Corporate

Governance
By: 1. Kenneth A. Kim
John R. Nofsinger
And
2. A. C. Fernando

Course Review
32nd Lecture

Creditors and Credit Rating

Agencies

Outlines
Introduction
Who care about the firm 1. stock holders 2. Creditors

Two types of lenders

Commercial Banks
Individual (bondholders)

Credit Rating Agencies (CRAs)

Analysis of the situation having different credit ratings

by different CRAs

Creditors and Credit Rating

Agencies
How did CRAs start?
High credit rating vs. Low credit rating
Another view of credit rating
New company vs. Mature company

The BIG 3
PACRA
The Ratings

Creditors and Credit Rating

Agencies

Criticisms
Consulting firms
First Amendment Right to CRAs
Mistakes
CRAs as watchman
Relationship with management
blackmailing

International Perspective
Japan (main bank)

Corporate Governance and Other

Stakeholders

Outlines
Corporate Governance and Employees
Trade unions, Co-Determination (Employee representation),
Profit sharing, Earning sharing, and Team production
solution.

Corporate Governance and Customers

Corporate Governance and Institutional Investors
Corporate Governance and Creditors
Corporate Governance and the Community
Corporate Governance and the Government

Corporate Takeovers: A Governance

Mechanism

Outlines
Definition
What are mergers and acquisitions?
Importance of discussing M & A in corporate
governance.
General process: Acquisition
General process: Merger

Corporate Takeovers: A Governance

Mechanism
Characteristics of M & A
Type (vertical/horizontal)
The valuation of firm involved
The payment (Cash, Newly created stocks)
The new corporate structure
The legal issue

Corporate Takeovers: A Governance

Mechanism
Brief overview of M & A.
Strategic reason (to reduce cost, to get new business)
Synergistic reason (combined effort)
Diversification (reduce the risk by making investment
in different locations)

Are corporate takeover good for shareholders

Acquirer firms shareholders perspective
Acquiree firms shareholders perspective

Corporate Takeovers: A Governance

Mechanism

The Target Firm

Increase in share price

Is it appropriate to acquire
Successful firm
Unsuccessful firm

What if the management (acquiree firm)

didnt accept the takeover bid

Corporate Takeovers: A Governance

Mechanism

Hostile takeover is in the eye of the beholder

Acquisition/merger being approved by the target
firm.
Target firm may go for friendly deal
Perks for the management
Premium for the shareholders

Corporate Takeovers: A Governance

Mechanism
takeover Defences
1. Firm Level Pre-emptive defences
Poison Pills
Acquirer firm stocks at a deep discount rate
Target firms debt immediately due

Golden Parachute (payment to managers)

Super majority rule (2/3 shareholders approval)
Staggered Board

Corporate Takeovers: A Governance

Mechanism
1.1 Firm Level Reactionary Takeover Defences
Greenmail (purchasing shares from the major
shareholders at a premium to prevent takeover)
Convincing (by management to convince the
shareholders)

2. State Level Anti-Takeover Laws

Freeze-out Laws
Fair price law (later shareholders get the same price)
Poison pill endorsement laws
A control share acquisition law ( shareholders approval)
A constituency statute (include non-shareholders)

Corporate Takeovers: A Governance

Mechanism

Assessment of takeover Defences

Are takeover defences bad for governance system
Takeover defences are bad for governance system
But the pros and cons of takeover defences should
be evaluated.
But normally these defences are just to increase the
company price

Role of Media in ensuring Corporate

Governance

Outlines
Role of Media in ensuring Corporate Governance
Media can play role in CG by effecting in three
ways;
Pressure on politicians to go for corporate law reforms
Pressure on managers to take care of the shareholders
money
Pressure on managers to take care of the societal
norms

Role of Media in ensuring Corporate

Governance
Importance of media
Can play role even in the absence of legal act

Harms of using advertisement as a media tool.

Misrepresentation of facts

Media and corporate governance

Should be broadened rather than just legal and
contractual aspects
Managers focus should be shareholders but also the
societal norms

Role of Media in ensuring Corporate

Governance
Individual as well as institutional investors can
use press to fight with the management.
Selective coverage and media credibility
Sometimes foreign newspapers are more credible
than the local.
The issue of credibility can question the investigation
made by the newspaper

Role of Media in ensuring Corporate

Governance
Management side deals can increase the query of

credibility.
A single credible newspaper cant fight with lots more

incredible newspapers.

