checks on manager behavior

the capital budget items
November 7, 2019
an unwarranted audit
November 7, 2019

checks on manager behavior

1. 29-1. What inherent characteristic of corporations creates the need for a system of checks on manager behavior?

The corporation allows for the separation of management and ownership. Thus, those who control the operations of the corporation and how its money is spent are not the same who have invested in the corporation. This creates a clear conflict of interest and this conflict between the investors and managers creates the need for investors to devise a system of checks on managers—the system of corporate governance.

2. 29-2. What are some examples of agency problems?

Examples of agency problems are excessive perquisite consumption (more company jets/company jet travel than needed, nicer office than necessary, etc.). Others are value-destroying acquisitions that nonetheless increase the pecuniary or non-pecuniary benefits to the CEO on net.

3. 29-3. What are the advantages and disadvantages of the corporate organizational structure?

The corporate organizational form allows those who have the capital to fund an enterprise to be different from those who have the expertise to manage the enterprise. This critical separation allows a wide class of investors to share the risk of the enterprise. However, as mentioned in the answer to question 1, this separation comes at a cost—the managers will act in their own best interests, not in the best interests of the shareholders who own the firm.

7. 29-10. Is it necessarily true that increasing managerial ownership stakes will improve firm performance?

No. There are two counter arguments here. First, as Demsetz and Lehn (1985) argue, there is no reason to expect a simple relation between ownership and performance. There are many dimensions to the corporate governance system and a one-size-fits-all approach is too simplistic; the correct ownership level for one firm may not be the correct level for another. Second, some studies have shown a non- linear relationship between firm valuation and ownership—specifically that increasing ownership is good at first, but that in a certain range, managers can use their ownership level to partially block efforts to constrain them, even though they still own a minority of the shares. In this “entrenching” range, increasing ownership could reduce performance.

8. 29-11. How can proxy contests be used to overcome a captured board?

Proxy contests are simply contested elections for directors. In a proxy contest, two competing slates of directors rather than just one slate are proposed by the company. If a board has become captured or unresponsive to shareholder demands, shareholders can put their own slate of new directors up for election. If the dissident slate wins, then shareholders will have succeeded in placing new directors, presumably not beholden to the CEO, on the board.

9. 29-12. What is a say-on-pay vote?

A say-on-pay vote is a non-binding vote whereby the shareholders indicate whether they approve of an executive’s pay package or not.

10. 29-13. What are a board’s options when confronted with dissident shareholders?

When confronted with a dissident shareholder, a board can:

· Ignore the shareholder, which will result in either the shareholder going away or launching a proxy fight, in which case the board will need to expend resources in an attempt to convince shareholders not to side with the dissident; or

· Negotiate with the dissident shareholder to come to a solution on which the board and the shareholder can agree.

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