L00 - Macro

Monitoring

Principal-Agent framework

• shareholders are the principals
• managers are the agents

Agency Problem A conflict of interest inherent in any relationship where one party is expected to act in another’s best interests.

Agency costs reduce firm value due to agency problems:

• value lost because managers do not make value-maximising decisions
• Costs of monitoring managers

Stockholders want three things:

• maximise current wealth
• transform wealth into most desirable time pattern of consumption
• manage risk

Who monitors a company?

• (Primary) Board of Directors
• Auditors issue reports (unqualified, qualified, adverse) opinions through the GAAP (generally accepted auditing principles).
• Lenders (banks, shareholders) monitor assets, activities and profitability.
  • shareholders through activist investors for example
• other managers (risk of takeovers)

Bank monitoring is not necessarily aligned with that of shareholders (but necessarily with lenders) → bank wants less risks to get principal back

• shareholders might want more risk, as they get nothing back if default

Incentives:
Compensation plans:
“say on pay” shareholder vote (non-binding in US)
UK is forward and backwards voting on compensation → binding

usually you give “locked” up shares = restricted stock options → this makes long-term thinking more valuable to CEO

In Different Countries

Japan: Kereitsu → system of companies organised around a main bank → cross holdings between companies and bank

Germany:
before:

• shareholders → mainly bank holdings (Daimler AG)
  today:
• smaller investors
  this changed in 2002 → before there were capital gains taxes on shares 52%
• now no capital gains on shares +1 year for corporate
• Before, they were locked up at 52% basically exit-tax

In Fr, DE, Ru large majority shareholders are through a pyramid holding structure → family businesses

Market Based vs. Bank Based economies

Market based

• usually suggested that it’s more myopic
  • less likely to view long-term investments
• better for new industries
• opacity

Bank Based:

• less innovative as more risk-averse
• monitoring is more thorough → banks check on their loans

Different Economy types

Friedman “social responsibility of a business is to increase it’s profits”
Shareholder Capitalism (Milton Friedman)

• the government regulations will protect stakeholders (social responsibility) and manage externalities through laws and taxes
• firms should maximise profits within rules
• company → no comparative advantage in serving society
  • shareholders can donate their proceeds to shareholders directly

Problems:

• NPV only useful if perfectly predictable
• only doing project if NPV + then missing opportunities to create value
• Companies that care about stakeholders perform better! Measurable

ESV (Enlightened Shareholder Value)

• stakeholders are a means to an end
• invest in them (via bonus, salary) if it is NPV +
• but increasing shareholder value is still the final goal.
  If total pie increases but shareholder part decreases → Not NPV > 0 and thus rejected
• stakeholder capitalism would accept this!
  Problem: Not clear what to do, no clear decision rule! Which stakeholder to prioritise?
• coal plant workers vs. environment

Stakeholder Capitalism

• justified when Friedman’s assumptions fail
• freedom as manager to take decisions without caring about NPV calculation
  • but comes as a cost, no clear replacement of NPV (no decision rule)
  • accountability to everyone means accountability to none
• Weighting shareholders vs stakeholders (how much shareholder value shall be “sacrificed”)
• How to measure stakeholder value (salary, happiness, etc…)

Not the same as CSR (department for corporate social responsibility - like in a tobacco company)
Responsible Businesses

• create shareholder value via society
• mixture of shareholder and stakeholder capitalism
• create value for society by the business itself.
• more value creation vs. value extraction
  What principles can a responsible business use to make decisions? Incorporate negative externalities into the investment decisions.

Principle of Multiplication:

• social benefits exceed private costs
  • ex: feeding homeless through company canteen → 1$ invested returns more
    Comparative Advantage:
• benefit to stakeholders > value others could provide
  • ex: soup kitchen could do better than staff canteen → feeding homeless does not pass
    Principle of Materiality:
• priorities most important stakeholders!
  • is stakeholder X benefit material to company (close suppliers)

Note
Most US companies → incorporated in Delaware so have fiduciary duty to shareholders

• no ESV or Responsible Business

Benefit Corp vs. B-Corp

Benefit Corp

• US legal status
• has to have a mission
• publish “benefit report”
• can get sued for not delivering on this

B-Corp:

• B-Labs independent certifier → NGO
• independent assessment, no legal obligations

but all companies can have a “reason to exist” (Danone: feed the world better)

• shareholders can vote on this
  • “say-on-purpose”

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ESG (Environmental, social and governance)

• CEO pay linked to ESG targets (principal agency problem - hit metric not actually care)
• ESG ratings for a company (like credit-worthiness)
  • These ratings are inconsistent (correlation of 0.38-0.71 between rating companies)