Corporate governance Course Outline - 1

Corporate Governance and Ethics

Professor Raghavendra Rau

Corporate governance is concerned with how owners of capital make sure that the managers (the

persons to whom they lend capital to earn a return) do not simply steal their money or misuse it in

ways that the owners do not want. It raises some key issues for contemporary management. Who

are the relevant owners of capital? What weight should managers give to the interests of all the

different stakeholders in the firm, including shareholders, employees, creditors, customers,

suppliers and society? How do managers succeed in aligning and reconciling these different

interests?

The course seeks to address these questions, using a combination of lectures and case studies. The

course is not intended to be a primer in company law, or in philosophical aspects of business ethics,

although aspects of law and ethics will be encountered from time to time. Rather, the aim is to

study the role played by governance within organisations, to look at justifications for governance

reforms, and to consider problems in the concrete setting of corporate governance issues such as

takeovers and mergers, restructurings, shareholder engagement, and the auditing process.

The course sets out to provide a strong theoretical understanding of corporate governance, whilst

at the same time providing a number of practical skills. More generally, the course will encourage

reflection on the place of the modern corporation in society, and its potential role in meeting

challenges in the societal and physical environment. We will attempt to come up with a basic

framework that will help you analyse current issues such as the recent scandals that you have read

about in the financial press.

Course grades will be based on class participation, and a final essay. The weights for each of these

are:

Class participation: 40%

Final essay: 60%

You are encouraged to work in teams to complete daily readings and case study assignments (but

not the quizzes), but you should come to class prepared to discuss your solution independently to

cases, quizzes and problems.

Class Participation

The approach to attaching a grade to class participation is as follows:

At the end of each class period, I assign each student a score of 1, 2, 3 or 4. We

assess the scores after each class with the intent of taking into account both the

quality and quantity of each student’s participation for the day. I recognize that not

every student will be able to participate every day, so I expect to have lots of 1s.

If a student is absent, the student will be assigned a zero for the day. If a student is

excused from class with reason for any day, for that day, the student will be

assigned the average grade of his or her grades for other days minus 0.5. This will

be assessed at the end of the module. (Prior to the end of semester, a grade of zero

will be assigned for excused absences, so your score may not reflect your actual

final score).

Corporate governance Course Outline - 2

At the end of the module, a total numerical score will be calculated by summing

the daily scores.

Hints on Class Participation

What factors contribute to the overall quality of class participation?

1. Being present (unless excused for a reason).

2. Getting to class on time (ready to go when the class begins).

3. Being prepared to respond to questions asked by the instructor or your colleagues.

4. Being able to support responses to the questions you give (i.e., if you prepared the solution to

a problem in a group, you personally should be able to explain how the group arrived at the

solution).

5. Being willing and able to constructively and critically evaluate and respond to your classmates’

contributions.

The list is not prioritized, i.e., simply showing up for class will not be sufficient to merit high

marks for class participation. In the parlance of economics, it is a necessary, but not sufficient,

condition to doing well in class participation. Similarly, a response that simply reiterates a point

made earlier by another student will not receive points for participation.

Course Outline

Daily Class Schedule

Day 1

Topic: Setting up the course: An introductory case study Case: Al Dunlap at Sunbeam (HBS-9-899-218)

Assignment: 1. Consider Dunlap’s statement on page 4 of the case:

Stakeholders! Every time I hear the word, I ask ‘How much

did they pay for their stake?’ Stakeholders don’t pay a penny

for their stake. There is only one constituency I am concerned

about and that is the shareholders.

Do you agree or disagree with Dunlap’s view of shareholder primacy?

Explain. If you believe that stakeholders have rights that are

qualitatively similar to those of shareholders, what specifically are

those rights? How do stakeholders obtain or earn those rights?

2. Describe the first compensation package offered to Dunlap. Was it

well-designed? What are the strengths and weaknesses of the

package? What type of behavior did it motivate?

3. Was the second compensation package offered to Dunlap well-

structured? Was it excessive? Was it necessary?

4. Did the board make the right decision in firing Al Dunlap? Is this an

example of effective or poor corporate governance?

