measure of firm performance, giving senior managers a
strong interest in the financial success of the firm.
4-Employees
1. Interest in the sustainability and success of the firm.
2. Interest in their rate of pay, opportunities for career advancement, training, and working conditions.
5-Creditors
1. Supply debt capital to the firm.(bonds. Loans)
2. Do not have a vote in firm management
3. Do not participate in firm growth beyond receiving their promised interest and principal payments.
4. Interests of creditors are protected to varying degrees by covenants in their debt agreements with the
firm.
 6-Suppliers of resources (short-term creditors)
1. Interest ongoing relationship with the firm
2. Interest in the growth and ongoing stability of the firm.
3. Interest in the firm’s solvency and financial strength.
Describe principal–agent and other relationships in corporate governance and the conflicts that may
arise in these relationships
Principal-agent: an agent is hired to act in the interest of the principal.
1-shareholders (principal) and managers or directors (agent)
1. Managers and directors may choose a lower level of business risk than shareholders(diversity)
2. Directors or manager favor management interests at the expense of shareholder
3. Director favor on group of shareholders at expense of another
4. Information asymmetry between shareholders and managers lead to decreases the ability of
shareholders or non-executive directors to monitor and evaluate whether managers are acting in the
best interests of shareholders
2-groups of shareholders (majority and minority)
1. Single shareholder or group of shareholders may hold a majority of the votes and act
against the interests of the minority shareholders or class of outstanding stock gives higher voting rights
2. In acquisition controlling shareholders may be in a position to be better to themselves
3. Related party transactions, agreements or specific transactions that benefit entities in which they have
a financial interest that harm minority
3-creditors and shareholders (default risk)
Shareholders may prefer more business risk than creditors, equity owner may take new debt or make high
dividend payment.
4-shareholders and other stakeholders
1. Customer: to raise prices or reduce product quality in order to increase profits
2. government: employ strategies that significantly reduce the taxes they pay to the government
Describe stakeholder management, Describe mechanisms to manage stakeholder relationships and
mitigate associated risks.
Stakeholder management is the management of company relations with stakeholders, based on having a
good understanding of stakeholder interests and maintaining effective communication with
stakeholders.

1) The management of stakeholder relationships is based on four types of infrastructures:

1. The legal infrastructure identifies laws relevant stakeholders when rights are violated.
2. The contractual infrastructure the contracts between the company and its stakeholders
3. The organizational infrastructure a company’s corporate governance procedures, including its
internal systems and practices that address how it manages its stakeholder relationships.
4. Governmental infrastructure regulations under which company operates

2) Relationship with shareholder:

1. General meeting
2. Ordinary resolutions: approval of auditor and election of director(simple majority vote)
3. Special resolution: extraordinary general meeting(supermajority vote 2-3 or 3-4)
4. Proxy: assign the right to vote to another who attend the meeting
 Majority vote: one vote for each board seat
 Cumulative :vote= shares x seats; may cast all votes for one board candidate
Describe functions and responsibilities of a company’s board of directors and its committees
Board structure:
1. One-tier: include internal directors (senior managers) and external directors( called independent
directors if the has no other relationship with company)
2. Two-tier: Supervisory board (external directors) - management board (internal directors).
3. Lead independent director: is appointed, he has the ability to call meetings of the independent
directors, separate from meetings of the full board.
4. All board member elections to be held at the same meeting and each election to be for multiple
years-staggered board elections for some board positions are held each year
Board responsibilities
1. Set strategic direction for company
2. Select and evaluate senior managers
3. Set management compensations and plan for succession and continuity of management
4. Approve capital structure changes, acquisitions, large investment
5. Establish and monitor internal control
6. Ensure quality of financial reporting through internal and external auditors
 Board committees:
1. Audit: oversee financial reporting, internal control and internal audit; recommend external audit to
board.
2. Governance: oversight corporate governance code, implement code of ethics, monitor changes in
law and regulation, ensure company compliance.
3. Nominations: search for and purpose candidates for board; align board compensation with
company goals.
4. Investment: review proposed capital investment projects, acquisition, and asset sales
5. Compensation (remuneration): recommend compensation levels and types for the directors and
managers; oversee employee benefits plan.
6. Risk: recommend appropriate risk policy and risk tolerance, oversee risk management process

