GGSR Lecture 2

8/6/2019 GGSR Lecture 2

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Corporate Governance

Lecture 2


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- It is the relationship among various

participants in determining the direction &

performance of corporations.

- The primary participants are:

1. Shareholders

2. The management (led by the Chief Executive

Officer)

3. The Board of Directors


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We suggest 3 governance mechanisms for

improving corporate governance:

1. Shareholder activism2. Effective managerial rewards & incentives

3. Committed & involved Board of Directors


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How can the potential conflicts between the

managers of the firm & the owners of the firm

be reduced?

How are leading-edge firms practicing

effective corporate governance?


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STRATEGIC CONTROL VIA CORPORATE GOVERNANCE

Management can exercise strategic control over afirms overall operations through the use ofinformational & behavioral controls.

Our reports & discussions will center on howcorporations can succeed (or fail) in aligningmanagerial motives & the interests of the owners

of the business (the shareholders) through theirown efforts as well as the efforts of their electedrepresentatives, the Board of Directors.


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STRATEGIC CONTROL VIA CORPORATE

GOVERNANCE

Effective corporate governance can affect a

firms bottom line.

Good corporate governance plays an

important role in the investment decisions of

major institutions & a premium is often

reflected in the price of securities of

companies that practice it.


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STRATEGIC CONTROL VIA CORPORATE

GOVERNANCE

The corporate governance premium is larger for

firms in countries with sound corporate

governance practice compared to countries with

weaker corporate governance standards.

There is a strong correlation between strong

corporate governance and superior financial

performance. What follows is a RESEARCH EVIDENCE of GOOD

CORPORATE GOVERNANCE & PERFORMANCE


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3 studies found a positive relationship between the extent to which a

firm practices good corporate governance and its performance

outcomes. The results of these studies are summarized below.

1. A strong correlation between corporate governance & price

performance of large companies. Over a recent three-year

period, the average return of large capitalized firms with the

best governance practices was more than 5 times higher than

the performance of firms in the bottom corporate governance

quartile.

2. Across emerging markets. In 10 of the 11 Asian & Latin

American markets, companies in the top corporate governance

quartile for their respective regions had a significantly higher(averaging 10 percentage points) return on capital employed

(ROCE) than their market sample. In 12 of the emerging

markets analyzed, companies in the lowest corporate

governance quartile had a lower ROCE than the market

average.


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3 studies found a positive relationship between the

extent to which a firm practices good corporate

governance and its performance outcomes. The

results of these studies are summarized below.

3. Attitudes toward investing.Mc Kinsey & Company conducted threesurveys from September 1999 to April 2000 which studied attitudestoward investing in Asia, Europe, the United States, & Latin America.Over three-quarters of more than 200 investors surveyed agreed thatboard practices were at least as important as financial performance.Over 80% of investors agreed that they would pay a premium for theshares of a better-governed company than for those of a poorlygoverned company with comparable financial performance.Interestingly, the study demonstrated that the value of good corporategovernance that is, the premium that investors are willing to pay varied across regions. Good corporate governance in the United States &United Kingdom brought the lowest premium, at 18 %. However, forinvestments in Asian & Latin American countries, the premium rose tobetween 20 and 28 %. The difference in premium reflected the lack ofgood governance standards in Asia & Latin America compared to thestandards of companies in the US and the UK.


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FLAWED CORPORATE GOVERNANCE

Widespread suspicion & mistrust on the part

of the public will lessen investing interest. An

unrelenting barrage of headlines that tell of

Securities & Exchange Commission

investigations, indictments, guilty pleas,

government settlements, financial

restatements, and fines has only lent greatercredence to the belief that the system is

inherently unfair.


