Gov Tutorial PDF

1. What are the three main external mechanisms that ensure that the corporation adds the maximum value to society? do these mechanisms always work as intended? Illustrate citing an actual case for the failure of each of those mechanism in achieving their objective. The very elements of the cor...

1. What are the three main external mechanisms that ensure that the corporation adds the maximum value to society? do these mechanisms always work as intended? Illustrate citing an actual case for the failure of each of those mechanism in achieving their objective. The very elements of the corporate structure that have made it so robust – the limitation on liability, the legal personality that can continue indefinitely – make it very difficult to impose limits to ensure that the corporation acts in a manner consistent with the overall public interest. Indeed, the corporate structure creates both the motive and the opportunity for externalizing costs to benefit the insiders. Therefore, we must make sure that we have created a structure that is not just perpetual, but sustainable. This can be achieved by minimizing its ability to externalize the costs of its activities on to others by the force of law or/and by means of the invisible hand (free market forces). The law: What are the most significant laws imposed on corporations? 1. Corporate law enables individuals to establish corporation and the sets the rules of governing these corporation. Corporate law grants the corporation its legal personality and limited liability. This law enables shareholders to be represented by an elected board which control the strategic decisions while the daily business is handled by officers appointed by the board. This law imposes fiduciary duties on boards, officers and other agents to act with care and loyalty. 2. Securities law and stock exchange standards: the securities law requires disclosures, including audited financial statements (during the IPO process and after listing over regular intervals). Securities law also mandates rule for governance-specific disclosures and prescribes rule for specific governance choices (for example, the composition of the board and its committees). Most notably, it restricts insider trading. >> These laws mitigate the owner-manager (principle-agent) conflict of interests (agency problems)–it is shareholder-centric in which the board of director has a fiduciary responsibility to the shareholders only. >> Constituency Statutes introduced in the 1980s in the US. These statutes theoretically permit directors to uphold social and environmental objectives, as well as maximize value for the shareholders of the company. However, Delaware and California don’t offer constituency statutes at all, which means this option is not available where 60% of all US companies choose to be incorporated. 3. Civil and Criminal law which includes the executive, legislative, and judicial branches of state and local government regulation, legislation, and enforcement. Indeed, there exist numerous cases for corporate criminal behavior (antitrust like price fixing, financial fraud like bribing government officials, and environmental like the oil spill). However, problem of meting appropriate corporate punishment arises. In this context, Legal scholar John C. Coffee, Jr. of Columbia University has stated the problem succinctly: “At first glance, the problem of corporate punishment seems perversely insoluble: moderate fines do not deter, while severe penalties flow through the corporate shell and fall on the relatively blameless.” These punishments include the following A. Fines B. Jail sentences C. Community service D. Debarment E. Probation F. Suspension of directors  G. Registration of CEOs >> Severe punishments can impose on society the same harm as does the crime it is designed to punish. Explain how? See pages 30 to 32 of the book. It seems that these punishments have failed to deter criminal behavior. Therefore, shareholders should elect boards who employ internal mechanisms of checks and balances and effective information systems to ensure compliance with laws and regulations. But why is that? This because they share some of the responsibility for failing to make sure that the directors they elect establish mechanisms for preventing and responding to corporate crime. In addition, they may have received unjustified returns as a result of the criminal behavior. However, it may be that the shareholders during the time of the gains and the shareholders at the time of the sentencing are two completely different groups. >> The cases of failure of the law (see cases in the book pages 21-28, especially BP)—the problem of serial offenders In theory, the government can ensure that corporations act in a manner that benefits society. In practice, however, corporations have influenced government at least as much as government has influenced business. The corporate “citizen,” with the right to political speech (and political contributions) has had a powerful impact on the laws that affect it. In theory, corporations support the free market, with as little interference from government as possible. In reality, whenever corporations can persuade the government to protect them from the free market, by legislating barriers to competition or limiting their liability, they do so. (see page 19 of the book)—mention two examples: Gillette and the anti-usury laws cases. The market (refer to the books on page 36 the material “corporate governance” page 22 to page 28) The foundation of capitalism is the Darwinian idea that the market will decide whether goods or services or stock should continue to exist. If a company does not adapt to changing times and competition, it will fail. Market pressures ( see page 22 -28 “corporate governance” case) can change the behavior of offices (managers) and lower agency costs. But how and through which markets? - Competition in product and factors markets a. The product market: