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Corporate Governance

Corporate Governance
FSS 2014
Dr. Inga van den Bongard
Dr. Erik Fernau

Organization of the course

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Lecturer
Dr. Inga van den Bongard
Email: ivdb@uni-mannheim.de
Office: L 9, 1-2, Room 401
Office hours: on appointment

Dr. Erik Fernau


Email: fernau@uni-mannheim.de
Office: L 9, 1-2, Room 401
Office hours: on appointment
Lecturer changes a few times during the semester.
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Chair of Finance

Chair of Finance:
L9,1-2

Address & website:


L 9, 1-2

http://finanzierung.bwl.uni-mannheim.de/en/home/
Research & teaching at the Chair of Finance
Market Microstructure

Corporate Finance

Empirical Asset Pricing

Corporate Governance

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Time & location


Lectures & exercises
Monday 12.00 01.30 pm (O 151)
Tuesday 03.30 05.00 pm (O 151)
Exercises accompany the lectures at irregular intervals.
The course is worth 6 ECTS.

Therefore the course will only take place on the dates


depicted on the following slide.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Time schedule
Monday

Tuesday

Lecture

10.02.2014

11.02.2014

17.02.2014

18.02.2014

No lecture

24.02.2014

25.02.2014

03.03.2014

04.03.2014

10.03.2014

11.03.2014

17.03.2014

18.03.2014

24.03.2014

25.03.2014

31.03.2014

01.04.2014

07.04.2014

08.04.2014

14.04.2014

15.04.2014

21.04.2014

22.04.2014

28.04.2014

29.04.2014

05.05.2014

06.05.2014

12.05.2014

13.05.2014

19.05.2014

20.05.2014

26.05.2014*

27.05.2014

Easter break

* Question time
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Registration period & course material


Registration period

Tuesday, February 11 Monday, February 24


The number of participants is limited to 100 students.
No first come, first served if number of applicants>100.

A manual regarding the registration for the course and the


E-learning group is provided on our website:
http://finanzierung.bwl.uni-mannheim.de/de/lehre/bachelor_bsc/corpgov/

Course materials (including this lecture) can be downloaded at:


https://portal.uni-mannheim.de/ (.LRN Plus)
Lecture:

FIN 350 Corporate Governance (FSS 2014)

Password: CorpGFSS2014
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Exam
Student evaluation is based on a written exam
(60 minutes, closed book)

The exam will take place between


Monday, June 2, 2014, and Saturday, June 14, 2014
Preparation for the exam
The exam may cover all materials discussed in the lecture.
The course material is meant to accompany the course. It is not
intended to provide a substitute for attendance in class.
In order to prepare for the exam it is highly recommended to
attend both the lecture and the exercise sessions.
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Target group & prerequisites


For whom is the course intended?
Exchange students BSc

6 ECTS
Prerequisites
Introductory course in corporate finance on the level of
Brealey/Myers/Allen is strongly recommended.
Brealey, R.A., Myers, C.S. and F. Allen, 2008, Principles of
corporate finance, 9th edition, Mcgraw-Hill Higher Education.
Focus of the course
The course covers both theoretical concepts and empirical
studies in the field of corporate governance.
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Contents (preliminary schedule)


1. Introduction
2. Principal-Agent Problem
3. Financing under Asymmetric Information
4. Internal Corporate Governance Mechanisms

4.1. Ownership & Control


4.2. Board of Directors
4.3. Manager Compensation

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Contents (preliminary schedule)


4.4. Leverage & Payout
5. Regulation
6. Corporate Governance Systems
7. Valuation Effect/ Problems in Empirical Research

8. (Corporate Social Responsibility)


9. Behavioral Corporate Governance

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Learning outcomes
By the end of this course, students should be able to:
1. Contrast the different definitions of corporate governance
2. Critically review the principal-agent model
3. Describe differences in corporate control across the world
4. Explain the reasons why control may be different from
ownership
5. Compare the main classifications of corporate governance
systems
6. Assess the effectiveness of the different corporate governance
mechanisms, such as for example the board of directors
7. Critically assess the empirical evidence on the importance and
effectiveness of various corporate governance mechanisms
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Recommended reading
Goergen, M., 2012, International Corporate Governance, Prentice
Hall.
Shleifer, A., and R. Vishny, 1997, A survey of corporate
governance, Journal of Finance 52, 737-784.

