Assignment# 01

Hafiz M Zain Ul Abideen

Sp18-Bba-042
Corporate Governance
1)
Ownership signifies how much stake you have in an organization. Control means how much
controllability you have in a company. Adolf Berle and Gardiner Means pointed out that
ownership and control in large corporation was separated. Separation of ownership and control
refers to the phenomenon in which the shareholders possess a little or no direct control over
management decisions. Most of the Stakeholders are passive in nature means that they do not
want to get involved in daily operations of the company as compare to the active shareholders
who are more interested in performance of the company. Passive shareholders are more
interested in Risk and Return of their investment. In this concept, there is a conflict of interest
between management and owners known as Agency Problem. Managers, who acts as an agent of
the shareholders, supposed to make decisions that will maximize the shareholders wealth. But
the problem arises when managers or agents acts solely in their own interests. The solution of
this problem is by giving the incentives to the managers. Through incentives we can align the
manager incentives with shareholders desires. We can also tackle or overcomes agency problem
through monitoring (by checking the behavior of the managers through different monitoring
mechanism).
2)
Corporate Monitors is an individual or organization that has the obligation of checking exercises
of corporations and assessing their consistence with regard to specific corporate practices.
Potential Monitors of Corporation are:
 BOD
BOD holds very much importance in any corporation because it has to make
important decisions. In the annual meeting of the shareholders, BOD are elected
and they have to keep an eye on the management practices and of course represent
the shareholders interests. Recruiting, supervising and compensating the CEO’s or
 general managers are the most important functions of the BOD. BOD has the
authority to hire, fire or replace the executives.
 Auditors
Auditors are the most important part of the organizations. Auditor is someone
who has the authority or responsibility to review the financial records and
accounting systems to check whether the company is fair or not. Auditors protect
companies from fraud and point out any discrepancies in accounting system. After
reviewing, they have to give their own independent report and explain their
findings.
 Investment Analyst
Investment Analyst who collects data, perform research and conduct their own
independent evaluation of the firm financial statements and different currencies
and report their findings to the investment community. Their findings must me
unbiased.
 Government
Through federal laws and regulations like taxes and foreign trade which effects
the firms, government monitoring the business practices. Government created
different institutions like SEC, IRS and FBR to check and balance or monitor the
firms.

 Auditors has the best potential to be the best monitor because they knows
the company’s financial health and positon. They knows the private
information which they only have the authority to access and based on that
they evaluate companies performance. Banks, creditors, investors all are
rely on auditors report to assess the value of the company.
3)
Executives of the companies get different incentives from the company and one of them
is Bonuses which is based on the firm performance and also based on EPS, EBIT and EVA.EPS,
EBIT and EVS are the most common criteria of executive incentives because the goal of the firm
is to maximize the shareholders wealth. Shareholders wealth maximizes only if the share prices
of the company increases which is based on EPS. The higher the EPS the more money
shareholders will get on their shares. Similarly, EBIT is the earnings of the company. If EBIT of
the firm increases it means companies profit increases and shareholders will get more dividend.
EVA, also used to measure the true economic profit and the value of the company produces or
generates from the funds.
So if EPS, EBIT and EVA increases it means the performance of the company also increases and
company’s executives will get more incentives or Bonuses.
4)
Stock options are the contracts or the right to buy the specific number of companies share
to the executives at a fixed price, known as exercise or strike price. Companies offers different
stock options to their executives to buy at fix price and sell it if the prices of the stocks increases.
Let’s say company offer stocks at $20 and similar stock price in market is $30 after one month. It
will surely motivate the executives to buy the company’s stock and sell it in the market and grab
the difference of $10. So for that reason executives will try to increases the prices of the stocks
which will definitely increases the value of the firm. So companies motivates the executives
through stock options and as well as to increase the value of the company.
There are two school of thoughts about expensing executive options. One says that the cost
associated with the option is rest cost and it should be treated as an expense because it has a
value and real effect on firm through shares outstanding.
Opponents to expensing options says, perhaps options might not be cashed in for 10 years and
has a negative effect on companies’ earnings. So it should not be treated as an expense.
5)
 Executives don’t pay the dividend to the shareholders so they have more cash and try to
increase the stock price.
 Executives try to accept more risky projects. Risky projects, in short term, benefits the
stock prices immediately but it can put a company in great danger.
 CEO’s try to manipulate the earnings of the company in some specific target years to
gain more earnings or profit and as a result stock price maximizes. But after that period
or year earnings of the company falls which decreases the value of the company.
  If stock prices falls below the exercise price and options go too far underwater to
motivate the CEO’s to sell it results decreases in value of the company. Incentive will not
be an incentive, if price falls.
 Economic condition: Stock price doesn’t depend only on the performance of the firm but
to the economic condition as well. When economy thrives so as well share price. So even
poorly run firms stock price may rise and executives can get reward on their options
when they don’t deserved.

6)
Backdating option:
It is a techniques of providing options that is dated before its actual issuance means that
issue options on a date where prices of stocks was lower than today. Executives and board
members used this technique to gain more value on a stock by selling it for $50 with a strike
price $40 and gain a value of $10. There is no way to check or verify the options documents that
are actually signed and in past years backdating has been considered unethical.
Repricing:
It is a technique of repricing or lowering the option’s prices when stock price falls below
the exercise price. Because executives gain less value on their options so they ask board to
reprice the options to get more benefits.
Board uses these methods to motivate the executives because they are the essential part of the
company and the company wants to keep them.