# Corporate Governance Concept Card: [Company or case name] > A concept card for the corporate governance elective of a leading MBA programme: why governance exists (the > separation of ownership and control), the two agency problems (managers against shareholders, controlling against > minority shareholders), the mechanisms that address them (the board, executive pay, ownership, debt, the market for > corporate control, activism, disclosure and law), how ownership structures such as pyramids and dual-class shares > separate control from cash-flow rights, and how the governance codes stood in October 2026. It builds on the > governance session of `mba/mba-ethics-guide` and on the agency ideas in `mba/mba-capital-structure-card`, and does > not re-teach them. It is for MBA students in a governance, ethics, finance or strategy elective, future board members > and managers who report to a board. Worked example A (Northfield Outdoor Co.: board and CEO incentives) is fully > solved, Worked example B (a family pyramid) is half solved and Exercise C (the Tallow Creek Medical Center board) is > left to you; the self-test answers sit in a separate key. > Source basis: Berle and Means (1932), Jensen and Meckling (1976), Fama and Jensen (1983), Jensen and Murphy (1990), > Shleifer and Vishny (1997), La Porta, Lopez-de-Silanes and Shleifer (1999), Johnson et al. (2000) and the G20/OECD > Principles of Corporate Governance (2023), written up in original words. Northfield Outdoor Co. (treated as listed), > Group F, Holding H, Company L and Tallow Creek Medical Center are fictional, and every number was computed in Python. > Replace every [bracketed] value and every row marked *Example*. > This is a learning aid, not legal or regulatory advice: listing rules, company law and codes differ by jurisdiction > and change, so check the text that applies to your company. ## Document control | Field | Value | |---|---| | Course or project | [Corporate governance elective, session 4 / board review / case] | | Learner or team | [Your name or learning team] | | Company analysed | [Northfield Outdoor Co. (fictional) / your company] | | Jurisdiction and listing | [Country, exchange, company law] | | Code applied | [G20/OECD Principles 2023 / UK Corporate Governance Code 2024 / local code] | | Evidence sources | [Annual report, proxy statement, articles, board minutes extracts] | | Reviewed by | [Instructor, mentor or company secretary] | | Date | YYYY-MM-DD | | Version | [0.1] | ## Contents 1. When to use it 2. The idea in plain language 3. Formulas and notation 4. Assumptions and limits 5. How boards and investors use it 6. Codes and rules as of October 2026 7. Worked example A (fully solved): Northfield Outdoor Co. 8. Worked example B (half solved): Group F's pyramid 9. Exercise C (unsolved): Tallow Creek Medical Center 10. Connections to other cards 11. Common mistakes and misconceptions 12. Self-test questions 13. My notes and next steps 14. Sources and further reading 15. Answer key ## When to use it **One-sentence rule:** use this card when a case or a real decision turns on whether the people who control a company have the incentives, information and accountability to run it in the interest of its owners and within the law. | Use it when | Use something else when | |---|---| | A case asks whether a board is effective or independent | The question is an individual ethical dilemma (`mba/mba-ethics-guide`) | | You must judge a CEO pay plan or a say-on-pay vote | The question is which stakeholders matter and what to report (`mba/mba-stakeholder-esg-card`) | | A controlling shareholder, family group or founder with super-voting shares is involved | The question is how much debt the firm should carry (`mba/mba-capital-structure-card`) | | An activist investor or a takeover bid challenges management | The question is the price and terms of the takeover (`mba/mba-deal-structuring-card`) | | A related-party transaction must be approved | The question is AI system oversight (`mba/mba-ai-risk-governance-card`) | | You prepare for a non-executive or advisory board role | You need the board pack itself (`business/board-pack`) | ## The idea in plain language **Separation of ownership and control.** Berle and Means (1932) documented that ownership of the largest US corporations had become dispersed among many small shareholders while control sat with salaried managers. Dispersed owners have little reason to monitor: each bears the full cost of monitoring and gets only a small share of the gain. Corporate governance is the set of mechanisms that let suppliers of finance assure themselves of a return on their investment, in the definition of Shleifer and Vishny (1997). **Agency costs.