Managerial economics and organizational architecture 5e ch018

Corporate Structure• Corporations have the legal standing of an individual • Shareholders elect a board of directors with primary decision control rights • Shareholder-owners have limite

Managerial Economics and Organizational Architecture, 5e

Chapter 18: Corporate

Governance

Corporate Governance

• Describes the organizational structure at

the top of the firm

Corporate Structure

• Corporations have the legal standing of an individual

• Shareholders elect a board of directors

with primary decision control rights

• Shareholder-owners have limited liability

• Corporations may establish governance

procedures within legal boundaries

Corporate Ownership

• Stock in closely-held corporations is not

freely traded

• Stock of publicly-traded corporations may

be freely bought and sold

– Widely held corporation

• No one owner controls more than 10 percent of the shares

Corporate Governance Objectives

• Maximizing value

• Protecting assets

• Production of proper financial

statements that meet legal requirements

• Despite governance concerns, the corporate

form seems both productive and resilient

Government Impacts

on Decision Rights

• State regulations affect firms incorporated

within those states

• Federal laws and regulations further

stipulate decision rights

• Courts have impact through interpretations

of laws

• Ultimate owners

• Limited participation in management

– Elect board

– Board oversees management

– Some ratification rights

Shareholder Incentives

• Small shareholders (individuals) have

incentive to free ride rather than be

actively involved

• Institutional investors (e.g pension funds)

differ in incentives to challenge

management

• Blockholders internalize more of the

benefits of active involvement

– Hire, monitor, fire CEO

– Authorize strategic directions

– Approve large capital outlays

Board Composition and Work

• Size can vary from 4 to 33+

• Over half are outside directors

• CEO usually sits on board

– Frequently chairs the board

• Much work done in committees

– Audit

– Compensation

– Nominating

Board Member Incentives

• Some stock ownership aligns financial

interests with other shareholders

• High-profile board members have

self-Top Management

• CEO’s decision authority flows from the

board

• More decision rights are delegated as

firm size and complexity increase

• Senior management retains important

decision rights

– Shape strategic direction

– Establish overall architecture

Top Management

• CEO often deals with investor relations,

media, and customers

• COO manages internal operations

• CFO supervises senior financial managers

Top Management Incentives

External Monitors

• Public accounting firms

– Annual independent audits increase

shareholder confidence

• Stock market analysts

– May have incentives to promote stocks that

use their firm’s banking services

• Commercial banks

• Credit-rating agencies

Monitoring Effect of Market

Sarbanes-Oxley Act of 2002

• Establishes Public Companies Accounting

Oversight Board

• Prohibits certain transactions between

companies and managers

• Holds CEOs and CFOs accountable for

financial statements

• Establishes civil and criminal penalties for

violations

Chapter 18 Appendix

Legal Forms of Organization

Individual Proprietorships

• Resolve owner-top management conflict

• Limited ability to raise capital

• Income passes through to owner’s tax

return

General Partnership

• Income passes through to partners’

individual tax returns

• Partners exposed individually and jointly to unlimited liability

• fosters mutual monitoring

• Take advantage of teamwork opportunities

• Entails incorporation fees

• Lenders still require personal

C Corporations

• Attractive for large companies

• Easier to raise capital

• Shareholders subject to “double taxation”

• Limited liability for shareholders

• Small risk-bearing costs

• shareholders have diversified portfolios