Corporate Governance Consequences

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Questions and Answers

What is one consequence of the failure of internal governance mechanisms in companies?

Improved financial statements

Increased regulatory oversight

Erosion of investor confidence (correct)

Lower cost of capital

Which of the following was NOT mentioned as a factor in the failure of investor confidence?

Regulatory failures

Bank failures

Investment in technology (correct)

Auditor negligence

What is suggested as a way to strengthen corporate governance?

Increasing the number of insider board members

Strengthening the independence of Boards of Directors (BODs) (correct)

Reducing compliance requirements

Partnership with foreign investors

What outcome is linked to the lack of reform in capital markets?

Stagnation in capital market development Signup and view all the answers

Which of the following consequences is related to distorted capital allocation?

Increased cost of capital Signup and view all the answers

What role do large shareholders typically play in company governance?

They monitor management due to their significant shareholdings. Signup and view all the answers

Which ownership structure involves a holding company controlling multiple firms?

Pyramidal ownership Signup and view all the answers

In which region is the practice of large shareholders owning significant portions of firms rare?

UK Signup and view all the answers

What is a feature of equity cross-holdings?

They enable concentration and leverage of voting rights. Signup and view all the answers

What can large shareholders extract when they have control exceeding cash flow rights?

Private benefits Signup and view all the answers

Which type of company structure is commonly found in Japan and South Korea?

Chaebols and keiretsu Signup and view all the answers

Which of the following best describes the concept of weak minority shareholder protections?

They amplify the control of large shareholders. Signup and view all the answers

What is a common characteristic of concentrated ownership in Germany?

Influential banks and insurance companies Signup and view all the answers

How does improving accounting standards impact shareholder relations?

It reduces information asymmetry. Signup and view all the answers

What is the impact of concentrated ownership on management?

It fosters close monitoring of management activities. Signup and view all the answers

Which of the following best describes private benefits of control?

They can be enjoyed disproportionately by controlling shareholders. Signup and view all the answers

What is a feature of interfirm cross-holdings?

They allow for sharing of control among firms. Signup and view all the answers

What is the governance role of large shareholders?

To ensure effective oversight of management decisions. Signup and view all the answers

In which regions are founders and family members often significant shareholders?

China and parts of Asia Signup and view all the answers

What is a potential way senior executives might misuse incentive contracts?

By artificially manipulating accounting numbers Signup and view all the answers

What consequence may arise from managers undertaking unprofitable projects?

Personal job security for managers Signup and view all the answers

What was the primary purpose of the Consumer Financial Protection Bureau established by the Dodd-Frank Act?

To monitor and prevent predatory loan practices Signup and view all the answers

What was a significant change made by the Economic Growth, Regulatory Relief & Consumer Protection Act regarding the Dodd-Frank Act?

It exempted most small and mid-size banks from enhanced prudential standards. Signup and view all the answers

What does strong investor protection encourage in capital markets?

Higher securities prices Signup and view all the answers

Which of the following may exacerbate market declines during financial crises?

Weak investor protection Signup and view all the answers

Which of these groups is legally represented by the Board of Directors in the context of corporate governance in Germany?

Shareholders and creditors Signup and view all the answers

What measure can be taken to reduce the agency problem in corporate governance?

Offering incentive contracts Signup and view all the answers

What is one of the risks associated with concentrated ownership in a company?

Reduced accountability to other stakeholders Signup and view all the answers

What is a characteristic of well-developed financial markets?

Strong investor protection Signup and view all the answers

How does the presence of insider-dominating boards impact corporate governance in Japan?

Increases conflicts of interest Signup and view all the answers

Which of these describes the Role of shareholders in corporate governance?

They can elect the Board of Directors. Signup and view all the answers

What is a key aspect of the Volcker Rule?

It limits the ability of banks to engage in proprietary trading. Signup and view all the answers

What is the impact of high corporate debt levels?

It may lead to financial instability and crises. Signup and view all the answers

What would encourage higher capital markets activity?

Strong corporate governance structures Signup and view all the answers

What might reduce the temptation for managers to misrepresent financial information?

Mandatory timely release of accurate accounting information Signup and view all the answers

What aspect of accounting laws is highlighted as differing significantly across countries?

The level of law enforcement Signup and view all the answers

What is one of the primary objectives of reforming the regulatory functions of the SEC?

To enhance the accuracy of corporate disclosures Signup and view all the answers

In the context of corporate governance, who are considered crucial stakeholders in many developing economies?

Shareholders, managers, and other stakeholders Signup and view all the answers

What is considered the central problem addressed by corporate governance?

How to protect outside investors from expropriation Signup and view all the answers

Study Notes

Corporate Governance Around the World

Corporate governance is the framework of economic, legal, and institutional rules surrounding the distribution of corporate control and cash flow rights amongst company shareholders, managers, and other stakeholders.
A key issue is protecting outside investors from expropriation by controlling insiders so they receive fair returns on their investments.
Public corporations, spread amongst many shareholders, benefit from reduced risk and large capital raising. However, they also can lead to conflicts of interest between managers and diffused shareholders.
In contrast to this, concentrated ownership can incentivise monitoring of management, however, it also risks disproportionate private benefits from controlling shareholders.

Sarbanes-Oxley Act (SOX)

SOX was enacted to address corporate governance issues.
It mandates that public companies assess and report on internal controls to the SEC, which is costly, particularly for smaller companies.
SOX raises compliance costs for US-listed foreign firms.

Dodd-Frank Act

Designed to regulate systematic risk and protect consumers, especially in financial markets.
It had provisions aimed at strengthening investor protection.
The Economic Growth, Regulatory Relief and Consumer Protection Act weakened certain provisions of the Dodd-Frank Act.

Accounting Transparency

Improving accounting standards reduces the information asymmetry between corporate insiders and the public.
This reduces the incentive for managers to manipulate accounting information.
This would lead to more accurate and timely reporting.

Shareholder Activism

Shareholder activism involves investors buying company stocks to influence management.
Often lead by individuals, pension funds or hedge funds and play a significant role in promoting shareholder rights and interests.
Activist investors push for changes in environmental, social, and governance (ESG) practices.

Market for Corporate Control

This market disciplines managers by attracting outsiders to initiate takeovers when internal governance is weak.
Hostile takeovers are common, with the bidder offering a significantly higher price than the current share price through a tender offer.

Legal Systems and Corporate Governance

Legal origins (English common law, French civil law, German civil law, etc.) significantly affect corporate governance.
Differences in laws and legal enforcement across countries can lead to variations in protections for minority shareholders.
Measures like proxy by mail voting, cumulative voting, and oppression mechanisms significantly affect protections for minority shareholders and their voice in governance.

Ownership and Control Patterns

Countries with weak investor protection often follow ownership structures like pyramidal ownership or interfirm cross-holdings to gain control.

Corporate Governance Reform

Necessary improvements encompass strengthening the independence of boards, enhancing transparency in financial statements, and empowering regulators.
Modernization of legal frameworks plays a crucial role in countries with weak investor protection.

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Description

This quiz explores the implications of failures in internal governance mechanisms within companies. It covers factors affecting investor confidence and suggests potential reforms to strengthen corporate governance. Understand the critical issues linked to capital markets and distorted capital allocation.