** Jensen and Meckling (1976) modelled the firm as a nexus of contracts in which a manager (agent) acts for owners (principals). Because the manager bears only part of the cost of perquisites, shirking or empire building, there is a loss. Agency costs are the sum of monitoring costs paid by the principal, bonding costs paid by the agent to show good faith, and the residual loss that remains. Fama (1980) added that a managerial labour market disciplines managers through their reputations. Fama and Jensen (1983) separated **decision management** (initiating and implementing) from **decision control** (ratifying and monitoring) and argued that in large firms the board performs decision control on behalf of residual claimants. **Two agency problems.** In dispersed-ownership firms the main conflict is between managers and shareholders (often called type I). In most of the world, however, firms have a controlling owner: La Porta, Lopez-de-Silanes and Shleifer (1999) found that outside economies with strong shareholder protection, large firms were typically controlled by families or the state, often through pyramids and cross-holdings. There the main conflict is between the controlling owner and minority shareholders (type II). The controller can extract private benefits through **tunnelling**: transfer pricing, asset sales or loans on favourable terms to companies the controller owns more of (Johnson et al. 2000). **Mechanisms.** No single mechanism solves the problem; they substitute for and complement each other. | Mechanism | How it works | Typical weakness | |---|---|---| | Board of directors | Hires, pays, monitors and if needed replaces the CEO; approves strategy and major transactions | Directors depend on the CEO for information and nomination (Hermalin and Weisbach 2003) | | Executive pay | Links managers' wealth to shareholder value (Jensen and Murphy 1990) | Managers may influence their own pay; options can reward luck and risk taking | | Large shareholders | Have the incentive to monitor | May use control for private benefits (type II) | | Debt | Commits free cash flow to payouts and limits empire building (Jensen 1986) | Distress costs and underinvestment | | Market for corporate control | Poorly run firms become takeover targets (Manne 1965) | Takeover defences, costly bids | | Shareholder activism | Hedge funds and other investors push for change; Brav et al. (2008) found positive abnormal returns around activist filings | Short horizon claims; cost of campaigns | | Disclosure and audit | Make performance and related-party dealings visible | Only as good as enforcement | | Law and enforcement | Protect minority rights, punish self-dealing (La Porta et al. 1999) | Varies widely by country | **Boards in practice.** Boards act through committees: audit (financial reporting, internal control, external auditor), remuneration (executive pay) and nomination (board composition and succession), plus risk or sustainability committees in many firms. Two common structures exist: a one-tier board with executive and non-executive directors, and a two-tier structure with a management board supervised by a separate supervisory board. Independence matters because decision control only works if the controllers are not the managers. Splitting the roles of chair and CEO, or appointing a lead independent director, is meant to give the board its own agenda. **Pay and incentives.** Jensen and Murphy (1990) estimated that CEO wealth changed by about USD 3.25 for every USD 1,000 change in shareholder wealth in their sample of US firms, and argued that pay was too weakly tied to performance. Pay-performance sensitivity rose sharply in later decades, mainly through equity grants. Bebchuk and Fried (2004) argued that managers' influence over their own boards produces pay that is high and less sensitive to performance than it appears (the managerial power view). Good design combines meaningful long-term equity holdings, vesting and holding periods, performance conditions that remove market-wide luck where possible, and clawback of pay awarded on misstated results. **Governance and value.** Gompers, Ishii and Metrick (2003) built a governance index from 24 shareholder-rights provisions and found that firms with stronger shareholder rights had higher valuations and, in their sample period, higher returns. Bebchuk, Cohen and Ferrell (2009) showed that six of these provisions (an entrenchment index) did most of the work. These are associations: better-run firms may also choose fewer defences. **Shareholder primacy and stakeholders.