Corporate Governance Golden Document

Lecture 1- Introduction to the course and corporate governance.......................................................2

Key lecture takeaways:.....................................................................................................................2
Key corporate governance words..................................................................................................2
Principal-agent theory (The firm as a nexus of contracts).............................................................3
Mandatory readings:........................................................................................................................3
Schleifer & Vishny (1997): A survey of corporate governance.......................................................3
Hart & Zingales (2022): The New Corporate Governance..............................................................4
Hart et al (2022) Private Sanctions................................................................................................4
Related articles:................................................................................................................................5
Elon Musk Twitter Takeover..........................................................................................................5
BlackRock pulls back support for climate and social resolutions (Mutual fund. Relevant)............5
Hindenburg research and adani group scandal.............................................................................5
ESG should be boiled down to one simple measure: EMISSIONS..................................................5
Lecture 2- Incentives part 1 (CEO pay and issues in executive compensation)...................................5
CEO pay:........................................................................................................................................5
Mandatory readings:........................................................................................................................5
2013 Cronqvist & Fahlenbrach: CEO contract design: How do strong principals do it...................5
2022 Bebchuk & Tallarita: The perils and questionable promise of ESG-based compensation.....6
Articles:.............................................................................................................................................7
HBR: Compensation Packages that actually drive performance: Principles for designing pay.......7
Remuneration Policy Danske Bank................................................................................................7
Lecture 3 – Incentives part 2 (Behavioral agency)................................................................................7
Mandatory readings:........................................................................................................................8
Pepper & Gore (2015) Behavioral agency theory: New foundations for theorizing about
executive compensation................................................................................................................8
Exam questions on this article.......................................................................................................8
Lecture 4 – Ownership..........................................................................................................................8
Mandatory readings:........................................................................................................................9
Helling et al. (2020): Exit as governance: Do blockholders affect corporate innovation................9
Machery et al. (2022): Institutional investors, alternative asset managers and ESG preference...9
Lecture 5+6: Owner Identity: Family Firms........................................................................................10
Mandatory readings:......................................................................................................................10
2015 Villalonga: Governance of family firms...............................................................................10
2020 Kang & Kim: Do family firms invest more than nonfamily firms in friendly policies?..........11
Case 1: Tesla’s compensation plan..............................................................................................11

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 Empirical articles.............................................................................................................................11
Elliot and fellow activist investors take on big tech (HEDGE FUND VS SALES FORCE)..................11
Lecture 7+8: Board of Directors + BoD (Behavioral agency)..............................................................12
Mandatory readings........................................................................................................................12
2020 Greene & Kahle: Do board gender quotas affect firm value?.............................................12
2013 Mcdonald & Westphal: Access denied: Low mentoring of women and minority first-time
directors......................................................................................................................................12
Empirical articles.............................................................................................................................13
2020 Nuno: 10 Trends for The Board of 2020..............................................................................13
Lecture 9: Financial Contracting and corporate governance of start-ups..........................................13
Mandatory readings:......................................................................................................................13
Filatotchev et al. (2006) The firm’s strategic dynamics and corporate life-cycle.........................13
Case 3: Founder-CEO Succession at Wily Technology..................................................................14
Empirical articles.............................................................................................................................14
Lecture 10: Firm theory and corporate governance...........................................................................14
Mandatory readings:......................................................................................................................15
2002 Williamson “The Theory of the Firm as governance structure: From choice to contract”.. 15
Case 2: White (2016) British Land................................................................................................15
Exam case: Facebook Faces the Regulators.................................................................................16

Lecture 1- Introduction to the course and corporate governance

Learning objective: Be able to discuss the concepts of incomplete contracts, moral hazard, asymmetry of information
etc. and critically analyze the agency issues and their solutions in private corporations

Corporate governance is defined as setting the direction of companies and controlling the implementation. It’s about
aligning incentives between principals (owners) and managers (agents) so both work for a mutual goal to increase firm
value.

Key corporate governance words

1. Adverse selection: Adverse selection refers to a situation in which one party in a transaction has information the
other party does not have leading to a disadvantageous outcome for the less-informed party.
2. Moral hazard: When an individual takes more risks because he knows he is protected because another
individual bearing the cost of those risks (Insurance)
3. Bounded rationality: Seeking a decision that will be good enough, rather than the best possible decision.
4. Information asymmetry: A situation where one party possesses more information compared to another party.
5. Agency costs: Costs arising due to conflicts of interest (diverging goals) between principals and agents
a. Direct: Reduced cash flows for investors (suboptimal investment decisions or theft)
b. Indirect: Higher cost of capital due to inability to attract cheap capital and external monitoring.
c. How to lower: Reputation, covenants etc.
6. Incomplete contracts: Writing a complete contract is impossible due to limited foresight of future events.

