Chapter 3 Key corporate participants.pdf

# The role of bargaining and contractual mechanisms in addressing corporate conflicts ### Core idea * Conflicts of interest among corporate participants can be addressed through bargaining and explicit contractual agreements [1](#page=1). * Achieving complete contractual specificity is often hindered by information asymmetries and transaction costs [1](#page=1). ### Key facts * Corporate governance analysis typically focuses on publicly traded companies [2](#page=2). * Shareholder investment duration is generally open-ended, unlike creditor debt contracts which have specified terms [3](#page=3). * Publicly traded shares are often transitory, leading to concerns about short-termism bias [3](#page=3). * Shareholders are residual claimants, entitled to what remains after all fixed claims are met [4](#page=4). * Share prices are influenced by market sentiment and may not always reflect a company's true value [4](#page=4). * Limited liability reduces shareholder risk, capping losses to the amount paid for shares [5](#page=5). * Diversification can mitigate unsystematic risk but not market or systematic risk [5](#page=5). * Shareholders have legal powers including appointing and removing directors, and approving fundamental changes [5](#page=5). * A collective action problem contributes to shareholder passivity in exercising control [6](#page=6). * "Blockholders" (founders, families) often engage in "defensive" shareholder activism to protect their investments [6](#page=6). * "Offensive" shareholder activism involves acquiring stakes to agitate for change, often by hedge funds [6](#page=6). * Conflicts can arise between shareholders, especially between blockholders and minority shareholders seeking private benefits of control [7](#page=7). * Creditors include trade creditors, institutional lenders, and bond/debenture holders [7](#page=7). ### Key concepts * **Agency costs:** Jensen and Meckling's breakdown highlights that conflicts are not entirely unresolved [1](#page=1). * **Bargaining elements:** Duration, return, risk, control, conflicts of interest, and contractual arrangements help analyze participant stakes [1](#page=1). * **Residual claimants:** Shareholders are ultimate beneficiaries of company success after fixed claims are satisfied [4](#page=4). * **Efficient Capital Market Hypothesis (ECMH):** Weak form (past prices reflect future), Semi-strong form (publicly available info reflected) [4](#page=4). * **Volatility risk:** A type of risk equity investors face due to variable potential returns [5](#page=5). * **Unsystematic risk:** Company-specific risk mitigated by diversification [5](#page=5). * **Systematic risk:** Market-wide risk affecting all stocks, not mitigated by diversification [5](#page=5). * **Capital Asset Pricing Model (CAPM):** Investment risk is directly correlated with return [5](#page=5). * **Collective action problem:** Rational self-interest leads individuals to not act for joint welfare, seen in shareholder disciplining of management [6](#page=6). * **Shareholder activism:** "Defensive" (protecting existing investment) and "offensive" (agitating for change in undervalued companies) [6](#page=6). ### Implications ### Common pitfalls --- ### Creditor-debtor relationships * Creditors normally cannot demand immediate repayment of debt unless the borrower defaults or the debt contract allows it [8](#page=8). * The standard debt contract involves repayment of principal plus interest, with the interest rate referred to as yield [8](#page=8). * A creditor's return is a fixed claim, unaffected by the company's success, unlike a shareholder's return [8](#page=8). * Default risk is the likelihood a debtor company fails to meet its obligations, partially or fully [8](#page=8). * Creditors manage default risk through screening potential debtors, negotiating higher yields, or contracting for prompt repayment [8](#page=8). * Bargaining for security against assets or demanding a short repayment period are strategies to mitigate risk [10](#page=10). * Creditors can stipulate "acceleration" clauses for immediate repayment upon breach of contract [10](#page=10). * Contractual restrictions can limit a debtor company's actions, such as taking on new debt or distributing dividends [10](#page=10). * Bargaining is imperfect due to the impossibility of anticipating all adverse conduct and the cost of negotiation and monitoring [10](#page=10). ### Shareholder-creditor conflicts * Conflicts arise when shareholders favor accumulating debt for lucrative opportunities, increasing default risk for existing creditors [9](#page=9). * Asset withdrawal, such as a generous dividend policy, erodes the equity cushion protecting creditors [10](#page=10). * Shareholders may pursue high-risk, high-return projects, benefiting disproportionately from success while creditors bear more risk if the venture fails [10](#page=10). * This creates a "heads we win, tails creditors lose" scenario for shareholders [10](#page=10). ### Employee-employer relationships * Employment relationships are characterized by employer authority and employee acceptance of directions, often managed internally rather than by formal contract [11](#page=11). * Supply and demand forces remain relevant to employment terms, despite internal firm administration [11](#page=11). * Employee return typically consists of fixed wages and benefits, not directly tied to corporate performance [12](#page=12). * While some profit-sharing