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Business Economics

Lecturer: MA. Nguyen Xuan Huong

Chapter 1: Introduction

Overview of the subject

Credit: 3 credits (15 lectures)

Textbook: Business Economics and Managerial Decision Making (Trefor Jones, John Wiley & Sons Ltd. 2004)Assessment:

Class participation and in-class activities: 10 %Presentation and assignment: 20%Mid-course test: 20 %Exam: 50 %Total: 100 %

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Overview of the subject (cont)

Lecture times and venues

From 15/4-9/6/2013

- Monday (7-9): A605

- Wednesday (10-12): A604

Chapter Objectives

• Study objectives of Business Economics

• Overview of company

• Distinguish ownership/shareholder rights and control, owner and managerial controlled firm

• Patterns of shareholding ownership

• Inside and outside system of corporate control

• External and internal factors constraining managers’ discretion

Key concepts

• Ownership, corporate control, shareholders, shareholdings, shareholder-owned company

• Dispersed ownership, owner-controlled managerial-controlled company.

• Outsider and Insider system of corporate control, external and internal constrains

• Managerial discretion

• Corporate governance, CG code

• Firm, company, corporate, enterprise

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What is Business Economics?

Spencer and Siegelman (1969) “integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by management.”

Main contents: Business Economics focus on answering the following questions: • Why firms establish or exit market• Why firms expand? Horizontally or vertically? • Roles of entrepreneurs and firms• Roles of corporate structure• Relationship between firms and employees, shareholders,

customers, suppliers, governments, as well the environment

Overview of company

1. Definition of company

- French Civil code: “Company is a contract through which 2 or more individuals agree to use their assets or capabilities into a common activities in order to share profits or other benefits from such common activities

In some cases under the law, company can be established by one individual.

Members of the company commit to share loss” (Article 1832)

Overview of Company (cont.)

According to the Enterprise Law of Vietnam (2005)

Enterprise means an economic organization that has its own name, assets, stable office and is duly constituted for the purpose of conducting business (Article 4.1)

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Common characteristics of firms

Firms are different in term of size, ownership types, products, but have things in common:

Owners - shareholders: set objectives, gain profit and bear the risk from firm operating

Managers: make day-to-day decision

Objectives: aimed at by owners, may not coincide those pursued by managers in case the ownership is dispersed

Resources: capital, labor, technology, land,…

Performance assessment: thorough certain criteria by owners, managers and other stakeholders

2. Classifying companies

a. According to size of companies (Number of employees)

Size of company Vietnam WB

Super small <10 <10

Small <200 <50

Medium 200 - 300 50 - 300

Large >300 >300

b. According to Enterprise law 2005Joint stock company (shareholding company)

Limited liability company with more than 1 member

Limited liability company with 1 memberPartnership

Sole proprietorship (private company)

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b1. Joint Stock companyCharter capital is divided into equal portions known as shares.Shareholder can be organization or individual; the minimum number of shareholders will be three and there is no restriction on the maximum number of shareholders.Shareholders are liable for debts and other liabilities of the company within amount of capital that they contributed.Shareholders are free to transfer their shares, except for restriction with founding shareholders and voting-preferred shareholders;A shareholding company will be given a legal status from the issuing date of the certificate of business registration.A shareholding company is entitled to issue securities for the purpose of capital mobilization

Advantages Disadvantages

-Less risky for shareholders as

each will responsible up to the

contributed capital

-Capital structure is flexible: many

people can participate

-Scope of business: very large

-Can mobilize capital more easily

by issuing securities

-Capital/ ownership are easily

transferred

-Complicated -> difficult to control

-Must follow strict regulations:

such as management and finance

and accounting regulation,

b2. Limited liability company with more than 1 membersMembers can be organisation or individual; the minimum number of members will be 2 and the maximum number of members will be 50.

Members are liable for debts and other liabilities of the company within amount of capital that they contributed.

Members are able to transfer their contributed capital.

A Limited liability company will be given a legal status from the issuing date of the certificate of business registration.

A Limited liability company is NOT entitled to issue securities for the purpose of capital mobilization

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Advantages Disadvantages

-Less risky for members as each will responsible up to the contributed capital

-Number of members limited -> easier in controlling

-Share transfer is regulated strictly -> can control members easily

-Can not mobilize capital by issuing security

-Follow strict regulations rather than private company or partnership

Discussion questions:

Compare and contrast the advantages and disadvantages of shareholding company and liability limited company?

