New Horizons in Law and Economics series
Edited by Hans Sjögren and Göran Skogh
Chapter 6: Corporate governance and financial distress
Karin S. Thorburn* INTRODUCTION How can providers of capital to corporations make sure that managers return some of the firm’s profits? Once the investors have parted with their money, they have little more to contribute to the firm. What then prevents managers from expropriating the funds provided by investors? As a matter of fact corporate insiders have access to an elaborate expropriation technology. For example, managers can sell the firm’s output or assets at below-market prices to an independent firm they own, get subsidized loans, issue underpriced securities to themselves or their relatives or pay themselves excessive compensation. Corporate governance is the set of mechanisms that regulate the actions of corporate insiders (managers and large shareholders) in order to protect the interests of outside investors (dispersed shareholders and creditors). Adequate protection of investor rights is necessary to induce outside investors to provide financing to the firm. As reviewed in Shleifer and Vishny (1997), Bradley et al. (1999) and La Porta et al. (2000), the past decade has seen an explosion of academic research in corporate governance, most of it empirical. Topics covered include the value of the right to vote, the market for corporate control, agency issues, optimal financial and compensation contracts, accounting transparency, insider trading, optimal board structure, and so on. This chapter reviews some of the issues and evidence specific to so-called corporate ‘tunnelling’ and other fraudulent activities by corporate insiders. There is an emphasis on financial distress and I try to review issues of particular relevance to...
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