** Governance codes increasingly ask boards to consider employees, suppliers, customers, communities and the environment. The G20/OECD Principles (2023) added a chapter on sustainability and resilience. Whether this changes the board's objective or only how it pursues long-term shareholder value is a live debate; `mba/mba-stakeholder-esg-card` covers the stakeholder and reporting side. ## Formulas and notation **Manager's share of the cost of perquisites (Jensen and Meckling):** $$ \text{Cost to manager of USD 1 of perks} = \alpha, \qquad \text{cost to other owners} = 1 - \alpha $$ **Option delta (Black-Scholes, no dividends) and delta-weighted equity:** $$ d_1 = \frac{\ln(S/K) + (r + \sigma^2/2)\,T}{\sigma\sqrt{T}}, \qquad \Delta = N(d_1), \qquad n_{\text{eff}} = n_{\text{sh}} + n_{\text{opt}}\,\Delta $$ **Pay-performance sensitivity (USD per USD 1,000 of shareholder value):** $$ PPS = \frac{n_{\text{eff}}}{N} \times 1{,}000, \qquad \Delta W_{1\%} = n_{\text{eff}} \times S \times 1\% $$ **Pyramid: cash-flow rights and control at the bottom of a chain:** $$ CF = \prod_{i=1}^{k} a_i, \qquad CR \approx \min_i a_i, \qquad \text{Wedge} = \frac{CR}{CF} $$ **Dual-class shares: voting share of a holder of class B shares:** $$ VS = \frac{e \, v}{e \, v + (1 - e)}, \qquad e_{\min}(VS = 50\%) = \frac{1}{v + 1} $$ **Tunnelling gain to a controller who moves USD $T$ out of a company in which it holds cash-flow share $CF$:** $$ G = T - CF \times T = (1 - CF)\,T $$ | Symbol | Meaning | Unit | |---|---|---| | $\alpha$ | Manager's fraction of the equity | % | | $S$, $K$ | Share price and option exercise price | USD | | $r$, $\sigma$, $T$ | Risk-free rate, volatility, years to expiry | %, %, years | | $N(\cdot)$ | Standard normal cumulative distribution | - | | $\Delta$ | Option delta: change in option value per USD 1 change in share price | 0 to 1 | | $n_{\text{sh}}$, $n_{\text{opt}}$ | Shares and options held by the executive | number | | $n_{\text{eff}}$ | Delta-weighted shares (share-equivalents) | number | | $N$ | Shares outstanding | number | | $PPS$ | Executive wealth change per USD 1,000 change in shareholder value | USD | | $\Delta W_{1\%}$ | Executive wealth change for a 1% rise in share price | USD | | $a_i$ | Ownership stake at link $i$ of a pyramid | % | | $CF$, $CR$ | Ultimate cash-flow rights and control (voting) rights | % | | $e$ | Class B holder's share of total equity (cash-flow rights) | % | | $v$ | Votes per class B share (class A has 1) | votes | | $VS$ | Class B holder's share of all votes | % | | $T$, $G$ | Value moved out (tunnelled) and controller's net gain | USD m | The weakest-link rule $CR \approx \min_i a_i$ follows La Porta et al. (1999): control along a chain is limited by its weakest stake. It assumes each stake is a controlling one and ignores other blockholders. ## Assumptions and limits - **Incentives are not behaviour.** A high pay-performance sensitivity does not prove that the CEO acts in owners' interests; it shows only what is at stake for the CEO. - **Delta is a local measure.** It changes as the share price moves, and it ignores the executive's risk aversion and undiversified wealth, which make options worth less to the executive than their Black-Scholes value. - **Options reward volatility.** Option value rises with $\sigma$, so heavy option pay can encourage risk taking; the vega of the package matters as well as the delta (`mba/mba-options-real-options-card`). - **Independence on paper.** Codes define independence by relationships (employment, business ties, family, tenure). Social ties and dependence on the CEO for nomination are not captured. - **Codes are not law everywhere.** "Comply or explain" codes allow justified departures; listing rules and company law are binding. Know which one you are applying. - **Governance indices are associations.** Firms choose their provisions, so causality is hard to prove. - **Context matters.** The right mechanism differs for a dispersed listed firm, a family-controlled group, a venture-backed company (`mba/mba-term-sheet-card`), a private-equity portfolio company (`mba/mba-pe-value-creation-card`) and a non-profit hospital. ## How boards and investors use it 1. **Map ownership and control:** who holds the votes, through which chain, with which share classes. 2. **Name the dominant agency problem:** type I (dispersed owners) or type II (controller and minorities). 3. **Review the board:** size, independence, skills matrix, tenure, chair and CEO roles, committees, evaluation. 4. **Review pay:** structure, sensitivity to performance, holding requirements, clawback, shareholder vote results. 5. **Review rights and defences:** voting rights, takeover defences, related-party approval rules. 6. **Check disclosure and audit:** quality of reporting, internal control statements, auditor tenure and fees. 7. **Compare with the applicable code** and note each departure and its explanation. 8. **Act:** engage, vote, propose changes, or for a board, set an action plan with owners and dates. A related-party transaction is the most common place where type II problems appear. A typical approval path: ```mermaid flowchart TD A["Transaction with a director, controller or their company proposed"] --> B["Interested party discloses the interest"] B --> C{"Above the materiality threshold in law, listing rules or policy?"