costumers vote using their wallets, thereby shunning poor products. b. The factor market (factor of production! What are they?) i. Labor market: poor performing companies fail to attract top talents. ii. Capital markets: poor performing companies will face difficulty obtaining finance. iii. Good and services market (inputs) poor performing companies will fail to obtain goods and services on credit. iv. The market for corporate control: the CEOs of poorly managed company are at risk of being replaced in the event of a hostile takeover There are other mechanisms including LBOs, bankruptcy, shareholder activism, hedge fund activism (though proxy fights)) However, corporations do not hesitate to persuade the government that they should be protected or supported by law, regulation, and sometimes a very big check written on the Treasury. The failure of the market is represented by case on Chrysler (see case on page to in the book)  Performance measurement How do we measure corporate performance? Economic performance is measured using balance sheets and earnings statements prepared according to Generally Accepted Accounting Principles (GAAP). However, accounting problems are widespread most importantly earnings management. These practices are undertaken to attain targets and get compensation packages that are linked to financial performance. This resulted in short term gains rather than long term value creation which is the ultimate objective of the corporation. Besides, Accounting standards are based on a time when real property, like machinery, was the most important asset. They do not reflect the value of “human capital.” The market value: Market value has statistical interest, but to whom is it really meaningful? The public’s valuation of a company in the marketplace has unique value, because it is the only judgment that cannot be manipulated, at least not for long. Various notions of value based on concepts like earnings per share, book value, rate of return on reinvested capital, and the like are based on accounting principles that are so highly flexible that they have limited significance. The fact that the market valuation is independent, however, does not make it accurate in absolute terms. Fair market value does not tell you everything about what a company is worth, only what it is perceived to be worth. We are all familiar with the Dutch tulip bulb mania and “Popular Delusions and the Madness of Crowds.” The public can value companies on bases that in retrospect appear idiotic. Examples, 2006 crisis in Saudi. How should society measure corporate performance? Of course, accounting performance required by regulation but also non-financial disclosures of ESG issues are becoming important. Also, ESG would be of interest to investors. Even at its best GAAP is an asset and liability-based system that is not very revealing about potential risk factors. GAAP would tell you that BP is a $134 billion company based on its market capitalization and that it lost $85 billion almost overnight following the oil spill. However, an ESG assessment before the oil spill might have given investors, regulators, employees, and communities a better sense of its investment and liability risks and an ESG assessment afterward might better reflect actual value than the volatility of news-related market swings. As with GAAP, though, it is easier to know what we would like to understand than it is to figure out what data will be available, accurate, and meaningful. One of the most widely accepted approaches is the Global Reporting Initiative, developed by representatives from 60 countries, which has guidelines for reporting on corporate sustainability. 2. Recite the four elements Robert Clark identified as the essential attributes of the corporation and discuss their pros and cons. 3. Compare and contrast governance models around the world. 4. There are many examples of companies that made arguably antisocial decisions for economic reasons. On the other hand, there are also several examples of companies that make uneconomic decisions for social reasons. Recite some examples of each group. The example for the first group is “A newspaper company with a liberal outlook frequently publishes strongly pro-environment editorials. It is printed on paper produced outside the US, which is cheaper than US paper, partly because the producers do not have to comply with US environmental laws. Is the newspaper a bad company? Is the paper company it buys from a bad company?” (page 56 of the book) The opposite the landmark 1919 case, Dodge v. Ford Motor Co. >> how it differs from Wrigley case??? To what extent do we want corporate leaders to exercise social judgments? To the extent that promoting goals other than maximizing long-term returns for the owners like giving to charity, exceeding regulatory or industry standards for pollution control, or employee benefits promotes the firm’s financial well-being (all of the above may create loyalty in employees and customers) or if the shareholders know (and presumably therefore approve) of the program. What is their authority to make determinations affecting the public good? They should practice their fiduciary duty: duty of care (discuss the business judgment rule) so rulings for the violation of the duty of care are rare. The duty of loyalty (discuss it) case of the “introduction to corporate governance” page 4). Who elected them to what? To whom are they accountable? The Board of directors is elected by shareholders and the board is responsible for hiring and firing CEOs (see the case of the “introduction to corporate governance”). In the Anglo-Saxon model the are primarily accountable to shareholders (Shareholder primacy, see the case of the “introduction to corporate governance” page 4)—Accountability requires not just a mechanism, but also a standard. That standard is usually described as “maximizing long-term returns for the owners.” (Milton Friedman adds “within the limits of the law”.