chapter 4
Private Securities Litigation Reform Act of 1995, p. 114
intended to rein in excessive levels of private securities litigation. The increase in the number of filings has been attributed to the financial crisis of 2008.
Executive Retirement Plans and Exit Packages
>>Retirement packages have come under scrutiny. Lavish executive packages contrast to most workers, many of whom to do have a retirement plan
corporate gadflies, p. 113
Activist shareholders, no longer dismissed as nuisance and are instead viewed as credible, powerful, and a force with which to be reckoned. In fact,money managers and hedge funds advertise their activist orientation in the belief that being seen as aggressive gives them an edge.
separation of ownership from control
Agency problems develop when managers pursue self-interest over owner interest
Stock Options
Allows the recipient to purchase stock in the future at the price it is today.
Improving Corporate Governance
Changes in boards of directors Board diversity Outside board directors Use of board committees for: Audit Nominating Compensation Public policy >The board should "get tough" with the CEO.
spring loading
Granting of a stock option at today's price, but with the inside knowledge that stock's value is improving.
The Role of the SEC
Is responsible for protecting investor interests. Critics argue that the SEC is more focused on businesses than on investors. >>SEC failed to catch the Bernard Madoff Ponzi scheme before losing investors billions.
Board Diversity is lacking
Only around 15% of directors in U.S. are women. Sixty-six Fortune 500 firms have no female board members. Hispanics, Asian Americans and African Americans also under-represented. Diverse boards are also less likely to fall prey to groupthink because they have a range of perspectives. >>Is a global problem.
outside directors, p. 100
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.
Outside Director Compensation
Paying board members is a recent concept. Controversy over whether directors should be paid at all, and whether they are paid enough.
Impact of the Market on Corporate Control
Poison pill Golden parachutes
Tax Gross-Up
Reimbursement for taxes one would have to pay on medical benefits or other such costs.
Excessive CEO Pay
Say on Pay Evolved from concerns over excessive executive compensation. Began in the United Kingdom in 2002 with regulations on pay. 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.
Board Member Liability
The "Caremark Standard," which heightened concerns over personal liability, states that directors can be held personally 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.
personal liability, p. 110
The Delaware Chancery Court ruled that it is the duty of the board of directors to ensure that a company has an effective reporting and monitoring system in place. If the board fails to do this,individual directors can be held personally liable for losses that are caused by their failure to meet appropriate standards.
out-of-pocket liability, p. 111
The issue of board members paying personal liability costs from their personal funds
legitimation, p. 95
dynamic process by which business seeks to perpetuate its acceptance. The dynamic process aspect should be emphasized, because society's norms and values change, and business must change if its legitimacy is to continue. It is also useful to consider legitimacy at both the micro, or company, level and the macro, or business institution, level. ***A dynamic process by which a business seeks to perpetuate its acceptance.
inside directors, p. 100
inside directors have ties of some sort to the firm. Sometimes they are top managers in the firm; at others, insiders are family members or others with a professional or personal relationship to the firm or the CEO.
poison pill, p. 104
intended to discourage or prevent a hostile takeover. They work much like their name suggests—when an acquirer tries to swallow (i.e.,acquire) a company, the poison pill makes the company very difficult to ingest. when a hostile suitor acquires more than a certain percentage of a company's stock, the poison pill provides that other shareholders be able to purchase shares, thus diluting the suitor's holdings and making the acquisition prohibitively expensive (i.e., difficult to swallow).
audit committee, p. 108
is responsible for assessing the adequacy of internal control systems and the integrity of financial statements. committee. In a recent survey, board members indicated that audit committee members have had the greatest increase in workload because of the added responsibilities stemming from SOX. SOX mandates that the audit committee be composed entirely of independent board members and that there be at least one identified financial expert, as defined in SOX. The principal responsibilities of an audit committee are as follows: 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
proxy access, p. 112
provides shareholders with the opportunity to propose nominees for the board of directors. This has been an issue of contention for years. In the prevailing system, shareholders must file a separate ballot if they want to nominate their own candidates for director positions. This procedure is time-consuming and costly, so shareholder groups are asking for the ability to place their candidates directly on the proxy materials. ***Provides shareholders with the opportunity to propose nominees for the board of directors.
