ABSTRACT
Because the yoyo model can be employed to analyze nonlinear interactions, as described in the previous chapters, we will in this chapter apply this method to look at how the systemic yoyo model can be employed to study the problem of corporate governance, where corporations need capital to fund their ventures or provide the founders with cash-out opportunities, and suppliers of finance want to be assured that they get a return on their investment. We will study the mutual restrictions and interactions between a firm’s board of directors, which is dominated by longterm, large shareholders, and the CEO, who is not a long-term, large shareholder. Before establishing a concrete analytic model, we first develop the systemic yoyo model foundation for some of the relevant empirical discoveries. On such a qualitative foundation, we provide an explanation for:
1. Why an elaborate legal system is needed for venture capital to flow smoothly and why certain governments around the world are willing to go extra miles to establish such as legal system
2. Why the agency problem existing between the large shareholders and the CEO cannot be resolved completely and the best one can do about this problem is to reduce its severity
3. Why outside financers still leave their money to managers in all market economies from around the world even with the knowledge of the unsolvable agency problem
4. Why there are boards of directors in the first place, among others
With these new and deepened understandings about the mutual interactions and restrictions between the board and the CEO, we establish a simple analytic model to study the price behaviors of different investment projects, the dynamics between long-term and short-term projects and assets, and the power struggle between the board and the CEO. Our quantitative analysis indicates that when assets are undervalued, the mispricing of the long-term asset in equilibrium is worse than that of the short-term asset. When the assets are overpriced, the mispricing of the short-term asset in equilibrium is worse than that of the long-term asset. Based on this result, we provide an explanation for why CEOs would prefer undervalued short-term investment projects.
