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CHAPTER 16
FINANCING AND GOVERNING THE CORPORATION
GLOBALLY
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. outline the two means of financing decisions, equity and debt.
2. differentiate various ownership patterns around the world.
3. articulate the role of managers in both principal–agent and principal–principal conflicts.
4. explain the role of the board of directors.
5. identify voice-based and exit-based governance mechanisms and their combination as a
package.
6. acquire a global perspective on how governance mechanisms vary around the world.
7. articulate how institutions and resources affect corporate finance and governance.
8. participate in two leading debates concerning corporate finance and governance.
9. draw implications for action.
GENERAL TEACHING SUGGESTIONS
Debate teams would be useful for some of the topics covered in this chapter. In particular,
debates could cover (1) the extent to which the CEO and the Chairman of the Board should be
separate and (2) the net value (positive or negative) of private equity takeovers.
OPENING CASE DISCUSSION GUIDE
High Drama at Hewlett-Packard (HP)
The CEO’s chair at HP has been a hot seat for several years. In 2005, the CEO (Carly Fiorina)
was fired after HP lost half of its value. In 2010, the CEO (Mark Hurd) quit suddenly after
allegations of sexual harassment were made against him. In 2011, the CEO (Léo Apotheker) was
fired after HP lost $30 billion in market capitalization. In 2011, another CEO (Meg Whitman)
was hired. In 2014, HP stock had recovered some of its value and plans were made to split HP
into two companies. In 2015, Whitman continued to serve as a leader at HP. Hopefully, HP will
continue to improve for employee and shareholders.
CHAPTER OUTLINE: KEY CONCEPTS AND TERMS
Sections I through IX of Chapter 16
I. FINANCING DECISIONS
1. Key Concept
Equity refers to the stock (usually expressed in shares) in a firm, and debt refers to the
loan that the firm needs to pay back at a given time with a prespecified interest. Tapping
into a larger pool of capital globally allows firms to lower their cost of capital.
2. Key Terms
Bond is a loan issued by the firm and held by creditors.
Bondholder is a buyer of bonds.
Corporate governance is the relationship among various participants in determining
the direction and performance of corporations.
Cost of capital is the rate of return that a firm needs to pay to capital providers.
Cross listing is listing shares on a foreign stock exchange.
Debt is a loan that the firm needs to pay back at a given time with interest.
Default is a firm’s failure to satisfy the terms of a loan obligation.
Equity is the stock in a firm (usually expressed in shares), which represents the
owners’ rights.
Financing is the management of a firm’s money, banking, investments, and credit.
Shareholder is a firm owner.
II. OWNERS
1. Key Concept
In the U.S. and UK, firms with separation of ownership and control dominate.
Elsewhere, firms with concentrated ownership and control in the hands of families or
governments are predominant.
2. Key Terms
Concentrated ownership and control is founders starting up firms and completely
owning and controlling them on an individual or family basis.
Diffused ownership is publicly traded corporations owned by numerous small
shareholders but none with a dominant level of control.
Separation of ownership and control is the dispersal of ownership among many
small shareholders, in which control is largely concentrated in the hands of salaried,
professional managers who own little (or no) equity.
III. MANAGERS
1. Key Concept
In firms with separation of ownership and control, the primary conflicts are
principal–agent conflicts. In firms with concentrated ownership, principal–principal
conflicts prevail.
Key Terms
Agency cost is the cost associated with principal–agent relationships.
Agency relationship is the relationship between principals (such as shareholders)
and agents (such as professional managers.
Agency theory is a theory that focuses on principal-agent relationships (or in short,
agency relationships)
Agent is an individual (such as a manager) to whom authority is delegated.
Chief executive officer (CEO) is the main executive manager in charge of the firm.
Expropriation is activities that enrich controlling shareholders at the expense of
minority shareholders.
Information asymmetry is asymmetric distribution and possession of information
between two sides.
Principal is an individual (such as an owner) delegating authority.
Principal–agent conflict is conflict between principals and agents.
Principal–principal conflict is conflict between two classes of principals:
controlling shareholders and minority shareholders.
Related transaction is controlling shareholders selling firm assets to another firm
they own at below-market prices or spinning off the most profitable part of a public
firm and merging it with another private firm they own.
Top management team (TMT) is the team consisting of the highest level of
executives of a firm led by the CEO.
Tunneling is a form of corporate theft that diverts resources from the firm for
personal or family use.
IV. BOARD OF DIRECTORS
1. Key Concept
The board of directors performs (1) control, (2) service, and (3) resource-acquisition
functions. Around the world, boards differ in composition and leadership structure.
2. Key Terms
CEO duality is the CEO doubling as a chairman of the board.
Inside director is a member of the board who is a top executive of the firm.
Outside (independent) director is a nonmanagement member of the board.
V. GOVERNANCE MECHANISMS AS A PACKAGE
1. Key Concept
Internal, voice-based mechanisms and external, exit-based mechanisms combine as a
package to determine corporate governance effectiveness. The market for corporate
control and the market for private equity are two primary means of external mechanisms.
2. Key Terms
Exit-based mechanism is a corporate governance mechanism that focuses on exit,
indicating that shareholders no longer have patience and are willing to “exit” by
selling their shares.
Leveraged buyout (LBO) is a means by which investors, often in partnership with
incumbent managers, issue bonds and use the cash raised to buy the firm’s stock.
Private equity is equity capital invested in private companies that, by definition, are
not publicly traded.
Shareholder capitalism is a view of capitalism that suggests that the most
fundamental purpose for firms to exist is to serve the economic interests of
shareholders (also known as capitalists).
Voice-based mechanism is a corporate governance mechanism that focuses on
shareholders’ willingness to work with managers, usually through the board, by
“voicing” their concerns.
VI. A GLOBAL PERSPECTIVE
1. Key Concept
Different combinations of internal and external governance mechanisms lead to four
main groups.
2. Key Terms
None
VII.INSTITUTIONS, RESOURCES AND CORPORATE FINANCE AND GOVERNANCE
1. Key Concept
Institution-based and resource-based views shed considerable light on finance and
governance issues.
2. Key Term
Managerial human capital is the skills and abilities acquired by top managers.
VIII. DEBATES AND EXTENSIONS
1. Key Concept
Leading debates consist of (1) opportunistic agents versus managerial stewards and (2)
global convergence versus divergence.
2. Key Terms
Stewardship theory is a “pro-management” theory that suggests that most managers
can be viewed as owners’ stewards interested in safeguarding shareholders’ interests.
IX. MANAGEMENT SAVVY
1. Key Concept
Understand the rules, anticipate changes, and be aware of differences. Develop
firm-specific capabilities to differentiate on corporate finance and governance
dimensions.
2. Key Terms
None