corporate governance, p. 96
refers to the method by which a firm is being governed, directed, administered, or controlled and to the goals for which it is being governed. Corporate governance is concerned with the relative roles, rights, and accountability of such stakeholder groups as owners, boards of directors, managers, employees, and others who assert to be stakeholders. ***Refers to the method by which a firm is being governed, directed, administered, or controlled and to the goals for which it is being governed. >>Is concerned with the relative roles, rights, and accountability of such stakeholder groups as owners, boards of directors, managers, employees, and other stakeholders.
compensation committee, p. 108
responsibility of evaluating executive performance and recommending terms and conditions of employment. This committee should be composed of outside directors. Both the New York Stock Exchange (NYSE) and NASDAQ require that the compensation committee be composed of independent board members. ****Evaluates executive performance and recommending terms and conditions of employment.
Corporate Period
shareholders (ownership) Board of directors management (control)
clawback provisions, p. 102
which are compensation recovery mechanisms that enable a company to recoup compensation funds, typically in the event of a financial restatement or executive's misbehavior. At this writing, financial reform legislation is scheduled to include"clawback"provisions to recall bonuses from financial services employees whose risky practices create problems for investors. ****Compensation recovery mechanisms that enable a company to recoup compensation funds, typically in the event of a financial restatement or executive's misbehavior.
nominating committee, p. 108
which should be composed of outside directors, has the responsibility of ensuring that competent, objective board members are selected. The function of the nominating committee is to nominate candidates for the board and for senior management positions. The suggested role and responsibility of this committee notwithstanding, in most companies, the CEO continues to exercise a powerful role in the selection of board members. ***Is composed of outside directors. Has the responsibility of selecting competent, objective board members.
full disclosure, p. 115
(also known as transparency) responsibilities. Disclosure should be made at regular and frequent intervals and should contain information that might affect the investment decisions of shareholders. This information might include the nature and activities of the business, financial and policy matters, tender offers, and special problems and opportunities in the near future and in the longer term. Of paramount importance are the interests of the investing public, not the interests of the incumbent management team. Board members should avoid conflicts between personal interests and the interests of shareholders. ***SEC requires disclosure of executive compensations. Disclosure forms are long and difficult. ****Information filed at regular and frequent intervals that contains information that might affect investment decisions. >>Management is responsible for communicating with shareholders.
charter, p. 96
authority or rights issued by the state, giving the corporation the right to exist and stipulating the basic terms of its existence. Figure 4-1 presents these four groups, along with the state charter, in a hierarchy of corporate governance authority.
business judgment rule, p. 109
business judgment 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. The argument for the business judgment rule is that board members need to be free to take risks without fear of liability. The issue of good faith is key here because the rule was never intended to absolve board members completely from personal liability. ****Holds that courts should not challenge board members who act in good faith, making informed decisions that reflect the company's best interests. >>>Board members need to be free to take risks without fear of liability.
golden parachute, p. 104
contract in which a corporation agrees to make payments to key officers in the event of a change in the control of the corporation. that golden parachutes provide top executives involved in takeover battles with an incentive for not fighting a shareholder wealth-maximizing takeover attempt in an effort to preserve their employment.
agency problems, p. 98
developed when the interests of the shareholders were not aligned with the interests of the manager, and the manager (who is simply a hired agent with the responsibility of representing the owners best interests) began to pursue self-interest instead of the owners best interests.