exists, employees are often hesitant to link pay closely to performance due to income fluctuation [12](#page=12). * The primary risk for employees is job loss, with limited diversification protection compared to shareholders or creditors [13](#page=13). * Linking remuneration to corporate performance can compound risk, especially if the company's stock value falls when job security is threatened [13](#page=13). * Employees can gain influence through equity stakes or worker representatives on boards, though full employee ownership is rare [13](#page=13). * Agency costs arise when employees, paid fixed amounts, are tempted to work at a leisurely pace or over-consume perks [14](#page=14). * Conversely, companies may manage in ways contrary to employee interests, such as cost-cutting downsizing [14](#page=14). * Alignment can occur in successful firms where stakeholders benefit from growth, but this can be difficult to sustain in hard times [14](#page=14). --- ### Bargaining and employment contracts * Employment contracts are often brief, focusing on core matters like wages and hours, rather than detailed obligations [15](#page=15). * Contractual brevity allows flexibility for changing circumstances in long-term relationships [15](#page=15). * Gaps in employment contracts are addressed by mechanisms like unions, whose collective agreements are more intricate [15](#page=15). * The legal system also addresses employment contract gaps through statutes, e.g., written statements of employment particulars in the U.K. [15](#page=15). * Statutes directly regulate employment topics like health and safety and discrimination [15](#page=15). * "Tin parachute" clauses provide severance pay to rank-and-file workers if jobs are lost due to acquisitions [15](#page=15). ### Directors and contractual mechanisms * Non-executive directors (NEDs) advise and monitor executive decision-making [16](#page=16). * Director terms of service vary, from one year in Sweden and Delaware to longer terms in other European countries (#page=16, page=17) [16](#page=16) [17](#page=17). * The U.K. Corporate Governance Code suggests annual re-election for directors of listed companies [17](#page=17). * Directors can leave office via removal (usually by shareholders) or resignation [17](#page=17). * NEDs' terms are suggested to be shorter now, with over nine years potentially impairing independence [17](#page=17). * Directors' fees are generally modest compared to executive pay and are typically fixed, not performance-based (#page=17, page=18) [17](#page=17) [18](#page=18). * Risks for outside directors are generally not substantial, with liability often covered by company insurance (D&O) [18](#page=18). * Reputational risk is a significant incentive for NEDs to take responsibilities seriously [18](#page=18). * Conflicts of interest for NEDs arise because their returns are not linked to corporate profitability, leading to caution on risky ventures [19](#page=19). * Nominee directors, appointed to represent specific constituencies, can face conflicts between their appointers' interests and their duties to the company [20](#page=20). ### Directors' and Officers' (D&O) insurance * D&O insurance covers directors for legal liability and expenses arising from their service [20](#page=20). * Policies can reimburse the company for indemnifying a director or reimburse the director directly [20](#page=20). * D&O insurance is more common in the U.S. due to higher litigation risks, but is becoming standard globally [20](#page=20). * Coverage limits and exclusions (e.g., dishonest behavior) mean D&O insurance is not a complete solution for liability risk [20](#page=20). ### Bargaining and executive contracts * Executive contracts are typically explicit, often with fixed durations ranging from one to five years, with three years being common for CEOs in the U.S. [21](#page=21). * Contractual duration is relevant for calculating damages in cases of unjustified immediate termination [21](#page=21). * Severance payments can be negotiated if an executive is dismissed before their contract expires [21](#page=21). * The U.K. Corporate Governance Code recommends notice or contract periods of one year or less for executives [21](#page=21). * Notice periods in contracts influence severance pay size if an executive is dismissed without cause [21](#page=21). --- * Contractual mechanisms and bargaining serve as corrective measures for managerial conduct that negatively impacts other corporate participants [26](#page=26). * These mechanisms aim to align executive interests with those of shareholders and mitigate conflicts of interest [26](#page=26). * However, bargaining cannot fully resolve all executive conflicts of interest, and inherent limitations persist [26](#page=26). * CEO tenure in publicly traded firms has been declining, averaging five years by the end of the 2010s [22](#page=22). * Most new CEOs in American public companies are internal hires, with a substantial proportion being former board members or executives of the hiring firm [22](#page=22). * Senior executives are generally not personally responsible for corporate debts, absent specific legislation [22](#page=22). * Forced departures of senior management are difficult to distinguish from voluntary ones, with "retirement" before age 60 often classified as forced [23](#page=23). * Empirical studies show CEO turnover is more frequent after periods of poor firm performance [23](#page=23). * Markets for products, services, capital, and