Berkshire Hathaway Vice Chairman Charlie Munger is well known as the partner of CEO Warren Buffett and also for his advocacy of “multi-disciplinary thinking”—the application of fundamental concepts from across various academic disciplines to solve complex real-world problems. One problem that Munger has addressed over the years is the optimal system of corporate governance. How should an organization be structured to encourage ethical behavior among organizational participants and motivate decision-making in the best interest of shareholders? His solution is unconventional by the standards of governance today and somewhat at odds with regulatory guidelines. However, the insights that Munger provides represent a contrast to current “best practices” and suggest the potential for alternative solutions to improve corporate performance and executive behavior. In our paper, Corporate Governance According to Charles T. Munger, which was recently made publicly available on SSRN, we examine this solution in greater detail.
Posts Tagged ‘General governance’
2013 was the strongest year for venture-backed initial public offerings (IPOs) in almost a decade: 82 deals (the most since 2007) generated aggregate proceeds of over $11.2 billion, an average offering amount of $137.2 million. At least one venture-backed company went public each month in 2013, and the pace of IPOs has accelerated in the first three months of 2014.
Much corporate finance research is concerned with causation—does a change in some input cause a change in some output? Does corporate governance affect firm performance? Does capital structure affect firm investments? How do corporate acquisitions affect the value of the acquirer, or the acquirer and target together? Without a causal link, we lack a strong basis for recommending that firms change their behavior or that governments adopt specific reforms. Consider, for example, corporate governance research. Decisionmakers—corporate boards, investors, and regulators—need to know whether governance causes value, before they decide to change the governance of a firm (or all firms in a country) with the goal of increasing firm value or improving other firm or market outcomes. If researchers provide evidence only on association between governance and outcomes, decisionmakers may adopt changes based on flawed data that may lead to adverse consequences for particular firms.
The 2008 financial crisis and the slow recovery that has followed has brought further evidence tending to support the view that the structure of our corporate sector needs adjustment, and that its faults affect the competitiveness of our economy. The crisis has resulted, as would be expected, in a raft of new rules and regulations, which as usual have been implemented before there emerged any consensus about the nature of the problems. There has also been a vigorous competition of ideas over causes and remedies.
Capitalism is abundant in contradictions that result in the production of crises. During such crises capital goes through devaluations that give rise to unemployment, bankruptcies and income inequality. The ability of a nation to resist the forces of devaluation depends on the array of institutional or spatio-temporal fixes it possesses, which can buffer the effects of the crisis, switch the crisis to other nations or defer its effects to the future. Corporate governance configurations in a given social order can function as institutional or spatio-temporal fixes provided they are positioned within an appropriate institutional environment that can give rise to beneficial complementarities.
The recent announcement of the formation of the Shareholder-Director Exchange, a new group that aims to facilitate direct communication between institutional shareholders (namely, mutual funds and pension programs) and non-management directors of the U.S. public companies they own, has been accompanied by a flurry of articles regarding the purposes and possibilities of this new group. From my perspective, the Shareholder-Director Exchange has tremendous potential to help improve corporate governance and performance in this country.
Amid the recent uptick in U.S. IPO transactions to levels not seen since the heady days of 1999 and 2000, Davis Polk’s pipeline of deals remains robust, leading us to believe that strength in the U.S. IPO market will continue in the near future. With ongoing pressure on companies that are past the IPO stage to update or modify their corporate governance practices to align with the views of some shareholders and proxy advisory groups, we thought this would be a good time to review corporate governance practices of newly public companies to see if they have also shifted in recent years. Our survey is an update of our October 2011 survey and focuses on corporate governance at the time of the IPO for the 100 largest U.S. IPOs from September 2011 through October 2013. Results are presented separately for controlled companies and non-controlled companies in recognition of their different governance profiles.
Institutional Shareholder Services Inc. (ISS) has announced the governance factors and other technical specifications underlying its new Governance QuickScore 2.0 product, which ISS will apply to publicly traded companies for the 2014 proxy season. Companies have until 8pm ET on Friday, February 7th to verify the underlying raw data and can submit updates and corrections through ISS’s data review and verification site. ISS will release company ratings on Tuesday, February 18th, and the scores will be included in proxy research reports issued to institutional shareholders. While previous QuickScore ratings remained static between annual meeting periods, ISS has now committed to update ratings on an on-going basis based on a company’s public disclosures throughout the calendar year.
In our paper, How Does Corporate Governance Affect Bank Capitalization Strategies?, which was recently made publicly available on SSRN, we examine how corporate governance and executive compensation affect bank capitalization strategies for an international sample of banks over the 2003-2011 period.
We find that ‘good’ corporate governance—or corporate governance that causes the bank to act in the interests of bank shareholders—engenders lower levels of bank capital. Specifically, we find that bank boards of intermediate size (big enough to escape capture by management, but small enough to avoid free rider problems within the board), separation of the CEO and chairman of the board roles, and an absence of anti-takeover provisions lead to lower capitalization rates. ‘Good’ corporate governance thus may be bad for bank stability and potentially entail high social costs. This disadvantage of ‘good’ corporate governance has be balanced with presumed benefits in terms of restricting management’s ability to perform less badly in other areas—for instance, by shirking or acquiring perks—at the expense of bank shareholders.
In the paper, Blockholders and Corporate Governance, forthcoming in the Annual Review of Financial Economics, I review the theoretical and empirical literature on the different channels through which blockholders (large shareholders) engage in corporate governance. Berle and Means’s (1932) seminal article highlighted the agency problems that arise from the separation of ownership and control. When a firm’s managers are distinct from its ultimate owners, they have inadequate incentives to maximize its value. For example, they may exert insufficient effort, engage in wasteful investment, or extract excessive salaries and perks. The potential for such value erosion leads to a first-order role for corporate governance—mechanisms to ensure that managers act in shareholders’ interest. The importance of firm-level governance for the economy as a whole has been highlighted by the recent financial crisis, which had substantial effects above and beyond the individual firms involved.