Corporate Governance

Diane Denis →

• stakeholders and shareholders are not necessarily in in clonflict with each other, because companies also compete not just in financials but also on the market for the best product and workers → LT thinking
• So somewhere government involvement is needed to reduce the firm value maximization and to protect stakeholders from the negative effects of market frictions and negative externalities, however government ability its not one size fits all

Problems with Stakeholder approach

• It may discourage financing and make financing more expensive
• It is not clear what social obligations are
• The success of management is immeasurable
• The fiduciary duty of the manager becomes difficult because in first instance the duty of the managers is in the interest of shareholders, and shareholder often have less protection than stakeholders

Instead → social obligations should be put into the law than managers making up their own mind. Since shareholders are residual claimants, shareholder value is taken care of in legal claims

Pro stakeholder approach

• Due to maximization of firm value, workers can be exploited by negative externalities → especially thus when contracts are incomplete.
• Contracts can be thus not complete or implicit.

Solutions → control rights to stakeholders, CSR, SRI, better and more law enforcements.

Key not of Diane Denis → stakeholders and shareholders are not necessarily in conflict with each other, because they compete in financials it does not mean they compete in the market. Because Long term they want to have best workers and good products on the market.

Somewhere government involvement can reduce the firm value maximization and protect stakeholders from negative externalities and market frictions. However government has limitation on their one-size fits all.

Why need corporate governance? → We need it so the market stays confident and thus financing does not become expensive.

Because at higher financing costs

Projects become not feasible → less growth

Products become more expensive → higher price → less sales → less growth

Become more dependent on internal sources

And overall welfare losses

Conflicts between different players

Shareholders prefer more risk than bondholder, employers enjoy stable/keeping job and shareholder prefer larger firm return

Auditors independent but are hired by the firm itself

Analysts independent but need access to management information

Conflicts between classes of players

• Large investors may tunnel out for own benefits form small investors
• Small investors would prefer more risk (due to diversification)
• Directors (inside, independent,family)

Agency costs leads to reduction/more expensive financing → and this can lead to welfare losses

1st agency problem → between management and shareholders

2nd agency problem → between shareholders itself

...