corporate control act as external constraints on managerial discretion [24](#page=24). * **Managerial Remuneration Components:** Includes base salary, performance-oriented pay (bonuses, share options), and "perks" or "benefits in kind" (company car, lavish offices, pension plans) [22](#page=22). - **Executive Risk and Overinvestment:** Senior executives have substantial human capital tied to their jobs, leading to reservations about variable pay linked to corporate performance and a preference against compounding this * **External Constraints on Management:** Market forces like the labor market for executives, product/service markets, capital markets, and the market for corporate control discipline managerial behavior [24](#page=24). * **Managerial Conduct and Conflicts:** * "Shirking" relates to the choice of effort level, as executives may reap little gain from diligence and are not personally liable for debts [25](#page=25). * "Looting" includes less egregious conduct like lavish offices, personal use of expense accounts, and nepotism [25](#page=25). * Divergent risk preferences between diversified shareholders (favoring high-return risky projects) and executives (preferring stability of their human capital) create conflicts [25](#page=25). - **Situational Bargaining Shifts:** During business distress, shareholders and employees favor risky gambles for potential upside, while creditors fear increased debt. Management may align with shareholders and employees in hopes of * Debt contracts can include restrictions to mitigate creditor concerns about managerial "Hail Mary" ventures [26](#page=26). * Managerial services contracts with variable pay tied to shareholder returns (e.g., stock options) aim to align executive and shareholder interests [26](#page=26). * The "overinvestment" of senior executives in their firms can discourage them from pursuing lucrative but risky ventures, even with equity-linked pay [26](#page=26). * The persistent scope for executives to engage in conduct detrimental to others, despite monitoring and market forces, may justify corporate governance regulation [26](#page=26). - > **Tip:** The difficulty in perfectly aligning executive and shareholder interests through contracts highlights the ongoing debate and necessity for robust corporate governance frameworks and potential state intervention [26](#page=26) --- # Shareholder considerations in corporate governance ### Core idea * Shareholders are the ultimate beneficiaries of corporate success, entitled to residual claims after all fixed obligations are met [4](#page=4). * Corporate governance analysis typically focuses on publicly traded companies due to their numerous, often disengaged shareholders [2](#page=2) [3](#page=3). * Shareholders possess legal rights including appointing directors and approving fundamental corporate changes [5](#page=5). * Despite legal rights, shareholders often exhibit passivity due to limited liability, expertise asymmetry, and collective action problems [6](#page=6). ### Key facts * Privately held companies usually have few shareholders actively involved in management, unlike publicly traded ones [2](#page=2). * Shareholder investment duration is generally open-ended, contrasting with creditors' fixed contract terms [3](#page=3). * Many shareholders in public companies trade shares frequently, potentially biasing firms towards short-term results [3](#page=3) [4](#page=4). * Shareholders receive returns through cash distributions (dividends) and capital gains from selling shares [4](#page=4). * Limited liability is a key feature that reduces equity investor risk [5](#page=5). * Diversification is a strategy shareholders use to reduce unsystematic risk [5](#page=5). * Shareholders have appointment rights over directors and decision rights on fundamental corporate changes [5](#page=5). * Collective action problems often lead to shareholder apathy and management oversight gaps [6](#page=6). * "Blockholders" (individuals or families with substantial stakes) are an exception to shareholder passivity [6](#page=6). ### Key concepts * **Residual Claimants:** Shareholders are entitled to what remains after all other claims are satisfied [4](#page=4). * **Efficient Capital Market Hypothesis (ECMH):** Posits that share prices reflect available information, with semi-strong form being most plausible [4](#page=4). * **Volatility Risk:** The potential for highly variable returns associated with shares due to fluctuating company profits [5](#page=5). * **Unsystematic Risk:** Risk specific to an individual company's shares, reducible by diversification [5](#page=5). * **Systematic Risk:** Market-wide risk affecting all shares, not reducible by diversification [5](#page=5). * **Capital Asset Pricing Model (CAPM):** Suggests investment risk is directly correlated with return [5](#page=5). * **Collective Action Problem:** Individuals rationally refrain from acting for collective benefit, leading to inaction [6](#page=6). * **Shareholder Activism:** Can be "defensive" (protecting existing investment) or "offensive" (agitating for change in undervalued companies) [6](#page=6). * **Private Benefits of Control:** Disproportionate returns secured by dominant shareholders at the expense of minority shareholders [7](#page=7). ### Implications * Publicly traded firms may face pressure for short-term results, potentially conflicting with long-term success [3](#page=3) [4](#page=4). * Informationally efficient share prices are the market's best