Chapter 4 Study Guide
Senior executives at Enron had been secretly selling off their stock before losses were public. This practice is known as:
insider trading
shareholder-primacy model
A working group to develop protocols for director-shareholder engagement for U.S. public companies.
clawback provisions
Compensation recovery mechanisms that enable a company to recoup compensation funds, typically in the event of a financial restatement or executive's misbehavior.
Say on Pay
Evolved from concerns over excessive executive compensation and failures to link CEO pay to performance.
Which of the following has been an unexpected outcome of Sarbanes-Oxley?
it has led to a boom of new accounting businesses
_____ provides shareholders with the opportunity to propose nominees for the board of directors.
proxy access
According to the Sarbanes-Oxley Act, if a CEO is found to have willfully misrepresented company finances, they could face a penalty of:
20 years in prison and a 5 million dollar fine
tax gross-up
A compensation provision that reimburses executives for the taxes he would have to pay on his medical benefits.
shareholder engagement
A lawsuit created by a shareholder against a third party, on behalf of the company.
shareholder activism
A movement of shareholders fighting to have their voices heard in corporate governance, stemming from the lack of power shareholders have felt, particularly in board elections.
Council of Institutional Investors (CII)
A nonprofit association of corporate, public and union employee benefit funds, issued a policy that both current and former executive officers should be subject to clawback in cases of financial misstatements or fraud.
golden parachute
A provision in an employment contract in which a corporation agrees to make payments to key officers in the event of a change in the control of the corporation.
board of directors
A smaller group representing all shareholders that ascertain that the manager puts the interests of the shareholders first.
shareholder lawsuit
A strategy and set of formal procedures for opening communication between shareholders and a company on a variety of issues, including executive compensation, CEO succession, and company financial and ESG performance.
Which of the following is true regarding the problems that arose after separation of ownership from control?
Agency problems developed when the interests of the shareholders were not aligned with the interests of the managers.
stock options
Allows the recipient to purchase stock in the future at the price it is today, that is, "at the money." If the stock value rises after the granting of the option, the recipient will make money. The logic behind giving CEOs stock options is that those CEOs will want to increase the value of the firm's stock so that they will be able to exercise their options, buying stock in the future at a price that is lower than it's worth. Stock options are designed to motivate the recipient to improve the value of the firm's stock.
Accounting Reform and Investor Protection Act of 2002
Also known as the Sarbanes-Oxley Act (aka SOX or Sarbox), amends the securities laws to provide better protection to investors in public companies by improving the financial reporting of companies.
Sarbanes-Oxley Act of 2002 (aka SOX or Sarbox)
Amended the securities laws to provide better protection to investors in public companies by improving the financial reporting of companies.
Dodd-Frank Wall Street Reform and Consumer Protection Act
An act passed in the wake of the global financial crisis and signed into law on July 21, 2010.
Clean Capitalism
An economic system in which prices fully incorporate social, economic, and ecological costs and benefits, and actors are clearly aware of the consequences of their marketplace actions.
Pay-Ratio Disclosure Rule
An equity pay provision adopted in 2015 that requires firms to reveal the difference in salaries between executives and rank-and-file workers. It is intended to have the SEC improve the transparency of firm operations.
tipper
An individual who provides inside information.
tippee
An individual who receives inside information.
full disclosure
An obligation that disclosure should be made at regular and frequent intervals and should contain information that might affect the investment decisions of shareholders.
outside directors
Are independent from the firm and its top managers. They can come from a variety of backgrounds (e.g., top managers of other firms, academics, former government officials) but the one thing they have in common is that they have no other substantive relationship to the firm or its CEO.
employees
Are those hired by the company to perform the actual operational work.
seperation of ownership from control
As the public corporation grew and stock ownership became widely dispersed, shareholders (owners) became more distant from managers and a separation of ownership from control became the prevalent condition.
shareholder resolutions
Asserts that maximizing share value is the ultimate firm goal and that improving corporate governance entails reducing board power, maximizing shareholder power, and tying incentives to share price.
out-of-pocket liability
Board members paying personal liability costs from their personal funds.
director-primacy model
Challenges the status quo and asks whether the balance of power in corporate governance should favor shareholders or board members.
_____ provisions are compensation recovery mechanisms that enable a company to recoup compensation funds, typically in the event of a financial restatement or executive's misbehavior.
Clawback
agency problems
Developed when the interests of the shareholders were not aligned with the interests of the manager, and the manager (who is a hired agent with the responsibility of representing the owners' best interests) began to pursue self-interest instead of the owners' best interests.
charter
Gives the corporation the right to exist and stipulating the basic terms of its existence.
nominating committee
Has the responsibility of ensuring that competent, objective board members are selected.
compensation committee
Has the responsibility of evaluating executive performance and recommending terms and conditions of employment.
inside directors
Have ties of some sort to the firm. They can be top managers in the firm, family members, or others with a professional or personal relationship to the firm or to the CEO.
business judgement rule
Holds that courts should not challenge board members who act in good faith, making informed decisions that reflect the company's best interests instead of their own self-interest.
material information
Information that a reasonable investor might want to use and that is likely to affect the price of a firm's stock once that information is released to the public.
Private Securities Litigation Reform Act of 1995
Intended to rein in excessive levels of private securities litigation.
Which of the following is true regarding legitimacy and corporate governance?