} C -- No --> D["Approve under delegated authority and record it"] C -- Yes --> E["Refer to independent committee: interested directors leave the room"] E --> F["Independent valuation or fairness opinion"] F --> G{"Terms at arm's length and in the company's interest?"} G -- No --> H["Reject or renegotiate"] G -- Yes --> I{"Minority shareholder approval required?"} I -- Yes --> J["Vote of disinterested shareholders"] I -- No --> K["Board approval and disclosure"] J --> K K --> L["Monitor execution and report in the annual report"] ``` ## Codes and rules as of October 2026 Checked 2026-10-28; check before you rely on any of them. | Instrument | Dated fact | Official source | |---|---|---| | G20/OECD Principles of Corporate Governance | Revised by the OECD Council meeting at Ministerial level on 8 June 2023 (the Principles were first adopted in 1999, revised in 2004 and 2015); endorsed by the G20 and published in September 2023. Six chapters: I. ensuring the basis for an effective corporate governance framework; II. the rights and equitable treatment of shareholders and key ownership functions; III. institutional investors, stock markets and other intermediaries; IV. disclosure and transparency; V. the responsibilities of the board; VI. sustainability and resilience. | OECD Legal Instruments, OECD/LEGAL/0413 (legalinstruments.oecd.org) | | UK Corporate Governance Code 2024 | Published by the Financial Reporting Council on 22 January 2024; applies to financial years beginning on or after 1 January 2025, except Provision 29, which applies to financial years beginning on or after 1 January 2026. Provision 29 asks the board to monitor and review the risk management and internal control framework at least annually and to declare whether its material internal controls were effective. Applied on a "comply or explain" basis by companies within its scope. | frc.org.uk, UK Corporate Governance Code page | | US clawback rule | The SEC adopted Rule 10D-1 on 26 October 2022 (Release No. 33-11126, implementing Section 10D of the Securities Exchange Act), requiring the exchanges to make listed issuers to adopt, disclose and file a policy to recover erroneously awarded incentive-based pay from current and former executive officers after an accounting restatement; the rules took effect on 27 January 2023. The NYSE and Nasdaq listing standards took effect on 2 October 2023, with issuers' policies due by 1 December 2023 (check the exchange's current rule). | sec.gov, "Listing Standards for Recovery of Erroneously Awarded Compensation" | Other codes follow the same broad pattern (board independence, committees, disclosure, shareholder rights) with different details, and stock exchange listing rules often add binding requirements. Before you write "the code requires", find the provision number in the current text. ## Worked example A (fully solved): Northfield Outdoor Co. **Situation (*Example*, fictional).** Northfield Outdoor Co., treated as listed, has 60.0m shares at USD 30.00 (equity value USD 1,800m, as in `mba/mba-mergers-acquisitions-guide`). A pension fund holds 12% and nominates one director; the rest is dispersed. The board has 11 members: the chair (Northfield's former CEO, retired two years ago), the CEO, the CFO, the pension fund's nominee and seven non-executives who meet the code's independence tests. Committees: audit (three independent directors), remuneration (two independent directors and the chair), nomination (the chair and two independent directors). The CEO holds 600,000 shares and 1,000,000 at-the-money options (exercise price USD 30.00, five years to expiry). Salary USD 0.90m, target bonus USD 1.10m, annual grant 300,000 options on the same terms. Use $r$ = 4%, $\sigma$ = 30% and no dividends. **Step 1: ownership and agency problem.** No holder controls the company; the 12% holder can monitor but not dictate. The dominant problem is type I (managers and dispersed shareholders). The board and pay are the first mechanisms to examine. **Step 2: board independence.** | Item | Value | Excel | |---|---|---| | Independent directors excluding the chair | 7 of 10 = 70.0% | `=7/10` | | Independent directors of the whole board | 7 of 11 = 63.6% | `=7/11` | | Chair independent? | No: former CEO, employee within the last five years | Judgement against the code's independence tests | | Remuneration committee wholly independent? | No: includes the chair, who is not independent | Judgement | The board meets a majority-independence test, but two features need explaining under a code such as the UK Code: a former CEO as chair, and a non-independent chair on the remuneration committee. Under "comply or explain" the board can explain why (continuity during a transition, for example) but investors will press for a timetable. **Step 3: CEO incentives.