Adverse effects of advertising

Deception
Fear appeals

Positive effects of advertising

Guidance to children in making decisions
Developing skills
socialization

Role of Media in ensuring Corporate

Governance
Materialism
Advertising Alcoholic Beverages
Competitive Advertising
Increasing cost
Absence of full disclosure
Use of celebrities
Fantasy and reality

New Governance Rules-SOX

2002

Outlines
Introduction
Also know as Public Company Accounting Reforms and
Investor Protection Act of 2002.
SOX contain laws pertaining to corporate governance

SOX
To regulate auditors
Created laws pertaining to corporate responsibilities
And increased punishments for corporate white-collar
crime

New Governance Rules-SOX

2002

Public Company Accounting Oversight

Board
1. registration
2. standard auditing
3. inspection of firms
4. investigations and sanctions
5. improve auditing services
6. compliance with the rule of Board
7. oversee the board budget

New Governance Rules-SOX

2002
Auditors independence
Accounting firms will not perform both auditing as
well as consulting activities for a single firm.
Changes after five years in audit team.
An executive from the accounting firm within the
past year will disqualify the public company to be
audited
Rotation of accounting firms conducting audits.

New Governance Rules-SOX

2002
Corporate Responsibilities
Making audit committee independent from the
management.
CEO and CFO will be responsible for the financial
statement.
Separate any profit from bonuses or stock sales that
needs to be restated as a result of misconduct.
No stock transaction during employee pension plan.

New Governance Rules-SOX

2002
Enhanced Financial Disclosure
All transactions must be disclosed
Report to SEC within 2 days
Encourage code of ethics and report everything to
SEC

Analysts conflicts of Interests

Analysts should be separated from the investment
banking

New Governance Rules-SOX

2002
SEC Resources and Authority
SEC budget expanded greatly

Corporate and criminal fraud, accountability and

penalties
Different sentences and penalties were introduces

New Governance Rules-SOX

2002
Will the act be beneficial?
Most rules are misplaced or repetition
Cant guarantee corporate scandals
Expensive
Cost for firms and no firm value
Still debatable

New Governance Rules-SOX

2002
Other Regulatory Changes
The NYSE
NYSE cant effect non-listed firms as well as other business

members like auditors, financial analysts.

Focus on more independent directors
In nominating, compensation and audit committees.

NYSE require shareholders approval all executive equity

based compensation plan

It brings transparancy.

New Governance Rules-SOX

2002
NASDAQ
Small firms can work with small number of independent
directors.
So independent directors can perform the duties of
different committees as well as executive
compensations
The US government is looking to tighter the securities
regulations but there is a long way to go.

Monopoly, Competition and Corporate

Governance

Outlines
1. Introduction
Monopoly is that one person or company controls 1/3
of the local or national market
Abuses of monopolies are

High prices
Wrong allocation of resources
Abuse of investors/markets by giving wrong information.
Preventing inventions
Economic instability
Corruption and bribery
Economic power in the hands of few

Monopoly, Competition and Corporate

Governance
Anti-monopoly laws
Prevents firms to make monopoly
Prevent unfair price discrimination

Competitive firm is preferred because

Low prices
Avoid wastages for competition
Efficiency
Consumers tastes and preferences

Monopoly, Competition and Corporate

Governance
2. The concept, logic and benefits of
competition
Entrepreneurial culture leads to more producers and
sellers
Increased supply capabilities
Cost-cutting through research efforts
Reduction in wastages, & improvement in efficiency
& productivity
Customer focused
More access to foreign market
Favourable environment for trade and investment
Best sources utilization
Wide range of available goods and services

Monopoly, Competition and Corporate

Governance
Regulation of competition
Competition must be regulated through some
legislation which helps in;
Firms dominance
Prevents monopolies
Controlling anti-competitive acts like
Full line forcing
Predatory pricing

Corporate governance under limited competition

Regulatory barriers weaken the managerial efforts
and board supervisions leads to governance issues.

Monopoly, Competition and Corporate

Governance
Constraints to competition in developing countries
Nationalization and public interest cause
constraints for firms to work efficiently.

Banks role in restraining emergence of securities

markets
Banks credit reduces the need to invest in the
securities markets
Banks can play vital role to analyse the companies
value for further businesses.

Monopoly, Competition and Corporate

Governance
Lack of competition promotes ownership
concentration
More competitive markets result in more public firm
Less competitive markets result in more private firms

3. Benefits of competition to stakeholders

Managers
products

Monopoly, Competition and Corporate

Governance
Benefits of competition
Competition in the product market
Quality products
Low prices

Competition in the capital market

Relationship of firms and financial institutions

Economic Power and Political Influence

Firms can take political influence for their benefits
Monopolistic market can lead toward the political
influence, would results in bad governance.
Competition is the only solution.

Monopoly, Competition and Corporate

Governance
Enforcement of Good Governance
First go for private enforcement through market
mechanism
Or self-regulation through trade associations
Or public enforcement
Positive competition reduces the burden of
enforcement
Enforcement is vital

Monopoly, Competition and Corporate

Governance
Challenges to Good Enforcement
Resources
Meaningful sanctions
A real big challenge

Competition Agencies and Competition Policies

To prevent anti-competitive practices

To resist the lobbying of interest groups
Competition policy should be at the top.
Adequate resources to investigate anti-competitive
practices.