Legitimacy is a condition that prevails when there is congruence between the organization's activities and society's expectations.
ponzi scheme
Lures investors in with the fake promise of profit but actually pays earlier investors with later investors' money until the scheme collapses.
team production model
Notes that work of a corporation requires the combined input of two or more individuals or groups.
CEO duality
Occurs when the CEO serves the dual function of CEO and chairman of the board.
backdating
Occurs when the recipient is given the option of buying stock at yesterday's price, resulting in an immediate and guaranteed wealth increase.
Anglo-American Model
One characterized as having outside directors, following common law, with market-oriented and shareholder-centered governance.
Shareholder-Director Exchange (SDX)
One of the major vehicles by which shareholder activists communicate their concerns to management groups is through the filing of shareholder resolutions.
shareholders
Own stock in the firm and, according to the shareholder-primacy model, that makes them the firm's owners and gives them ultimate control over the corporation.
risk committees
Provide oversight about risks regarding strategy and tactics across operational, financial, and compliance areas.
proxy access
Provides shareholders with the opportunity to propose nominees for the board of directors.
legitimacy
Refers to the perceived validity or appropriateness of a stakeholder's claim to a stake. Therefore, owners, employees, and customers represent a high degree of legitimacy due to their explicit, formal, and direct relationships with a company. Stakeholders that are more distant from the firm, such as social activist groups, NGOs, competitors, or the media, might be thought to have less legitimacy.
audit committee
Responsible for assessing the adequacy of internal control systems and the integrity of financial statements.
The Accounting Reform and Investor Protection Act of 2002 is also known as the:
Sarbanes-Oxley Act
Which movement arose from concerns over excessive executive compensation, and resulted in a compensation report to be put to a shareholder vote at each annual meeting?
Say on Pay
Regulation FD (Fair Disclosure)
Sets limits on the common company practice of selective disclosure.
shareholder democracy
Shareholders have discovered the benefits of organizing and wielding power. Historically, these are socially-oriented shareholders; that is, they want to exert pressure to make the companies in which they own stock more socially responsive. While this remains true for many, activist shareholders are now also driven by a concern for profit. Shareholder activists have put forth a record number of proposals that have led to a shift toward greater shareholder power, but have also created tensions between shareholders and board members.
personal liability
The concept that individual directors can be held personally liable for losses that are caused by their failure to meet appropriate standards.
fragile mandate
The concept that the legitimacy of business is constantly subject to ratification; and it must realize that it has no inherent right to exist. Business exists solely because society has given it that right.
bullet-dodging
The delaying of a stock option grant until right after bad news. Backdating is not inherently illegal, but it can be deemed so if documents were falsified to conceal the backdating.
legitimation
The dynamic process by which business seeks to perpetuate its acceptance.
management
The group of individuals hired by the board to run the company and manage it on a daily basis.
corporate gadflies
The method by which a firm is being governed, directed, administered, or controlled and to the goals for which it is being governed.
insider trading
The practice of buying or selling a security by someone who has access to material information that is not available to the public.
spring-loading
The practice of granting of a stock option at today's price but with the inside knowledge that something good is about to happen that will improve the stock's value.
Transparency
The practice that disclosure should be made at regular and frequent intervals and should contain information that might affect the investment decisions of shareholders.
majority vote
The requirement that board members be elected by a majority of votes cast. This is in contrast to the previously prevailing norm of plurality voting.
classified boards
Those boards that elect their members in staggered terms. For example, in a board of 12 members, 4 might be elected each year, and each would serve a three-year term.
staggered boards
Those boards that elect their members in staggered terms. For example, in a board of 12 members, 4 might be elected each year, and each would serve a three-year term.
corporate governance
Typically deal with such issues as diversity, equal employment opportunity, environmental affairs, employee health and safety, consumer affairs, political action, and other areas in which public or ethical issues are present.
corporate responsibility committee
Typically deal with such issues as diversity, equal employment opportunity, environmental affairs, employee health and safety, consumer affairs, political action, and other areas in which public or ethical issues are present.
restricted stock
Unlike stock options, restricted stock always has value, even in a down market, and it can deliver the same value with fewer shares than options because it does not have an exercise price.
Continental-European Model
Where inside directors and civil law dominate, as well as block ownership, a bank-orientation and stakeholder-coordinated governance.
information asymmetry
Where one party has information that another does not.
Congress passed Sarbanes-Oxley into law as a response to:
financial scandals and corporate fraud
The four major groups involved in corporate governance are the:
shareholders, boards of directors, managers, and employees
Sarbanes-Oxley:
all of these
When the recipient of a stock option is given the option of buying stock at yesterday's price, resulting in an immediate and guaranteed wealth increase, _______ has occurred.
backdating
How does Sarbanes-Oxley attempt to improve business ethics?
by legally requiring companies to certify the truth of their statements to investors
According to Sarbanes-Oxley, accounting firms that provide consulting services to businesses are prohibited from providing auditing services. This prevents:
conflict of interests
A _____ is intended to discourage or prevent a hostile takeover.
poison pill
The granting of a stock option at today's price with the inside knowledge that something good is about to happen that will improve the stock's value is known as_____.
spring-loading
Which aspect of Sarbanes-Oxley has created severe difficulties for businesses?
the cost and difficulties of compliance
What ethical concept does Sarbanes-Oxley promote and institutionalize?
transparency