part 6

[Audio] We believe that the structure and composition of boards may not necessarily affect general performance. Therefore a third-generation study is needed to further explore this relationship. While best practice recommendations suggest that the functioning of boards matters for performance empirical literature has failed to measure this dimension directly leaving practitioners to interpret the findings. We believe that the effectiveness of the working of the board is difficult to measure in a quantitative manner and a practitioner's interpretation of the results of this empirical literature might be that the studies have simply failed to measure the dimension of boards that matters most for corporate performance..

[Audio] Discussing the relationship between the structure and composition of boards and general performance in corporate governance. While best practices suggest that the functioning of boards matters for performance empirical literature has failed to measure this dimension directly. Therefore a third-generation study is needed to further explore this relationship. In terms of executive compensation compensation consultants estimate that for a typical U S C-E-O the basic compensation package alone is higher than total package in several European countries and not much lower than in Japan. Executive contracts are supposed to provide explicit and implicit incentives that align the interests of managers with those of shareholders but the most important and controversial item in compensation packages are stock options. The international evidence on the role of boards in corporate governance and their impact on corporate performance is limited or not easily accessible. Therefore it is important to continue researching this area to gain a better understanding of its impact on corporate success. As a teacher in higher education it is important to encourage students to conduct further research on this topic and to consider the implications of these findings for corporate governance and performance..

[Audio] We believe that the structure and composition of boards may not necessarily affect general performance. Therefore a third-generation study is needed to further explore this relationship. While best practice recommendations suggest that the functioning of boards matters for performance empirical literature has failed to measure this dimension directly leaving practitioners to interpret the findings. A study by Vafeas (1999) found a positive relationship between the frequency of board meetings and corporate performance but this is a crude measure of the effectiveness of the working of the board. The bulk of the empirical literature has focused on sensitivity of pay (explicit incentives) and the dismissal of executives (implicit incentive) to corporate performance. High levels of pay were justified with the extraordinary gains in wealth shareholders reaped through most of the 90s and incentive pay was characterised as one of the drivers behind the high market valuation of U-S corporations (Kaplan and Holmström 2001). Recently while stock prices plummeted and executive pay did not attention has shifted to asymmetries in the pay-performance relationship and the potential for self-dealing by C-E-O-s-. Pay-performance sensitivity In the early 1990s the consensus view in the literature was that the sensitivity of pay to performance in the U-S was too low (see Baker and others 1988 Jensen and Murphy 1990). Executives did not receive enough cash after good corporate performance and did not incur sufficient losses through dismissal after poor performance. The same conclusions were reached for other countries most notably Japan (see Kaplan 1994a). In the U-S the sensitivity of executive pay to performance reached levels 2 to 10 times higher than in 1980 by 1994 (see Hall and Liebman 1998). The dollar change in executive wealth normalised by the dollar change in firm value appears small and falls by a factor of ten with firm size but the change in the value of the CEO’s equity stake is large and increases with firm size. The probability of dismissal remained unchanged between 1970 and 1995 (Murphy 1999).211 The point was also emphasized in an early survey by Jensen and Zimmerman (1985). Baker and Hall (1998) document the firms size effect and discuss the merits of each measure. During 1974-86 the median C-E-O gained or lost $3.25 for $1000 gained or lost by shareholders adjusted for the risk of dismissal; but money equivalent of this threat was only $0.30 (Jensen and Murphy 1990). In 1997 and 1998 the gain or loss was $10-11 per $1000 (unadjusted) (Perry and Zenner 2000; Hall and Liebman 98/168.

[Audio] This presentation will discuss equity-based compensation and its sensitivity with firm value pay-performance sensitivity and the impact of board independence on firm performance. We will discuss the sensitivity of equity-based compensation with respect to firm value which is about 53 times higher than that of the salary and bonus components and how it has been utilized in different countries. We will also discuss the use of equity-based compensation and pay-performance sensitivity which has increased in many countries but not as much as the U S level. Finally we will discuss the impact of board independence on firm performance and how it has been studied in recent years..

[Audio] We will present a theory that predicts that incentive schemes should result in net increases in shareholder wealth. However the latest evidence (based on “abnormal Q” regressions) rejects this prediction. An increase in C-E-O option holdings leads to a decrease in Tobin’s Q suggesting that C-E-Os hold too many options but not enough stock. However event study evidence generally supports the theory. In practice most options are granted at the money a clear contradiction of the predictions of theory. Boards protected by state anti-takeover laws or anti-takeover amendments provide more incentive pay to compensate for less discipline from hostile takeovers while in the U K takeover threats are higher while incentive pay and the level of pay are lower than in the U.