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 a. The principal knows that the agent might exploit information asymmetries to their own benefit but also
cannot write a contract that would restrain the agent in every future instance.
7. Agency problem: Separation of ownership and control

Principal-agent theory (The firm as a nexus of contracts)

The principal hires the agent to fulfill a task based on a contract. The agent dislikes effort (effort averse) although higher
effort leads to higher outcome, which is beneficial for the principal (conflict of interests=>agency costs). The agent acts
opportunistic to obtain private gains and the principal cannot fully observe this behavior while the agent holds superior
information (information asymmetry/adverse selection). The principal knows that the agent might exploit information
asymmetries to their own benefit (moral hazard) but also cannot write a contract that would restrain the agent in every
future instance (bounded rationality and incomplete contracts). As a result, the optimal contract involves compensation
contingent on a set of signals which are observable and correlated with the agent’s effort to maximize value.

Mandatory readings:
Schleifer & Vishny (1997): A survey of corporate governance
Abstract: This article surveys research on corporate governance, with special attention to the importance of legal
protection of investors and of ownership concentration in corporate governance systems around the world.

o (1)The agency problem: Why do investors give their money to managers when both the theory and the evidence
suggests that managers have enormous discretion about what is done with that money.
 (2) Financing without governance: Discuss the idea that firms and managers have reputations and the idea that
investors are gullible and get taken
 Reputation building: The argument is that managers repay investors because they want to come to the
capital market and raise funds in the future, and hence need to establish a reputation.
 Excessive investor optimism: Investors get excited about companies, and hence finance them without
thinking much about getting their money back, simply counting on short run share appreciation.

 (3) Legal protection: Investors provide external financing to firms because they receive control rights in exchange
through a contract: If firms violate, financiers go to court.

 (4) Large Investors (Concentrated ownership): If legal protection does not give enough control rights to small
investors to induce to give money, then perhaps investors can get more effective control rights by being large.
o Large shareholders: A large shareholder has enough voting control to put pressure on management.
o Hostile Takeovers: A tender offer to the dispersed shareholders of the target firm, to gain control of
the company and the management. rapid-fire mechanisms for ownership concentration.
o Large Creditors: Banks have a variety of control rights they when firms default or violate debt
covenants and they typically lend short term, so borrowers must come back at regular for more funds.

o (5) Cost of large investors: Large investors are not diversified and thus bear excessive risk.
o (6) Specific governance arrangements
 A: Debt vs equity:
 B: LBO’s:
 (C) JV and State Ownership: JV or state ownership might be a more efficient ownership
structure especially for health care, childcare, railroads, prisons, schools etc. where profit is
not the sole purpose for these activities, but high quality is important.

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 o (7) Which system is best? Large investors and legal rights.

Hart & Zingales (2022): The New Corporate Governance

Key takeaways: Shareholder Value, Shareholder Welfare, Proxy Voting (If one cannot partake in AGM, vote can be put on
a proxy for ESG and another part will vote on that for you).

Abstract: There has been a increase in shareholder engagement on environmental and social issues because younger
investors are more sensitive to social issues arguing against shareholder value maximization. They propose the criterion of
shareholder welfare maximization and argue that it can better explain observed behavior. Externalities important
because individuals care about others, thus government subsidies important to push towards SWM.

1. Shareholder value maximization (SVM): Maximize value for shareholders no matter other outcome this brings
2. Shareholder Welfare maximization (SWM): Shareholder puts weight on the welfare of others affected by the
decision of a firm and not solely profit maximization (CSR). However this also brings problems:
a. Which topic to address? Animal rights, gun rights etc.
b. How to prioritize vote?: Mutual funds vote on behalf of several investors thus almost voting for the
value-maximizing outcomes: Proxy voting: guidelines geared towards specific areas: Making it easier
for mutual funds to vote on behalf of investors.
c. Distraction: Multiple focus areas may deviate companies from main agenda and ruin company.

Hart et al (2022) Private Sanctions.

Keywords: economic sanctions, business objectives of the firm, Ukranian invasion

Abstract: Discussion of RUSSA and exit of business. What are the geopolitical and economic implications of private
corporations discontinuing profitable business relationships for moral or political reasons.

What pushes firms to impose sanctions?

1. Protect reputation: Sanctions to value maximize company and minimize risk of sanctions by own government.
2. “Woke-washing”: Companies make the cheap decision to look morally virtuous.

Implications

1. Firms see exiting Russia of more than “pure business decision”; the moral component also matters.
2. Keeping personal costs fixed, customers seem the ones most willing to punish firms for the wrong moral choices.

Related articles:
Elon Musk Twitter Takeover
Elon Musk, taking control of the company and reportedly firing several top executives.

BlackRock pulls back support for climate and social resolutions => Profit over society
Abstract: BlackRock’s support for US shareholder proposals on environmental and social issues fell by nearly half in this
year’s annual meeting season. Profit matter more than environmental issues.

Hindenburg research and adani group scandal

Abstract: Hindenburg Research, a New York investment firm, published a report accusing the Adani Group of pulling “the
largest con in corporate history”. Hindenburg (Shareholder/Hedge fund activism), which had taken short positions, detailed
allegations of stock manipulation and other financial mischief.

