Corporate Governance: Foundational Issues

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Corporate Governance Foundational Issues
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Chapter 4
Professor Craig Diamond BA 385 October 14, 2009
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Outline of Topics

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• Legitimacy and Corporate Governance
• Problems in Corporate Governance
• Improving Corporate Governance
• The Role of Shareholders

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Legitimacy and Corporate Governance
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Legitimacy and Corporate Governance
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Micro Level of Legitimacy
Macro Level of Legitimacy

• Adapt operational methods to perceived societal
  expectations
• Attempt to change societal expectations or norms
  to conform to firms practices

• Focus is on the totality of business enterprises
• Existence is solely because society has given it
  that right

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Corporate Governance

• The word governance comes from the Greek word
  for steering.

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The Corporations Hierarchy of Authority
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Figure 4-1
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Separation of Ownership from Control
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Precorporate Period
Corporate Period
Owners(ownership) Managers(control)
Figure 4-2
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The Need for Board Independence
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Top managers Friends, family, or colleagues of
top managers Firms hired lawyers, bankers
Independent from the company and its top managers
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CEO Compensation

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Ratio of CEO pay to average worker pay 1982
421 2006 4111
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Stock Options
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CEO Compensation

• Executive Retirement Plans
• Examples
• Richard Grasso, New York Stock Exchange
• Jack Welch, General Electric

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Addressing Excessive CEO Pay
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2007 SEC rules on disclosure of executive
compensation designed to increase transparency
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Board/CEO Relationship

• Boards are protecting CEOs less than they used
  to
• From 2005 to 2006, there was a 68 increase in
  turnover of CEOs and board members.

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Director Compensation

• Original idea dont pay board members anything
• Keeps maximum independence
• Board members increasingly want to be paid more
• 1992 average board member worked 95 hrs/yr for a
  company.
• In 2000, that number had increased to 173 hrs/yr.
• Sarbanes-Oxley
• Creating more accountability for Board members,
  which also causes them to want more compensation

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Mergers Acquisitions
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Poison pill
Golden parachutes
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Insider Trading
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Examples 1980s wide spread scandals, 2003
Martha Stewart
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Improving Corporate Governance

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Accounting Reform and Investor Act of
2002 (Sarbanes-Oxley)

• Improves auditing and financial reporting
• Limits the nonauditing services an auditor can
  provide
• Requires auditing firms to rotate the auditors
  working with a specific company
• Makes it unlawful for accounting firms to provide
  services where conflicts of interests exist

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Improving Corporate Governance

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Accounting Reform and Investor Act of
2002 (Sarbanes-Oxley)

• Enhances financial disclosure with requirements,
  such as
• reporting off-balance sheet transactions
• prohibiting personal loans to executives and
  directors
• requiring auditors to assess and report upon
  internal controls
• Audit committees must have at least one financial
  expert
• CEOs and CFOs certify and are held responsible
  for financial representations
• Whistle-blowers are afforded protection
• Code of ethics disclosure

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Improving Corporate Governance

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• Changes in boards of directors
• Board diversity (make greater of women and
  minorities)
• Outside board directors
• Use of board committees for
• Audit
• Nominating (selecting Board members)
• Compensation (for top management)
• Public policy (stakeholder issues)
• Board should get tough with the CEO

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Use of Board Committees

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Principal Responsibilities of an Audit Committee

1. To ensure that published financial statements are
   not misleading.
2. To ensure that internal controls are adequate.
3. To follow up on allegations of material,
   financial, ethical, and legal irregularities.
4. To ratify the selection of the external auditor.

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Board Member Liability
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Board Member Liability
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• In November 2006, the Delaware Supreme Court
  affirmed the Caremark Standard, which states
  that directors canonly be held liable if
• The director utterly failed to implement any
  reporting or information system or controls, or
• Having implemented such a system or controls,
  consciously failed to monitor or oversee its
  operations, disabling their ability to be
  informed of risks or problems requiring their
  attention.

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Shareholder Democracy Board Elections
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Shareholder Activism
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Investor Relations
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