Corporate Financial Strategy 4th edition Dr Ruth Bender Corporate governance and financial strategy contents Learning objectives Illustrative stages in the ownership life cycle Changing role of corporate governance over the ownership life cycle ID: 658349
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Chapter 6Corporate governance and financial strategy
Corporate Financial Strategy
4th edition
Dr Ruth BenderSlide2
Corporate governance and financial strategy: contentsLearning objectivesIllustrative stages in the ownership life cycleChanging role of corporate governance over the ownership life cycleIndicative attributes of lack of independence in a director
Problems with performance measures in executive pay
EPS growth as a target in different growth scenarios
Control enhancement mechanisms (CEMs)Control enhancement mechanisms (CEMs)Structures of control: the PyramidStructures of control: Indirect controlCase study 6.3: Hollinger control structureCorporate governance mechanisms and the minority shareholderCorporate governance mechanisms and the lenderCorporate responsibility and the drivers of value
2Slide3
Learning objectivesApply a model to determine which aspects of corporate governance are most relevant at different stages of a company’s life cycle.
Recognize
the limitations of different types of executive remuneration plan, and evaluate how their performance measures link to the creation of value.
Understand and explain how differences in corporate governance regimes can affect the financing strategies of companies in those jurisdictions.Contrast the different mechanisms by which block-holders can control a company, and explain the impact, positive and negative, that this can have.Explain why stakeholders merit consideration in a discussion of financial strategy.
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Illustrative stages in the ownership life cycle4
Agency problems and accountabilities increase lower down the pyramidSlide5
Changing role of corporate governance over the ownership lifecycle5
Sole trader
Partnership
Ltd company owned by mgt
Ltd company owned by associates
Ltd company with private equity investment
Ltd company with wide ownership
Agency problems
None
None until organization size requires delegation
Some
Some
Many
Internal control & reporting
Manage the money
Manage employees
Regular accounts
Division of duties and formalised internal controls.
Sophisticated reporting systems.
Reporting to outside shareholders.
(All increase as the business develops)
External reporting
Not required
May need to file accounts
Reporting to investors
Reporting to investors, and possibly to regulators
Extensive reporting
External audit
No need
Optional
Compulsory in some regimes
Generally required by investors
Generally compulsory / demanded by investors
Compulsory
Management and direction
Self
Partners
Directors
Management and investors
Management, with input from PE investors
Professional mgrs & NEDs
Management remn
To suit self and business needs
To suit partners and business needs
To suit owners and business needs
Agree with external investors
Agree with investors; will include equity as incentive to grow capital and exit
Agree with external investors and governance regulationsSlide6
Indicative attributes of lack of independence in a directorHas been an employee or executive of the company or a related company in the past X years.Is a close family member of a director of the company or a related company.Has had a significant business relationship with the company in the past
Y
years.
Is a professional adviser to the company, or has some other business relationship.Represents a block shareholder or a major lender to the company, or has significant business transactions with same.Holds cross-directorships with other members of the company’s board.Participates in the company’s pension scheme or share option scheme.Has served on the board continuously for more than Z years6Slide7
Problems with performance measures in executive pay7
Profit, earnings per share, and eps growth
Accounting policies can be chosen selectively
Use of debt distorts eps
Investment requirements can distort figures
Risk is not taken into account
Dividend policy vs. share buybacks can distort
Does profit clearly relate to shareholder value?
Return on Capital Employed
All issues as per eps, etc.
Distorted over project life
Affected by company’s growth rate
Effects of inflation can distort
Not comparable to ‘cost of capital’
Total shareholder return (TSR)
Is the share price a good measure for exec performance?
Complex for execs to understand
Treadmill of expectations
Non-financial measures
Quality of information? (not audited)
Subjective?