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ESG should be boiled down to one simple measure: EMISSIONS
Key message: ESG is the hottest topic in investment. However, better to simply focus on the e. The environment is an all-
encompassing term, including biodiversity, water scarcity and so on. By far the most significant danger is from emissions,

Lecture 2- Incentives part 1 (CEO pay and issues in executive compensation)

Learning objective: Be able to identify the opportunities and potential pitfalls in the use of incentive-based
remuneration as a tool to motivate managers and to critically asses the efficiency of various incentive schemes

CEO pay:
Consist of the following:

1. Basic fixed salary payment

2. Variable pay:
a. Short term: Annual bonus paid in cash based on predetermined measures.
b. Long term: Options or Restricted stock units or restricted options based on time- or performance
(company performance + individual performance) vesting.
3. Benefits:
a. Pension plan, insurance and severe pay and other perks and perquisites.

A balanced contract should reward the agent enough to participate, leave enough compensation “to be achieved” through
high effort, balance the agents perspective to both consider short and long term target, and have metrics measuring both
individual achievement, and group achievement, so as to inspire leadership. All in all, the exact contract is context specific,
and following theory on behavioral agency it also needs to be adapted to the specific agent in question.

Mandatory readings:
2013 Cronqvist & Fahlenbrach: CEO contract design: How do strong principals do it
Abstract: We study changes in chief executive officer (CEO) contracts when firms transition from public ownership with
dispersed owners to private ownership with private equity sponsors. The most significant changes are that a significant
portion of equity grants performance-vests based on prespecified measures, and that unvested equity is forfeited by
fired CEOs. Private equity sponsors redesign contracts away from qualitative measures. They use some subjective
performance evaluation, do not use indexed (matched against industry due to this fluctuating with general market) or
premium options (Exercise price above current share price).

1. Do strong principals redesign CEO contracts? If so, which features do they change?
a. Redesign contract from qualitative (non-finance) measure to cash flow measures (EBITDA + IRR)
b. Strong increase in the % of CEO ownership post LBO.
c. Performance-vesting rather than time vesting options, with focus on exit event.
d. Unvested options and RSU are forfeited if the CEO is dismissed.
e. Restrictive sale of vested options for CEO: impossible to unwind equity before liquidation scenario.
f. Increase in base + bonus: Compensation risk because of levered firm + performance-sensitive contract.
g. Severence pay worse post-LBO to force bad CEO to resign.
2. How do the CEO contracts square with contracting theory?
a. Informativeness principle: Any signal that reveals information about an agent’s effort should be
included in the contract (EBITDA, IRR and Multiples).
b. Precision of signals: Use precise signals to measure CEO (Long-term=IRR, short-term=EBITDA), avoid
imprecise signals because they create noise (P/E), avoid easily manipulated signals (EPS).
c. Screening and selection effects: PE design CEO contracts to induce an agent’s effort and to affect which
agents will select the contract. Performance contracts induce better CEO to take job.
d. Sensitivity of compensation to signals: Contracts should maximize the sensitivity of the agent’s
compensation to the signals => CEO compensation is sensitive to the signals to account for risk aversion

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 e. Multitasking and subjective performance evaluation: Agent exerts effort only on the tasks whose
signals pay off the most (EBITDA or IRR), optimal to simultaneously use time-vesting to make the agents
pay contingent on the principal’s decision not to dismiss the agent. Complements and not substitutes.
f. Perquisite theories: Perks as either “private benefits” which reduce value or perk as “productivity
boost” increasing value.
g. Severance pay theories: Contractual provision for termination prior to LBO more favorable than after
LBO designed by PE sponsors (Incentive for poor CEO to resign).
3. Do the CEO contract avoid some of the most criticized compensation practices in U.S public firms?
a. ‘‘Pay for luck’’, Indexed contracts: No use of indexed contracts in LBO- DO AVOID
b. No usage of premium options (OTM vs ATM): No use of premium options in LBO either. DO NOT
c. US: Heavy usage of time-vesting options: PE sponsors use performance-vesting – DO AVOID
d. US: Freedom to unwind equity: PE restrict equity unwinding – DO AVOID

2022 Bebchuk & Tallarita: The perils and questionable promise of ESG-based compensation

Stakeholderrism=>ESG based CEO comp=> Problems because of narrowness and multitasking=> suboptimal outcome =>
Outside reviewability as governance mechanism (Disclose goals, disclose outcome, provide context).

1. Stakeholderrism: Corporate leaders should consider the interests of all stakeholders, (SWM > SVM).
2. ESG Metrics in CEO Compensation: Growing adaptation of ESG metrics in CEO pay.
3. Problems with ESG comp: Narrow dimension, multitasking problem, limited transparency: ESG metrics only focus
on a limited dimension of welfare and metrics induce CEO to favor easy achievable => Hurting not serving overall
welfare. (Reduce emission by selling intensive assets to another party that still uses them.
4. Solution: outside reviewability: Three key requisites for effective outside reviewability
1. Disclose clear and objective goals.
2. Disclose outcome.
3. Provide meaningful context. Provide enough information to allow outsiders to access achievement.

