Corporate Governance

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

Corporate Governance • 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.

Corporate Governance • 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.

Corporate Governance • . 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.

Corporate Governance • 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

Corporate Governance • 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

Corporate Governance • 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”.

Corporate Governance • 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.

Corporate governance • 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

Corporate Governance • 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 management • Separation of ownership and 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.

Corporate Governance • 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

Corporate Governance • 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

Corporate Governance