References (required and supplementary) will be provided at the


end of each set of lecture notes.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Corporate Governance
FSS 2014
Dr. Inga van den Bongard
Dr. Erik Fernau

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

An Example for Misaligned Interests


Tyco International Ltd.
Tycos former CEO, Dennis Kozlowski lived a lavish lifestyle
$29 million vacation home in Boca Raton, Florida
$15 million rare 1930s-vintage yacht
$18.5 million Fifth Avenue apartment in Manhattan
$6,000 gold-and-burgundy, floral-patterned shower curtain
What is wrong with that?
Even though Kozlowksi was one of America's best-paid corporate
executives, he didn't reach into his own pocket to finance his life of
opulent luxury. Instead, everything was paid for by the company
In September 2002, Kozlowski and Swartz (CFO) were indicted on
charges for stealing more than $600 million from Tyco
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Background
1946: Kozlowski was born in New Jersey
1960: Tyco is founded as a research laboratory doing experimental
work for the government.
1962: change focus to high-tech products for the commerical sector
Went public in 1964
Between 1970 and 1980: growth through acquisitions/ market
leadership across a range of electronics, fire & safety products and
packaging
1974: Tyco stock is listed on the NYSE
1975: Dennis Kozlowski joined Tyco as an assistent controller
1992: Appointment of Kozlowski as CEO

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

It was the appointment of Kozlowski as CEO in 1992 that the


company grew excessively. Between 1994 and 2002 Tyco spent
$63 billions for acquisitions.
Kozlowski was the most prolific corporate acquirer ever -> at the
height of his hyperactivity, he accumulated 200 companies a year!

Tycos problems emerge


1999: when rumours of accounting irregularities started to resurface
concerning Tycos acquisitions, the SEC initiated an investigation in
Dec 1999 till July 2000
July 2000: the SEC sent a letter informing Tyco that it was not taking
action, because it was not able to find anything illegal
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

2001: Business Week named him one of the top 25 managers to


watch
And wrote in 2000, Kozlowski came charging back. In July the
SEC, in effect, gave the company a clean bill of health by ending its
inquiry. And since then, Kozlowski has kicked his dealmaking
machine back into full throttle, snapping up some 40 companies in
2000 for a total of $9 billion, while profits have soared.
This Midas touch in deal after deal has transformed Tyco from an
obscure manufacturer into a powerhouse worth 50 times more than
when Kozlowski took charge eight years ago. It's an achievement
that has led some to compare Kozlowski with General Electric Co.'s
Jack Welch.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

The scandal begins


In June 2002, Kozlowski was indicted by Manhattans District
Attorney Robert Morgenthau for evading over $1 million in sales
taxes
Morgenthau claims that between August 2001 and June 2002,
Kozlowski purchased paintings for roughly $13 million for his Fifth
Avenue apartment in Manhattan while Tyco was paying for the
fine art.
They were bought in New York, but shipped to Exeter, N.H.,
where Tyco's operational headquarters were located.
By shipping out of state, Kozlowski got around paying New York
sales tax on the art.
However, the paintings were returned to his apartment
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Kozlowski resigned on June 2, 2002


The scandal broadens
Morgenthau widened his investigation to check whether Tyco had
been paying for Kozlowskis personal expenses
On September 12, 2002, Kozlowski and the former CFO Swartz
were indicted for looting $600 million from the company
According to the SEC, they granted themselves hundreds of
millions of dollars in secret low interest and interest-free loans from
the company that they used for personal expenses
In some cases, loans were never repaid. Kozlowski and Swartz
caused Tyco to forgive tens of millions of dollars they owed the
company, again without disclosure to investors
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

They treated Tyco as their private bank, taking out hundreds of


millions of dollars of loans and compensation without ever telling
investors," said Stephen M. Cutler, the SEC's Director of
Enforcement. "Defendants put their own interests above those of
Tyco's shareholders. Those shareholders deserved better than to be
betrayed by the management of the company they owned.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Those funds allowed Kozlowski to purchase:


$29 million vacation home in Boca Raton, Florida
$15 million rare 1930s-vintage yacht
Jewelry from Tiffanys and Harry Winston
(e.g. a $5million diamond ring)
Kozlowski also misappropriated funds to make philanthropic
contributions in his own name (in total: $43 million); e.g. he gave $5
million to Seton Hall, which named the building of its new businessschool Kozlowski Hall
$18.5 million Fifth Avenue apartment in Manhatten
The apartment had needed furnishing and refurbishment:
the famous $6000 shower curtain
$2200 wastebasket
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

