Control, Governance, and Financial Architecture

Chia sẻ: Nguyễn Thanh Hưng | Ngày: | Loại File: DOC | Số trang:4

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Nội dung Text: Control, Governance, and Financial Architecture

CHAPTER 34 Control, Governance, and Financial Architecture Answers to Practice Questions 1. a. In the U.S., the largest shareholders of corporations are financial institutions. However, since ownership is usually widely dispersed, effective control often rests with management. In many countries outside the U.S., families and governments often have large equity stakes. b. False. Top managers in Germany are more likely to balance the interests of all stakeholders (rather than just those of shareholders), but poor performance can still result in management turnover. c. True. Carve-out or spin-off of a division improves incentives for the division’s managers. If the businesses are independent, it is easier to measure the performance of the division’s managers. d. False. The limited life of a private-equity partnership reassures the limited partners that the cash flow will not be reinvested in a wasteful manner. It also tends to ensure that partnerships focus on opportunities to reorganize poorly performing businesses and to provide them with new management before selling them off. e. True. The remuneration package for the general partners typically includes a 20% carried interest. This is equivalent to a call option on the partnership’s value and, as is the case for all options, this option is more valuable when the value of the assets is highly variable. 2. In general, firms with narrow margins in highly competitive environments are not good candidates for LBO’s or MBO’s. These firms are often highly efficient and do not have excess assets or unnecessary capital expenditures. Further, the thinness of the margins limits the amount of debt capacity. 3. The common theme is that investors do not want companies to waste resources. Investors would much prefer that companies pay out their free cash flow, instead of wasting it on poor capital investments or using it to subsidize an inefficient operation. Financial leverage was a necessary part of both deals because it increased the companies’ cash obligations and, thus, reduced managers’ flexibility. 63
4. RJR issued a lot of debt and repurchased shares to reduce the equity base. Sealed Air issued a lot of debt and paid a special dividend to all shareholders to reduce the equity base. RJR was seen as a company that needed to streamline operations and reexamine its capital expenditures and asset holdings. The firm was in a highly competitive environment, but had the advantage of brand name recognition for its products. Sealed Air needed to streamline its operations because it had grown inefficient due to the patent protection it had for its products. Sealed Air remained public in order to increase the pressure to perform by remaining exposed to buying and selling pressure in the market. 5. Answers will vary depending upon the examples chosen. 6. The story told in Barbarians at the Gate is a very complicated one. Those who favor mergers can find much evidence in this story to support their position, as can those who oppose mergers. In a similar fashion, those who espouse one particular theory or another as to why companies merge can find evidence here to support their position (and evidence to refute the positions of others). Thus, the answer will vary, depending on one’s views. 7. Private equity partnerships are usually run by professional equity managers representing larger institutional investors. The institutional investors act as the limited partners while the professional managers act as general partners in the limited partnership. The general partners are companies that focus on funding and managing equity investments in closely-held firms. The incentive for general partners is a management fee plus a share in the company profits that they can increase if they successfully “fix” the firm. The limited partners get paid first but are not entitled to all the profits. Further, the limited life of the partnership precludes wasteful reinvestment. These partnerships are designed to make investments in various types of firms from venture capital start-ups to mature firms that need to re- invigorate management. 8. There are, in general, four reasons for conglomerates to exist outside of the United States. First, you can be limited by the size of the local economy. To be a larger firm is to be a diversified firm. Second, increased size often means increased political power when dealing with centrally managed economies or operating in countries with unstable economic policies. Third, companies may need to be of a certain size to attract professional management. Finally, size is important if the external capital market is poorly developed and internal capital is an important source of funds. 64
9. The internal capital market refers to free cash flow, generated by companies in mature industries, that can be funneled to other divisions with profitable growth opportunities. The allocation will be efficient if managers correctly allocate funds to the most potentially profitable projects and avoid incurring transactions costs associated with issuing public securities. Unfortunately, funds are not allocated by an actual market mechanism. Rather, conglomerates are centrally run and internal corporate politics can play as important a role as economies. 65
Challenge Question 1. The major problem with financial management of a conglomerate is that the division is not forced to face the scrutiny and judgement of an external capital market. Thus, there may easily be serious misallocations of capital within the firm. Many of the problems might be resolved by basing performance measurement and compensation on residual income or EVA but this may be fraught with problems of implementation. For example, in order to measure performance, divisional costs of capital have to be developed, as well as other arbitrary allocations, such as determining the amount and cost of debt to be borne by any division. Recall also that one of the important roles of an external capital market is to assess future expectations. Measures of residual income and EVA tend often to be single period measures. As a consequence, they can introduce short-term incentives to avoid long-term benefits, such as declining to purchase land at a bargain price to sit idle for five years in preparation for a major expansion. 66