Corporate Governance

By: 1. Kenneth A. Kim

John R. Nofsinger
And
2. A. C. Fernando
Corporate Governance
 Chapter outline
◦ Studying global political system from business
point of view
◦ Goal of business i.e. profit maximization
◦ Forms of businesses
◦ What is corporate Governance
◦ Investors influence on management
◦ How to monitor management
◦ Corporate governance: An integrated and complex
system.
Corporate Governance
 Introduction
◦ There are two major political systems in the world
from business point of view

1. Communism
 refers to a political system that stresses
the primacy of collective goals over
individual goals
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 Characteristic of Communism
◦ Needs of the society are viewed as a whole than
individual freedom.
◦ State-owned enterprises are managed to benefit
society as a whole, rather than individual capitalists
◦ Examples are:
 Cuba
 Vietnam
 China (market based economic reforms)
Corporate Governance

 Capitalism

◦ Capitalism is an economic system based on the private

ownership of capital goods and the means of production,

with the creation of goods and services for profit.

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 Characteristics of Capitalism
◦ Ownership belongs to “YOU”
◦ Freedom of own economic growth
◦ Suitable environment for business
◦ Profit in your “Pocket”
◦ Reward based system
◦ Creative and innovative environment
Corporate Governance
 Goal of a Business
◦ Maximum profit by increasing business
◦ How?
 1. Increasing sales in the existing
market
 2. Creating new markets for the
existing products.
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 . Enhancing business requires
capital which brings risk.
 . So, the ability to access
capital and control risk
are important in the
success or failure of a
firm.
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 Forms of Business Ownership
 Sole proprietorship – a business own by a single
person
 . Easy to start
 . More than 70% of all US business
 . But limited lifespan
 . Die with the owner’s death or retirement
 . Limited ability to obtain capital
 . Owner bears unlimited personal liabilities for the
firm
 . Less trustworthy
Corporate governance
 Partnership – similar to sole proprietorship but
there is more than one owner.
 .The ability to pool capital
 But may not be as important as combining service-
oriented expertise and skill, especially for larger
partnerships, for example;
 Accounting firms
 Law firms
 Investment banks
 And advertising firms
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 Corporation –
the corporation is its own legal entity, as if it
were a person.

Advantages
 . The owner of the corporation enjoys limited financial
liabilities
 Which is very hard in the case of sole proprietorships
and partnerships.
 For example
 Bill Gates of Microsoft
 Tim Cook of Apple
 Larry Ellison of Oracle
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 Fewer than 20% of all US businesses are corporation but

are generating approximately 90% of the country’s
business revenue.

 . The most important advantage of corporation business
is access to capital market and can raise money by
issuing stocks and bonds to investors.

 . It doesn’t die when its owner do because corporation is

not in single person ownership, it has many owners.
Corporate Governance
 Example
 “Between 1977 and 1980, Apple Computers sold
a total of 121,000 computers. To meet the
potential demands for millions of computer per
year, Apple needed to expand operations
significantly. As a result, in 1980, Apple became
the public corporation and sold $65 million
worth of stocks”.
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 Main disadvantages of corporations are;
 . Corporate profits are subject to business taxes
before any income goes to share holders in the form
of dividends.

 . Subsequently, shareholders must also pay personal

taxes on dividend income.
 Which means shareholders are exposed to double
taxation.
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 Running corporation cab be expensive. For
example
 The cost of hiring accountants
 Legal experts
 Cost of communicating with all shareholders
 Cost of complying with Regulations and so forth.
 Perhaps the main disadvantage is of governance
problems.
 Small stake and lack of true sense of ownership
bring RISK and lack of CONTROL
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 What is Corporate Governance?
“Problems that result from the separation of
ownership and control
 Focusing on
 The internal structure and rules of the board of
directors;
 The creation of independent audit committees;
 Rules for disclosure of information to shareholders
and creditors
 And control of the management
 This explain how a corporation is structured.
 Corporate Governance
Separation of ownership and
 Separation of ownership and management
management
Shareholders

Board

Management

Employees
 Corporate Governance
Separation of Ownership and Control

 . Stockholders own the firm and officers (or

executives )control the firm.

 . Hundreds of thousands of investors can’t

collectively take decisions. So firms hire
managers for that work.

 .The shareholder’s main focus is toward business

performances and return of their stock, rather
than in decision making process.
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 Why should managers should care about the owners?

 Satisfactory profit for the stockholders and massive

perks for themselves (principal-agent problem or the
agency problem)

 Managers may be tempted to use the firm’s assets for

their own ends.
 Secretaries may take the supplies
 Managers may take extra food or fancy furniture for their
offices
 Executives can use expensive jets for travelling
 Etc;etc
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 Ability to steel from the shareholders, the
most are the executives.

 This problem can be solved by

 Incentives
 Common incentives
 Offering stocks, restricted stocks or stock options
(normal practice in US companies)
 And monitoring