estimate of value but not a guarantee of future cash flows [4](#page=4). * Diversification is crucial for managing equity investment risk, especially unsystematic risk [5](#page=5). ### Common pitfalls --- # Conflicts of interest among corporate stakeholders ### Core idea * Conflicts of interest arise when the interests of different corporate stakeholders diverge [9](#page=9). * Shareholders, creditors, employees, and directors all have distinct objectives that can clash [14](#page=14) [9](#page=9). ### Key facts * Shareholders may favor accumulating debt for lucrative opportunities, increasing risk for existing creditors [9](#page=9). * A generous dividend policy can erode the equity cushion protecting creditors [10](#page=10). * Shareholders may pursue high-risk, high-return projects that benefit them disproportionately if successful [10](#page=10). * Creditors often receive a fixed return, diminishing their incentive to improve profitability for solvent debtors [9](#page=9). * Employees paid fixed wages may be tempted to work at a leisurely pace and over-consume perks [14](#page=14). * Companies may "downsize" to save costs, negatively impacting employees regardless of individual capabilities [14](#page=14). * Employee share ownership schemes can be risky as stock may plunge when job security is jeopardized [13](#page=13). ### Key concepts * **Claim dilution:** Shareholders seeking new debt can dilute existing creditors' claims [9](#page=9). * **Asset withdrawal:** Generous dividend policies can deplete assets protecting creditors [10](#page=10). * **Risky managerial strategies:** Shareholders may favor risky ventures for potential high returns, increasing creditor default risk [10](#page=10). * **Agency costs:** Employees, as agents, may impose costs on shareholders and creditors by not working diligently [14](#page=14). * **"Shareholder-first" capitalism:** Criticized for potentially being unsafe and unfair to company workers [14](#page=14). * **Alignment of interests:** In successful firms, employees benefit from growth, potentially leading to more hiring and better pay [14](#page=14). * **Employee satisfaction linkage:** Treating employees well can foster loyalty and adaptability, potentially improving corporate performance [14](#page=14). ### Implications * Creditors use debt contracts with security, short repayment, and acceleration clauses to mitigate risk [10](#page=10). * Contractual restrictions can limit debtor company actions like taking on new debt or distributing dividends [10](#page=10). * Bargaining for creditors is imperfect due to difficulty in anticipating all risks and drafting comprehensive terms [10](#page=10). * Competitive debt markets may force creditors to offer less restrictive terms and enforcement [10](#page=10). * Employee remuneration linked to corporate performance has potential downsides like incentive misalignment [12](#page=12). * Large fluctuations in pay linked to performance make financial planning difficult for employees [13](#page=13). * Employee conflicts of interest can arise from fixed pay not tied to performance, leading to potential overconsumption of perks [14](#page=14). ### Common pitfalls * Creditors may be deterred from active involvement by diversified risks and resource limitations [9](#page=9). * Assuming all conflicts can be analyzed solely through agency analysis might be inappropriate [14](#page=14). --- # The role of employees in corporate structure and decision-making ### Core idea * Employees accede to a zone of acceptance, expecting to follow directions from employers [11](#page=11). * Employment arrangements can be analyzed using bargaining elements like duration, risk, return, control, conflicts of interest, and bargaining power [11](#page=11). * Employee roles are influenced by both internal firm administration and external labor market norms [11](#page=11). * Authority in employment can be explained by efficiency considerations, offering predictability for both employers and employees [11](#page=11). ### Key facts * Standard employment contracts lack specified durations, continuing until resignation, retirement, or dismissal [11](#page=11). * English courts imply terms requiring employers to provide notice before dismissal [11](#page=11). * In the U.S., many states follow "at will" employment, allowing discharge without cause or immediate effect [12](#page=12). * Firm-specific training can decrease employee mobility due to highly specialized skills [12](#page=12). * Employee returns are typically wages, salaries, and benefit packages, constituting fixed claims [12](#page=12). * Profit-sharing and employee share ownership schemes aim to align employee incentives with corporate success [12](#page=12). * Employees primarily risk job loss, which can lead to significant financial and lifestyle adjustments [13](#page=13). * Employee stock can present a "uniquely ruinous kind of risk," plummeting when jobs are jeopardized [13](#page=13). * Employees can influence decisions through equity stakes or worker representatives on boards [13](#page=13). * Conflicts of interest arise as employees, paid fixed amounts, may be tempted to work leisurely [14](#page=14). * Companies may downsize or act in ways contrary to employee interests for cost savings or stock market reactions [14](#page=14). * Collective agreements between unions and employers are often more detailed than individual contracts [15](#page=15). * Statutes in many jurisdictions regulate employment topics like health