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External Governance Control Mechanisms

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by

Krisha Alcantara

on 18 September 2012

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Transcript of External Governance Control Mechanisms

Reporter: External Governance Control Mechanism External Governance
Control Mechanisms

methods that ensure that managerial actions lead to shareholder value maximization and do not harm other stakeholder groups and that are outside the control of the corporate governance system.

External Governance Control Mechanisms
Market for corporate control
Auditors
Banks and analysts
Regulatory bodies
Media and public activists Market for corporate control
an external control mechanisms in which shareholders dissatisfied with a firm’s management sell their shares.
managers tend to behave opportunistically
Maricris Opportunistic Behavior
1. Shirking- managers fail to exert themselves fully, as is required of them.
2. On the Job Consumption- consumptions by managers that does not in any way increase shareholder value.
3. Excessive Product-Market Diversification- serves to reduce only the employment risk of the managers rather than the financial risk of the shareholders.
Takeover Constraint
the risk of being acquired by a hostile raider.
deters management from engaging in opportunistic behavior.
Defense tactics:
1. Poison pills- to reduce its worth to the acquirer
2. Greenmail- buying back the stock
3. Golden parachutes- employment contracts
Auditors
managers may deliberately disclose false information or withhold negative financial information as well as use accounting methods that distort results based on highly subjective interpretations.

Auditing firms- independent organizations staffed by certified professionals who verify the firm’s book of accounts.
Banks and Analysts
commercial and investment banks have lent money to corporations and therefore have to ensure that the borrowing firm’s finances are in order and that the loan covenants are being followed.
Regulatory Bodies
-all corporations are subject to some regulations by the government. The extent of regulation is often a function of the type of industry.
Reasons for disclosure:
1. Market can operate efficiently only when the investing public has faith in market system.
2. Disclosure of information such as insider trading protects the small investor to some extent from the negative consequences of information asymmetry Sarbanes-Oxley Act
Auditors
Barred from certain types of non-audit work
Not allowed to destroy records for five years
Lead partners auditing a firm should be changed at least every five years

Sarbanes-Oxley Act

CEOs and CFOs
Must fully reveal off-balance sheet finances
Vouch for the accuracy of information revealed
Executives
Must promptly reveal the sale of shares in firms they manage
Are not allowed to sell shares when other employees cannot Sarbanes-Oxley Act

Corporate Lawyers
-must report to senior managers any violations of securities law lower down. External Governance Control Mechanisms
Media and Public Activists
-public perceptions about a company’s financial prospects and the quality of its management are greatly influenced by the media.

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