** | Item | Value | Excel | |---|---|---| | $d_1$ | 0.6336 | `=(LN(30/30)+(4%+30%^2/2)*5)/(30%*SQRT(5))` | | Option delta $N(d_1)$ | 0.7368 | `=NORM.S.DIST(0.6336,TRUE)` | | Black-Scholes value per option | USD 10.19 | `=30*NORM.S.DIST(0.6336,TRUE)-30*EXP(-4%*5)*NORM.S.DIST(0.6336-30%*SQRT(5),TRUE)` | | Delta-weighted shares $n_{\text{eff}}$ | 1,336,814 | `=600000+1000000*0.7368` | | Value of shares held | USD 18.00m | `=600000*30` | | Value of options held | USD 10.19m | `=1000000*10.1885` | | Effective ownership | 2.23% | `=1336814/60000000` | | Pay-performance sensitivity | USD 22.28 per USD 1,000 | `=1336814/60000000*1000` | | Wealth change for a 1% price rise | USD 401,044 | `=1336814*30*1%` | | Annual grant value | USD 3.06m | `=300000*10.1885` | | Total annual pay (salary, target bonus, grant) | USD 5.06m | `=0.9+1.1+3.0566` | Reading the numbers: the CEO gains about USD 22 for every USD 1,000 created for shareholders, roughly seven times the USD 3.25 that Jensen and Murphy (1990) estimated for their sample. On shares alone the CEO bears 1 cent of every dollar spent on perquisites; counting options at their delta, about 2.2 cents. A 1% move in the share price changes the CEO's wealth by about USD 401,000, about 20% of the cash pay (salary plus target bonus) of USD 2.0m. ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Northfield Outdoor Co. (fictional): CEO equity value at option expiry against share price, intrinsic values, USD m", "width": 360, "height": 220, "data": {"values": [ {"price": 15, "holding": "Shares", "value": 9.00}, {"price": 20, "holding": "Shares", "value": 12.00}, {"price": 25, "holding": "Shares", "value": 15.00}, {"price": 30, "holding": "Shares", "value": 18.00}, {"price": 35, "holding": "Shares", "value": 21.00}, {"price": 40, "holding": "Shares", "value": 24.00}, {"price": 45, "holding": "Shares", "value": 27.00}, {"price": 50, "holding": "Shares", "value": 30.00}, {"price": 15, "holding": "Options", "value": 0.00}, {"price": 20, "holding": "Options", "value": 0.00}, {"price": 25, "holding": "Options", "value": 0.00}, {"price": 30, "holding": "Options", "value": 0.00}, {"price": 35, "holding": "Options", "value": 5.00}, {"price": 40, "holding": "Options", "value": 10.00}, {"price": 45, "holding": "Options", "value": 15.00}, {"price": 50, "holding": "Options", "value": 20.00} ]}, "mark": {"type": "area"}, "encoding": { "x": {"field": "price", "type": "quantitative", "title": "Northfield share price at expiry (USD)"}, "y": {"field": "value", "type": "quantitative", "stack": "zero", "title": "CEO equity value (USD m)"}, "color": {"field": "holding", "type": "nominal", "title": "Holding"} } } ``` The chart shows the asymmetry. Below USD 30 the options are worthless and only the shares fall; above it each USD 1 rise adds USD 1.6m (600,000 shares plus 1,000,000 options). The package rewards upside more than it punishes downside, which is the risk-taking incentive of option pay. **Step 4: recommendations (*Example*).** (1) Agree a date by which an independent chair replaces the former CEO, or appoint a senior independent director with a clear mandate in the meantime. (2) Make the remuneration committee wholly independent. (3) Shift part of the annual option grant to performance shares with relative total shareholder return and return on invested capital conditions and a two-year post-vesting holding period, so that pay depends less on volatility and market-wide moves. (4) Confirm that the clawback policy covers all incentive pay. ## Worked example B (half solved): Group F's pyramid **Situation (*Example*, fictional).** A family (Group F) owns 51% of Holding H. Holding H owns 51% of listed Company L. The family also owns 100% of a logistics firm that sells services to Company L. | Item | Value | Excel | |---|---|---| | Family's cash-flow rights in Company L | 26.01% | `=51%*51%` | | Family's control of Company L (weakest link) | [ ] | `=MIN(51%,51%)` | | Wedge (control divided by cash-flow rights) | [ ] | `=51%/26.01%` | | Family's net gain if USD 10m is moved from L to the logistics firm through prices above market | 7.40 | `=10-26.01%*10` | | Loss to L's other shareholders | [ ] | `=(1-26.01%)*10` | Now suppose instead that Holding H owns only 15% of Company L's equity, in class B shares carrying 10 votes each (class A has one vote). | Item | Value | Excel | |---|---|---| | Holding H's share of the votes in Company L | 63.83% | `=15%*10/(15%*10+85%)` | | Family's cash-flow rights in Company L | [ ] | `=51%*15%` | | Family's net gain on USD 10m tunnelled | [ ] | `=10-51%*15%*10` | | Minimum equity share for a 10-vote class to hold 50% of votes | 9.09% | `=1/(10+1)` | ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Voting share of a holder with 20% of equity in class B shares, against votes per class B share (fictional)", "width": 320, "height": 200, "data": {"values": [ {"votes": 1, "measure": "Voting share", "share": 20.00}, {"votes": 5, "measure": "Voting share", "share": 55.56}, {"votes": 10, "measure": "Voting share", "share": 71.43}, {"votes": 