and safety and anti-discrimination [15](#page=15). ### Key concepts * **Zone of acceptance:** The range of directions an employee expects to follow [11](#page=11). * **Efficiency considerations:** Management's authority can be justified by reduced costs and increased predictability compared to market-based contracting [11](#page=11). * **Firm-specific knowledge:** Skills honed for an employer's needs that may limit an employee's transferability to other firms [12](#page=12). * **Fixed claims:** Employee entitlements (wages, benefits) that a corporation must pay regardless of its financial performance, provided it remains in operation [12](#page=12). * **Incentive misalignment:** Difficulty for employees to link their individual contributions to overall corporate performance when remuneration is tied to company-wide success [12](#page=12). * **Agency costs:** Costs imposed on principals (shareholders/creditors) by agents (employees) who act in their own self-interest [14](#page=14). * **"Tin parachute" clauses:** Provisions in employment contracts granting severance pay to workers if they lose their job due to a corporate acquisition [15](#page=15). ### Implications * Employee involvement in decision-making is limited, with "doers, not thinkers" being a common perception [14](#page=14). --- # Corporate executives and their functions ### Core idea * Top executives are delegated managerial authority by the board of directors and make key strategic and administrative decisions for the company [21](#page=21). * The CEO is the primary executive responsible for setting and implementing corporate policy, with other top managers handling specialized duties [21](#page=21). * Executives face risks primarily related to their human capital (reputation, training, knowledge) tied to their job [23](#page=23). ### Key facts * Executive employment contracts often specify a fixed duration, with one to five years being common for CEOs of publicly traded companies in the U.S. [21](#page=21). * The U.K. Corporate Governance Code suggests notice or contract periods of one year or less for executives unless longer is required [21](#page=21). * In the U.S., the trend shows a decrease in CEO tenure, from nearly eight years in the 1990s to five years by the end of the 2010s [22](#page=22). * Average CEO tenure in other countries is also around five to six years [22](#page=22). * About three-quarters of new CEOs in American public companies are internal hires [22](#page=22). * Executives are usually very well paid, with remuneration comprising salary, variable pay, and perks [22](#page=22). * Variable pay components like bonus schemes and share options are performance-oriented [22](#page=22). * Executives are not personally responsible for corporate debts unless legislation imposes personal liability [22](#page=22). * Forced departures of senior executives are more frequent after periods of bad firm performance [23](#page=23). * The term "retirement" for a CEO under 60 is often treated as "forced" departure in academic studies [23](#page=23). ### Key concepts * **Managerial services contracts:** Explicit agreements defining terms of employment, often including duration and notice periods [21](#page=21). * **Severance payment:** Compensation provided to an executive upon early termination of their contract, influenced by remaining contract duration or notice periods [21](#page=21). * **"Working at will":** An employment arrangement without an explicit contract, offering no legal entitlement to severance [22](#page=22). * **Executive remuneration components:** - **Salary:** Fixed, periodically adjusted base pay [22](#page=22). - **Variable pay:** Performance-oriented pay like bonuses and share options [22](#page=22). - **Perks/Benefits in kind:** Non-cash benefits such as company cars or pension plans [22](#page=22). * **Human capital risk:** The risk executives face due to their professional reputation, specialized training, and knowledge being tied to their current role [23](#page=23). * **Control:** Encompasses formal authority and discretion to act without substantial constraints, with management typically controlling firms through delegated board powers [23](#page=23). * **Corporate governance:** Defined as the checks and balances affecting those who run companies, with a historical focus on internal checks like board scrutiny [23](#page=23). ### Implications * Executives may prefer remuneration not directly tied to company performance due to their substantial human capital investment [23](#page=23). * Forced departures can significantly jeopardize future employment prospects and reputational standing [23](#page=23). --- ## Common mistakes to avoid - Review all topics thoroughly before exams - Pay attention to formulas and key definitions - Practice with examples provided in each section - Don't memorize without understanding the underlying concepts

| Term | Definition | |------|------------| | Zone of Acceptance | The range of directions and tasks that employees expect to follow as part of their employment agreement with a company. | | Firm's Internal Administrative System | The established procedures and structures within a company that govern the day-to-day operations and management of its workforce, distinct from formal market negotiations. | | Employment at Will | A legal doctrine, prevalent in many U.S. states, that allows employers to discharge employees with immediate effect and without cause, meaning the employment relationship can be