Accounting, Analysis and Governance in Complex Deals
Governance in Complex Deals?
BMME303
Accounting, Analysis and Governance in Complex Deals
Corporate Governance
What & Why?
- Protect stakeholder interests against factors that are internal and external to the firm
- Horizontally balance interests between stakeholders
- Vertically balance interests with management
Horizontal Disputes
Balancing Interests between Stakeholders
Shareholder viewpoint
- Primary purpose of the firm: maximize shareholder value
Stakeholder viewpoint
Societal obligation that somehow conflicts with maximizing shareholder value
Employment safety, creditor protection, improvements to the community & environment
Are shareholder and stakeholder value maximization mutually exclusive?
“You can please some of the stakeholders all the time, all stakeholders some of the time, but you can’t please all of them all the time.”
Did Abraham Lincoln say that?
Are shareholder and stakeholder value maximization mutually exclusive?
Yes!
- Conflicting Objectives: Shareholder value focuses on financial returns, while stakeholder value includes broader societal and environmental goals, which may not always align.
- Resource Allocation: Prioritizing stakeholder interests might divert resources from profit-maximizing activities, potentially reducing shareholder returns.
- Short-Term & Long-Term Performance: pursuing stakeholder value often means sacrificing short‑term results, leaving shareholders to absorb uncertainty about whether long‑term gains will ultimately materialize.
Are shareholder and stakeholder value maximization mutually exclusive?
No!
- Sustainable Growth: Addressing stakeholder concerns (e.g., environmental sustainability) can lead to long-term profitability, benefiting shareholders as well.
- Reputation and Trust: Companies that prioritize stakeholder value often build stronger reputations, attracting customers and investors, which can enhance shareholder value.
- Regulatory and Market Trends: Increasing regulatory and market pressures favor companies that balance shareholder and stakeholder interests, aligning both goals over time.
Vertical Disputes
Balancing Interests with Management
Vertical disputes arise from direct disagreement between management and shareholders
Managers make decisions that may not align with shareholder interests, e.g. excessive risk-taking, empire-building, or misreporting performance
\(\Rightarrow\) brings us “back” to one of the most relevant theories in accounting! Which?
Agency Theory
Corporate Governance
- Moral hazard: “post-decision” (e.g., misreporting performance to shareholders)
- Adverse selection: “pre-decision” (e.g., CEO hiring/compensation)
Why do these issues arise?
Agency Theory
Corporate Governance
Information asymmetry
- Can shareholders perfectly observe what the management is doing? No!
- Agency problem \(\rightarrow\) rational executives maximize their own utility and incentives are often not perfectly aligned with shareholders, leading to potential conflicts of interest and suboptimal decisions from the perspective of shareholders
Some examples of agency problems
- Manipulating financial reports or taking excessive risks to increase bonus or stock price
- Empire-building \(\rightarrow\) overinvestment in unprofitable projects, incl. acquisitions
Control Mechanisms
Corporate Governance
From Corporate Governance to Complex Deals
Control Mechanisms
- Advise and monitor management: set incentive-compatible pay
- Approves major decisions, such as acquisitions
- If target, consider antitakeover defenses1 to negotiate higher purchase price
Corporate Governance in Complex Deals
Takeaways
Corporate governance is an important device to balance interests
In the context of complex deals, corporate governance gains relevance for the …
… Board of Directors, which has a major influence on decisions such as acquisitions, and negotiates on behalf of shareholders in the event of a takeover attempt
… Shareholders, who can influence corporate policies through voting rights and activism
… CEO, whose professional role as agent may conflict with shareholder interests when pursuing acquisitions. What about a CEO’s private life?
GameStop’s Push to Acquire Ebay
Things People Love?
GameStop’s Push to Acquire Ebay
Things People Love?
Gamestop’s CEO, Ryan Cohen, expressed interest in acquiring Ebay
The May/4 move surprised many given the companies’ different business models and market positions
The next day, he gave an interview to CNBC which earned him the headline “GameStop’s Ryan Cohen is either the new Buffett or the anti-Buffett” (FT & FT Summary)
\(\Rightarrow\) Watch the Video on Youtube (or Canvas)!