Describe market and non-market factors that can affect stakeholder relationships and corporate
governance
 Capital market factor:
1. Activist shareholders: pressure companies in which they hold a significant number of shares for
changes, they believe will increase company (shareholder) value.
2. Proxy fight: in which they seek the proxies of shareholders to vote in favor of their alternative
proposals and policies
3. Tender offer: for a specific number of shares of a company to gain enough votes to take over the
company
4. Hostile takeover :
 Replacement of senior managers and boards of directors by shareholders
 Costly if their a straggled board

 Non market factor:

1. Legal environment: protects under common and civil –law systems
2. Communication channels :social media increase dissident shareholder ability to influence public
opinion
3. Third-party of corporate governance

Risks of poor corporate governance and stakeholder management

Decrease value and performance of company due to:
1. Weak controls (audit ,board oversight)
2. Poor recordkeeping or fraudulent accounting
3. Some shareholders gain adv. On the dis. Of other shareholders
4. Legal and reputational affect; poor compliance with procedures of reporting and regulation
5. lax oversight of management: sub-optimal risk level, related party transaction, compensation not
align with company goal
 Benefits of effective governance and stakeholder management
1. Improving operational efficiency
2. effective control and monitoring
3. Avoid many legal and regulatory risks. Strong control systems
4. Reduce the risk of debt default/respect interest of creditors
5. Reducing the cost of debt financing
6. Better operating results: Formal policies regarding conflicts of interest and related party transactions
7. Better financial performance and greater company value
Describe factors relevant to the analysis of corporate governance and stakeholder management
1. Company ownership and voting structure:
 Single class of shares: class of shares is entitled to one vote per share
 Dual class structure: (company founders) one class of shares may be entitled to several votes
per share class of shares is entitled to one vote per share.
2. Board Composition :
 Director independent from management or too close ,executive ,non-executive
 Related party transaction involved in
 Expertise that suit company strategy

3. Management compensation:
 The remuneration plan:
 Paid in cash-short-term performance goals
 Equity based incentives: of building long-term company value
 Performance-based incentive pay is fairly stable over time, indicating that the performance
targets are possibly easy to achieve.
 Management remuneration is very high relative to that of comparable companies in the
industry.
 Management incentives aligned with current company strategy and objectives.

4. Shareholder composition:
 Significant portion held by an affiliated company or institution, made it able to exert enough
influence to dictate the company’s policies and direction.
 Activist shareholder who buy share attempt to profit from their activism can change composition
of shareholder, board and corporate strategy in short period of time

5. Shareholders rights strength:

 Weaker with straggled board / anti-takeover provision / dual class shares
 Weak = perceived increase in shareholder return difficult or impossible to realize

6. Management of long-term risks

 Manage conflict and issues of shareholders
 Manage long-term risk affect company stability
 Describe environmental and social considerations in investment analysis
EGS investing: considering environmental, social and governance factors in making investment
decisions-but not to be a conflict with fiduciary duty
Also known sustainable investing or responsible investing
EGS investment analysis
1. Negative/exclusionary/norm-based screening: exclude companies based on ESG factors Ex:
mining and oil production, tobacco that has poor record on human right practice.
2. Positive screening:
 Identify companies with best practice related to EGS factor
 best-in-class approach: identify companies within each industry group with the best EGS
practice
 EGS incorporation

3. Impact investing:
 Seek to profit while having positive impact on social and environmental goal
 Green finance approach: Producing economic growth achieved in a more sustainable way be
reducing emission and better management natural resources use.
o Green bonds: bond for which the funds raised are used for projects with a positive
environmental impact
4. Thematic investing: invest in industry based on ESG factor