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Concepts
Corporate Governance

Description
Corporate Governance and ESG - Introduction
Definition:
- System of internal controls and procedures by which individual companies are managed
- Provide a framework that defines the rights, roles and responsibilities of various group within an organisation
- Is an arrangement of checks, balannces and incentives a company needs, to minimise and manage conflicts of interests between insiders and external shareholders
Shareholder theory:
Primary focus on the interests of shareholders - maximise market value of firm's common equity
Corporate governance focuses on managers - owners conflict
Stakeholder theory:
Consider conflict among groups that have interest in the firm's activities and performance (shareholders, employees, suppliers, customers)

Stakeholder groups and interests Sharehoders

1
...
BOD
Responsibility:
- protect the interest of shareholders
- Hire, fire and set the compensation of firm's senior managers
- Set strategic direction of the firm
- Monitor the financial performance and other aspect of the firm's ongoing activities

Stakeholder groups and interests Senior managers

3
...
Employees
Interest:
- pay rate, opportunities for career advancement, training and working conditions
- Sustainability and success of the firm

Stakeholder groups and interests Creditors

5
...
Directors

Shareholders = Principal ; Director = agent
Reasons for conflict:
- Risk of directors (more dependent on firm performance) ≠ Risk of shareholders (hold a diersified portfolio)
- Directors favor self-iinterest at the expense of shareholders
- Directors favor a group of shareholders at the expense of another
- Information asymmertry: Directors have more and better information about the functioning of the firm and its trategic direction than shareholders

Conflict of interest: Group of
shareholders

A single shareholder / group of shareholders might hold a majority of votes and act against the interest of the minority shareholders
...
g
...

shareholders

- Shareholders prefer more business risk than creditors, since creditors have limited upside from good results compared to shareholders
- Shareholders could act against the interest of creditors by issuing new debt / paying greater dividend →↑ default risk faced by creditors

Conflict of interest: Shareholders
vs
...
Legal infrastructure: Identify relevant laws and legal recourse of stakeholders whien their rights are violated
2
...
Organisational infrastructure: Company's corporate governance procedures, including internal systems and practices that address how to manage stakeholders relationships
4
...
g
...
)

Board structure

One-tier board: Single BOD, with both internal directors (EDs) and external directors (NEDs)
Two-tier board: Includes supervisory board (NEDs only) and management board (EDs only)
...
Audit committee
- Oversight of the FR function and implementation of accounting policies
- Effectiveness of the company's IS and internal audit function
- Recommending external auditor and its compensation
- Proposing remedies based on their review of internal and external audits
2
...
Nomination committee
- Proposed candidates for board election
- Manage the search process
- Align board composition with corporate governance policies
4
...
Risk committee
- Inform appropriate risk policy and risk tolerance of the organisation
- oversee risk management process of the organisation
6
...
Communication and engagement with shareholders to support management in the negative events
2
...
Threat of hostile takeover (management pursue policies more in allignment with the interest of shareholders) and existence of anti-hostile takeover provisions (↑issues of corporate
governance and conflicts of interest)
4
...
Proxy fight a group of shareholders may seek proxies to vote in favor of their proposals and policies

Risks of poor corporate governance Risks of porr corporate governance
Benefits of effective corporate governance
/ Benefits of effective corporate
- Some stakeholders could gain advantage, at the costs of others (e
...
: accounting fraud, poor - Align managers' interest with shareholders' interest → ↑ opera onal efficiency
governance
recordkeeping)
- Avoid legal and regulatory risks
- Manager may choose lowe-than-optima risk →lower company's value
- Better operating results
- Managers might have incentive that causes them to pursue their own interest, rather than - ↓ risk of debt default and bankruptcy → ↓ cost of debt financing
the company's benefit
- Better performance, ↑ company value
- Legal risks: stakeholders lawsuits
- Reputation risks: failure to comply with Government's regulations
- Failure to manage creditors' rights →debt default and bankruptcy
Factors relevant to analysis of
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...
Composition of board
Consideratons on whether directors:
- are ED, NED or independent directors
- involve in RPTs with the company
- have diversified of expertise that suits the company's strategy and challenges
- have served for too long and may become too close to the company's management
3
...
Composition of shareholders
Affiliate company holds a significant portion of shares → able to dictate company's policy and direc on, hinder change by protec ng from poten al hos le takeovers and ac vist shareholders
5
...
Management of LT risks
Failure to manage stakeholder issues / Failure to manage other LT risks to company's sustainability → bad consequences for shareholders