\(\Rightarrow\) We will revert back to this example regularly throughout the course!
GameStop’s Push to Acquire Ebay
Things People Love?
Governance Questions (among others)
\(\Rightarrow\) When asked about why the deal is “unsolicited” [1:50], Cohen replies that “there’s all kinds of perverse financial incentives for the board and management” Which?
\(\Rightarrow\) Which aspect discussed in the interview [e.g., 12:00] raises the question whether this is a case of a CEO pursuing an acquisition that may not align with shareholder interests?
A CEO’s Personal Life
Should the personal life of a CEO be part of corporate governance?
Corporate Governance
Should the personal life of a CEO be part of corporate governance?
Current Regulatory Landscape
- No explicit disclosure requirements for private matters, other than general “financial materiality”
- Companies determine materiality case-by-case
- Inconsistent disclosure across companies
The Case for Disclosure
- Information asymmetry might create inefficient capital allocation
- Material information is decision useful for investors
- Executive position demands enhanced accountability
Trigger warning. Subsequent slides contain sensitive content.
Should the personal life of a CEO be part of corporate governance?
Corporate Governance
Steve Jobs (Apple, 2008)
- Appeared visibly ill at product announcement
- Stock moved on his appearance alone
- Company refused to comment on his health
- Later revealed he had pancreatic cancer
- Created significant stock volatility
Should the personal life of a CEO be part of corporate governance?
Corporate Governance
Charles Bell (McDonald’s, 2004)
- Diagnosed with colorectal cancer as new CEO
- Company immediately disclosed his condition
- Resigned within months
- Died shortly thereafter
- Created leadership transition challenges
Should the personal life of a CEO be part of corporate governance?
Corporate Governance
John Browne (BP, 2007)
- Successful CEO who transformed BP
- Career ended when newspaper published article about his relationship
- Unexpected resignation damaged leadership continuity
- Created significant reputational impact
Should the personal life of a CEO be part of corporate governance?
Corporate Governance
Steve Appleton (Micron Technology, 2012)
- CEO and aviation enthusiast killed in experimental plane crash
- Had previous plane crash in 2004 but continued flying high-risk aircraft
- Trading halted after news broke
- Stock had risen 26% that year before the crash
- Company faced unexpected leadership transition
- Raised questions about limits on executive risk-taking behaviors
CEO Personal Risk-Taking and Corporate Policies
Cain and McKeon (2016)
Research Question
Is personal risk-taking of CEOs associated with firm risk, specifically corporate policies such as acquisitions?
CEO Personal Risk-Taking and Corporate Policies
Cain and McKeon (2016)
Research Question
Is personal risk-taking of CEOs associated with firm risk, specifically corporate policies such as acquisitions?
Findings
- CEOs with private pilot licenses (proxy for personal risk-taking) lead riskier firms with higher equity return volatility.
- Elevated firm risk stems from policies like leverage and acquisition activity.
- Nonpecuniary risk preferences outside the firm influence project selection and corporate policies.
CEO Personal Risk-Taking and Corporate Policies
Cain and McKeon (2016)
Acquisitiveness of Pilot CEOs
CEO Personal Risk-Taking and Corporate Policies
Cain and McKeon (2016)
Pilot CEOs and M&A Announcement Returns
Corporate Governance
Takeaways
Governance Essentials: Corporate governance provides the framework to control businesses, primarily aiming to balance interests vertically and horizontally
Agency Theory 101: A key fundamental of corporate governance is that it addresses agency problems that are fueled by information asymmetry
Who’s in Charge?: Key players include shareholders, the Board of Directors (monitoring, approving major decisions, incentivizing management), and CEOs
Beyond the Boardroom: A CEO’s personal life and risk appetite can significantly influence corporate decisions, including M&A (these deals don’t necessarily yield better announcement returns)
Thank You!
Copyright
© Erasmus University Rotterdam, all rights reserved. No text and data mining.
Titlepage photo by Dennis Möller on Unsplash
References