20, "measure": "Voting share", "share": 83.33}, {"votes": 1, "measure": "Cash-flow share", "share": 20.00}, {"votes": 5, "measure": "Cash-flow share", "share": 20.00}, {"votes": 10, "measure": "Cash-flow share", "share": 20.00}, {"votes": 20, "measure": "Cash-flow share", "share": 20.00} ]}, "mark": {"type": "line", "point": true}, "encoding": { "x": {"field": "votes", "type": "quantitative", "title": "Votes per class B share"}, "y": {"field": "share", "type": "quantitative", "title": "Share of total (%)", "scale": {"domain": [0, 100]}}, "color": {"field": "measure", "type": "nominal", "title": null} } } ``` 1. Which agency problem dominates at Company L? [ ] 2. Why does the dual-class version give the family a stronger incentive to tunnel than the pyramid version? [ ] 3. Name two mechanisms that limit tunnelling, one inside the company and one outside it. [ ] 4. Some founder-led companies argue that dual-class shares protect long-term strategy. Give one argument for and one against, and one design feature (for example a sunset clause) that addresses the concern. [ ] ## Exercise C (unsolved): Tallow Creek Medical Center **Situation (*Example*, fictional).** Tallow Creek Medical Center is a non-profit regional hospital. Its board has 14 voting members: the chief executive, three physicians with admitting privileges at the hospital, two representatives of the founding community foundation, and eight community members. One community member co-owns an imaging centre that is bidding for a five-year outsourced imaging contract worth about USD 3.2m a year. The board has a finance committee and a quality committee, but no separate audit or compensation committee; the finance committee sets the chief executive's pay using a consultant chosen by the chief executive. 1. Who are the principals of a non-profit hospital board, and what is the agency problem? 2. How many members would you treat as independent, and why? State your independence tests. 3. Design the approval process for the imaging contract, using the related-party flowchart above. 4. Propose a committee structure and say which members should sit on each. 5. What would make the chief executive's pay process defensible to regulators and the community? Name the questions to ask counsel about the rules that apply to non-profit hospitals in your jurisdiction. ## Connections to other cards - `mba/mba-ethics-guide`: shareholder primacy, stakeholder theory and the governance session this card builds on. - `mba/mba-stakeholder-esg-card`: stakeholder salience, materiality and the reporting side of board oversight. - `mba/mba-capital-structure-card`: agency costs of debt and equity and the free cash flow argument (Jensen 1986). - `mba/mba-options-real-options-card`: Black-Scholes, delta and vega behind executive option packages. - `mba/mba-deal-structuring-card`: board approval, deal protections and fiduciary outs in acquisitions. - `mba/mba-corporate-strategy-card`: how the corporate centre allocates capital, and how a weak board lets empires grow. - `mba/mba-pe-value-creation-card`: governance engineering in private equity portfolio companies. - `mba/mba-term-sheet-card` and `mba/mba-venture-finance-cap-table-card`: board seats and protective provisions in venture-backed firms. - `mba/mba-ai-risk-governance-card`: board oversight of AI risk. - `business/board-pack` and `startup/board-deck`: what the board actually reads. ## Common mistakes and misconceptions 1. **Assuming dispersed ownership.** In most countries the main conflict is between a controller and minority shareholders, not between managers and shareholders. 2. **Counting heads for independence.** A majority of "independent" directors who owe their seats to the CEO may not act independently. 3. **Equating more pay at risk with better alignment.** Options reward volatility and market-wide moves; look at what the payout actually depends on. 4. **Ignoring the chair.** A former CEO as chair can make it hard for the board to challenge the strategy the chair designed. 5. **Reading a governance score as cause.** Indices show associations; firms choose their provisions. 6. **Treating "comply or explain" as "comply".** A reasoned explanation is a legitimate choice under a code; a missing explanation is the failure. 7. **Forgetting related-party transactions.** They are where type II problems show up, often in small amounts that add up. 8. **Assuming takeovers will discipline everyone.** Controlled firms, dual-class firms and firms with strong defences are insulated from the market for corporate control. 9. **Confusing control rights with cash-flow rights.** In pyramids and dual-class firms, votes and economic interest can be far apart. 10. **Citing a code without its version.** Codes are revised; cite the year and the provision. ## Self-test questions 1. What did Berle and Means (1932) document, and why does dispersed ownership weaken monitoring? 