MODULE 22.1: CORPORATE GOVERNANCE

LOS 22.a: Describe the principal-agent relationship and conflicts that may arise between stakeholder groups.

LOS 22.b: Describe corporate governance and mechanisms to manage stakeholder relationships and mitigate associated risks.

LOS 22.c: Describe potential risks of poor corporate governance and stakeholder management and benefits of effective corporate governance and stakeholder management.

1. Principal-agent conflict: the principal hires an agent to act on the principal's behalf, but the agent usually knows more about the actual work and may choose actions that help the agent more than the principal.
2. Governance mechanisms include an independent board, audit committee, shareholder voting rights, disclosure, internal controls, compensation design, and takeover defenses that are not abused.
3. Direct agency costs are cash costs paid to monitor and control behavior, such as audit fees or governance systems. Indirect agency costs are opportunity costs, such as a manager rejecting a valuable risky project to protect their own job.
4. Good governance should protect shareholders without ignoring lenders, employees, customers, suppliers, regulators, and communities.

Existing Governance Notes Moved From Capital Structure

1. An extraordinary general meeting (EGM) would most likely be called to address matters such as mergers, approvals, any amendments to corporate bylaws.
2. According to best practices, an audit committee should be composed of Solely independent directors and one of them should be an expert in finance and accounting.
3. Direct and indirect agency cost of management is an important topic to understand. If there is a fees paid directly in cash to ensure accountability, then it is direct. If this statement rings of opportunity cost such as gone opportunity because of risk aversion, then it is indirect.
4. The principal agent conflict in corporate governance happens because agent who has been hired to perform certain tasks usually has more information about the task, than the principal.
5. A poison pill works as follows: control requires >50% ownership; a hostile bidder accumulates shares; once a ~10–20% threshold is crossed, trigger alarm sounds and all other shareholders can buy discounted shares; the share count explodes, the bidder’s ownership % collapses, and the takeover becomes prohibitively expensive unless the board agrees.
6. Entrenchment means managers use their power to protect their jobs, not shareholder value.
7. MM Proposition II — No Taxes (Cost of equity vs leverage)
8. MM With Corporate Taxes — Debt tax shield adds value
9. Costs of Financial Distress — Why firms don’t lever to 100%
10. Static Trade‑Off Theory — Balance tax shield vs distress
11. Target Capital Structure — Practice and estimation