Corporate Governance

Dao Thanh Tung,

PhD, FBM

2021 Faculty of Business Management

 Course Overview

• Why we study corporate governance?

• Relationship between CG and other subjects in business
management
• Course materials
• Grading and requirements
• Course objective
 Why Corporate Governance?

Phạm Thanh Bình

Chairman and CEO Vinashin

Đinh La Thăng
Chairman PVN

Nguyen Duc Chung

Chairman
People’s Committee of Hanoi
‘Bầu’ Kiên
Chairman B&B
Why governance?, Why now?
 Why study corporate governance
• Collapse of many giant companies in US and other part
of the world such as Worldcom, Enron, Lehman
Brothers, Vinashin,
• The Asian financial crisis and 2008 global crisis
• CG has become of great interest to both practitioners and
academics in the last decades
• Good CG encourages investor confidence, creates
competitive advantage and improves company
performance
• CG lies at the heart of organisational theory and
economic analysis
Relationship with other subject

Corporate governance

Strategic
Management

Management

Operation Management
Logistics and Supply Chain

Corporate Finance
 Course textbook and materials
• Corporate Governance Manual
(2010), 2nd Edition, IFC of World
Bank in collaboration with SSC
of Vietnam
• Edited Reading Materials
• Case studies provided
• Other materials as advised
 Gradings and Requirements
• Requirements:

Students are required to attend all

class sessions and to participate
actively in discussions. For
participation to be meaningful,
students should read assigned
material before coming to class.
• Gradings:

- Attendance and Participation: 10%

- Discussion paper and presentation:
40%
- Final exam: 50%
 Course objectives
At the conclusion of this course you will

• know about the characteristics and the importance of

corporations in modern economies;

• be familiar with working definitions of Corporate Governance;

its theories, models and mechanisms

• know how Corporate Governance relates to Corporate Finance;

• have a general understanding of the key role of Governance in

achieving (or not) company goals.

• Understand contemporary issues of CG in Vietnam

 Course Content
Course consists of the following main topics:

1. Characteristics and importance of corporation

2. History and Emergence of Corporate Governance
3. Main Corporate Governance Theories
4. Corporate Governance Systems and Models
5. Approaches to Corporate Governance
6. Board of Directors
7. CEO Compensation
8. Contemporary Issues on Corporate Governance
 What is Corporation?
Different Perspectives, Different Answers

• Lawyers: “A corporation is a legal business structure

that establishes the business as being a separate entity
from the owners”

• Economics: “A bundle of contracts”

Essential Characteristics of a Corporation According to
Prof. Robert Clark (HLS)
1. Limited liability for investors
– Individual members of a corporation are not liable in case of
bankruptcy
– Limited liability and limited control
2. Free transferability of investor interests
– Low control is only acceptable given the ease of transferability
(“vote with the feet”)
3. Legal personality
– Right of ownership, but different consequences for unlawful
behavior
– Endless life given existence of capital
4. Centralized Management
– Managers (and not owners) decide on day-to-day operations
 Corporation Forms in Vietnam
• According to Corporate Law (2005), there are 4 types of
corporations
 Private company
 Limited liability company
 Joint stock company
 Partnership
Comparison of Private and Public Joint Stock Companies
 Introductory lecture

Consider the following pairs:

(a) (b)
Patient ↔ Doctor
Client ↔ Lawyer
Citizen ↔ Government
Student ↔ Professor
Shareholder ↔ Board of Directors
What do they have in common?
 Introductory lecture

Consider the following pairs:

(a) (b)
Shareholder ↔ Board of Directors
 Discussion
 How to solve the problems?

- Rules and regulations

- Compensation

- Disclosure and transparency

- Oversight or monitoring from third party: regulators

and policy makers, independent auditors, financial
institutions, banks
 Emergence of Corporate governance
• CG is not new concept.
• Since the early 1990s, technological developmenet and
market expansion have increased the scale and complexity of
enterprise
• Forcing business firm to seek more effective form of
economic organisation
• Traditional firms that entirely owned by a single entrepreneur
or family owner are insufficient for need of increasing capital
• Emergence of limited liability company  separation of
ownership from control.
• The owners do not manage but delegate their right to
managers
 Emergence of CG
• Adam Smith (1776):

“The director of such joint-stock companies, however,

being the managers rather of other people’s money than
of their own, it can not well be expected that they should
watch over it with the same anxious vigilance with
which the partners in a private copartnery frequently
watch over their own” (p.700)
 Emergence of CG
• There is a concern:

How the suppliers of finance ensure that capital being

used in their best interest?

