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Level I CFA CF: Corporate Governance and ESG-Lecture 1 - YouTube
Channel: IFT
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corporate governance and esg
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and introduction here are the sections
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of this reading section 2 deals with
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corporate governance overview
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the key point here is to understand the
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different descriptions of corporate
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governance section 3 company
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stakeholders
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here you need to be able to describe the
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different stakeholder groups
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and compare their interests section 4
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stakeholder management so you need to
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understand the description of
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stakeholder management
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section 5 deals with the board of
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directors and committees
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so you need to understand the functions
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and responsibilities
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of the board of directors and the
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various committees
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section 6 you need to understand the
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factors which
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impact stakeholder relationships and
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corporate governance
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section 7 deals with the various risks
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associated with poor corporate
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governance
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and then the benefits of having a good
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corporate governance structure section 8
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gives an overview of analyst
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considerations in corporate governance
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in other words when you as an analyst
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are evaluating the corporate governance
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of a company
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what are the items that you need to look
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at
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and finally section 9 has to do with esg
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considerations here e stands for
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environmental
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s is for social and g is for governance
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sections one through eight largely cover
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the governance
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aspect section nine focuses primarily on
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environmental issues and social issues
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this is a very long and theoretical
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reading and it will be almost impossible
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to remember
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all the details but it is essential that
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you keep your eye
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on the learning outcomes and make sure
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that you remember the most important
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points
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these are the points that i've
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emphasized in this lecture
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in some cases i simply read out segments
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from the curriculum and the benefit
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there is that
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the curriculum expresses some points in
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a very good manner
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and hopefully by listening to me you
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will be able to
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remember those points also this is the
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sort of reading that you can easily
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listen to on your commute to work
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because
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there are no calculations so if you just
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hear it a few times
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that will help you remember the most
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important points
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section 2 corporate governance overview
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the first point here is that corporate
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governance can be described in
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many different ways here is one
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definition
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corporate governance is the system of
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internal controls
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and procedures by which individual
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companies are managed
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it provides a framework that defines the
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rights roles and responsibilities
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of management board controlling share
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owners
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and minority or non-controlling
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share owners here is another definition
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corporate governance is the system by
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which companies are directed
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and controlled and a third definition is
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that corporate governance includes a set
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of relationships
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between a company's management its
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board its shareholders and other
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stakeholders
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now given the different definitions of
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corporate governance it is easy to
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imagine that corporate governance
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practices
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vary from country to country and in fact
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even
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within a particular jurisdiction
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corporate governance
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practices can vary from company to
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company
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very broadly speaking there are two
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major theories
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which define specific corporate
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governance practices
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one theory is the shareholder theory and
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this is the traditional theory which
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says
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that the most important responsibility
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of a company's managers is to maximize
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shareholder returns and in fact you'll
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find this definition in many
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traditional textbooks if you notice
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the first definition is somewhat aligned
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with shareholder theory
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because it emphasizes the relationship
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between
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management the board and shareholders
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the board in a sense represents the
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shareholders
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the third definition seems to align with
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shareholder theory because not only is
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it talking about the relationship
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between the management the board and
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shareholders
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but it also talks about other
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stakeholders
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and this is something we'll discuss in
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more detail later
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this point related to other influences
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is that
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specific corporate governance practices
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are also
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influenced by the historical cultural
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legal and political aspects of a given
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region while corporate governance
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systems and practices vary from region
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to region
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there is some convergence which is
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underway the idea here is that even
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though specific
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practices might vary but corporate
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governance principles should be the same
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regardless of where a company is
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operating
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section 3 has two sub-sections
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3.1 deals with the different stakeholder
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groups
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and their interests 3.2
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deals with the principal agent problem
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which has to do
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with the conflicts between different
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stakeholder groups
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here is a quick view of the different
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stakeholders perhaps the most important
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stakeholder
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is the shareholders shareholders provide
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capital to the company and they are in a
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sense the owners
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of the company shareholders want the
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company to do well
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because as the company value increases
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share price goes up and obviously
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shareholders are happy
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now at large public companies
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the shareholders elect a board of
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directors
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to oversee the company management
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so the board of directors is responsible
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for