Session 2

Title: Corporate governance – A framework

Corporate governance Course Outline - 3

Topic: This session serves as an introduction to the course. It discusses how

corporate governance and ethics can be analyzed as part of an integrated

framework. It assumes investors are rational and analyze information

correctly

Goal: To set up the theoretical framework for the course

Session 3

Topic: Corporate governance – A framework II Reading: Individual and group biases in behavior

Goal: How corporate governance changes if investors do not understand

information correctly and instead rely on heuristics

Session 4

Topic: Structuring incentives Case: Sally Jameson: Valuing Stock Options in a Compensation Package

(Abridged) (HBSP 9-202-117)

Assignment: 1. If we ignore tax considerations and assume that Sally Jameson is free

to sell her options at any time after she joins Telstar, which

compensation package is worth more?

2. How should we factor in the complications ignored in the above

question? How would they affect the value of the option to Ms.

Jameson? What should Ms. Jameson do? Why?

3. Does granting stock options cost companies anything? If so, who

pays? What incentives do executive stock option plans create for their

recipients? How might firms create more effective or more efficient

incentives?

4. What if Ms. Jameson decided that the option was a better deal, but that

she didn't want all of her financial wealth (as well as her human

capital) tied to the fortunes of Telstar? Assuming she works at Telstar

and accepts the option grant, is there anything she can do to "untie"

some of her wealth from Telstar?

Goal: To understand how incentive compensation plans using options work.

Session 5

Topic: Agency conflicts: Shareholders vs. stakeholders

Case: Hershey Foods Corporation: Bitter times in a sweet place (Darden UVA-F-

1409)

Assignment: 1. Assume that you are a member of the Hershey Trust board. To whom (or

what) do you owe your fiduciary responsibility? How does the legacy of

Milton S. Hershey affect your thinking as a member of the board?

2. Is diversification a valid reason to sell HFC? How would such

diversification have served the Hershey School 10 years ago, for example?

3. Based on your valuation of HFC, do you feel the company was fairly valued

by the market before the announcement of the sale? Are the Nestlé–Cadbury

Schweppes and Wrigley bids fair to their own shareholders (i.e., what needs

to happen in order for these bids to create value for the bidding companies)?

(Hint: use a discount rate of 7.5% for your analysis of HFC’s value.)

Corporate governance Course Outline - 4

4. Which, if any, bid would you vote to accept for the purchase of Hershey

Foods Corporation? Is your decision primarily based on the economics of the

bids or the desire to honor the legacy of Milton S. Hershey?

5. If you decided to reject both bids and not sell HFC, what will you do to

achieve the diversification objective? If you decided to accept one of the bids,

what (if anything) would you want to communicate to the constituents who

opposed the sale?

Goal: To compare the stakeholder versus shareholder primacy models of corporate

governance. Are executives accountable to shareholders alone? Or to other

stakeholders as well? Should they be?

Session 6

Topic: Agency conflicts: Shareholders vs. shareholders

Case: Magna International, Inc. (A) (HBS-9-211-044)

Assignment: 1. What are the advantages and disadvantages of a dual-class ownership

structure? When and for what type of firms is such a structure most

appropriate? Least appropriate?

2. From the perspective of a Magna Class A shareholder, what are the

primary costs and benefits of Magna's dual-class ownership structure?

3. How much value do you believe would be created if Magna

successfully unwinds its dual class structure? How would you propose

to divide this value between Magna's class A and class B

shareholders?

4. What initial proposal should the Magna board make to Mr. Stronach?

As a Class A shareholder, what do you believe is the maximum

consideration that should be offered per class B share? What is the

minimum value you expect Mr. Stronach to consider?

Goal: To illustrate the agency problem associated with controlling shareholders

and its impact on firm value.

Session 7

Topic: Agency conflicts: Shareholders vs. managers

Reading: British Land (HBS-9-208-064)

Assignment: 1. Why is Laxey targeting British Land? What criticisms has Laxey

made? Why?

2. Is British Land undervalued? If so, what are British Land’s possible

responses to this? Why might they or not work?

3. As a shareholder in British Land, would you vote for any of Laxey’s

three resolutions? What changes if any, would you want to see in the

company’s strategy? (Note: British Land’s Annual Report for 2002

states that they have a target ratio of debt to assets of 50%. Assume

that this implies a debt/equity ratio of 1. The corporate tax rate for

large companies in the UK is 30%.

