Corporate Governance and International Investors

• Managers may pursue goals other than maximizing shareholders' wealth, such as:

  • Growth: investing in projects that create overcapacity and do not have a positive net present value
  • Increasing managers' power: "empire building" by building a large department of staff to boost an individual manager's career prospects
  • Creating job security for managers and staff: holding excessive amounts of cash and not investing it in risky projects
  • Increasing managers' pay and other rewards
  • Pursuing their own social objectives or pet projects, like donations to political parties
• The agency problem in a public limited company refers to the divorce of ownership and control, leading to divergent goals and asymmetry of information between shareholders (principal) and managers (agent). Ways to reduce the agency problem include:

  • Doing nothing if the costs of divergent behavior are low
  • Monitoring agents through reports and audits if contracting or divergent behavior costs are high
  • Using reward/punishment contracts if monitoring and divergent behavior costs are high
• The financial manager's job falls under the control of the financial director, overseeing the financial controller and corporate treasurer. Tasks include:

  • Investment decisions, capital budgeting, and investment appraisal
  • Financing decisions, raising debt and equity finance
  • Managing working capital, including cash, trade receivables, and inventory
  • Dividend policy formulation
  • Interest rate and foreign currency management
• You are asked to calculate the present value of an amount of money to be received in the future. Which three of the following factors would you consider?

  Select one or more

  A.Risk

  B. Pure time value

  C. Net present value

  D. Inflation

  A C and D
• Which one of the following accurately describes 'risk'?

  A.The fact that the value of money changes over time.

  B. The possibility that actual return may differ from the expected return.

  C. The financial rewards gained as a result of making an investment.

  D. The possibility that actual return may be less than the expected return.

  B
• The financial manager’s main emphasis is the use of:

  A.cash flow.

  B. accrued earnings.

  C. profit incentives.

  D. organisation charts.

  A
• Which of the following are essential aspects of a financial managers knowledge?

  Select one:

  A.Investment appraisal methods

  B. Financial markets

  C. Cash and risk management

  D. All of the above

  D
• Which three of the following are reasons why a firm should maximise shareholder wealth?

  A.The shareholders own the firm.

  B. It counters the tendency for management to pursue goals for their own benefit.

  C. This approach encourages high levels of motivation in managers.

  D. To survive in a competitive world.

  A B and D
• Which one of the following options best describes the principal-agent problem?

  A.When there is a breakdown of communication between shareholders and brokers.

  B. When the shareholders have to incur the expense of ensuring that managers act in the interest of the shareholders.

  C. When stockbrokers fail to collect principal payments on a financial security on behalf of the owner.

  D. When brokers ask for additional payments to carry out a transaction.

  B
• Which three of the following are most likely to be solutions to the principal-agent problem?

  A.Selling shares and the takeover threat.

  B. Link managerial rewards to shareholder wealth improvement.

  C. Corporate governance regulation.

  D. Increasing management pay levels.

  A B and C
• Institutional investors


  Large organizations investing on behalf of others
• Covenants


  Restrictive clauses in debt agreements
• Agency problem


  Managers' decisions not consistent with shareholder wealth maximization
• Dividend policy


  Balance between retained earnings and shareholder payouts
• Equity finance


  Raising funds by issuing shares
• Debt finance


  Raising funds through borrowing
• Discounting


  Determining present value of future cash flows
• Compounding


  Determining future value of money invested
• Cash flows


  Substantial cash movements over different time periods
• Risk


  Possibility of actual return differing from expected return
• Inflation


  Reduces purchasing power of money over time
• Time value of money


  Value of money changes over time
• Efficient management


  Optimal allocation of scarce resources
• Corporate finance


  Management of organization's finances to achieve objectives
• Agency problem


  Divergence of ownership and control, managers' goals differing from shareholders', and asymmetry of information.
• Shareholder wealth maximisation


  Main aim of financial managers, achieved through sound investment, financing, and dividend decisions.
• Dodd-Frank Act


  Requires US public companies to give shareholders a 'say on pay' with respect to senior executives every three years.
• Sarbanes-Oxley Act (SOX)


  US legislation post-Enron and WorldCom, overhauled financial reporting standards and established new ones.
• Dialogue with shareholders


  Facilitate communication and encourage participation via general meetings.
• Remuneration committee


  Set remuneration for chairman and executive directors, designed for long-term success.
• Accountability


  Balanced assessment of company's performance, risk management, and financial controls.
• Nomination committee


  Majority of members should be independent NEDs, and their work detailed in the annual report.
• Leadership


  Board effectiveness, separate CEO and chairman roles, and appointment of independent NED.
• UK Corporate Governance Code


  Revised seven times since 2005, with the latest version in force from January 2019.
• Smith Report


  Examined the role and structure of audit committees in UK companies.
• Higgs Report


  Recommended enhancing independence and effectiveness of non-executive directors (NEDs).
• Turnbull Report


  Focused on internal control systems and significant risk types for companies.
• Combined Code


  Revised and reinforced the Cadbury Report, overseen by the London Stock Exchange.
• Cadbury Report


  1992 UK report recommending a voluntary Code of Best Practice for listed companies.
• Corporate governance


  Self-regulation to influence owner-manager mechanisms for fairness, accountability, and transparency.