• The aim of CG is to ensure that managers of delegated

finance work in the best interest of shareholders
Corporate Governance System
 Definitions of CG
• Most popular definition is given by Cadbury Report (1992) and
OECD (1999)
“CG is a system by which companies are directed and controlled”
• Narrow CG definition:
“CG deals with the ways in which suppliers of finance to
corporation assure themselves of getting a return on their
investment” (Shleifer and Vishny, 1997)
• Broader CG definition:
“CG involves the relationship among various participants in
determining the direction and performance of corporation. They
include not only shareholders but also long term employees,
suppliers, customers and others who make specialised investment
and those who direct and manage its business (BoD and
managers)” (Monks and Minow, 1996)
Berle and Means Model of Ownership and Control
Securities markets

SHAREHOLDERS

Institutional

consultation
Investors

Direct
power
Voting
Board of Directors
Dividends
Supervisory power
Dept capital
Wages
Employees Corporation Lenders
(management and
Labour physical capital) Interest payments
(market rates)
s
Go

ut

Ma
PUBLIC GOODS

e
np
od

ic

rke
I Pr
s&
TAXES

tp
ke
ar
Se

ric
M
rvi

e
ce
s

Suppliers
Suppliers Customer
Customers
National &
Local
Government

Adapted from: M. Blair, Ownership and Control (1995)

Mandatory and voluntary governing bodies
 CG relationships
Banks
Shareholders
Creditors

Financial governance

Management Work
Customers Management Employees
Governance

Contractual governance

Competitors Suppliers
Problems when there is a separation between ownership
and management

1. Shield actual information or provide fault information to

shareholders. Eg: Enron, WorldCom, Lehman Brothers
and BBT.
2. Management uses company’s resources for their personal
interest other than shareholders’ interest. Eg: high salary
paid to management despite poor company performance.
3. Management may have wrongdoing that shareholder and
community do not expect. Eg. Toyota management do
not inform customers about the safety fault
 Corporate governance emerges to ensure that
managers of delegated finance work in the best interest
of shareholders
Governance vs. Management
 Distinguish between Mgmt. and CG
• Business management • Corporate governance
concerns with daily concerns with the
operations of the company relationship between
shareholders and
and is conducted by
management teams and is
executive managers (CEO or conducted by Board of
executive managers) directors

• Main duties of managers: • Main duties of BoD: set a

Planning, Organising,
Coordinating to run the
company
long term plan for the
company, make strategic
decision, oversee and
support the activities of
executive management to
meet the expectation of
shareholders
 Main themes in CG
• Information disclosure and transparency

• Dispute of interest between shareholders and management

• Dispute of interest between large shareholders and small

shareholders

• Roles of independent directors and auditors

• Compensation

• Private property rights

• Law enforcement
The Legal and Regulatory Framework

• In International Standard:
– OECD Principles of Corporate Governance

• In Vietnam:
– Law on Enterprise (2014)
– Decree 71/2017 on Corporate Governance for listed
Companies in Vietnam
– Company Charter

31
 Roles of corporate governance
• McKinsey & Company and WB researches found that there
is a strong relationship between good CG policies and
practices and high stock price and good company
performance.

• In contrast, weak CG results in negative company

performance, even collapse of the whole company such as
Enron and WorldCom

• Lower the cost of capital and raise the value of assets

• Attract investment capital

• Minimise corruption and self interest behaviour

Case study
 Main theories of CG

• Agency theory

• Stewardship theory
 Agency theory
Agency theory is concerned with the “agency problem”
that exists when there is an agency relationship.
 Agency Relationship:
Owners and Managers

Shareholders
(Principals)
• Firm owners

Managers
• Decision makers
(Agents)

• Risk bearing specialist (principal)

pays compensation to An Agency
Relationship
• A managerial decision-making
specialist (agent)
 Agency Problem

• The agency problem occurs when:

the desires or goals of the principal and agent conflict
and it is difficult or expensive for the principal to verify
that the agent has behaved inappropriately
 Agency problems (cont’)
• Difference in risk aversion

• Difference in retaining dividend: Management prefer

paying less proportion of dividend to shareholder while
shareholders expect high dividend

• Difference in vision: Shareholders expect management

to make a long term decision, whereas management
prefers making short term decision
 Agency theory
• Assumption: Agents are self-interested, risk-adverse and rational actor
• Two problems could arise:
- Monitoring problem arises when principal can not verify if agent
behaved appropriately
- The problem of risk-sharing that arises when the principal and the
agent have different attitudes toward risks
• Solution:
- Information disclosure
- Good compensation and incentive schemes
- Separation between oversight and management function
- Enforcement mechanisms such as the managerial labour market to
mitigate the agency problem
 Agency Theory Conflicts