$15000 dog-umbrella stand


$17000 antique traveling toilet box
$ 6300 antique sewing basket
two sets of sheets on sale for $ 5960
pincushion for $445
In total, Tyco spent $30million to buy and decorate the apartment for
Kozlowski. This included the cost of the paintings on which sales tax
was not paid. His lawyers contended that Tyco properly paid for the
apartment and furnishings because Kozlowski used it for business.
He needed the apartment to impress other executives with whom he
was negotiating multibillion acquisitions for Tyco
And dont forget the birthday party for his wife, Karen
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

In June 2001, Kozlowski wanted to throw an unforgettable party for


his wife Karens 40th birthday:
He invited seventy-five of his dearest and closest friends to
celebrate the birthday on the Mediterranean island of Sardinia
Singer Jimmy Buffet was imported for their entertainment at a
cost of $250000
The party included paid models dressed in Roman togas and ice
sculpture of Michelangelos David urinating Stolichnaya vodka
Half of the $2.1 million cost of the birthday party was billed
directly to Tyco on the theory that the guests included employees
and there should have been also a board meeting. The board
meeting, however, was largely attended by phone because many
board members were not on the island.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

The Party:

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

The Party:

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

The Outcome:

On September 19, 2005 he was sentenced to serve 8.33 years to 25 years


in prison for his role in the scandal
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Eric M. Pillmore served as Senior Vice President of Corporate


Governance of Tyco International Ltd. From August 2002 to 2007.
He was charged with revamping a broken corporate governance
system. During an interview he was asked:
How come nobody figured this out before the SEC finally looked at
it?
This is one scandal that really didnt have a whistle-blower. []
I think the tone clearly set by the CEO (Kozlowski) created a very
intimidating culture where people were very unwilling to speak up.
He grow up in the company, he started actually as an internal
auditor and became CEO about 10 years before the problem
actually surfaced. I believe that he thought that the company were
his
(Turning around Tyco: How corporate governance saved the day,
INSEAD Knowledge, March 2010)
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

And what is Corporate Governance?


Corporate Governance deals with conflicts of interests between
the providers of finance and the managers;
the shareholders and the stakeholders;
different types of shareholders (mainly the large shareholder and
the minority shareholders)

and the prevention or mitigation of these conflicts of interests.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

The idea is not new and the fundamental insight dates back at least
as far as 1776
A much quoted comment by Adam Smith shows that he understood
the issue of corporate governance (even though he did not know the
phrase):
The directors of companies, being managers of other peoples
money than their own, it cannot 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.
(Smith, 1776, The wealth of nations)
However, the phrase corporate governance was scarcely used
until the 1980s

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Definition(s)
There exist several definitions of CG in the academic literature (and
elsewhere):
Corporate governance deals with the ways in which suppliers
of finance to corporations assure themselves of getting a
return on their investment (Shleifer and Vishny, 1997, JF)
Denis (2001) describes corporate governance as the set of
institutional and market mechanisms that induce selfinterested managers (controllers) to maximize the value of the
residual cash flows of the firm on behalf of its shareholders
(the owners) (Denis, 2001, RFE)
Shareholder perspective: Maximization of shareholder value!
What about other stakeholders?
Creditors, employees, customers, suppliers, etc.
University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Definition(s)
stakeholder society, e.g. Tirole (2001):
Corporate governance explicitly mentions stakeholder
maximization
The traditional shareholder value approach is too narrow a view
for an economic analysis of corporate governance. I will, perhaps
unconventionally for an economist, define corporate governance
as the design of institutions that induce or force management to
internalize the welfare of stakeholders. The provision of
managerial incentives and the design of a control structure must
account for their impact on the utilities of all stakeholders [] in
order to, respectively, induce or force internalization.

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

What is Corporate Governance?

University of Mannheim, Chair of Finance

FSS 2014

Corporate Governance

Suggested readings
Goergen, M., 2012, International corporate governance, 1st edition,
Chapters 1.
Shleifer, A., and R. Vishny, 1997, A survey of corporate
governance, Journal of Finance 52, 737-784.

University of Mannheim, Chair of Finance

FSS 2014