4. What are the corporate governance issues at British Land? Why do

shareholders care about corporate governance?

5. Who are British Land’s shareholders? Do they care about corporate

governance?

Corporate governance Course Outline - 5

6. How do you regard Laxey’s conduct in this affair (a) as an investor in

Laxey’s fund (b) as one of British Land’s other shareholders (c) as a

regulator at the Financial Services Authority?

7. As John Ritblat, what steps if any would you take in response to

Laxey’s criticisms?

Goal: To explore how shareholder activism affects firm value.

Session 8

Topic: Agency conflicts: Shareholders vs. bondholders

Case: Kelly Solar (Darden UVA-F-1614)

Assignment: 1. Calculate the value that would be added to Kelly Solar from making the

improvements to its products. Is this additional investment a positive net

value project? Assume here and in all questions that the cash flows all

occur sufficiently close in time that there is no need to discount. Instead,

focus only on the payoffs that would occur and the probability associated

with those payoffs.

2. Would Kelly make the investment in the improvements on her own? In

other words, would she invest an additional $3.20 million in Kelly Solar

if she had the funds? Note that Kelly is an equity holder and receives

payment only in the event that what is owed to Barkley is paid in full.

3. Would Barkley make the investment in the improvements on his own?

In other words, would Barkley provide an additional $3.20 million to

Kelly Solar without an adjustment to his claim on the firm (a change in

his promised debt payment)? Note that Barkley is a debt holder and will

have first claim to any cash flows, but will receive no more than his

promised $15 million.

4. Focusing only on the amount of the investment, describe a deal that

would satisfy both parties (a split of the investment amount without any

change in their respective claims). Now, allowing yourself to change

ANY terms of the two claims, can you describe an alternative deal where

Kelly would make the full amount of the investment?

5. Please conduct a simulated negotiation between Kelly and Barkley in

which you determine whether the additional investment will be made,

who will pay for the investment if it is made, and what each party will

obtain as a payoff. You will be assigned to play one of the two roles in

the Kelly Solar case. Your objective is to obtain the best expected

monetary value for your role. Further details will be provided to you

along with your assigned role.

Goal: To illustrate how the existence of debt claims would lead to situations where

a company does not take value-increasing projects.

Session 9

Topic: Board effectiveness

Case: Circon (A) Abridged (HBS-9-904-023)

Assignment:

1. In Cloutier's position, how would you handle the situation described

at the end of the case (on page 14)?

2. Has Richard Auhll fulfilled his responsibilities as chairman and CEO

of Circon?

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3. As Cloutier, would you have accepted Auhll's invitation to join the

board in April 1997?

4. Does Cloutier have the qualities necessary to be a good director?

Goal: To illustrate the responsibilities of company directors and officers during a

hostile takeover bid and the tensions that can arise when the director’s

professional responsibilities are in conflict with personal loyalties and

interests.

Session 10

Topic: Fintech and alternative finance Goal: To understand how to apply the governance framework to the field of

alternative finance

Session 11

Topic: Blockchains and smart contracting Goal: To understand the impact of distributed ledger and blockchain technologies

on corporate governance

Session 12

Topic: Microfinance Case: SKS Microfinance (HBS 9-208-137)

Assignment: 1. Why is SKS seeking to raise external finance?

2. What methods would you use to value SKS? What is the value of a

single SKS branch?

3. Assuming that SKS expands its branch network as discussed in the

case, what is a fair value of the firm?

4. Evaluate the offers SKS is facing. What are the advantages and

disadvantages of each?

5. What should Akula do?

Goal: To understand the advantages and disadvantages of taking investment from

various types of investors.

Session 13

Topic: Microfinance II Case: SKS and the AP Microfinance crisis (HBS 9-212-018)

Assignment: 1. What is your assessment of the AP Microfinance ordinances and the

Malegam report on the ability of SKS and other microfinance

companies to conduct business?

2. What strategy should SKS and other MFIs have for communicating

the social value of their service?

3. What if anything, should SKS have done differently? What should

SKS do now?

4. If you were a regulator, how would you regulate microfinance?

Goal: To understand the challenges of managing a firm with multiple objectives in

a sensitive sector.