Articles:
HBR: Compensation Packages that actually drive performance: Principles for designing pay
Abstract:

The four dimensions of compensation design:

1. Fixed versus variable pay – (Peer behavior also counts)

2. Short- versus long-term
3. Cash versus equity
4. Individual vs group

Remuneration Policy Danske Bank

Remuneration in the form of:

1. Base salary
2. Pension and other benefits
3. Short-term incentive programs (STI)
4. Long-term incentive programs (LTI)
5. Extraordinary payments

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Lecture 3 – Incentives part 2 (Behavioral agency)
(Positive) agency theory: Standard agency theory assuming per default that firms are profit seeking and agents are
motivated because agents are rational and rent seeking and effort is costly. Less emphasis on the objective of motivating
agents and more emphasis on the alignment of the interests of agents and principals.

Behavioral agency theory: Enhanced version of positive agency theory that don’t assume per default that agents are
motivated, but agents’ motivation are contingent on several factors; intrinsic/extrinsic motivation, inequity aversion, goal
setting, uncertainty aversion etc. The agents will perform if they have ability, motivation, and right opportunities.

 Agent’s motivation:
o Intrinsic motivation: Perform an activity because of satisfaction from it.
o Extrinsically motivation: Perform activity because of its reward (Pay)
o Equality seeking: If inputs are fairly rewarded by outputs, the agent is happy and motivated.
o Goals & Feedback: Goals positively corelated with agent work motivation
o Loss, risk & uncertainty: Agents are loss, uncertainty, and risk averse.
o Time discounting: Agents discount time with a hyperbolic discount rate (a rate that varies over
time) and not exponential discount rate.
o Peers and social norms

Mandatory readings:
Pepper & Gore (2015) Behavioral agency theory: New foundations for theorizing about executive compensation.
Main concept => tries to make agency theory less generic and more realistic/applicable

Abstract: In contrast to the standard (positive) agency framework, which focuses on monitoring costs and incentive
alignment, behavioral agency theory places agent performance at the center of the agency model, arguing that the
interests of shareholders and their agents are aligned if executives are motivated to perform to the best of their abilities.

Exam questions on this article

Pepper and Gore (2015) in their paper “Behavioral Agency Theory: New Foundations for Theorizing about Executive
Compensation” state that “positive agency theory places less emphasis on the objective of motivating agents than it
does on the alignment of the interests of agents and principals”. Discuss/explain this statement!

This is true. The positive agency theory assumes that organizations are profit seeking, that agents are both rational and rent
seeking and that effort is costly. Therefore, it does not account for the fact that the motivation might vary from individual to
individual, depending on one’s expectations, intrinsic motivation, goals & feedback, peers and social norms and inequality.
Since the agent’s effort is not observable, the positive agency has invested significant academic efforts into creating
corporate governance mechanisms that align the agent’s interests with those of the principal.

Lecture 4 – Ownership
Learning objective: Be able to identify the benefits and downsides associated with various types of structures, such as
corporations with concentrated ownership, family firms, etc.

Managerial myopia: When managers prioritize short-term results over long-term growth of the organization.

Small blockholders: Between 5-10% ownership + voting stake. Have incentive to privately gather information on
management and reveal to market to make market more informed.

The more blockholders the better: Multiple blockholders each one tries to quickly sell to minimize loss => Higher efficiency
in share price =>. If only one blockholder they are more reluctant to sell and reveal private information

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Controlling shareholder: Ownership (>10%): Not interested in revealing private information to market.

Principal-principal problem: Large owners use power to expropriate firm value to own benefit at the cost of minority
owners or other stakeholders.

Different ownership types

o Dispersed ownership and control: Mc Donalds =>Can lead to short term target focus (ROI)
o Concentrated ownership and control: Mærsk: AP holding own 45% and control 50%
o Concentrated control and dispersed ownership: Google ~ Ceo’s control 51% but own 10%.
o Concentrated ownership but dispersed control (Nestle)

Dual class shares: Dividing shares into class A and B shares. A shares has lower voting rights than B shares. Can obtain
financing without sacrificing control. Usually voting stocks trade at a premium compared to non-voting stocks.

5 Shareholder activism: Efforts attempting to positively influence corporate behavior.

 (1) Proxy fights (A group of shareholders joining forces to gather enough votes to win a corporate vote)
 (2) Hedge fund activism. – important
 (3) Shareholder proposal – Propose something to management.
 (4) Direct negotiation with management, - Negotiate with management.
 (5) Concentration of ownership, (Obtain voting power).

Mandatory readings:
Helling et al. (2020): Exit as governance: Do blockholders affect corporate innovation
KEY AGENCY PROBLEM TACKLED HERE: Managerial myopia:

Blockholders role: Exert corporate governance at shareholder meetings and mitigate managerial myopia.

 Large blockholders (>10%): Can exert CG via intervention (VOICE) by taking board seat, takeover bid, replace
CEO, jawboning (Force someone to do something) etc.
 Small blockholders (5-10%): Can exert CG via trading behavior and threat of exit or proxy fight
o Liquid market => Incentive for SB to collect private information=> because threat of exit more
credible=> force management to long-term approach =>increase corporate value.
 If exit occurs: Share prices pushed down because sale sends credible signal to market that the
blockholders believe the company is underperforming.
o Threat of exit is effective governance mechanism because exit it is “too late” to implement measure.

