Corporate Governance

External Governance Control Mechanisms

• Society also wants to maximize shareholder value without harming other stakeholders groups:

• The Market for Corporate Control:

o If internal controls fail and management is behaving opportunistically the likely response of the shareholders would be to sell their stocks rather than engage in activism. This will cause the stock price and value of the firm to decline leaving it vulnerable for �corporate takeover’. The takeover company would fire all the poor performing management, therefore this �takeover constraint’ deters management from misbehaving in the first place.

• Auditors:

o Usually auditors are good external control mechanisms because they are independent firms that are hired to unearth financial irregularities and ensure that accounting conforms to standard accounting practices.

o But lately auditors are not as reliable as seen at Ernon and WorldCom because they want to continue the business relationship with the company that hires them and most auditing companies also do consulting which involve lucrative contracts…. Thus auditors might be tempted to over look irregularities.

• Banks and Analysts:

o Two external groups that monitor publicly held firms.

o B/c they lend them money and need to ensure they keep to loan covenants and will eventually be repaid.

o Analysts’ reputations and rewards depend on doing analysis of firms and giving the right advice to their clients whether to buy or sell.

 Unfortunately, analysts’ companies also have holdings in the companies that they are advising clients on and if they give a negative recommendation