Separation of Ownership and Control

1
Separation of Ownership and Control

• Or . . . the separation of residual risk-bearing
  and decision initiation and decision
  implementation.

2
Blackboard

• Groups are populated and the following group
  functions have been turned on
• E-mail
• File exchange
• Group discussion board

3
Separation of ownership and control . . .

• We have talked about the ramifications of
  separate risk-bearing and decision rights before.
  (My boutique grocery)
• Residual risk bearing Residual claimants have
  the right to net cash inflows, but they are
  uncertain.
• Decision making Involves initiating, approving
  and implementing, and monitoring the outcome.

4
Delegating decision rights

• Decision management The combination of decision
  initiation and decision implementation is called
  decision management.
• Decision control The combination of decision
  approval and decision monitoring is called
  decision control.
• Residual claimants (or their representatives,
  Boards of Directors, for example) retain decision
  control to protect residual claimants.
• Decision management is transferred to managers.

5
Anatomy of a decision

• Define the problem
• Identify the criteria
• Weight the criteria
• Generate alternatives
• Rate each (based on criteria)
• Take the optimal decision

6
Discussion Question

• Oak Hill Country Club

7
Open Corporations

• Typically, decision management (initiation and
  implementation) and decision control
  (ratification and monitoring) are also separated.
  Why?
• Open corporations complex organizations.
• Boards of directors include some outside
  experts.
• Outside directors.
• Stock market unrestricted alienability.
• Market for takeovers external monitoring.

8
Professional partnerships

• Mutual monitoring, specific knowledge, and
  restricted residual claims.
• When residual claimants are diffuse, separate
  decision management and decision control.
• Managing committees (experts, decisions about
  admission and dismissals).
• Little demand for outside experts.
• No takeover threats.

9
Nonprofit organizations

• Donations
• No agents with alienable rights in residual net
  cash flows.
• Boards small with decision management powers
• Chosen, monitored and evaluated by boards of
  directors.
• Boards few internal agents, include substantial
  donors, board membership implied continued
  donations.

10
Venture Capitalists and Control

• What are venture capitalists?
• What is the situation they face?
• Information asymmetry
• It creates the potential for conflicts of
  interest
• How does separation of ownership and control
  apply to them?

11
Venture Capitalists

• Staging
• Syndication
• Incentive compensation
• Convertible securities

12
Venture Capitalists

• What do venture capitalists fear?
• Consumption of perquisites (non-pecuniary
  returns)
• Investments in negative NPV projects
• Slacking
• Too much or too little risk

13
Venture Capitalists

• Board seats control
• Covenants Restrictions
• Some actions or activities expressly forbidden
• Use of preferred stock and priorities shifts the
  risk to the entrepreneur
• Control the issuance of new securities

14
Venture Capitalists

• They try to reduce information asymmetries
• They are not passive investors
• They guide the business to IPO
• It is the non-monetary aspects of VCs that are
  critical to its success

15
Sky Air, Inc.

• Ask yourselves what kind of ownership/control
  structure would be required after the partial
  ownership sale.
• What incentives problems are created by the
  arrangement Kaplan has in mind?
• What can he do to get more money from the sale?
• When would you advise him to take those steps
  versus revise his expectations downward?

16
The end!

• Spend the remaining time planning how your group
  will get its work done.