• Principals may engage in monitoring behavior to assess

the activities and decisions of managers
• However, dispersed shareholding makes it difficult and
inefficient to monitor management’s behavior
• Boards of Directors have a fiduciary duty to
shareholders to monitor management
• However, Boards of Directors are often accused of being
lax in performing this function
 Stewardship theory

Assumptions:

- Managers are good stewards of the company

- They are trustworthy and work diligently to attain high
corporate profits and shareholders’ returns
- Instead of focusing on “goal conflict”, stewardship
theory proposes that the principal and the steward can
cooperate with each other and achieve a “goal
alignment”
 Stewardship theory
• Thus, stewardship theory focuses on developing mutual trust
and cooperation between principals and stewards

- First, trust and cooperation can be enhanced by having effective

information sharing mechanisms. Information systems are
primarily for the principal to share but not necessarily to
monitor - the stewards.

- Second, arrangements that foster understanding and

identification between principals and stewards will increase the
degree of trust between them  better firm performance.

- While agency theory focuses on the independence of different

groups, stewardship theory underlines understanding and
identification between them.
 Two perspectives in corporate governance
Agency theory
Assumptions of Agents are opportunistic and
human behavior self-serving
Primary role of Board members are to control
supervisory board and monitor managers
General advices Arrangements that enhance
principals’ control and
monitoring of agents have
positive impacts on firm
performance
CEO-chairperson Negatively related to firm
duality role performance
Large shareholders Positively related to firm
performance (strong control and performance (provide
monitoring)
Development of the Positively related to firm
job market for performance (easier to replace
managers managers)
Stewardship theory
Trustworthy and work for the
benefit of the corporate
Board members provide
managers with resources,
expertise, network and power
Arrangements that enhance
trust and cooperation between
principals and stewards have
positive impacts on firm
performance
Positively related to firm
performance
Positively related to firm
expertise and resources)
Negatively related to firm
performance (lost expertise,
experience, and bonding)
 Limitations of the two theories

• Confined ourselves to one form of financial claim issued

by the firm, ie. equity

• Issuing debt can also generate agency costs, depending

on whether we examine the conflict of interest between
debt holders and the owner-manager

• External lenders may act as monitors of management.

• This potential monitoring role is reflected in the

difference between ‘insider’ and ‘outsider’ system of
corporate governance
 Review Section
1. But what problem does this separation create? (Agency
problem)
2. In an efficient separation between shareholder and
managerial control, what roles do shareholders and top
managers play?
3. According to agency theory, how would you describe
basic human nature?
4. How does this basic human nature contribute to agency
cost?
 Discussion

Agency Theory and Stewardship theory: CEO Governance

and Shareholder Returns

1. What mechanisms are used to control agency problem?

2. What is popular board structure for both theories?
3. Which theory is more supported in explaining the
situation?
 Systems of Corporate Governance

• The dispersed or outsider CG system, which is

characterised by dispersed ownership and shareholder
protection and is prevalent in UK and US

• The concentrated or insider CG system, which is

characterised by concentrated ownership and weaker
shareholder protection, and is associated with European
systems of governance
 Outsider CG System
Main Ideology:
1. CG is treated as the relationship among three primary participants:
shareholders, executive management and board of directors
2. This system sees shareholders as the ultimate owners so the prime objective of
companies is to maximise shareholders’ interests.

MANAGEMENT SHAREHOLDERS

BOARD OF
DIRECTORS
 Outsider CG System
Characteristics:
• Shares are widely held and concentrated shareholding is
non-existent
• Managers are relatively free from control by the board
since the supervisory role of the board and the
management role of executive managers is often united.
• Outside disciplines such as capital market, market for
corporate control and hostile takeover play a leading role
in practicing CG and disciplining poor management.
• Banks only have a credit function and are prevented
from holding large blocks of shares
 Outsider CG System
Characteristics (cont.):
• Antitrust laws are hostile to cross holding of shares between
large companies
• Relationships with workers are also market-based and
competitive
• Long-term job security is low
• Top managers tend to be externally appointed and managerial
compensation is much higher than average employees’
compensation scheme.
Requirements:
• A strict and reliable information disclosure and transparency
• Large capital market, efficiency of the stock market, well
developed financial institutions and highly growth managerial
labour market
 Corporate Governance Mechanisms
External Governance Mechanisms
• Market for Corporate Control
the purchase of a firm that is
underperforming relative to industry
rivals in order to improve its strategic
competitiveness
• Managerial Labour Market
• Financial Institutions
• Competition Market
• Stock Market
• Legal system
 Insider CG System
Ideology:
• The insider CG system defines the firm as ‘a shared-fate
community of company people’.
• Objectives of companies not only enhance shareholders’
interest but also other stakeholders such as banks,
employees, suppliers and communities at large
Key players in insider CG system