Factors that influence the effectiveness of threat of exit:

o (1) The block size (+), (2) Stock liquidity (+), (3) The number of blockholders (+), (4) managers’
short-term incentives (+), (5) Private information (+).

Relate to voice mechanism: Both intend to improve firm value either through active intervention or discipline
management through the threat of exit.

o Controlling Shareholders/large blockholders: Use Voice/intervention to intervene by blocking

mergers, changing CEO, hostile takeover, board seat, jawboning.
o Small Blockholders: Use threat of exit to discipline management because of smaller stake

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Machery et al. (2022): Institutional investors, alternative asset managers and ESG preference
Abstract: institutional investors integrate ESG factors into their investment decisions more and more (Up 20% from 19-21).
ESG= positive effect on firm performance and investors avoid/exit stocks that don’t incorporate ESG.

o Direct: Increase bottom line (SVM)

o Indirect: Lower WACC (SWM) due to competitive advantage of being ESG attracting many investors.’

Motivation and factors driving ESG investments:

1. Limited partners: Motivated to incorporate ESG because they believe it is correlated with financial performance.
a. Performance motives: ESG lowers WACC and improve financial performance.
b. Financial motives: Part of Product strategy of being ethical while reducing downside risk (reputation)
2. General partners: Motivated to integrate ESG factors due to demand from LP for sustainable products.
a. Performance motives: ESG lowers WACC and improve stock price performance (investment)
b. Financial motives: Demand from LP’s
c. Risk and diversification: Reducing downside risk (reputation, regulatory and litigation risk).

3. Investors affect ESG in companies through 2 channels: Voice + Voting

1. Voice: PE uses voice to promote ESG in portfolio companies.
2. Voting: Mutual funds use proxy voting in favor of ESG in companies they own stocks in (up 50%)

Lecture 5+6: Owner Identity: Family Firms

Family definitions:

1. Closely held family firm: Control + decision in family

2. Delegated family firm: Control in family but decision outside (External CEO)
3. Family-driven firm: Control outside family but decision made by family.
4. Former family firms: Control and decision outside family.

Family assets and family roadblocks determine whether maintaining family control is beneficial for the firm or not.

Family assets (Family benefits): (1) Longevity (LMVH), (2) Values, (3) Networks, (4) Trust

Family roadblocks (Family costs): (1) Family: conflicts or health, (2) Capital market: No funding, (3) Institutional:
Corruption, inheritance taxes, (4) Human capital: Only 1 child per family in China.

Specific governance mechanisms in family firms

1. Family councils: Equivalent to BoD. Main CG tool to alleviate agency problem 4.

2. Family assemblies: Equivalent to shareholder meeting.
3. family constitutions: Written binding agreement among family members

Other mechanisms:

1. CEO ownership concentration:

2. Board of directors
3. Debt or dividend: Use this to reduce FCF under managers control
4. Dual-Class Unifications: Remove dual-class unifications to align incentives.

Mandatory readings:
2015 Villalonga: Governance of family firms
Abstract: Analysis of the for agency problems manifest themselves in family firms: .

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Agency Problem I: Conflict of interest between shareholders and managers

Agency Problem II: Conflict of interest between controlling (family) shareholders and non-controlling shareholders

Agency Problem III: Conflict of Interest Between Shareholders and Creditors

Agency Problem IV: Conflict of Interest Between Family Shareholders and the family at large (Superprincipal)

1. Conflict of interest between the family at large and family shareholders who act as agents for the family at large
i. Problem: Goals can diverge:
1. Superprincipal: Goals is to increase SWM and socioemotional wealth
2. Family shareholder: Maximize SVM
ii. Family as shareholder: Principal for managers in firm but agent for the family at large.
iii. Solution: Family assembly and the family council are the two main family governance
bodies, akin to the annual shareholders’ meeting and the board of directors.
2. Similar to the relationship between the state and the public it represents and PE and LP
i. State agent for public but principal for managers of firm. Public: Superprincipal;
i. PE: Principal for portfolio company but agent for their investors (LP) (SuperPrincipal).

2020 Kang & Kim: Do family firms invest more than nonfamily firms in friendly policies?
Abstract: This article seeks to investigate if family firms invest more in employee relations than nonfamily firms. Family
firms focus on investing in employee relations to avoid a negative family reputation among stakeholders. Family firms in
the early stage of their life cycle invest more in employee relations Nonfamily firms’ investment in employee relations is
impeded by several constraints such as managerial myopia, and managerial agency problems.

Family firms have several comparative advantages compared to non-family firms in implementing employee-friendly
policies and the advantages are higher in closely held family firms compared to delegated family firms:

1. Longer investment horizon: Longer horizon which improve employees’ perception of their firm’s
trustworthiness, leading to reduced employee turnover and improved loyalty.
2. Informational advantage: Family owner managers are better informed about their firm allowing family firms to
invest more in employee relations obtaining greater benefits from this
3. Lower short-term market pressure/managerial myopia: Family owners as long-term controlling shareholders
encounter lower short-term market pressures and managerial myopia.
4. Lower managerial agency conflicts: Family firms have lower managerial agency due to active monitoring by
controlling owners.