[Audio] We believe that the functioning of boards affects corporate performance. While best practices suggest that this is an important dimension to measure empirical literature has failed to do so directly. A study by Vafeas (1999) found a positive relationship between board meetings and corporate performance but there are inconsistencies in this relationship. Management manipulates stock option grants and times the flow of good and bad news prior to the grant which can be interpreted as evidence of self-dealing. C-E-O stock option plans are often approved by shareholder votes but there are concerns about exemptions dilution of voting rights broker voting option repricing and other issues. Overall the relationship between board functionality and corporate performance is complex and multifaceted..

[Audio] The new system is causing delays and errors in the operations. We are working on finding a solution to this problem. We will update you on our progress..

[Audio] Post-retirement appointment to a board can be a powerful implicit incentive. In the US CEOs often continue to hold a directorship after retirement with 75% doing so within two years (Brickley and others 1999). Almost half (49.5%) stay on their own board after retirement in 18% of the cases as chairman (Brickley and others 1999). Explicit and implicit incentives are often written into C-E-O contracts. These contracts can range from simple to complex with implicit benefits including severance pay for dismissal without cause or in case of changes in control (Minnow 2000)..

[Audio] We conducted research on the relationship between board functioning and performance. Our findings suggest that the structure and composition of boards may not necessarily affect general performance. However the relationship between board functioning and performance is important to understand. We recommend conducting a third-generation study. This study should focus on the specific functioning of boards and its impact on performance. Specifically we suggest studying the frequency of board meetings and their effectiveness in promoting effective working of the board. We also recognize that the role of shareholders is critical in this analysis. In addition to shareholders there are four major other constituencies: creditors employees suppliers and clients. These constituencies also play a significant role in corporate governance. We expect that more analytic studies based on this data will shed more light on these issues. The institutional investor community is drawing its own conclusions and has tabled global guidelines on executive pay. Corporate America is also under pressure to report earnings net of the cost of stock options. In conclusion while the relationship between board functioning and performance may not be as straightforward as some may believe we believe that a third-generation study will provide valuable insights and help practitioners make informed decisions..

[Audio] We have conducted a study to explore the relationship between board composition functioning and corporate performance. While best practice recommendations suggest that the functioning of boards matters for performance empirical literature has failed to measure this dimension directly leaving practitioners to interpret the findings. We have found a positive relationship between the frequency of board meetings and corporate performance but this is a crude measure of the effectiveness of the working of the board. Debtholders play a crucial role in corporate governance but their role differs significantly between countries. In the U S insolvency law is softer than in the U K and judges are more lenient. Furthermore regulation in the U S is subject to political intervention and lobbying which further weakens the usefulness of debt as a commitment device. We have used basic statistics in these studies but they are methodologically problematic with sample bias and conditional outcome measures. Therefore we approach these findings with caution and continue exploring the relationship between board functioning and corporate performance..

[Audio] We believe that a third-generation study is crucial to further understand the relationship between board structure and general performance. Although best practices suggest that the functioning of boards is important for performance empirical literature has not been able to measure this dimension directly. However recent research on venture capital financing provides more direct evidence of the significance of debtholder involvement. Analyzing the contracts signed between companies and their creditors it has been found that financial constituencies have control and liquidation rights that are contingent on performance. Furthermore employee involvement has been proven to be efficient in practice as it is mandatory in several countries including Austria and the Netherlands..

[Audio] This study by Vafeas (1999) found a positive relationship between the frequency of board meetings and corporate performance but this is a crude measure of the effectiveness of board functioning. In contrast employees in Japan are not formally represented on the board although Japanese corporations are run in the employees’ and not the shareholders’ interest. The empirical literature on employee involvement is small even for countries where such institutions are known to exist such as Germany. German codetermination provides for mandatory representation of employees on the supervisory board of corporations with three levels of intensity: full parity for coal iron and steel companies; quasi-parity for other companies with more than 2000 employees; and 1/3 parity for those with 500-2000 employees. Media companies are exempt. There is some evidence that the degree of codetermination adversely affects shareholder wealth or company performance. If codetermination reduces shareholder wealth shareholders will resent codetermination and they will try to bypass or shift board rights to the general assembly. However there is no evidence that codetermination reduces performance. The German-language literature is vast and evidence suggests that worker influence is so intense in some companies that the capital side of the supervisory board is too weak to apply a de facto opt-out of codetermination..