What do you understand by the terms “divorce between ownership and control”

CHAPTER 1 TEN PRINCIPLES OF ECONOMICS

Structure patterns of shareholder-owned company

If ownership is dispersed, the control of the firm may not belong shareholders but senior managers: Board of Chief Executive or Directors- Monistic: firm serves for one interest group –shareholders; commonly in US and UK- Dualistic: for two interest groups: shareholder and employees; in France and Germany- Pluralistic: for not only interest of groups of shareholders, employee but stakeholders such as suppliers; in Japan.

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Patterns of share ownership: United Kingdom

The percentage of individual shareholding in total decline sharply over 1963-2001 period, from 54 % to 14.8 %.

In contrast, during similar period that of financial institutions increases dramatically from 30.3% to 60.2 %, decreased to 50 % in 2001. But this group replaced the individual as the largest shareholding

Foreign ownership also has risen markedly from 7 % to a stable point of 31.9 % over 40 years.

Patterns of share ownership: other European

The share of financial institution is lower but that of non-financial companies is higher as compared to UK

Individual ownership is more significant than that of institution in Italy and Spain, but less in France

Foreign ownership is more important in France, Spain but less in Germany and Italy

Patterns of enterprises’ ownership : Vietnam

• 100 % state- owned enterprise (SOEs) was dominant type before the decade 1990s.The share of these firms in total firms’ capital has been decreasing to about 20 %. A number of equitizatedmember companies of these corporations, groups has been increasing.

• Wholly foreign-owned, joint-venture with state-owned firms, joint-venture with private fastest increased during 90s decade. Those participate to stock exchange are increasing.

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Patterns of ownership structure: Vietnam (cont.)

• The proportion of private-owned firms has been growing fast, especially since 2000. But shareholder owned/ join-stock company (with state-owned capital or not), still make up a small percentage.

• The share of financial institution is not significant in the join-stock firms but tend to increase since 2000 following the operation of the stock exchange, rapid establishment of numerous banks and stock companies.

Is firm owner- or manager- controlled?

Control of firm is defined as directing the firm to owners’ objectives

Dispersion control from ownership in shareholder firm: The owners still bear the risk of operating firm but they are not manager (or not only chief managers) thus may not control the firm or lead the firm to goals set by them. This is because managers who are appointed by owners but still have ends relatively separate from the owners.

Is firm owner- or manager- controlled? (cont.)

The easy classifying cutting-off point :

- An individual share owners holds > 50 % of the equity can outvote the remaining and control company (assume: one voter held one share)

- If that < 50 % of the stock, they can win the vote if it gain the sufficient support of the others to outvote. Or vice versa.

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Is a firm owner- or manager- controlled? (cont.)

The other cut-off points to distinguish:

- Berle & Means (1932): owning 20 % of stock is sufficient for owner-controlled, < 20 % for managerial controlled

- Radice (1971): 15 % for owner-controlled and 5 % for managerial-controlled

Cut-off points is the simplistic classification:

- Nyman & Silberston (1978): strongly criticized that method, stress one factor which does not emerge from crude data but affects substantially to voting.

Is firm owner- or manager- controlled? (cont.)

That is coalitions of interests, especially of families.

- Cubin & Leech (1983): create a probabilistic voting model, defining:

+ Control is arbitrary 95 % chance of winning a vote. The degree of control is probability the controlling group securing majority support in a contested vote.

+ In their samples: 10 % is essential (73 companies) and 5 % (in 37 companies)

Variables of control of a company

The size of the largest holding

The size and distribution of the remaining shares

The willingness of other shareholders to form a voting united front

The willingness of other shareholders to vote for the largest holding group.

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Discussion questions• Companies A, B and C have the following share ownership structure:

– Firm A: the largest shareholder is an individual owning 10% of theequity, a further five members of the family own 25%, with theremaining shares owned by financial institutions and with no oneinstitution owning more than 3%. The board of directors does notinclude the largest shareholder but does control 10% of the equity.

– Firm B: the largest shareholder is an institution owning 3% of theequity. The remaining shares are owned by 20,000 individual andinstitutional share-holders.