These unique characteristics are what makes investments in employees more attractive to family firms compared to
nonfamily firms and can explain why public firms underinvest in employees despite potential long-term benefits.

Case 1: Tesla’s compensation plan

Questions:

1. How does Tesla’s proposed compensation plan differ from the typical CEO compensation plan in the US and
Europe?
a. US and Europe: Mix of base salary and short- and long-term incentives
b. Tesla: Only variable performance-based pay in the form of RSO achieved by performance increase in
revenue, EBITDA and market cap. Granted stocks can’t be sold for 5 years.

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 2. Solely viewed from the perspective of aligning the CEO pay to performance, what are the strengths and
weaknesses of the proposed Tesla plan relative to the typical plans?
a. Strengths: Elon highly motivated to work towards mutual goal to get paid with unrealistic measures to
reach. Elon needs capital to achieve his milestone of making humanity become a multi-planet species.
Thus achieving the unrealistic goals would benefit all shareholders and the world by making it greener.
b. Weakneses: Revenue and market cap are weak performance measures not that valuable to investors.

3. What modifications, if any, would you recommend to the proposed Tesla compensation plan? In suggesting
these changes, what goals are you pursuing?
a. Put a cap on the potential upside: To limit a potential negative public profile if this got media attention

4. If you were Tesla’s shareholder at the time of the case, would you vote to support the proposed plan? Why
yes, why not
a. No: Simply because no one should be entitled to this large upside. Just see the debate regarding the
bonusses in energy companies without a cap due to the insane year 2022.

Empirical articles
Elliot and fellow activist investors take on big tech (HEDGE FUND VS SALES FORCE)
Abstract: Shareholder activism where hedge funds acquire big stakes in Salesforce in order to force them to lower costs.

Lecture 7+8: Board of Directors + BoD (Behavioral agency)

Learning objectives: Be able to critically assess the structure of corporate boards and discuss its implications for board
behavior and firm performance

BoD: The governing body of the firm to govern the firm and protect the interests of the shareholders.

Main object: (1) to advise CEO on strategic issues and (2) exercise independent control (supervise).

Board of directors: To understand why boards might not function as expected social psychology, i.e., social categorization,
similarity attraction paradigm, and social network theories can explain.

Board (Both principal and agent): Shareholder=> BoD=>Executives=>Firm. One tier: Board=>Firm

Two-tier-board-system: Supervisory board monitor =>Management board that monitor=>Firm.

Good board:

 Board comprise of:

o Independent directors for objectivity (Outside board members with no stake in company) – No bias
o Executive director: Member of day-to-day activity of company and board => Biased by subjectivity
o Non-executive directors: Not member of day to day=> More objective but can have stake in company
(Shareholders, family members of directors, former employees, researchers) : Can be biased
 No CEO-chair duality
 Diversity
o Benefit: Larger pool of competent members to choose from &stronger independence
o Costs: Longer less efficient meetings, challenges of group decisions, pushing for diversity.

Mandatory readings
2020 Greene & Kahle: Do board gender quotas affect firm value?
Abstract: The California state QUOTE, required: 1 female director by 2019 and 2 directors on Board spots by 2021 in
companies in California. Greater board gender diversity is related to improvements in stock price informativeness but
negative stock price reaction can be interpreted as the law imposing a constrained optimization on board composition.

Findings: Quotes affect firm value because of compliance costs. Less severe impact for firms with greater supply of female
candidates and for those who can easily replace male directors or attract female directors.

Costs of compliance: Likely the main driver of negative effects of the quota law.

1. Direct costs: Costs of adding new directors or search costs (difficult to find suited people with qualification)
2. Indirect costs: Lost value of the incumbent replaced + lost value due to board size exceeding the optimal level.

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2013 Mcdonald & Westphal: Access denied: Low mentoring of women and minority first-time directors.
Main question: Why are women and minorities underrepresented in the corporate elite (Person holding 2+ board seats).

Findings:

1. Disadvantages in the receipt of participation process mentoring regarding prevailing norms in corporate elite.
a. Women and minority receive less mentoring compared to white males from incumbent CEO regarding
norms in BoD behavior:
i. Reason:
1. Intergroup biases (White men CEO want to advice “In-Group members” that is
white men vs “Out-group” women + minority members)
2. Social psychology: Relate to people that look like you and did same as you did.
i. Similarity attraction + social identification

ii. Result: Relatively fewer appointments to other boards because higher likelihood of mistakes
putting them in bad light for the people who exercise control enforcing social inequality.
1. Need women to change norms for “in-group” to advance the gap in CE.

Norms for participating in board meeting proceedings.

(1) actively involve themselves in discussion of issues raised by the CEO.

(2) But recognize the preeminence of the CEO in strategy formulation (Hint: Align with
CEO prior to meeting)
1. Members that adhere to norms receive the support of other members.
(3) IN PUBLIC US MATURE FIRMS CEO HAS MOST TO SAY AND LEAD DISCUSSION

Empirical articles
2020 Nuno: 10 Trends for The Board of 2020
10 Trends for board going forward:

1. Fewer people in BoD

2. Better knowledge of the business and industry in which the company serve.
3. international experience needed.
4. More female representation.
5. Greater responsibility: More active role for BoD in critical business areas.