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helping establish the strategy of the
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company
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and then ensuring that managers run the
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company
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in alignment with the strategy and in
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the best interest
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of the owners or shareholders
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the board of directors play a central
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role in the corporate
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governance framework and this group will
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be discussed
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in a lot more detail later next we come
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to creditors
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creditors are typically banks
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or bondholders who provide capital
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to the company and obviously they expect
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a certain
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fixed return from the company creditors
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do not
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hold voting power and that's unlike the
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owners
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so owners elect the border directors and
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owners
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also have voting power over who comes
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on this board creditors do not have that
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voting power
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creditors are interested in the
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stability of a company and as long as
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the company is profitable enough
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to make principal payments and interest
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payments
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the creditors are happy
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next we come to suppliers so suppliers
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provide goods and services
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to the company and in return get paid
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the interest of suppliers is that they
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get paid
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as per their contract and in a timely
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manner
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as with creditors suppliers are also
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interested in the company's ability to
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generate
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sufficient cash in order to make the
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promised payments
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customers buy goods and services from
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the company
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and pay the company obviously the
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customers are interested in getting
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the best possible goods and services at
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the lowest
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possible price broadly speaking we can
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have
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two categories of customers we can
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either have
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tactical customers or strategic
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customers tactical customers are not
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impacted too much by the performance of
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the company because if the company is
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not doing too well
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customers will simply take their
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business elsewhere if a customer
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is a strategic customer then they would
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be more interested in the long-term
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stability and well-being of the company
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finally we come to the government or
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regulators
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the government or regulator is
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interested
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in ensuring that the company is
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operating in the best
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interest of the public and that the
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company is
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following the law of the land the
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government
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also gets tax revenue from the company
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so in that sense the government is a
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major stakeholder
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a quick word on stakeholders in
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non-profit organizations
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here the perspective is different
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relative to
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public companies the border directors
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are often called
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trustees and the stakeholders would
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include the board of directors
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trustees the managers and employees who
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are
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part of the non-profit organization
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instead of customers we would typically
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have
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donors and then they will be the people
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who benefit
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from the non-profit organization a key
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role here is paid by the trustees
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who need to ensure that the donations
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coming in are used for the stated
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purpose
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of the non-profit organization
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section 3.2 principle agent and other
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relationships in corporate
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governance the first point here is to
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understand
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the principal agent relationship
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this relationship is also called the
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agency
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relationship and is fairly
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straightforward the principal
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hires an agent to perform certain duties
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now since the principal has hired the
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agent the agent needs to
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act in the best interest of the
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principle the potential conflict is
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where the agent acts in his own best
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interest
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rather than the best interest of the
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principle
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now let's apply this to the shareholder
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and manager director relationship the
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shareholders are the owners of a company
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they elect the directors so
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we can say the principle in this context
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is the shareholder
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who elects the directors the directors
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are responsible for
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hiring the managers and then the
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managers in essence
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run the company so the directors set the
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strategy for the company
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and then oversee the managers they need
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to ensure that the managers are running
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the company
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in the best interest of the shareholders
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so in this context the shareholders are
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the principal
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and the directors slash managers are
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the agents so what are the possible
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conflicts of interest
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as we said earlier the major interest of
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shareholders
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is that the value of the firm is
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maximized
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the managers on the other hand will
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possibly be more interested in their own
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personal benefits
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so they would want their compensation to
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be maximized
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their perks or perquisites to be
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maximized and
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herein lies a potential conflict because
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if the managers are paying themselves
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too much
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that is negatively impacting the value
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of the firm
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another possible issue has to do with
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risk tolerance
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now generally shareholders will be well
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diversified
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so they would want the company to take
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an appropriate
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level of risk so as to maximize
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the value of the firm the managers on
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the other hand might be somewhat
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risk-averse
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because in addition to maximizing their
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compensation
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managers also want job security
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so they are more likely to engage in
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projects
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that are relatively safe so that's
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one potential mismatch between the
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risk tolerance level of shareholders and
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managers
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now there is another possible situation
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also
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this is where senior managers have stock