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AOL buys Time Warner in a deal worth $183

billion which later results in a $54 billion

write-off, the largest ever. (April 25.2002)

Oracle CEO Larry Ellison exercised 23 million

stock options for a record gain of more than

$706 million weeks before lowering earnings

forecasts, (January 2001)


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Arthur Andersen, the accounting firm, agrees to pay $110 to

settle a shareholders suit for alleged fraud in its audit ofSunbeam. (May 2011)

Al Dunlap agrees to pay $15 million to settle a lawsuit fromSunbeam shareholders & bondholders alleging that he cookedthe books of the maker of small appliances. ( Jan 11, 2002)

Global Crossing, once a high-flying telecom service provider, filesfor Chapter 11. In the preceding 3 years, the companys insidershad cashed in $1.3billion in stock. (Jan 28, 2002)

Tyco International discloses that it paid a director $10M in cash& gave an additional $10M to his favorite charity in exchange

for his help in closing an acquisition deal. (Jan 29, 2002) The New York State Attorney General charges thatMerrill Lynch

analysts were privately referring to certain stocks as crap andjunk while publicly recommending them to investors. (April 8,2002)


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Chapter 11

It is a chapter of the United States BankruptcyCode, which permits reorganization under thebankruptcy laws of the United States. Chapter 11bankruptcy is available to every business,whether organized as a corporation or soleproprietorship, and to individuals, although it ismost prominently used by corporate entities. Incontrast, Chapter 7 governs the process of a

liquidation bankruptcy, while Chapter 13 providesa reorganization process for the majority ofprivate individuals.


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Chapter 11 in general

When a business is unable to service its debt or pay itscreditors, the business or its creditors can file with afederal bankruptcy court for protection under eitherChapter 7 or Chapter 11.

In Chapter 7, the business ceases operations, a trusteesells all of its assets, and then distributes the proceedsto its creditors. Any residual amount is returned to theowners of the company. In Chapter 11, in most

instances the debtor remains in control of its businessoperations as a debtor in possession, and is subject tothe oversight and jurisdiction of the court.[1]


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Rationale

In enacting Chapter 11 of the Bankruptcy code, Congress concluded

that it is sometimes the case that the value of a business isgreater if sold or reorganized as a going concern than the value ofthe sum of its parts if the business's assets were to be sold off individually. It follows that it may be more economically efficientto allow a troubled company to continue running, cancel some ofits debts, and give ownership of the newly reorganized companyto the creditors whose debts were canceled. Alternatively, thebusiness can be sold as a going concern with the net proceeds ofthe sale distributed to creditors ratably in accordance withstatutory priorities. In this way, jobs may be saved, the(previously mismanaged) engine of profitability which is the

business is maintained (presumably under better management)rather than being dismantled, and, as a proponent of a chapter11 plan is required to demonstrate as a precursor to planconfirmation, the business's creditors end up with more moneythan they would in a Chapter 7 liquidation.


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Features of Chapter 11 reorganization

Chapter 11 retains many of the features present in all, or most,bankruptcy proceedings in the U.S. It provides additional tools fordebtors as well.Most importantly, 11 U.S.C. 1108 empowers thetrustee to operate the debtor's business. In Chapter 11, unless aseparate trustee is appointed for cause, the debtor, as debtor in

possession, acts as trustee of the business.[2] Chapter 11 affords the debtor in possession a number of

mechanisms to restructure its business. A debtor in possession canacquire financing and loans on favorable terms by giving newlenders first priority on the business' earnings. The court may alsopermit the debtor in possession to reject and cancel contracts.

Debtors are also protected from other litigation against thebusiness through the imposition of an automatic stay. While theautomatic stay is in place, most litigation against the debtor isstayed, or put on hold, until it can be resolved in bankruptcy court,or resumed in its original venue.


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Features of Chapter 11 reorganization

If the business's debts exceed its assets, the bankruptcyrestructuring results in the company's owners being leftwith nothing; instead, the owners' rights and interests areended and the company's creditors are left with ownership

of the newly reorganized company. All creditors are entitled to be heard by the court.The court

is ultimately responsible for determining whether theproposed plan of reorganization complies with thebankruptcy law.

