Economics 434 Theory of Financial Markets

Economics 434Theory of Financial Markets Professor Edwin T Burton Economics Department The University of Virginia

Corporate Governance • What is the objective of a corporation (or any business)? • Profit Maximization? • Maximize Share Value? • Benefit Stakeholders? • Board of Directors • Elected by shareholders • Hire and fire the CEO • Audit Committee • Compensation Committee • Governance Committee

Maximize Share Value • Since there is uncertainty • This means maximizing expected value • Of discounted future cash flows • This rules out diversification strategies (shareholders can do that on their own) • Stakeholder view is murky. Similar to governance patterns at tax free institutions

Directors • Inside director • A company employee • Outside director • Not a company employee • NYSE requires a majority of directors to be “outside” directors • Directors are paid well • Re-elected at regular intervals

Principle-Agent Problems • Board is supposed to “represent” the interests of the shareholders – “fiduciary” duty • But, do they? • Reasons to wonder: • Executive compensation • Mergers and acquisitions

Other Principal-Agent Problems • Shareholder might be • Pension fund • Endowment • May not be paying attention to what the board may be doing • May have Principal-Agent problems of their own

ISS • Classified board • Means terms are staggered • ISS proposes • One year terms • All board members elected annually • Say on pay by shareholders

The End

Economics 434 Theory of Financial Markets