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MLI28C060 - Corporate Finance
Seminar 8
Question 1. Describe the key features of Agency Theory in
terms of how it views the firm.
• Adopts a focus on shareholder value maximisation
• Principals: owners (shareholders) of a firm
• Agents: people hired by the owners to run the firm (managers
and workers)
• Agency Costs: costs associated with monitoring agent behavior
and enforcing contracts
• Goal: efficient arrangement (lowest agency costs) of agentprincipal relationships
Internal Governance Mechanisms
• Incentive alignment: Executive Compensation
– use of salary, bonuses, and long-term incentives to
align managers’ interests with shareholders’ interests
 Stock ownership (long-term incentive compensation)
» managers more susceptible to market changes which are
partially beyond their control
 Incentive systems do not guarantee that managers make the
“right” decisions, but do increase the likelihood that managers
will do the things for which they are rewarded
• Monitoring by top-level managers
– they may obtain Board seats (not in financial
institutions)
– they may elect Board representatives
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
– A key assumption is liquid (active) stock market
• Managerial Labour Market
– Assumes active market for executives – i.e. ability to
hire new executive talent
Question 2. Describe the key features of Stakeholder Theory in
terms of how it views the firm
• Stakeholder theory views the firm in terms of its social
embeddedness within wider society
• Two critical questions:
1. What is the purpose of the modern corporation?
2. To whom, or what, should the firm be responsible?
• Traditional view: “Ownership Theory of the
Firm”
– Firm is the property of its owners
– Purpose is to maximize returns to shareholders
– Shareholders’ interests are paramount and take
precedence over all others
• Contrasting view: “Stakeholder Theory of the
Firm”
– Argues the corporation serves a broader purpose, to
create value for society
– Must make profit for owners to survive, however,
creates other kinds of value too
– Corporations have multiple obligations, all
“stakeholder” groups must be taken into account
Market and Nonmarket Stakeholders
Stakeholder groups can be divided in to two
categories:
1. Market stakeholders
2. Nonmarket stakeholders
Market stakeholders are those that engage in
economic transactions with the company as it
carries out its primary purpose of providing
society with goods and services
Sometimes referred to as primary stakeholders
Market Stakeholder Map
Nonmarket Stakeholders
• Nonmarket stakeholders are people or
groups who—although they do not engage in
direct economic exchange with the firm—are
affected by or can affect its actions
– Sometimes called secondary stakeholders
Nonmarket Stakeholder Map
Question 3. What is the difference between unitary and dual
board structures?
• Unitary structure boards:
– Single board with roles separated between Executive and
Nonexecutive
– CEO separated from Chairperson
– Primarily based on Anglo-American shareholder value system (i.e.
based on Agency theory)
• Dual-tier boards:
– Two board tiers (a) supervisory and (b) management “board”
comprised of management
– CEO/Chairperson (often called President) sits on supervisory board
and heads up lower subordinate management board
– Common board structure in Continental Europe
– Loosely based on Stakeholder perspective
Question 4. What are the agency theory views on board
structure?
• Traditional agency view is board is separated with roles
defined as Executive and Nonexecutive
• Executives run the company on day-to-day basis
• Nonexecutives are in charge of monitoring and surveillance on
behalf of shareholders
• Roles of CEO and Chairperson separated