The standard view of CG (“The Shareholder Value Model”):

1. The standard view of CG (“The Shareholder Value Model”): Deals with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investments Both owner capital and debt financing

2. Prime aim: • To present the standard view of Corporate Governance, where shareholders and debtors are vital for corporate control.

3. Conflicting interests (managers vis-à-vis owners) • The founders of a firm sell shares to outside investors to raise money for additional investments (the firm “goes public”) • The decision to sell shares may affect incentives for maximizing profits (“ownership affects incentives”) • The fact that the founder retains only a part of the shares alone does not cause any distortions (maximization of a share of financial net benefits also maximizes total financial net benefits) • Distortions appear to the extent that decisions have non-financial costs and benefits hat are not easily observed and contracted over. • An owner-manager, who owns 50 % of the shares and decides to fly first-class, pays only 50% of the costs but receives all benefits of flying first-class

4. Types of conflicts: • Growth (investment) and longevity of companies: a) top managers in larger firms tend to earn higher salaries, b) when companies become bankrupt or are sold or taken over managers loose lucrative jobs • Advantages or benefits considered as part of the job as manager (perks): As owner-managers bear only part of the costs, they are tempted to spend too much on benefits to themselves • Managements prefer independence from outside interference

5. What can the suppliers of capital do in this situation? • Get decision and control rights enforced by a court of law • Shareholders have the right to elect boards of directors • Creditors can 1) force a firm that is in default to liquidate assets and 2) enforce restrictions on the debtor’s behaviour, which are written into the debt contracts. • Incentive systems of the management

6. Basic Shareholder Value model: • I : Set up cost of the project • A: “Initial equity” (contribution by the entrepreneur to cover part of investment costs) • R: Profit at the end of the project (R>0 a success; R=0 a failure) • pH: Probability of success if the entrepreneur “behaves” • pL: Probability of success if the entrepreneur “misbehaves” • B: Private benefit if the entrepreneur “misbehaves” • w: Compensation the entrepreneur receive in case of success (w=0 in case of failure)

7. Markets for corporate control • The critical corporate governance mechanism in the Anglo Saxon system (large shareholders are less common) • Hostile takeovers (control is bought despite active resistance by the top management of the target firm) • Corporate control: the rights to determine the management of corporate resources (the rights to hire, fire and set the compensation of top level managers) • The managerial competition model: the acquisition of a target firm implies that control rights are transferred to the board of the acquiring firm. • The free cash flow should be distributed to shareholders, who use the stock markets to allocate this flow to alternative uses.

8. Management (MBO) and Leveraged buyouts (LBO) • MBO:Changes in corporate ownership, where firms’ managers purchase outstanding shares in order to gain ownership control. • LBO: • Shareholders are bought out by a new group of investors usually including old managers, a specialized buyout firm and debt holders. • Most of the finance comes from “junk bonds” (corporate debentures that are considered particularly risky and so carries a high interest rate). • The financial structure is changed as equity is replaced with debt • The debt holders are organized in associations to monitor management intensively.

9. LBOs are efficient organizations • Old shareholders are bought out with a premium • Increased profits • Lower agency costs: non-core competences sold out