What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
Corporate Governance
Chapter 1 – Introduction
Lingtian Kong
CAFD@CUFE
February 16, 2020
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
Outline
1What is “corporate governance”?
What is “governance”?
What is a “corporation”?
What is “corporate governance”?
Why separate the ownership and control despite the agency
cost?
2How to achieve corporate governance (in general)?
The two main steps of corporate governance.
A major challenge of the CG in public corporations
3Main mechanisms of corporate governance (in details)
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
What is “governance”?
What is a “corporation”?
What is “corporate governance”?
Why separate the ownership and control despite the agency cost?
What is the “agency problem”?
Definition
The agency problem occurs when one person or entity (the
“agent”), is able to make decisions and/or take actions on behalf
of, or that impact, another person or entity: the “principal”.
a precondition: the agent and the principal cannot be the
same person.
reason: the agent wants to optimize his own best interest,
which is often not aligned with that of the principal.
“agency cost”: the cost as a result.
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
What is “governance”?
What is a “corporation”?
What is “corporate governance”?
Why separate the ownership and control despite the agency cost?
What is the “agency problem”?
Definition
The agency problem occurs when one person or entity (the
“agent”), is able to make decisions and/or take actions on behalf
of, or that impact, another person or entity: the “principal”.
a precondition: the agent and the principal cannot be the
same person.
reason: the agent wants to optimize his own best interest,
which is often not aligned with that of the principal.
“agency cost”: the cost as a result.
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
What is “governance”?
What is a “corporation”?
What is “corporate governance”?
Why separate the ownership and control despite the agency cost?
What is the “agency problem”?
Definition
The agency problem occurs when one person or entity (the
“agent”), is able to make decisions and/or take actions on behalf
of, or that impact, another person or entity: the “principal”.
a precondition: the agent and the principal cannot be the
same person.
reason: the agent wants to optimize his own best interest,
which is often not aligned with that of the principal.
“agency cost”: the cost as a result.
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
Main mechanisms of corporate governance (in details)
What is “governance”?
What is a “corporation”?
What is “corporate governance”?
Why separate the ownership and control despite the agency cost?
What is the “agency problem”?
Definition
The agency problem occurs when one person or entity (the
“agent”), is able to make decisions and/or take actions on behalf
of, or that impact, another person or entity: the “principal”.
a precondition: the agent and the principal cannot be the
same person.
reason: the agent wants to optimize his own best interest,
which is often not aligned with that of the principal.
“agency cost”: the cost as a result.
Lingtian Kong Corporate Governance
What is “corporate governance”?
How to achieve corporate governance (in general)?
What is “governance”?
What is a “corporation”?
In other words, “Governance” is the principal solving the
agency problem.
necessary only when the agent and the principal are not the
same person.
necessary only when the agent and the principal are not the
same person.
as a means to delegate management tasks, and to limit and
share risks.
Feature 2: limited liability of the shareholders.
legally: ensured by the legal personhood of the corporation.
financially: liability limited up to the share value.
when the agent and the principal are not the same person.
this is the case with the corporations: separation of ownership
(= principal) and control (=agent).
this is the case with the corporations: separation of ownership
(= principal) and control (=agent).
the founder-manager “sells” part of the risk to the
shareholders.
In other words, CG is the decision rule of the shareholders to
give the management rewards/punishments based on their
performance observed by the shareholders.
1. the shareholders accurately learn of the skill+diligence (level
of hard work) of the management.
2. the shareholders give the management their
rewards/punishments accordingly.
2. the shareholders give the management their
rewards/punishments accordingly.
Skill+diligence is not directly observable.
Skill+diligence+luck = “actual firm performance”
“actual firm performance”+accounting manipulation =
accounting performance (observable)
accounting performance+stock market noise = stock market
performance (observable)
The shareholders do not want to reward good luck or punish
bad luck, or have their reward/punishment be affected by the
accounting manipulation and market noise.
Skill+diligence+luck = “actual firm performance”
“actual firm performance”+accounting manipulation =
accounting performance (observable)
accounting performance+stock market noise = stock market
performance (observable)
The shareholders do not want to reward good luck or punish
bad luck, or have their reward/punishment be affected by the
accounting manipulation and market noise.
“actual firm performance”+accounting manipulation =
accounting performance (observable)
accounting performance+stock market noise = stock market
performance (observable)
The shareholders do not want to reward good luck or punish
bad luck, or have their reward/punishment be affected by the
accounting manipulation and market noise.
accounting performance+stock market noise = stock market
performance (observable)
The shareholders do not want to reward good luck or punish
bad luck, or have their reward/punishment be affected by the
accounting manipulation and market noise.
The shareholders do not want to reward good luck or punish
bad luck, or have their reward/punishment be affected by the
accounting manipulation and market noise.
accounting performance: by accountants and auditors
stock market performance: by the market (aggregate of all the
shareholders)
“actual firm performance” and Skill+diligence: imperfectly by
analysts
stock market performance: by the market (aggregate of all the
shareholders)
“actual firm performance” and Skill+diligence: imperfectly by
analysts
“actual firm performance” and Skill+diligence: imperfectly by
analysts
executive compensation: mostly positive. e.g.: stock options.
management turnover
negative: turnover
positive: severance package; “golden parachutes”
management turnover
negative: turnover
positive: severance package; “golden parachutes”
this happens because those that do the CG bear the cost, but
everybody enjoys the benefit.
the more shareholders there are, the more severe this problem.
the more shareholders there are, the more severe this problem.
