Tutorial Questions Week 2 Corporate Law

Tutorial Questions Week 2: Corporate Law 1. What are the three agency problems and can you give examples of these problems? 1. Owners vs Managers 2. Majority vs Minority Shareholders: Minority cannot choose board 3. Firm vs Stakeholders/Other Parties: misleading customers, exploiting workers 2. True or False – The greater the complexity of tasks undertaken by the agent, and the greater the discretion the agent must be given, the larger these “agency costs” are likely to be. Motivate your answer. True, as agent has more responsibilities and powers to make many decisions. 3. How does law in general and corporate law in particular play a role in reducing agency costs? Rules and procedures that enhance disclosure by agents or facilitate enforcement actions. Lawmakers constrain agents via rules that help prohibit specific behaviours. 4. What is the main distinction between the two main categories of legal strategies for controlling agency costs: regulatory strategies and governance strategies? Regulatory: Dictate terms that govern the principal agent problem. Ensures enforcement of regulation. Governance: Seek to facilitate the principal control over the agents’ behaviour. 5. Why is the ‘decision rights’ strategy of limiting agency problems less prominent in corporate law than the ‘appointment rights’ strategy? Disparity is an obvious fact that the corporate form is designed for the delegation of managerial power and authority to the board. They have much more influence in appointments but barely any in decisions. 6. The law can be instrumentally deployed to mitigate the vulnerability of principals to the opportunism of their agents. How can – as a legal strategy – terms of entry and exit constrain agents? Terms of Entry: Full disclosure before contracting so there is adequate supply of information about the possible board members and their performance Terms of Exit: Selling and transferring shares. Right to withdraw and right to transfer in cases such as mergers. 7. In regulatory strategies, give examples of terms of exit or exit strategies. Page 34 Right to withdraw the value of one’s investment Right to transfer/sell shares Similar to above 8. What is one well-known example of a trusteeship strategy? Why do you think it is used in most jurisdictions? The independent director 9. How can an independent director serve as a means of ameliorating agency problems? They will not disproportionally benefit from decisions made by them nor will they control shareholders. Means including guarding other interests such as minority shareholders, employees and external parties. 10. Explain why incentivizing managers by compensating them in the form of shares in their firm can be understood as an example of both the ‘sharing rule’ and the ‘pay-for-performance regime’ form of the reward strategy? Page 36 Sharing Rule: Tying agents’ (managers) monetary returns directly to those of the principal (original shareholders) by giving them shares essentially. So, they have incentive to maximise returns of shareholders. Pay for performance regime: Pays agents for successfully advancing in the principal’s interests 11. Why would a lot of smaller shareholders (as opposed to bigger majority shareholders) have increased agency costs? Explain in your own words. For the same access they need accountants and lawyers and so on. As a minority shareholder it costs the same as a majority shareholder overall but per person it costs more. Coordination costs amongst the minority shareholders as there are more fractions can also lead to this increase. 12. What would be the reason for directors having fiduciary duties towards the company but not towards the shareholders? Irrelevant right now. Too theoretical. If directors would have fiduciary rights towards the shareholders, the shareholders would be much more active and this would have an effect on the investor diversity of their capital. 13. In the discussion of the divergence and convergence of board function (lecture slides week 2), what are the main differences in the governance models (Anglo American versus Rijnlands model)? Anglo American: Shareholders value norms One-tier boards Low ownership concentration Rijnlands Stakeholder concerns Two-tier boards Focus on insider ownership 14. Mention three modalities of enforcement. 1. Public officials: Criminal and civil suits brought by public officials 2. Private parties acting in their own interests: class actions 3. Strategically placed private parties (‘gatekeepers’) conscripted to act in the public interest: accountants (must be independent) and lawyers conscripted to police the conduct of corporate actors 15. Explain how mandatory financial audits constitute a form of ‘Gatekeeper control’. Ex Ante/Preventive means of constraint, like auditors refusing to issue unqualified reports. Accountants review and must approve reports independently. 16. Why can public enforcement be seen as suffering from weaker incentives than private enforcement and what can be done to mitigate this? Public enforcement suffers from limitations. Public officials don’t always have the means nor capacity while private enforcement means hired lawyers will investigate the matter and the plaintiffs will hopefully be rewarded with financial payments. New corporate law: don’t only pay individuals but also to the government. 17. Give an example of private enforcement by a public actor. If the government is a shareholder, it can engage in private enforcement actions. Example: Airlines, Energy, Infrastructure 18. In some civil law jurisdictions, ex ante consequences of violating company law rules is an annulment of corporate decisions. Explain how this can reduce the agency costs (as opposed to ex post penalties)? Costs of cancelling and delaying until the corporate action is allowed can reduce agency costs. Example: Many companies at Schipol Airport: 6000 company cars provided had GPS tracking devices (allowed for private use). Working Council: according to Dutch law, measures to locate you is an infringement of privacy that can only be done when there is consent given. After court, all the cars had to go back and have GPS removed (6 Million euros) and then given back to companies. 19. Below are legal strategies for protecting principals. All legal strategies are ex ante except: A. Entry Strategy B. Trusteeship Strategy C. Selection Strategy D. Veto Strategy 20. Below are legal strategies for protecting principals. All legal strategies are ex post except: A. Entry Strategy B. Reward Strategy C. Removal Strategy D. Veto Strategy