Shareholders

Board of Stakeholder
Directors

Banks
Management
 Insider CG System
Characteristics:
• Corporate ownership is concentrated among a stable
network of strategically oriented banks and other
industrial firms, rather than fragmented among
individuals investors
• Market for corporate control is largely non-existent
and hostile takeover is exception
• Stakeholders’ interests are presented on the
supervisory board, which exerts a strong monitoring
role on management
 Insider CG System
Characteristics (cont.):
• Banks play a central role in providing financial services
and monitoring in times of financial distress
• Employee rights are recognised in exercising corporate
governance. Thus employees often a close connection
with company through long-term employment and on-
the-job training
• Top managements tend to be internally promoted and
managerial compensation is much closer to average
employees’ scheme so they are less finance-oriented and
focus more on long-term product strategy
 Corporate Governance Mechanisms

Internal Governance Mechanisms

Ownership Concentration
relative amounts of stock owned by
individual shareholders and institutional
investors
Board of Directors
individuals responsible for representing
the firm’s owners by monitoring top-
level managers’ strategic decisions
Strategic Investors
Internal Auditors
 Corporate Governance Mechanisms

Internal Governance Mechanisms

Executive Compensation
use of salary, bonuses, and long-term
incentives to align managers’ interests
with shareholders’ interests
Monitoring by top-level managers
they may obtain Board seats (not in
financial institutions)
they may elect Board representatives
 Discussion Question 5

How do governance devices (shareholder concentration,

institutional shareholders, boards of directors and managerial
compensation, and market for corporate control) relate to
controlling the agency problem? Are there tradeoffs among these
devices?
 Governance Mechanisms

Ownership • Large block shareholders (often

Concentration institutional owners) have a strong
incentive to monitor management
closely
• Their large stakes make it worth
their while to spend time, effort and
expense to monitor closely
• They may also obtain Board seats
which enhances their ability to
monitor effectively (although
financial institutions are legally
forbidden from directly holding
board seats)
 Governance Mechanisms

Ownership Insiders
Concentration • The firm’s CEO and other top-level
managers
Board of Related Outsiders
Directors • Individuals not involved with day-
to-day operations, but who have a
relationship with the company
Outsiders
• Individuals who are independent of
the firm’s day-to-day operations
and other relationships
 Governance Mechanisms

Ownership Recommendations for more effective

Concentration Board Governance:
• Increase diversity of board
Board of members’ backgrounds
• Strengthen internal management
Directors
and accounting control systems
• Establish formal processes for
evaluation of the board’s
performance
 Governance Mechanisms

Ownership • Salary, bonuses, long term incentive

Concentration compensation
• Executive decisions are complex and
Board of non-routine
• Many factors intervene making it
Directors difficult to establish how managerial
decisions are directly responsible for
Executive outcomes
Compensation
 Governance Mechanisms

Ownership • Stock ownership (long-term

incentive compensation) makes
Concentration managers more susceptible to
market changes which are partially
Board of beyond their control
Directors • Incentive systems do not guarantee
that managers make the “right”
Executive decisions, but do increase the
Compensation likelihood that managers will do the
things for which they are rewarded
 Governance Mechanisms

Ownership • Firms face the risk of takeover

Concentration when they are operated inefficiently
• Many firms begin to operate more
Board of efficiently as a result of the “threat”
Directors of takeover, even though the actual
incidence of hostile takeovers is
Executive relatively small
• Changes in regulations have made
Compensation
hostile takeovers difficult
• Acts as an important source of
Market for
discipline over managerial
Corporate Control incompetence and waste
Characteristics of insider CG system and outsider CG
system
Characteristics Outsider CG system Insider CG system
Financial system Capital market Banks
Corporate control Market based Insider-based
Mainstream ideology Shareholder value Social-oriented market
economy and job
security
Mechanism of corporate External takeovers Banks and Internal
control coalitions
Market for corporate control Developed Largely non-existent
Role of bank Prevented from holding Plays central role
large blocks of shares
Role of cross shareholding Very low High

Commitment of employee Rather short term Medium and long term

Lay off worker Have a free hand to lay Rarely lay off workers
off workers
 Managerial Defense Tactics

• Designed to fend off the takeover attempt

• Increase the costs of making the acquisitions
• Causes incumbent management to become entrenched
while reducing the chances of introducing a new
management team
• May require asset restructuring
• Institutional investors oppose the use of defense tactics
 Discussion Questions

1. What are the basic mechanisms that corporate

shareholders employ to exercise corporate governance?
2. How does the agency problem relate specifically to
diversification strategy? How does it relate to
managerial risk taking in general?
3. How do governance devices (shareholder concentration,
institutional shareholders, boards of directors and
managerial compensation, and market for corporate
control) relate to controlling the agency problem? Are
there tradeoffs among these devices?