legitimacy, p. 95
it helps explain the importance of the relative roles of a corporation's charter, shareholders, board of directors, management, and employees—all of which are components of the modern corporate governance system.At the micro level of legitimacy, we refer to individual business firms achieving and maintaining legitimacy by conforming to societal expectations. Companies seek legitimacy in several ways. First, a company may adapt its methods of operating to conform to what it perceives to be the prevailing standard. For example, a company may discontinue door-to-door selling if that marketing approach comes to be viewed in the public mind as a shoddy sales technique,or a pharmaceutical company may discontinue offering free drug samples to medical students if this practice begins to take on the aura of a bribe. Second, ***A condition that prevails when there is a congruence between an organization's activities and society's expectations.
ponzi scheme, p. 112
lures investors in with the fake promise of profit but actually pays earlier investors with later investors'money until the scheme collapses.
backdating, p. 101
occurs when the recipient is given the option of buying stock at yesterday's price, resulting in an immediate and guaranteed wealth increase.This puts the stock option"in the money"rather than"at the money,"which is where an option should be granted. Of course, backdating results in an immediate gain and is not in keeping with the purpose of stock options. a form of stock option abuse Backdating is not inherently illegal, but can be deemed so if documents were falsified to conceal the backdating. ***Allows the recipient to purchase stock at yesterday's price, resulting in immediate wealth increase.
public issues committee, p. 108
or public policy committee. Although it is recognized that most management structures have some sort of formal mechanism for responding to public or social issues, this area is important enough to warrant a board committee that would become sensitive to these issues, provide policy leadership, and monitor the management's performance on these issues. ***Responds to public or social issues. Deals with areas in which public or ethical issues are present.
Precorporate Period
owners (ownership) managers (control)
insider trading, p. 104
practice of obtaining critical information from inside a company and then using that information for one's own personal financial gain. ***The practice of obtaining critical information from inside a company and using that information for one's own personal financial gain.
Accounting Reform and Investor Protection Act of 2002 , p. 105
signed on July 30, 2002 Also known as the Sarbanes-Oxley Act (aka SOX or Sarbox), it amends the securities laws to provide better protection to investors in public companies by improving the financial reporting of companies. Senate committee report,"the issue of auditor independence is at the center of [SOX]." the act endeavors to ensure auditor independence are by limiting the nonauditing services an auditor can provide, requiring auditing firms to rotate the auditors who work with a specific company, and making it unlawful for accounting firms to provide auditing services where conflicts of interest (as defined by the act) exist. In addition, the act enhances financial disclosure with requirements such as the reporting of off balance-sheet transactions, the prohibiting of personal loans to executives and directors, and the requirement that auditors assess and report upon the internal controls employed by the company. ****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 CEOs and CFOs certify and are held responsible for financial representations >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 Whistle-blowers are given protection Code of ethics disclosure
board of directors, p. 96
smaller groups of shareholders which govern and oversee the management of the business. The board is responsible for ascertaining that the manager puts the interests of the owners (i.e., shareholders) first.
corporation hierarchy of authority
state charter shareholders board of directors management employees
bullet-dodging, p. 101
the delaying of a stock option grant until right after bad news. ***Delaying of a stock option grant until right after bad news.
majority vote, p. 112
the requirement that board members be elected by a majority of votes cast. ****The requirement that board members be elected by a majority of votes cast.
management, p. 97
third major group in the authority hierarchy group of individuals hired by the board to run the company and manage it on a daily basis. Along with the board, the top management establishes the overall policy. Middle- and lower-level managers carry out this policy and conduct the daily supervision of the operative employees.
employees, p. 97
those hired by the company to perform the actual operational work. Managers are employees, too, but in this discussion, we use the term employees to refer to nonmanagerial employees.
classified boards, p. 112
those 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. It would then take three years for the entire board slate to be replaced. Many shareholder activists oppose classified boards because of the time required to replace the board. Proponents of classified boards argue that board members need a longer time frame to get to make longer-term-oriented strategic decisions. ****Boards that elect their members in staggered terms.