Perception of ‘soft’ measuresSlide8
EPS growth as a target in different growth scenarios8
P
0
Share price
High
plc
Low
plc
Now
Time
T
1
P
1
P
2
eps growth of
RPI+X% is a commonly
used base measure
eps growth does not necessarily lead to shareholder value!Slide9
Control enhancement mechanisms (CEMs)CEMs which work by giving block-holders enhanced voting rightsShares with multiple voting rightsNon-voting sharesPyramid structures
CEMS which lock in control
Priority shares with veto rights over certain decisions
Voting rights ceilings (which limit voting power regardless of how many shares are owned)Ownership ceilings (which prevent transfer of shares to owners if they would take the holding above a certain percentage)Golden shares (often used by governments in sensitive privatized companies)Source: Report on the Proportionality Principle in the European Union Available via http://ec.europa.eu/internal_market/company/shareholders/indexb_en.htm At the time of writing, the EU is considering giving additional voting rights and dividends to investors holding shares for a period of years, with the aim of encouraging long-term investment.
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Control enhancement mechanisms (CEMs)CEMs which work by giving block-holders enhanced voting rights
Shares with multiple voting rights
Non-voting shares
Pyramid structures
CEMS which lock in control
Priority shares with veto rights over certain decisions
Voting rights ceilings (which limit voting power regardless of how many shares are owned)
Ownership ceilings (which prevent transfer of shares to owners if they would take the holding above a certain percentage)
Golden shares (often used by Governments in sensitive privatized companies)
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Source:
Report on the Proportionality Principle in the European Union
Available via
http://ec.europa.eu/internal_market/company/shareholders/indexb_en.htm
Slide11
Structures of control: the Pyramid11
Controlling shareholder
Holding 2
Holding 1
Target
51%
51%
51%
Control is obtained through ownership of 13.3
% of the sharesSlide12
Structures of control: Indirect control12
Controlling shareholder
Holding
Target
90%
15%
36%
Control is obtained through ownership of 47.4
%
of the sharesSlide13
Case study 6.4: Hollinger control structure13
Black
and Radler together control 79.2% of Ravelston, which in turn owned 78.2% of HLG, so their combined indirect ownership interest in HLG was approximately 62%. In turn, HLG owned a 30.3% interest in Hollinger. Through HLG, Black and Radler’s indirect ownership interest in Hollinger was approximately 19%. Thus, every $100 transferred out of Hollinger and into HLG
‘cost’ Black and Radler $19 but gave them $62, thereby tripling their funds at the direct expense of the Hollinger common stockholders other than HLG.
Extract and diagram are from page 8 of the Report of the Special Committee of Hollinger
http
://www.sec.gov/Archives/edgar/data/868512/000095012304010413/y01437exv99w2.htmSlide14
Corporate governance mechanisms and the minority shareholderReducing risk
for
minority shareholdersAbility to vote on all resolutions, including voting directors onto or off the boardEase of votingLegal mechanisms for minority shareholders to take action against oppression by the majority or against expropriations by managementLaws or codes protecting the minority during a takeoverLaws protecting against insider tradingRequirement for independent non-executive directors on the board
Requirement for high levels of relevant financial and non-financial disclosures, for example details of transactions with related
parties
Increasing risk for minority
shareholders
Control enhancement mechanisms (CEMs) such as certain shares carrying multiple votes, or no votes, or ceilings on voting rights, or vetoes in certain situations
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Corporate governance mechanisms and the lenderReducing risk
for
lendersEase of ability of a lender to enforce their security to repossess assets if loan terms are breachedStrong legal protection over property rights, including intellectual property rights (so that the company’s assets cannot be expropriated)
Increasing risk for
lenders
Bankruptcy laws that leave the existing executives in control of the company rather than letting creditors put in their own management
Bankruptcy laws that enable management to protect the company against creditor claims
Priority of social or government claims over the rights of secured lenders
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Corporate responsibility and the drivers of value16
Driver of value
Some
examples of driving performance through sustainability
Grow sales faster
Innovative products to meet sustainability needs.
Attract customers by corporate responsibility stance.
Increase operating profit margin
Better workforce efficiency by treating people better: attract better people, more training, less absenteeism, lower staff turnover.
Efficiencies due to energy and waste management.
Reduce cash tax rate
Possibly take advantage of incentives.
Fewer fixed assets
Improved efficiencies.
Less working capital
Reduced waste leading to reduced inventory.
Better supply chain practices as companies work in
coordination
.
Increase the period for which the organisation has a competitive advantage
Increased brand equity in the
sustainable
company.
Compliance leads to legitimacy which extends the ‘licence to operate’.
Lower cost of capital
Investors perceive lower risk in companies that are compliant with ‘best practice’ governance regulations.