Lecture 1 Introduction

Prof. Daniel Sungyeon Kim

▪Why FIN536?

▪Syllabus

▪Course outline

▪Corporate Governance and Agency Problem▪ The Corporation

▪ Stakeholders of the Firm

▪ Goal of the Firm

▪ Ownership vs. Control

▪ Agency Problem

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▪ Corporate failures of the first decade of the 21st century have shown us that corporate governance is best understood as a critical element of corporate finance, accounting, management and business law.

▪ In 90’s it was largely academic jargon, but now corporate governance is familiar to everyone.

▪ Challenges all economists, practitioners and policy makers are facing

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▪Students who should take this class▪ Those with career objectives in financial services,

corporate treasury, consulting, general management or government.

▪ Those with a willingness to learn the theoretical foundation for modern corporate finance.

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▪Contact Info.▪ Instructor: Daniel Sungyeon Kim

▪ Office #745

▪ Office hour: Monday/Thursday 9:00 – 10:00 am (or by appointment)

▪ Email address: kimds@phbs.pku.edu.cn

▪Prerequisites (Recommended)▪ Corporate Finance

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▪Resources▪ Lecture notes: to be posted

▪ Textbooks:

Corporate Governance by Monks, Robert A.G. and Nell Minow New York: John Wiley & Sons, 2011, 5th edition. ISBN 978-0-470-97259-5.

A Real Look at Real World Corporate Governance by David Larcker, Brian Tayan

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▪Grading: Student grades will be based on the following formula▪ Mid-term Exam : 30%

▪ Final Research Proposal: 30%

▪ Presentation and Assignment: 30%

▪ Class participation: 10%

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▪Mid-term Exam▪ No make-up exams will be given for the midterm

examination

▪ Alternative exam will be provided only in special cases following the PHBS policy (prior permission needed)

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▪Final Paper:▪ Each group of three students should submit a research

proposal on a topic selected in consultation with the instructor (no more than 10 double-spaced pages) by the final class session. The paper is to be an original work prepared for this class.

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▪Refer to the syllabus

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▪The most common form of business organization

▪Chartered by a state and given many legal rights as an entity separate from its owners

▪Multiple owners

▪Transferable shares

▪All owners have limited liability

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Shareholder

BondholderManager

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Employees

Communities

Customers

Suppliers

Government

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• What is the goal of the firm?

► Profit Maximization?

► Social responsibility?

► Maximize the wealth of existing shareholders

► Shareholders will agree that they are better off if management makes decisions that maximizes the value of their shares.

• Arguments supporting Shareholder Focus

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• In a corporation, ownership is

represented by shares of stock

• The owner of stock is referred to as:

► Shareholder

► Stockholder

► Equity holder

• The aggregate value of all shares is

called equity

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• In a corporation there are no limits on the

total number of owners

• There are no limitations on who may own

stock in a corporation

• The owners are the residual claimants

on the corporation's assets

• Owners receive dividend payments on a

pro rata basis.

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• Ownership and direct control are typically separate

• Board of directors (BOD)► have the ultimate decision-making authority

► Hire/fire the CEO

► elected by shareholders (usually one share, one vote)

► large shareholders may have rights to certain number of seats

• Chief executive officer (CEO)► endowed with authority by the BOD

► makes day-to-day decisions about the firm

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Board of DirectorsArthur LevinsonSusan WagnerMillard DrexlerAlbert GoreRobert IgerAndrea JungRonald Sugar

CEO: Timothy Cook

CFO: Luca Maestri

Senior VP Marketing

Senior VP ISS

Senior VP Software

Senior VP Hardware

Senior VP General C

Senior VP Operations

▪Do Firms Maximize Shareholder Value?▪Yes, if the CEO owns 100% of the firm.

▪Most modern corporations have separation of ownership and control.

▪ The median CEO share ownership of 1500 largest U.S. companies during 1992-2006 was 1% (mean = 2%).

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▪Do Firms Maximize Shareholder Value?▪What’s good for managers may not be good

for shareholders

▪ Personal loyalties toward employees

▪ suboptimal risk-taking in investments

▪ Insufficient efforts and shirking responsibilities

▪ Excessive corporate perks

▪ Empire building: private benefits of controlling large firms

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• Managers may act in their own interest rather than in the best interest of the shareholders.

► the managers may squander money on perquisites

► the managers may pursue actions that increase their non-pecuniary benefits

• The problem of management not working in the interest of shareholders is known as the agency problem.

► a major pre-occupation of corporate finance research

► plays a major role in the analysis of capital structure decisions

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• Examples

“$6,000 for a shower curtain? That's really cleaning up”, USA TODAY, Craig Wilson, 10/14/2003

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• Dennis Kozlowski

► a former CEO of Tyco International

► Dennis Kozlowski spent company money on

a $6,000 shower curtain, a $15,000 dog-

shaped umbrella stand, a $2,200 gilt metal

rubbish bin and $2,900 worth of coat

hangers.

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• Dennis Kozlowski

► Tyco paid $1 million (half of the $2 million bill) for the 40th birthday party of his second wife. The extravagant party, held on the Italian island of Sardinia, featured an ice sculpture of the Statue of David urinating Stolichnaya vodka. This birthday bash was disguised as a shareholder meeting in order to get corporate funding. In a camcorder video, Dennis Kozlowski states that this party will bring out a Tyco core competency - the ability to party hard.

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• Examples

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• Examples

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• The Enron Case

► Enron had created offshore entities,

– Units which may be used for planning and

avoidance of taxes

– Raising the profitability of a business

► These entities made Enron look more

profitable than it actually was.

– Financial deception to create the illusion of

billions in profits while the company was

actually losing money

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• The Enron Case

► In August 2000, Enron's stock price hit its

highest value of $90

– Enron executives, who possessed the inside

information on the hidden losses, began to sell

their stock.

► On Nov 28, 2001, news of Enron's problems,

including the millions of dollars in losses

they had been hiding went public and the

stock price soon fell to below one dollar.

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• The Enron Case

► It had an exemplary board of directors in the

summer of 2001

– CEOs, lawyers, academics, and former

regulators

– Only 2 of the 17 members were insiders

– The chairman of the audit committee: a former

dean of Stanford Business School

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• The Enron Case

► According to Senate subcommittee

investigation

– The Board or the Audit committee did not voice,

not even once, an objection to any of

management’s accounting practices

– The board even waived its own conflict-of-

interest guidelines to allow the CFO to set up its

infamous off-balance-sheet partnerships that

enabled the massive fraud.

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• The Enron Case

► Big accounting firms’ dual role as auditor

and consultant has compromised the

auditor’s independence.

– For its role in Enron’s accounting fraud, Arthur

Andersen has effectively ceased to exist.

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• Hyundai’s Gangnam Land Purchase

► Hyundai Motor Co. purchased 10.55 trillion

won ($10.1 billion) land in Seoul's upscale

Gangnam district

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• Hyundai’s Gangnam Land Purchase

► It has angered investors and sent its shares

down 14%

14% drop and more!!