2. Name the three components of agency costs in Jensen and Meckling (1976). 3. What is the difference between decision management and decision control (Fama and Jensen 1983)? 4. A CEO holds 200,000 shares and 400,000 options with a delta of 0.6; the company has 50m shares. What is the pay-performance sensitivity per USD 1,000 of shareholder value? 5. A family owns 60% of Company A, which owns 40% of Company B. What are the family's cash-flow and control rights in B under the weakest-link rule? 6. A founder holds 10% of the equity in class B shares with 10 votes each; class A has one vote. What share of the votes does the founder hold? 7. A manager owns 2% of the firm. How much of each USD 1 spent on perquisites does the manager bear? 8. Distinguish the type I and type II agency problems and give one mechanism suited to each. 9. What does "comply or explain" mean, and what makes an explanation acceptable? 10. Give two external governance mechanisms and one weakness of each. 11. Why can a pay package heavy in options encourage risk taking? ## My notes and next steps | Date | Note or action | Done | |---|---|---| | YYYY-MM-DD | *Example:* Map the ownership chain and board of the company in next week's case before class | [ ] | | YYYY-MM-DD | *Example:* Compute the CEO's pay-performance sensitivity from the latest proxy statement | [ ] | | YYYY-MM-DD | [Your action] | [ ] | ## Sources and further reading - Berle, A. A., and Means, G. C. (1932). *The Modern Corporation and Private Property*. Macmillan. - Manne, H. G. (1965). Mergers and the market for corporate control. *Journal of Political Economy*, 73(2), 110-120. - Jensen, M. C., and Meckling, W. H. (1976). Theory of the firm: managerial behavior, agency costs and ownership structure. *Journal of Financial Economics*, 3(4), 305-360. - Fama, E. F. (1980). Agency problems and the theory of the firm. *Journal of Political Economy*, 88(2), 288-307. - Fama, E. F., and Jensen, M. C. (1983). Separation of ownership and control. *The Journal of Law and Economics*, 26(2), 301-325. - Jensen, M. C. (1986). Agency costs of free cash flow, corporate finance, and takeovers. *American Economic Review*, 76(2), 323-329. - Jensen, M. C., and Murphy, K. J. (1990). Performance pay and top-management incentives. *Journal of Political Economy*, 98(2), 225-264. - Committee on the Financial Aspects of Corporate Governance (1992). *Report of the Committee on the Financial Aspects of Corporate Governance* (the Cadbury Report). London. - Shleifer, A., and Vishny, R. W. (1997). A survey of corporate governance. *The Journal of Finance*, 52(2), 737-783. - La Porta, R., Lopez-de-Silanes, F., and Shleifer, A. (1999). Corporate ownership around the world. *The Journal of Finance*, 54(2), 471-517. - Johnson, S., La Porta, R., Lopez-de-Silanes, F., and Shleifer, A. (2000). Tunneling. *American Economic Review*, 90(2), 22-27. - Gompers, P., Ishii, J., and Metrick, A. (2003). Corporate governance and equity prices. *The Quarterly Journal of Economics*, 118(1), 107-156. - Hermalin, B. E., and Weisbach, M. S. (2003). Boards of directors as an endogenously determined institution: a survey of the economic literature. *Economic Policy Review* (Federal Reserve Bank of New York), 9(1). - Bebchuk, L. A., and Fried, J. M. (2004). *Pay without Performance: The Unfulfilled Promise of Executive Compensation*. Harvard University Press. - Brav, A., Jiang, W., Partnoy, F., and Thomas, R. (2008). Hedge fund activism, corporate governance, and firm performance. *The Journal of Finance*, 63(4), 1729-1775. - Bebchuk, L., Cohen, A., and Ferrell, A. (2009). What matters in corporate governance? *The Review of Financial Studies*, 22(2), 783-827. - OECD (2023). *G20/OECD Principles of Corporate Governance 2023*. OECD Publishing, https://doi.org/10.1787/ed750b30-en. - Financial Reporting Council (2024). *UK Corporate Governance Code*, https://www.frc.org.uk. - US Securities and Exchange Commission (2022). Listing Standards for Recovery of Erroneously Awarded Compensation, Release No. 33-11126, https://www.sec.gov. - Textbooks (further reading, by name only): Monks and Minow, *Corporate Governance*; Tricker, *Corporate Governance: Principles, Policies, and Practices*; Larcker and Tayan, *Corporate Governance Matters*. - Open resource: OpenStax, *Principles of Management*, chapter on corporate governance, https://openstax.org/details/books/principles-management (check the licence on the book page). ## Answer key **Worked example B.