terminated by either party at any time. | | Firm-Specific Knowledge | Skills and information acquired by an employee that are unique to the needs and operations of their particular employer, potentially limiting their mobility to other companies. | | Remuneration Package | The total compensation an employee receives, typically including wages, salaries, and benefits such as pensions and health insurance, which are considered fixed claims on the company. | | Profit-Sharing Arrangements | Schemes where employees receive a portion of a company's profits, intended to align their financial interests with the company's performance and incentivize harder work and cost savings. | | Incentive Misalignment | A situation where the rewards an employee receives are not directly or clearly linked to their individual contributions, potentially diluting the motivational effect of performance-based pay. | | Diversification | A risk management strategy, typically employed by shareholders and creditors, of spreading investments across various assets to mitigate losses; employees, often relying on a single job, lack this protection. | | Employee Share Ownership Schemes | Programs that allow employees to own shares in the company they work for, providing them with a stake in the company's success but also exposing them to unique risks. | | Worker Representatives | Individuals elected or appointed to represent the interests of employees in discussions and negotiations with company management or on the board of directors. | | Strategic Management | The process of making major policy decisions that guide a company's long-term direction and objectives, a role typically reserved for senior management and directors. | | Agency Costs | Expenses incurred by principals (shareholders and creditors) due to the potential self-interest or suboptimal performance of their agents (employees), such as working at a leisurely pace or overconsuming perks. | | Director Primacy | A theoretical perspective that views the board of directors as the central decision-making body within a corporation, responsible for balancing the various interests present in the firm. | | Outside Director (Non-Executive Director - NED) | A member of a company's board of directors who is not an employee of the company and does not have a direct operational role. Their primary function is oversight and strategic guidance. | | Executive Pay | The remuneration received by full-time managers and top executives of a company, which is typically structured to include salary, bonuses, share options, and other benefits, often linked to company performance. | | Directors' Fees | The compensation paid to outside directors for their attendance at board meetings and for carrying out their related duties and responsibilities to the company. These fees are generally modest compared to executive pay. | | D&O Insurance (Directors' and Officers' Liability Insurance) | An insurance policy purchased by a company to protect its directors and officers from financial losses arising from legal liabilities and expenses incurred as a result of their service to the company. | | Nominee Director | A director appointed to the board to represent the interests of a specific appointing party, such as a significant shareholder, a creditor, or employees, rather than the general interests of all shareholders. | | Managerial Services Contract | A formal agreement between a company and its executives outlining the terms of employment, including duration, responsibilities, compensation, and conditions for termination. | | Fixed Period Contract | An employment contract with a specified start and end date. Unless renewed, the employment relationship formally concludes upon the expiration of the agreed-upon term. | | Notice Period | A clause in an employment contract that specifies the amount of advance warning either the employer or employee must give to terminate the agreement. This period can influence severance payments. | | "At Will" Employment | An employment arrangement where either the employer or employee can terminate the relationship at any time, for any reason (or no reason), without legal entitlement to severance pay, unless otherwise specified by contract or law. | | Bonus Schemes | Compensation plans designed to reward executives based on the achievement of specific performance targets, which can be awarded annually or over a longer-term basis, and may be paid in cash, shares, or a combination. | | Share Options | A form of performance-related pay that grants executives the right to purchase company stock at a predetermined price within a specified future period, offering potential profit if the company's share price increases. | | Shareholder | An owner of shares in a company, representing a claim on the company's assets and earnings. Shareholders are the ultimate beneficiaries of a company's success, receiving what remains after all fixed claims are satisfied. | | Corporate Governance | The system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community. | | Publicly Traded Company | A company whose shares are listed and traded on a stock exchange, making them available to the general public. These companies typically have numerous shareholders, with few involved in day-to-day operations. | | Privately Held Company | A company whose shares are not traded on a public stock exchange. These companies usually have a smaller number of shareholders who are often involved in the firm's management. | | Residual Claimants | Shareholders are referred to as residual claimants because they are entitled to the company's assets and earnings only after all other obligations and fixed claims have been met. | | Efficient Capital Market Hypothesis (ECMH) | A theory suggesting that asset prices fully reflect all available information. The weak form posits that past prices do not predict future prices, the semi-strong form suggests public information is incorporated, and the strong form implies all knowable information is reflected. | | Volatility Risk | The risk associated with the highly variable potential return of an investment, particularly in equity. This arises from the fluctuation of a company's net profit flow over time, making potential returns for shareholders unpredictable. | | Unsystematic Risk | Risk that is specific to an individual company or industry, arising from company-specific perils. This type of risk can be substantially reduced through diversification. | | Systematic Risk | Risk that affects the entire stock market or a large segment of it, caused by broad economic or market-wide factors. Diversification across many companies does not eliminate this type of risk. | | Capital Asset Pricing Model (CAPM) | A model that describes the relationship between systematic risk and expected return for portfolios or securities. It posits that investment risk is directly correlated with return. | | Appointment Rights | The significant powers bestowed upon shareholders by corporate law, including the right to appoint directors to the board. This allows shareholders to influence the company's leadership. | | Equity Cushion | The residual value of an enterprise remaining after all liabilities have been accounted for, which serves as a protective buffer for creditors against potential losses. | | Claim Dilution | A situation where shareholders may favor a company taking on new debt, even if it increases the risk of default for existing creditors, because the new debt could fund potentially profitable ventures. | | Asset Withdrawal | A source of conflict where a company's shareholders might benefit from a generous dividend policy, receiving cash directly, while this action erodes the equity cushion protecting creditors and increases their risk. | | Risky Managerial Strategies | The pursuit of business opportunities that offer the potential for high returns but also carry substantial risks that could threaten the firm's survival, creating a conflict between shareholders who stand to gain significantly and creditors who bear a greater risk of default. | | Acceleration Clause | A provision within a debt contract that grants a creditor the right to demand immediate repayment of the entire outstanding debt if the corporate borrower breaches any terms of the agreement. | | Loan Covenants | Contractual restrictions stipulated in debt agreements that limit a debtor company's actions, such as requiring permission before incurring additional debt, distributing funds to shareholders, or engaging in certain business strategies. | | Shareholder-First Capitalism | An economic model, particularly prevalent in the United States towards the end of the 20th century, where corporate management prioritizes maximizing shareholder value, which has been criticized for potentially being detrimental to company workers and other stakeholders. | | Tin Parachute Clauses | Provisions included in employment contracts, often seen during periods of hostile takeovers, that entitle rank-and-file workers to severance pay if they lose their jobs as a result of a corporate acquisition. | | Worker Representation on the Board | A governance structure, common in many European countries, where employees or their designated representatives have a formal role in the company's board of directors, allowing them to participate in strategic decision-making. | | Shareholder-Creditor Agency Costs | These are costs arising from conflicts of interest between shareholders and creditors within a corporation. However, the text notes that creditors are unlikely to rely significantly on shareholders due to limited liability. | | Agency Analysis | A framework used to understand conflicts of interest within a corporate context, particularly between principals (like shareholders) and agents (like managers). The text suggests a more direct approach to conflicts rather than always applying an "agency cost" label. | | Information Asymmetries | Situations where one party in a transaction has more or better information than the other, which can hinder complete contracting and lead to potential conflicts. | | Transaction Costs | The expenses incurred when buyers and sellers interact in a market, including costs associated with searching for information, bargaining, and enforcing contracts. These costs can prevent parties from contracting for all possible outcomes. | | Corporate Participants | The key individuals or groups involved with a company, such as shareholders, creditors, employees, directors, and executives, each with distinct interests and stakes. | | Bargaining Elements | Six concepts used to analyze interactions between corporate participants: duration of arrangements, anticipated return, risk of loss, degree of control, existence of conflicts of interest, and the possibility of explicit contractual arrangements. | | Collective Investment Vehicles | Financial products, such as index tracking funds, that allow individual investors to invest in a diversified portfolio of stocks, often at lower costs. |