Introduction to

Corporate Governance
University of Languages and International Studies
Objectives

§ Understand the definition of Corporate Governance

§ Understand the roles of Corporate Governance
§ Understand the concept of ownership, separation of ownership and management
§ Know about different types of shareholders
§ Understand rights and obligations of shareholders
§ Learn about some popular types of institutional investors
Definition of Corporate Governance

´ Corporate governance is the system of principles, policies, procedures

which clearly define the responsibilities and accountabilities of all
stakeholders of a corporation.
´ Corporate governance is used to overcome the conflicts of interest
inherent in the corporate form.
 Stakeholder
Who are Stakeholders?
A person, group, or organization that has direct or indirect stake in an organization because
they can affect or be affected by the organization's actions, objectives, and policies.
The Classifications of Stakeholder:
´ INTERNAL STAKEHOLDER: Shareholders, Board of Directors, Management Employee and
Employees
´ EXTERNAL STAKEHOLDER: Supplier, Bank, Government, Competitor, Consumer, Community,
Distributor
´ PRIMARY STAKEHOLDER (Main): People that actively participated with the company and directly
work there.
´ SECONDARY STAKEHOLDER (Supporter): Is stakeholder that has no directly business due to a
project, but they concern so they have impact.
Forms of businesses
1. Sole proprietorship
• Only one single owner
• Unlimited liability
• Is not a legal entity, there is no separation between ownership and
management
2. Partnership
• More than two members
• Unlimited liability
• Is not a separated legal entity from the owners, there is no separation between
ownership and management (except for limited liability members)
3. Corporation
• Limited liability
• Is a separated legal entity from the owners, there is separation between
ownership and management
• Limited Liability Company: don’t have rights to issue stocks and bonds
• Joint Stock Company: have rights to issue stocks and bonds
Definitions: Ownership
Generally, we think of ownership (O) of property (P) as including three
elements:
´ O has the right to use P as he wishes.
´ O has the right to regulate anyone else’s use of P.
´ O has the right to transfer rights to P on whatever terms he
wishes.
´ There is less general agreement on a fourth component of
ownership:
Ownership is therefore a combination of rights and responsibilities with respect
to a specific property.
=> What does it mean to own a share of stock? What are the rights of share
ownership and what are the responsibilities?
Shareholders

Who are Shareholder?

A shareholder, also referred to as a stockholder, is a person, company, or
institution that owns at least one share of a company’s stock, which is known
as equity.
´ Shareholders are different from full owners of properties (they own “a part” of the
property only)
´ Their stocks cannot be linked to specific asset of the corporation
The Classifications of Shareholders
´ INSTITUTIONAL INVESTORS: Banks, Investment Companies, Insurance
companies,…
´ INDIVIDUAL INVESTORS: Person who buy shares with his/her personal savings.
´ MAJORITY SHAREHOLDER: A single shareholder who owns and controls more
than 50% of a company's outstanding shares => Have bigger voting rights,
more authority
´ MINORITY SHAREHOLDERS: those who hold less than 50% of a company’s
stock => Have less voting rights, less authority
´ COMMON SHAREHOLDERS: having voting rights, but temporary dividend
´ PREFERRED STOCKHOLDERS: generally have no voting rights, but fixed or
larger dividend than those paid to common stockholders.
 Separation of Ownership &
Managerial Control
Historically, firms were managed by founder-owners and their descendants
´ Ownership and control resided in the same persons
´ Over time these firms faced two critical issues:
§ As they grew, they did not have access to all the skills needed to manage the
growing firm and maximize its returns, so they needed outsiders to improve
management
§ They also needed to seek outside capital (whereby they give up some ownership
control)
´ Firm growth lead to the separation of ownership and control in most large
corporations
 Separation of Ownership and
Managerial Control
The Modern Public Corporation is based on the efficient separation of ownership
and managerial control
This separation allows shareholders to purchase stock, giving them an ownership
stake and entitling them to income (residual returns) after expenses
´ This right implies a ‘risk’ for shareholders that expenses may exceed revenues
´ This risk is managed through a diversified investment portfolio
´ Shareholder value is thus reflected in the price of the firm’s stock
Shareholders specialize in risk bearing while managers specialize in decision making
The separation and specialization of ownership and managerial control should
produce the highest returns for the firm’s owners
Ownership and Managerial Control
Agency Theory
§ Agency relationship exists when one or more persons (principals) hire
another person or persons (agents) as decision-making specialists to
perform a service
§ Decision making responsibility is delegated to a second party for
compensation
§ Agents manage principals' operations and maximize their returns
Agency Theory
§ Possible agency problems:
´ Shareholders lack direct control
´ Principals and agents have different interests and goals
´ Managerial opportunism: seeking self-interest with guile (i.e., cunning or
deceit)
´ Principals don’t know which agents will act opportunistically
§ Principals establish governance and control mechanisms to prevent
agents from acting opportunistically
Agency Theory: Agency costs and
governance mechanisms
Agency Costs: Sum of all costs (incentive costs, monitoring costs,
enforcement costs) and individual financial losses incurred by principals
because governance mechanisms cannot guarantee total compliance
by the agent
´ There are costs associated with agency relationships – principals incur
costs to control their agents’ behaviors
´ Effective governance mechanisms should be employed to improve
managerial decision making and strategic effectiveness
Agency Theory: Agency costs and
governance mechanisms
Governance mechanisms: used to control managerial behavior – to
make sure they are acting in the best interest of shareholders
´ Governance mechanisms are costly
´ Includes internal mechanisms (ownership concentration, board of
directors, and executive compensation) and external mechanisms
(market for corporate control)
Rights of Shareholders

§ Shareholder does not participate in activities of the

management; Shareholder has the exclusive control of
the stock itself, but gives the control of the company to
the management
§ Shareholders don’t have the right to use the property;
he/she does not use the intangible fraction of the
company
§ He/she owns a certificate of the stock, but the
corporation is an owner of its own property
Rights of Shareholders
The certificate entitles shareholders to particular rights and
obligations which are classically defined as:
´ (1) the right to sell the stock,
´ (2) the right to vote the proxy,
´ (3) the right to bring suit for damages if the corporation’s
directors or managers fail to meet their obligations,
´ (4) the right to certain information from the company,
´ (5) certain residual rights following the company’s liquidation (or
its filing for reorganization under bankruptcy laws), once
creditors and other claimants are paid off.
Who The Institutional Investors Are?
An institutional investor is a legal entity or organization that pools funds
from numerous investors, such as retail investors or other legal entities,
to invest in different financial instruments such as stocks, bonds, real
estate, or other investment vehicles.
´ Institutional investors are considered sophisticated investors who possess
extensive investment knowledge and experience.
´ Institutional investors often buy and sell substantial blocks of stocks,
bonds, or other securities and, for that reason, are considered to be the
whales on Wall Street.
How do Institutional Investors Make Money?
´ Since Institutional Investors are investing on behalf of others, returns
from investments do not go directly to them. Institutional Investors
make money from asset management fees charged for managing
investments, or by taking a share of profits should investments make
money.
Types of Institutional Investors

´ 1) Hedge Funds
´ 2) Mutual Funds
´ 3) Private Equity and Venture Capital
´ 4) Insurance Company
´ 5) Endowment Funds
´ 6) Pension Funds

Details of Institutional Investors will be discussed in W10 (Chapter 12:

Institutional Shareholders and Activist Investors)