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options
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and let's say we have a situation where
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the
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options are just out of the money
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in this case managers might be tempted
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to take
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excessive risk because when they take
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risk
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there is a chance that the company will
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do well and
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the options will become in the money and
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this level of risk might be suitable for
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the senior managers
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with stock options but it might not be
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the appropriate level of risk
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for the shareholders so the larger point
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is
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that there is a potential mismatch
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between the risk tolerance of
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shareholders slash owners and the
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managers
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another issue has to do with information
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asymmetry
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clearly the managers have a lot more
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information about the company
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relative to shareholders and they might
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make
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decisions that are not in the best
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interest of shareholders
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and shareholders will not have enough
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information
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to evaluate the decisions made by
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managers
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another conflict arises when the board
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is influenced by
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insiders so we have the shareholders who
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elect the board of directors and the
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board of directors is responsible for
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overseeing the managers if this board of
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directors
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is dominated by company insiders
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then clearly there is an issue because
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the board then
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will be acting in the interest of
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managers rather than shareholders
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conflicts can also arise between
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controlling shareholders
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and minority shareholders now consider a
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situation
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where a given shareholder has
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51 percent of the votes and
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the minority shareholders have 49
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in this case the controlling
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shareholders
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can vote in a way that benefits them
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and in a way that hurts the minority
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shareholders the curriculum gives a
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couple of examples
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of how this can happen so there was a
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situation
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where a given company had
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a controlling shareholder and then they
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were minority shareholders
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when the company was sold the
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deal was negotiated such that the
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controlling shareholders got a higher
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price
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for their shares relative to what the
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minority shareholders
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got for their shares another conflict
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can happen
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with related third-party transactions
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so let's say that this controlling
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stakeholder
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has an ownership stake in another
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company
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let's call this the third party
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if the controlling stakeholder also owns
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this third-party company potentially
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this company could buy goods and
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services here
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at prices that are above market value
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now when this happens
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obviously the third party benefits
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this company loses out but
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the controlling stakeholders benefit
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because they also have ownership over
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here
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since the company loses out the minority
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shareholders
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lose out so this is another possible
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area of conflict between controlling and
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minority shareholders
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related to this is a situation where we
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have an equity structure with
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multiple share classes so if you have
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let's say share classes
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a and b where share class
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a has voting rights but share class b
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does not then obviously the
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shareholders with voting rights will
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execute transactions which are
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beneficial
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to them and potentially not beneficial
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to
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the other owners of the company who do
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not have
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voting rights
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manager and board relationships so we
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have a board of directors
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which is responsible for overseeing
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the managers of a company in a situation
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where we largely have independent
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directors
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who are not involved in the day-to-day
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running of the company
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we can have a potential issue whereby
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the managers
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do not provide sufficient information to
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the board
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and if the board doesn't have sufficient
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information then they cannot adequately
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oversee
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the managers shareholder versus
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creditor interests now this is fairly
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straightforward
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we have a company the company gets money
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from
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the shareholders and also from creditors
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the shareholders are interested in
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maximizing the value of the company so
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the shareholders would like the company
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to take
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projects that are somewhat risky
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so that the overall return is maximized
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the creditors on the other hand are
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going to be more risk-averse
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the creditors would prefer that the
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company engages
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in relatively low risk projects
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so that the risk of default is minimized
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there are a few other conflicts that you
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need to be aware of
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one is the conflict between customers
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and shareholders
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obviously customers would like that the
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company sells
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products and services at as low a price
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as possible
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which would impact the value of the firm
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we have a conflict between customers and
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suppliers
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customers would like easy payment terms
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but
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if a company is getting late payments
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from customers
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then that impacts their ability to pay
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suppliers
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in time there is also a potential
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conflict between
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shareholders and governments or
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regulators
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in the sense that shareholders would
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like to
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adopt accounting practices that minimize
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taxes
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another example would be in the banking
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sector where
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the regulator would like to see
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relatively high equity capital
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whereas the owners and shareholders
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would prefer to have
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lower equity capital so that return on
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equity is high
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you
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