** Control 51%; wedge $51\% / 26.01\% = 1.96$; loss to other shareholders USD 7.40m (they own 73.99% of L and bear that share of the USD 10m). Dual-class version: family cash-flow rights $51\% \times 15\% = 7.65\%$; family gain on USD 10m tunnelled $10 - 0.765 = $ USD 9.24m. (1) Type II: the family controls L with a minority of its cash flows. (2) The family bears only 7.65% of any value taken out of L, against 26.01% in the pyramid, while keeping control (63.83% of the votes); the less of the cash flows a controller owns, the cheaper tunnelling is. (3) Inside: an independent committee and disinterested-shareholder approval for related-party transactions, with independent valuation. Outside: securities law and enforcement against self-dealing, disclosure rules, auditors, and minority shareholder litigation where it is available. (4) For: founders can invest for the long term without pressure from short-horizon investors. Against: entrenchment, since control persists even when the founder no longer adds value and holds little of the economic interest. Design: a time-based or ownership-based sunset that converts class B to one vote, and conversion on transfer. **Exercise C (outline).** (1) The principals are the community the hospital serves and the purpose in its charter, represented by the board; the regulator and donors also have claims. The agency problem is management and insiders pursuing their own interests (pay, physician income, contracts) without owners who can sell or vote. (2) A reasonable count is eight: the community members except the imaging centre co-owner, who is conflicted on this matter and has a business relationship; the CEO, the three physicians with privileges (who earn income from the hospital's decisions) and the two foundation representatives (if the foundation is a related party) are not independent. State your tests: employment, material business relationships, family ties, compensation from the hospital. (3) Disclosure by the co-owner, recusal, review by independent members with an independent benchmark or competitive bid comparison, documentation of arm's-length terms, approval by disinterested members, disclosure in reports. (4) Audit committee of independent members with financial expertise; compensation committee of independent members that hires its own consultant; quality committee may include physicians; nominating and governance committee led by independent members. (5) An independent committee, a consultant it hires, comparable-organisation data, written minutes of the basis for the decision; questions for counsel on the jurisdiction's rules for non-profit executive pay and conflict-of-interest policies. **Self-test.** 1. That ownership of large corporations was dispersed and control rested with managers who owned little. Each small owner bears the full cost of monitoring and receives only a small share of the benefit, so few monitor. 2. Monitoring costs (principal), bonding costs (agent) and the residual loss. 3. Decision management is initiating and implementing decisions; decision control is ratifying and monitoring them. Separating the two, with the board holding control, limits agency costs. 4. $(200{,}000 + 400{,}000 \times 0.6)/50{,}000{,}000 \times 1{,}000 = $ USD 8.80. 5. Cash-flow rights $60\% \times 40\% = 24\%$; control 40% (weakest link). 6. $0.10 \times 10 / (0.10 \times 10 + 0.90) = 52.63\%$. 7. 2 cents; the other owners bear 98 cents. 8. Type I: managers against dispersed shareholders; mechanisms such as an independent board, equity pay, takeover market. Type II: controller against minorities; mechanisms such as related-party approval by disinterested holders, minority protection in law, disclosure. 9. Companies may depart from a code provision if they explain why, how the departure is consistent with good governance, and for how long. A good explanation is specific to the company, gives the reason, the mitigating action and a timetable. 10. Market for corporate control (weak where defences or control blocks exist); shareholder activism (campaign costs, possible short horizon); debt (distress costs); law and enforcement (varies by country). Any two. 11. Option value rises with volatility and the downside is capped at zero, so the holder gains from riskier strategies that raise the chance of large upside, while shareholders bear the losses. ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | First draft from the template | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Updated for the new proxy statement and the chair succession plan | ## Standard and licence note Based on the corporate governance literature (Berle and Means 1932; Jensen and Meckling 1976; Fama and Jensen 1983; Jensen and Murphy 1990; Shleifer and Vishny 1997; La Porta, Lopez-de-Silanes and Shleifer 1999; Johnson et al. 2000) and structure aligned with the G20/OECD Principles of Corporate Governance (2023) and the UK Corporate Governance Code (2024), described in own words; facts about codes and rules are dated 2026-10-28 and must be checked on the official pages. The text, examples and numbers are original, and all organisations are fictional. The card has no affiliation with any school, regulator, standard setter, publisher or author named. It is not legal or regulatory advice. Template licence: MIT.