Lecture 9: Financial Contracting and corporate governance of start-ups

Agency theory lens: Primary role of governance is to align incentives of managers and owners (wealth protection)

Resource-based theory lens: The provision of advice to managers is beneficial to utilize resources at hand to facilitate
growth (Wealth creation)

As firms grow, incentives and control evolve in line with agency issues

 Board tend to grow organically with size due to need of new expertise
 The relations between founders will change as firms grow (Step down as CEO etc)
 Founders might need to include other key employees in firm’s ownership to provide incentives.
 Founders need to share cash flow rights with external investors to reassure return on investment.
 Reluctance from founder to give up control or information can limit access to financing growth.

There are two ways in which founders and investors can mitigate pre-contractual asymmetries

a. Signaling: The private informed part adopts the behavior that reveals the information.
i. Entrepreneur own investment as a signal of firm prospects.
b. Screening: Due diligence by party without private information.
i. Monitoring or repeated relationship

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Mandatory readings:
Filatotchev et al. (2006) The firm’s strategic dynamics and corporate life-cycle.
Main question: Presentation of a novel framework that integrates firm life cycle with changes in its governance systems.

Findings: This paper rejects the universal governance template and argues that corporate governance parameters
are linked to different stages in the firm’s life cycle thus in need of the role of CG between wealth-protection and
wealth-creation functions of governance.

Wealth protection: CG is about providing shareholders a ROI while ensuring sustainable firm behavior by ensuring
accountability of management to minimize downside risk => Tight Monitoring and control => Larger board and multiple
owners => Often recent IPO companies or mature companies. AGENCY THEORY LENS

Wealth creation: The wealth-creation function is concerned with enabling managerial entrepreneurship so that
shareholders benefit from the upside potential of firms by assisting managers through strategic advice and providing
access to resources => Smaller BoD and fewer ultimate owners. => Often the case for Start-ups or declining companies
taken P2P by private equity owners. RESOURCE-BASED LENS

Firm life cycle:

(1). Start-up (small organization and low transparency) - difficult to predict future: From 1-2.

I. Wealth creation company (Start-up/IPO stage)

a. Monitoring: Low (Small BoD & limited external ownership)
b. Resource (Access to external resource): High
c. Strategy (Provision of advice that CEO use as input): High
(2) Firms ready to IPO (limited organization but high transparency) – difficult to predict future. 2-3
i. Wealth protection (IPO/maturity stage)
a. Monitoring: Medium
b. Resource: Medium
c. Strategy: High
(3) Mature listed firms (Big organization +extensive transparency). Easy to predict future.3-4
i. Wealth protection (Maturity/decline stage)
a. Monitoring: High
b. Resource: Low
c. Strategy: Low
(4) Declining organizations (Big organization but limited transparency). Easy to predict future. 4-1
i. Wealth creation company => (Re-invention stage (decline/founder)
a. Monitoring: Low
b. Resource: Medium
c. Strategy: Medium

Would you say that the benefits of dual class shares are higher in the start-up companies compared to mature companies!

Yes – Need to compensate low salaries with equity stake. Uncertain environment meaning you need to keep control. Dual
shares allow to give up equity without sacrificing control. This is a key advantage for start-up firms because they are often
cash constrained and thus cannot reward their key employees with high salaries

Case 3: Founder-CEO Succession at Wily Technology

Debate: The case is all about how much founders must give up (BoD seats, CEO, equity stakes etc.) to make their start-up a
success.

 Cirne had to give up his CEO title, let his equity stake be restricted to vesting conditions, step down as Chair of
board and give Williams as much equity in Wily as himself, and Williams get way higher pay than Cirne.

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Empirical articles
Silicon Valley Investors Haven ’t Let the Theranos Scandal Change the Way They Do Business

Despite the Theranos case of fraud within health technology, investors are still willing to invest because extraordinary
teams are building the future and the culture of trust and wanting to move the world forward is impossible to kill

Lecture 10: Firm theory and corporate governance

Principal-agent theory: views the firm as a nexus of (incomplete) contracts between parties.

 Incomplete contracts lead to conflicts of interests between the various participants in nexus (principal+agent)
 Focus on how to align the incentives of all those connected to the firm towards maximization of firm value
 The theory does not discus the boundaries of the firm (Internal operation vs external operation.)

Transaction costs theory/”Lens of contract”: The firm as a governance solution to reduce transaction costs. Firms can
mitigate the need for extensive market transactions and minimize costs by having an organization.

 Comparing the costs and benefits of transactions we can determine the boundaries of the firm (intern vs ex).
 Transaction costs:
o Search costs
o Bargaining costs
o enforcement costs:

Private ordering: Ex-ante incentive alignment between actors in a transaction to design governance structures to support
contractual relations and prevent contractual breaches for mutual gain.

Extra:

Three dimensions of transactions relevant for governance: Specialized assets, disturbance (uncertainty about future) and
frequency of transactions. Thus, governance mechanisms need to be designed.