Environmental and social
considerations in investment
analysis

ESG integration / ESG investing: making investment decisions with the use of environmental, social and governance factors
Considered issues: harm to the environment, risk of loss due to environment accidents, changing in demographics of workforce changing in work preference

ESG integration method

1
...
g
...
Positive screening: identify companies with best practices across environmental sustainability, employee right and safety, and overall governance practices
3
...
Thematic investing: investing based on single goal (e
...
: development of alternative energy sources; clean water resoruces)

Concepts

Description

Capital budgeting process

Capital budgeting
Definition: process of identifying and evaluating capital projects, with CF over more than 1 year
4 steps:
Step 1 - Generate investment ideas
Step 2 - Analyse project ideas : Accept / Reject project based on expected future CF
Step 3 - Create firm-wide capitak budgeting : Prioritise projects according to the timing of project's CF, available resource and overall strategic plan
Step 4 - Monitor decisions and conduct post-audit ; compare actual result with projected result, identify systematic errors in the forecasting process and improve company operations

Categories of capital budgeting
projects

1
...
Capital asset pricing model approach
(Kce)
𝑘 =𝑅 +𝛽× 𝑅 −𝑅

In which:
𝑅 = 𝑟𝑖𝑠𝑘 𝑓𝑟𝑒𝑒 𝑟𝑎𝑡𝑒
𝑅 = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑓 𝑡ℎ𝑒 𝑚𝑎𝑟𝑘𝑒𝑡
𝛽 = 𝑠𝑡𝑜𝑐𝑘 𝑠 𝑏𝑒𝑡𝑎 (𝑠𝑡𝑜𝑐𝑘 𝑠 𝑟𝑖𝑠𝑘 𝑚𝑒𝑎𝑠𝑢𝑟𝑒)
2
...
Bond yield plus risk premium approach

Calculating Beta of project

𝑘 = 𝑏𝑜𝑛𝑑 𝑦𝑖𝑒𝑙𝑑 + 𝑟𝑖𝑠𝑘 𝑝𝑟𝑒𝑚𝑖𝑢𝑚
Step 1: estimate the beta for a comparable company (group of comparable companies)
Step 2: Unlever the beta to asset beta
𝛽

=𝛽

×

1
𝐷
1 + (1 − 𝑡) × 𝐸

Step 3: Relever the beta

𝛽
Country risk premium

=𝛽

𝐷
× [1 + (1 − 𝑡) × ]
𝐸

Increased risk associated woth investing in a developing country

𝑘

= 𝑅 + 𝛽 × (𝑅 − 𝑅 + 𝐶𝑅𝑃)

In which:
CRP = country risk premium

𝐶𝑅𝑃 = 𝑠𝑜𝑣𝑒𝑟𝑒𝑖𝑔𝑛 𝑦𝑖𝑒𝑙𝑑 𝑠𝑝𝑟𝑒𝑎𝑑 ×

𝑎𝑛𝑛𝑢𝑎𝑙𝑖𝑠𝑒𝑑 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑖𝑛𝑑𝑒𝑥 𝑜𝑓 𝑑𝑒𝑣𝑒𝑙𝑜𝑝𝑖𝑛𝑔 𝑐𝑜𝑢𝑛𝑡𝑟𝑦
𝑎𝑛𝑛𝑢𝑎𝑙𝑖𝑠𝑒𝑑 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑠𝑜𝑣𝑒𝑟𝑒𝑖𝑔𝑛 𝑏𝑜𝑛𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑖𝑛 𝑡𝑒𝑟𝑚𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑒𝑣𝑒𝑙𝑜𝑝𝑒𝑑 𝑚𝑎𝑟𝑘𝑒𝑡 𝑐𝑢𝑟𝑟𝑒𝑛𝑐𝑦

Where:
Sovereign yield spread - yields of Gov's bonds in developing - Treasury bonds of similar maturities
Marginal cost of capital

Definition: Cost of additional new capital raised
↑ capital raised → ↑ cost of financing, due to:
- ↑ addi onal financial risk → higher cost of debt
- ↑ Flota on cost (fees charged by bank when a company raised external equity capital)
...


Measure of Leverage

Business risk: risk related to operating income, result from uncertainty about revenues and expenditures necessary to produce those revenues

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