Monopoly, Competition and Corporate

Governance
Good competition policy should be there to;

Prevent monopoly
Ensure economic efficiency
Control dominant firms
Discourage merger and acquisition
Check barriers for new entrants to market
prevent anti-competitive agreements
Apply to all major segments of the economy
Protect small firms

Competition boosts corporate governance

Corporate Governance in Developing and Transition

Economies

Outlines
Introduction
Corporate governance: advanced vs. developing nations
Globalization tends the standards of corporate governance
from local to global perspective
So developing nation should have to work hard.

Problems faced by developing and transition economies

Still in process of basic market institutions to regulate

Internal owner vs. external owner
Inflow of new capital is not facilitated
Lack of property rights, contract violations and self-dealing
are the core issues, not just the owners and controllers
relationship

Corporate Governance in Developing and Transition

Economies

Act are there but it is hard to implement.

Judiciary, bureaucracy and regulatory bodies are not
alert to stop corporate misgovernance.

Summary of problems facing these economies

Low economic growth
Public sectors dominance i.e. CG is for private
sectors
Lack of effectiveness of privatization
Lack of awareness among shareholders
Govt. influence
Internal owners are more influential than external
owner (no voting powers)
More concentration toward family-owned
corporations.

Corporate Governance in Developing and Transition

Economies

Lack of legal protection for investors

No inflow of new capital
Low property rights and contract laws.
Lack of well regulatory banking sector
Exit mechanism, bankruptcy and foreclosure (taking
possession of mortgage property) norms are absent.
No sound securities market
Lack of competition
Corruption and mismanagement
Non-uniform guidelines by the govt. for all
companies

Corporate Governance in Developing and Transition

Economies

Corporate Governance Models

Insider system
Insider own majority of the company shares
Voting rights
Power to monitor management
Keep their investment for long period in a firm
Support decisions for long period of time
Dominant owners can use the firms assets by colluding
with the management, at the expense of minority
shareholders.
Irresponsible exercise of power resulting waste resources
and drain company productivity levels.

Corporate Governance in Developing and Transition

Economies
Outsider system
Large number of owners hold small number of company
shares
Cant monitor management
Cant involve in management decisions
Common law countries (UK, USA) own this system
Independent board members to monitor managerial
behaviour
More accountable and less corrupt
Having dispersed ownership structure with some weaknesses
Looking for short term maximization

Conflicts between directors and owners

Manual of Corporate Governance-SEC

Pakistan

Contents
I. INTRODUCTION

II. WHAT IS CORPORATE GOVERNANCE?

(i) The Background

(ii) Definition of Corporate Governance
(iii) The Benefits of Corporate Governance
(iv) The Pakistani Corporation
(v) The Origins of Corporate Governance in
Pakistan

Manual of Corporate Governance-SEC

Pakistan
III. THE NEED FOR CORPORATE
GOVERNANCE
IV. THE STAKEHOLDERS
(i) General
(ii) Shareholders
(iii) Directors
(iv) Employees
(v) Creditors

Manual of Corporate Governance-SEC

Pakistan
V. PROMOTING REFORM AND SHAREHOLDER ACTIVISM
VI. ROLE AND RESPONSIBILITIES OF DIRECTORS AND
MANAGERS

(i) Directors and Managers Distinguished

(ii) Appointment and Proceedings of Directors
(iii) Fiduciary Duties
(iv) Powers and Responsibilities of Directors
(v) Liability of Directors
(vi) Executive and the Non-Executive Directors
(vii) The CEO
(viii) The Company Secretary
(ix) The CFO
(x) Internal Control System
(xi) Reporting Requirements

Manual of Corporate Governance-SEC

Pakistan
VII. SCRUTINIZING FINANCIAL STATEMENTS WHAT EVERY DIRECTOR SHOULD KNOW

(i) General
(ii) Liability of Directors
(iii) Preparation of Financial Statements
(iv) Tools for Directors' Review
(v) How to Prevent Misleading and Fraudulent Financial
Statements
(vi) External Auditors
(vii) Role of the Audit Committee
(viii) Role of Internal Audit

VIII. CONCLUSION

Corporate Citizenship

Outlines
Introduction
Stakeholders of the firm
Primary
secondary

Legal Foundation
Corporate Social Responsibilities

Level
Level
Level
Level

1.
2.
3.
4.

Economic
Legal
Ethical
Philanthropy

Corporate Citizenship

Drivers of citizenship trends inlude;

Globalization
Governments involvements
Pressure from other social organizations
Related popular movements like environment etc
Education
Global capital market pressure

Corporate Citizenship

Benefits of CSR to firms

Long-term thinking
Customer engagement
Employee engagement
Brand differentiation
Cost saving (cost-benefit analyses)
Innovation

Corporate Citizenship

Governance and Stakeholders Theory

Criticism
Considering stakeholders theory as Descriptive
theory
More focus on solid reforms will give you;
Cost
Reducing competition and
Worsening economic performances