Corporate Governance

Corporate Governance represents the relationship among stakeholders that is used to

determine and control the strategic direction and performance of organizations.
Corporate Governance focuses on three main areas:
Internal Governance Mechanisms
(1) Ownership Concentration Relative amount of stock owned by individual
shareholders and institutional investors.
(2) The Board of Directors Individual responsibilities for representing the firms
owners by monitoring top-level managers strategic decisions
(3) Executive Compensation Use of Salary, bonuses, and long-term incentives to
align managers interest with shareholders interest.
External Governance Mechanism
Market of Corporate Control The purchase of a company that is underperforming
relative to industry rivals in order to improve the firms strategic competencies.
Separation of Ownership and Managerial Control
Agency Relationship Agency relationship exist when one or more persons (the
principal or principals) hire another person or persons (agent or agents) as decision
making specialist to perform a service. Problems associated with the separation of
ownership and management control are:
a. Different Interest between the Owner and Manager
b. Different Goals
c. Shareholder lacks direct control.
d. Manager makes decisions that are in conflict with those of the Principal Owners
e. Managerial Opportunism The seeking of self interest with guile(ie. Cunning or deceit).
Product Diversification as an Example of Agency Problem Managers might want to
diversify the operations of the organization, while Owners might not be too keen on the
diversification of the operations of the organization due to the inherent risks associated
with diversification.
Agency Costs and Governance Mechanism Agency costs are the sum of incentive costs,
monitoring costs, enforcement costs, and individual financial losses incurred by principal
because governance mechanisms cannot guarantee total compliance by the agent.

Ownership Concentration

Ownership concentration is defined by both the number of large blocks shareholders and
the total percentage of shares they own.
Large block shareholders typically own at least 5 percent of a corporations issued shares.
The Growing Influence of Institutional Owners are financial institutions such as stock
mutual funds that control large block shareholder position.
Shareholders Activism - How active are the shareholders of an organization.

BOARD OF DIRECTORS
The Board of Directors is a group of elected individuals whose primary responsibility is to act in
the owners interest by formally monitoring and controlling the corporations top-level
executives.
Classification of Board of Directors Members
Insider The firms CEO and other top level managers
Related Outsider Individuals not involved with the firms day-to-day operations, but who have
a relationship with the company.
Outsider Individual who are independent of the firm in terms of day-to-operations and other
relationships.
Enhancing the Effectiveness of The Board of Directors
Increase the diversity of the backgrounds of board members
Strengthening of internal management and accounting control systems
The establishment and consistent use of formal processes to evaluate the boards
performance.
EXECUTIVE COMPENSATION
Executive Compensation is a governance mechanism that seeks to align the interest of managers
and owners through salaries, bonuses, and long-term incentives compensation, such as stock
awards and options.

MARKET FOR CORPORATE CONTROL

The market for corporate control is an external governance mechanism that becomes active when
firms internal controls fail.

 Hostile Takeover
Leverage Buy out