– Firm C: the largest shareholder is an individual owning 40% of theequity. A single bank owns 20% and three companies the remaining40%.

• Classify each firm according to whether it is owner or manageriallycontrolled and whether it is likely to be part of an insider or outsidersystem of corporate governance

Systems of corporate control: Insider

Concentrated ownership: large-holding, dominance of institution/corporate shareholder

Shares are not frequently sold, but large block

Firm mergers rarely thorough merger, but agreement

Owners and other stakeholders are represented on the board of companies; active participation in controlling company

Countries applying: Europe (typically Germany) and Japan

Systems of corporate control: Outsider

Dispersed ownership: dominated by non-bank institution and private individuals.

Owners and other stakeholders are not represented on the boards of companies; passive investor, rarely question the operation of company.

Share is easily traded not for investment purpose

Managerial control; changing management and policies is very slow; may be via takeover.

Countries: US, UK

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Constrains on managerial discretion: External factors

Large shareholders: use their voting power to change their policies or management if they are dissatisfied

Acquirers of share blocks sold by existing unhappy shareholders

Bidders who state to buy all the voting shares if the company undergoes takeover process

Debtors/s investors secure their interest, especially in financially difficult time

Constrains on managerial discretion: External factors (cont.)

External regulators: company law, and independent auditors, lodging company’s account to regulator

In outsider system: these external factors mostly affects via stock market, following movements in the share price.

In insider system: the external constrains exercise through the voting powers since selling share is not simple.

Constrains on managerial discretion: Internal factors

Non-executive directors(UK) or supervisory board (Germany): their duty is to constrain executive directors. But they are appointed by executive managers, outvoted by executive directors thus may not be independent. In Germany the board members are selected more widely

Owners/shareholders: control by:

a) using the voting power at meetings of firm or informal with managers: Vote against re-election of ED or their decisions;

b) Organizing coalitions to influence management informally and force voting at the general. (in UK)

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Constrains on managerial discretion: Internal factors (cont.)

Stakeholder within the company: customers, suppliers, lenders and local community. Their constrain actions being undertaken in two ways:

+ Direct criticism or comments to the executives

+ Indirect information, affecting to shareholders, medias, outside experts

Constrains on managerial discretion: aligning the interests of managers and shareholders

Devising incentive mechanism to align interest of managers and shareholders:

Profit-related bonus + share options based on successful performance of managers in term of owners objectives. Difficulties: Manager’s non-monetary motivation.

A survey of around 300 companies in UK in the 1980s –early 90s: weak correlation between rewarding system and firm performance.

Constrains on managerial discretion: improving corporate governance

Corporate governance concepts:

• In broader term, CG cover not only management’s responsibility to shareholders but also to stakeholders as well as wide community.

• From government point of view : CG is “ensuring accountability in the exercise of power and financial responsibility, while not discouraging firm from being enterprising and risk taking.” (Jones, 2004)

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Constrains on managerial discretion: improving corporate governance (cont.)

The main instrument of CG over the world and in OECD is codes of practice to ensure two mentioned aspects of good corporate practice.

In UK, Combined Code 1998, requires each corporate:

+ A non-executive chairman bearing responsibility clearly distinguished from chief executive

+Three non-executive directors of management

Constrains on managerial discretion: improving corporate governance (cont.)

+ A remuneration committee of at least three non-executive directors to decide the reward for directors

+ A nomination committee composed 100% non-executive directors to appoint new directors.

+ Annual report to shareholders should contain:

a) A narrative account of how the broad principles was applied, explain any departures from Code

b) Payment to chief executive and highest paid director

Constrains on managerial discretion: improving corporate governance (cont.)

+ Directors should receive appropriate training to complete duty well

+ The company need to justify if chairman and chief executive are the same.

+ Directors who retire before the end of term should explain

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Constrains on managerial discretion: limitations for improving corporate governance

o In practice the Code doest not completely prevent bad conduct of a part of executives

o The compliance with the Code doest not guaranty the profitability of company

o Non-executive directors are the directors of the other, not ensuring their independent scrutiny

o Non-executive limited ability to carry out their expected duty

Discussion questionCompare and contrast the constraint of CEO working for a firm of insider system and of outsider system?