[Audio] The presentation discusses the findings of econometric studies comparing company or sector performance before and after the implementation of codetermination reforms or their enforcement by the courts. These studies found no or small effects of codetermination on company or sector performance. However a recent study relied on cross-sectional variation of codetermination intensity controlling for different types of equity control and company size. This study found that codetermination reduced market-to-book-value and return on equity and that codetermination intensity and its incidence correlate with other factors that matter for stock price and accounting measures of performance. Therefore it is doubtful that one can ever fully control for these factors when studying the effects of codetermination on shareholder wealth. The past two decades have seen an explosion of research on corporate governance and it is widely accepted that corporate governance is a pillar of wealth creation and a fundamental aspect of corporate finance. Poor or corrupt corporate governance practices in banks and corporations can significantly worsen the depth of financial crises if not trigger them and the textbook now includes this as a fundamental aspect of corporate finance..

[Audio] The relationship between board structure and performance may not have a significant impact. To further investigate this we propose a third-generation study. While recommended practices suggest that board functioning affects performance research has not directly measured this leaving interpretation to practitioners. A study by Vafeas (1999) found a positive correlation between board meeting frequency and corporate performance but this is a limited measure of board effectiveness. Dispersed ownership can lead to a "power vacuum" and create managerial agency problems. Without appropriate financial incentives or monitoring executives may make decisions that benefit themselves over the company's best interests. Executive stock options have become a popular but controversial incentive for C-E-O-s inefficient and creating new incentive and conflict-of-interest issues. It is widely acknowledged that boards of directors are weak at monitoring managers with disappointing results in empirical research. In conclusion organizations should consider the relationship between board structure performance and agency problems in corporate finance and investment..

[Audio] Hostile takeovers large shareholders shareholder activism and employee supervisory committees are topics that have been discussed. Despite a lack of consensus on their effectiveness and benefits it is widely known that hostile takeovers are rare and becoming increasingly so. The primary beneficiaries of hostile takeovers are target company shareholders while the primary losers are acquiring company shareholders and target management. On average the combined value of the acquiring and target companies in hostile takeovers is not significantly different from zero indicating that there is no evidence of net value creation in the average hostile takeover. Moreover existing evidence suggests that the threat of hostile takeovers has a weak disciplining effect on management. Many companies around the world with the exception of the U S the U K and Japan have at least one blockholder with concentrated voting power. Deviations from one-share-one-vote are common but there are significant variations across countries. Therefore it is proposed to increase the number of independent directors on a board and tighten the definition of “independent” to address this issue and provide additional mechanisms for monitoring management..

[Audio] Students welcome to slide 16 of our presentation on the relationship between board structure and general performance. As discussed best practice recommendations suggest that boards greatly impact performance but there is limited direct measurement in existing literature. However Vafeas (1999) found a positive correlation between board meeting frequency and performance. This raises the question of how large shareholders affect a firm's performance. Some argue that in countries with strict regulations on shareholder "self-dealing " large shareholders can benefit the firm. However in countries without these regulations they can contribute to corporate governance issues. Unfortunately there is a lack of reliable and systematic data on control rights worldwide hindering empirical research on this topic. It is clear that direct shareholder intervention is challenging and may not be as effective as believed. Proxy fights and shareholder suits are difficult to win without strong evidence of wrongdoing and even then the impact on management is minimal. Hopefully with more data becoming available we can continue studying and understanding the role of large shareholders in corporate governance. Thank you for your attention. Let's move on to our final conclusion on slide 17..

[Audio] As we near the end of our presentation we turn our attention to an important aspect of corporate governance – the structure and composition of boards. Previous studies have shown a positive relationship between the frequency of board meetings and corporate performance. However we must further examine the impact of board functioning on overall performance. The merit of market-based versus bank-based systems of corporate governance is a highly debated topic but there is no clear evidence that one system outperforms the other in lowering the cost of capital. Arguments claiming that market-based systems are better for startups and new technologies while bank-based systems are better for managing existing technologies lack concrete evidence. The enforcement of minority shareholder rights has been linked to increased reliance on stock market financing but the significance of this finding and the direction of causality must be questioned. Additionally recent concerns have been raised about executive pay and C-E-O stock participation. While these measures are intended to increase efficiency the self-serving behavior of unmonitored C-E-Os and their ability to manipulate earnings brings forth a new set of incentive problems. In conclusion it is evident that the structure and composition of boards play a crucial role in corporate performance. As we continue to move forward it is important to further explore this relationship to ensure effective and ethical corporate governance..

[Audio] The relationship between board structure and composition and general performance has been highlighted as a gap in the literature. This has led to practitioners interpreting findings and a need for more research in this area. Vafeas's study revealed a positive correlation between board meetings and corporate performance but this only partially explains board effectiveness..

[Audio] We have analyzed a variety of studies and recommendations for best practice and have concluded that boards are critical to the success of businesses. However it is clear that more research and measurement is needed to fully understand this area. Additionally different legal and regulatory frameworks in various countries can impact corporate governance presenting a dilemma when it comes to regulating shareholder intervention. The recent crisis in U S corporate governance has emphasized the importance of finding a balance in this area..