Common triple: Transactions incorporate three aspects: conflict, mutuality, and order – Governance to infuse order,
mitigating conflicts and to realize mutual gain.

Property rights theory of the firm: The size of the firm determined by complementarity of assets and the consideration of
hold up and incentive problems between parties.

 The party that brings most in terms of “non-contradictible effort” should own the key assets.

Knowledge-based theory of the firm: Because knowledge-based resources are usually difficult to imitate and complex
heterogeneous knowledge bases among firms are the major determinants of sustained competitive advantage.

Mandatory readings:
2002 Williamson “The Theory of the Firm as governance structure: From choice to contract”.
Findings: Williamson argues that the choice of a governance structure for a firm depends on the costs and risks associated
with conducting transactions in the market versus within the boundaries of the firm. The author proposes that firms
emerge as a response to the existence of transaction costs and is contingent on a set of contracts, which include search
and information costs, bargaining and negotiation costs, and enforcement costs.

Case 2: White (2016) British Land

1. What are the corporate governance problems at British Land?

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 a. Bad governance structure in British land (Draw parallels to private family business).
i. Non-executive board members whose independence could be questioned (family+ advisor)
ii. CEO duality which is rare in FTSE 100 companies
iii. Bad leadership: Stock trading at discount but no SBB despite competitors do it to raise stock
b. RESULT: Hedge fund activism by Laxey Partners
i. Intent to stir up shareholders against CEO by proposing resolutions:
1. SBB: To increase stock price because buyback at discounted value of NAV
2. Bring in outside managers to manage different parts of the portfolio (better CG).
2. Who are the British Land’s shareholders? Do they care about corporate governance and, if so, why?
a. Shareholders: Banks (93.62%) & pension funds (40% of equity in UK RE market).
b. Care about CG: They act on behalf of several million people’s savings and are very sensitive to media
coverage and criticisms which a case like this could bring.
3. How would you evaluate the Laxey’s conduct in this affair:
a. (a) as an investor in Laxey’s fund;
i. Appropriate. They are a hedge fund, thus also earning money when companies stock
devaluates, thus doing everything in favor of their shareholders.
b. (b) as one of the British Land’s other shareholders;
i. Appropriate. They are ensuring the right corporate governance of the company by voicing up
the problems in the company for other shareholders to address.
c. (c) as a regulator at the British Financial Service Authority?
i. Inappropriate: Dubious methods used: Minimum 5% company stock to sign up the resolution
or else 100 shareholder signatures.
1. Split the 2% ownership stake across 100 entities to obtain signings.
ii. Before AGM, Laxey borrow stocks to vote in favor for resolutions (2% =>9% stake).
4. How does the case relate to the academic insights discussed in class on the hedge funds’ activism more
generally?
a. Align perfectly: hedge funds activism is associated with positive long-term returns when they prompt
changes in control or other significant operational changes in target companies:
i. Following hedge funds’ activism target firms tend to: Decrease CAPEX, increase payout
(dividend or SBB), increase divestment of assets.
ii. Activism often prompts firms to adopt specific changes in their governance rules.

Exam case: Facebook Faces the Regulators

Main subjects: Fake news + privacy leaks => HOW TO STRUCTURE PLATFORM GOVERNANCE

Monopolistic power=> How to address this when no motivation to do so? Independent board to oversee content decisions

Privacy leaks + fake news=> Need better platform CG => Facebook lack incentive to fix due to monopolistic market
power + Concentrated control, dispersed ownership. => Regulators must step in

Question

1. How would you evaluate Mark Zuckerberg’s role in Facebook?

2. What are the specific problems facebook needs to fix?
3. Does the oversight board help solve facebook’s problems?

Exam questions

1. What role does corporate governance play for business and society
o Exist to alleviate principal-agent problem and maximize SVM and SWM

Shareholder perspective: The most important is protecting the interest of the owners of the firm.

Stakeholder perspective: acknowledges the interest of the different stakeholders connected to the firm and its context.
This perspective suggests that the firm should allow non-shareholders to contribute to corporate decisions.

2. What typical characteristics of family firms are mentioned in the article from German Times “Gasoline in his
veins”? Does the article states anything that is not in line with what generally observed for family firms?

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Highlights agency problem 4, and agency problem 2. Largely the article shows how strong principals in the form of family
owners can largely ignore shareholders and stakeholders in the company, given that the family owner has large voting
rights. It showcases the ability of family owners to both monitor intensely and actively participate in governance.

3. How does the transaction cost theory framework relate to the shareholder/stakeholder approach to corporate
governance? The stakeholder versus shareholder approach to corporate governance revolves around the
discussion of whether a firm should focus on serving the interest of its shareholders exclusively, or the
environment of stakeholders somehow related to the firm more broadly.

The transaction cost theory does not take a stance in this debate; It moves away from the focus on what role the firm has,
and rather focuses on what limits the firm has and what structure it should assume. One could almost argue that the
shareholder vs stakeholder debate takes a normative stance on corporate governance, while the transaction cost theory is
rather focused on economizing “transaction costs”, which are not defined by the two former perspectives.

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