One controversy that has broken out in bankruptcy courtssince 2007 concerns the proper amount of disclosure thatthe court and other parties are entitled to receive from themembers of the ad hoc creditor's committees that play alarge role in many such proceedings.


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The chapter 11 plan

Chapter 11 usually results in reorganization of thedebtor's business or personal assets and debts,but can also be used as a mechanism forliquidation. Debtors may "emerge" from aChapter 11 bankruptcy within a few months orwithin several years, depending on the size andcomplexity of the bankruptcy. The BankruptcyCode accomplishes this objective through the use

of a bankruptcy plan. With some exceptions, theplan may be proposed by any party in interest.[4]

Interested creditors then vote for a plan.


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Section 1110

Section 1110 (11 U.S.C. 1110) generally

provides a secured party with an interest in an

aircraft the ability to take possession of the

equipment within 60 days after a bankruptcy

filing unless the airline cures all defaults.More

specifically, the right of the lender to take

possession of the secured equipment is nothampered by the automatic stay provisions of

the U.S. Bankruptcy Code.


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Stock

If the company's stock is publicly traded, a Chapter 11 filinggenerally causes it to be delisted from its primary stock exchange iflisted on the New York Stock Exchange, the American StockExchange, or the NASDAQ. On the NASDAQ the identifying fifthletter "Q" at the end of a stock symbol indicates the company is in

bankruptcy (formerly the "Q" was placed in front of the pre-existingstock symbol; a celebrated example was Penn Central, whosesymbol was originally "PC" and became "QPC" after the companyfiled Chapter 11 in 1970).Many stocks that are delisted quicklyresume listing as over-the-counter (OTC) stocks. In theoverwhelming majority of cases, the Chapter 11 plan, when

confirmed, terminates the shares of the company, rendering sharesvalueless.

Individuals may file Chapter 11, but due to the complexity andexpense of the proceeding, this option is rarely chosen by debtorswho are eligible for Chapter 7 or Chapter 13 relief.


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Clearly, because of the many lapses in corporate

governance, one can see the benefits

associated with effective practices. However,

corporate managers may behave in their own

self-interest, often to the detriment of

shareholders.


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Next, we address the implications of the separationof ownership and management in the moderncorporation, which can result in a divergence

between the interests of managers & those ofshareholders (the owners of the firm).

We then address some mechanisms that can beused to ensure consistency (or alignment)

between the interests of shareholders and thoseof the managers to minimize these potentialconflicts.


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Assignment

What is insider trading?

What is the relationship of insider trading to

good corporate governance?


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GGSR

LECTURE 3


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TheModern Corporation: The Separation of Owners (Shareholders) &

Management)

Two proposed definitions for a corporation include:

The business corporation is an instrumentthrough which capital is assembled for the

activities of producing & distributing goods &services & making investments. Accordingly, abasic premise of corporation law is that abusiness corporation should have as its objectivethe conduct of such activities with a view to

enhancing the corporations profit & the gains ofthe corporations owners, that is, theshareholders. (Melvin A. Einsenberg)


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TheModern Corporation: The Separation of Owners (Shareholders) &

Management)

A body of persons granted a charter legallyrecognizing them as a separate entity having its

own rights, privileges, and liabilities distinct from

those of its members. (American HeritageDictionary)

The corporate form of business organization has

the ability to draw resources from a variety of

groups & establish and maintain its own persona

that is separate from all of them. As Henry Ford

once said, A great business is really to big to be

human.


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Interest in Corporate Governance

Articles written about firms such as

Enron

Arthur Andersen

Global Crossing

Adelphia

.poster children of poor corporate governance


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Business Weeks Annual Report Card on

Corporate Governance, The Best & the Worst

Boards: How the Corporate Scandals are

Sparking a Revolution in Governance

Documents

GGSR Lecture 2