Corporate Governance Exam 2

Greenmail, poison pills, and anti-takeover devices

1) Greenmail→ extortion/someone buying a large stake in a company which management doesn't want so they offer to buy them out to be able to stay in control. 2) Poison Pills→ a tactic used to make a company look unattractive to potential buyer in a hostile takeover dilutes shares for acquirer. 3) Anti-takeover devices→ white-knight defense; a friendly buyer over the firm.

Creation of the Public Company Accounting Oversight Board

Before enactment of this legislation, the accounting profession was self-regulated, overseen by its own American Institute of Certified Public Accountants. Sarbanes—Oxley created a private-sector, nonprofit corporation with members appointed by the SEC.

HR-ER Implications

Corporate culture and the people management system are often key aspects of the failure of integration.

Responses to Hostile Takeovers I

Persistent negative answer Restructuring by implementing some of the ideas of the potential acquirer or related ideas to raise shareholder value. Change in the board of directors to admit more independent directors. Agreement to do more stock buybacks or specific deals, e.g. spin-off of company parts.

Portfolio theory and the risk problem of employee stock ownership and how to address it

Portfolio theory: states the best long term investment in the market is diversified assets. Deals with how you manage risk through diversification.

The range of basic elements of executive pay are..

a fixed salary, profit/gain sharing, employee stock ownership (maybe in the form of stock options or restricted stock), Long-Term Incentive Plans (that often include equity and profit/gain sharing) , and various retirement benefits;

Restricted stock

- Restricted stock is stock that one cannot sell or transfer for a set or restricted period time and the employee does not own it until that period passes.

The Evidence For Dilution

-National Bureau for Economic Research 8 year study supported by a million dollars from the Russell Sage Foundation and the Rockefeller Foundation -41,206 workers at 320 work sites in 14 companies with size and industry differences and many countries -All the practices are grouped together as the Shared Capitalism Score or Shared Capitalism for short. -We used the General Social Survey as a national control group.

Improper or Illegal Issues

-Stock option back dating -Accounting fraud -Risky structure of firm's capital position -Use of special securities to grow the firm -Improper rating of securities.

Main Thesis of Bebchuk and Fried

-There is a direct connection between greater managerial power (that is, the agents having more control than the principals) and increased executive compensation.

Effect of poor incentives on society as a whole From chat with professor:

As I said in the lectures, try not to focus out of jealousy or class ideology or inequality issues on the amount of executive pay, but try as corporate governance experts and scholars to focus on evidence that it is or is not tied to actual corporate performance.

Section 404

As noted above, the most controversial section of the law is the requirement that companies report on the effectiveness of their internal controls. It is important to note, however, that companies have been required to have internal controls since 1977, when the Foreign Corrupt Practices Act became law. All Sarbanes—Oxley adds is the requirement that companies find out whether they work or not and report on their findings. It may be expensive to answer that question; it is certainly expensive not to answer it.

The Closely-Held Sector

Family transitions are the major event and they are the principal problem of small businesses Acquisitions of start-ups is the second major event IPOs of closely-held firms the the next major event Outside of the US, privatization of smaller firms that were state-owned is becoming very common

The role of union pension funds as institutional investors

From chat with professor: The role of unions is that they have pension funds and they use their own votes on their pension funds' own shares to press issues of corporate governance reforms in shareholder meetings. Being large institutional investors unions will get the support of other institutional investors

The free rider problem as an objection by economists of broad-based rewards

Irresponsible workers will "free ride" on the good working behavior of more productive and responsible workers so the rewards will be wasted

Why the United Airlines ESOP failed

It failed mainly because after United became employee-owned as the stock went up outside investors made money but workers had to wait until they retired to get their stock and the added value. Also, United had had very bad union-management and salaried employees-management relations which got in the way of them creating a supportive corporate culture. The company should have had a cash profit sharing plan so as outside shareholders profited so did regular employees

HOW DO BOARDS DIVIDE THE PIE?

Many boards divide the pie to favor the top five executives and evidence suggests that this hurts shareholders.

A Common Objection

Productive and devoted workers will be taken advantage of because free riders will shirk and share the rewards.

Big Elephant in the Room

Risk *excessive extrapolation is a problem *but regular workers actually have their motivation diluted by excessive economic insecurity and risk even corporate culture risk *new research with Harry Markowitz shows the optimal and prudent amounts of company stock in one's entire portfolio

Mergers

Shareholders must vote on mergers. Bigness is often identified with success. Two thirds of mergers will lose value on the stock market according to some studies. But many bad mergers get shareholder approval indicating that the shareholder voting and communication mechanism is broken. Reasons: -culture clash -merger was conceived in a rising stock market -theoretical complementarities are not achieved e.g. Sears and Dean Witter, United and Hertz and Westin -BUT the intent may be to benefit the agents not the principals

Types of Corporate Changes

Takeovers Mergers Proxy Fights Spin-offs Financial Crises Privatizations

John Adams' Words

The Balance of Power in a Society, accompanies the Balance of Property in Land. The only possible Way then of preserving the Balance of Power on the side of equal Liberty and public Virtue, is to make the Acquisition of Land easy to every Member of Society.

The goal of executive pay by the board of directors and in the view of shareholders

To connect their pay to the actual performance of the company so that pay helps the executive through incentives grow the value of their shares From chat with professor: It is hard to say for the board of directors, in theory it should be to design executive pay programs to tie pay to performance, certainly that is the goal of shareholders. Some boards however, as we have seen do not design executive pay programs to tie pay to performance.

Major Role of The Board

To manage changes in the corporation The criteria for such changes are the good of the shareholders and stakeholders. These changes often affect corporate governance in subtle and not so subtle ways. The changes often involve re-dividing the equity and profit sharing pie to insiders.

What shareholders are trying to achieve with profit and equity sharing with executives

Trying to tie pay to performance

Takeovers

Two types: friendly and hostile The context is the existence of a public stock market or a market for corporate control -- this market is a reality no matter what the corporate governance system of any particular corporation is. Both start with a letter to the board of the target company from the acquiring company. New standards in Delaware law as a result of rulings of the Delaware Chancery Court inform this situation.

Main sections of the proxy statement

annual meeting, letter, table of contents, proxy summary, board committees(compensation), director compensation, exec comp (peer group) (pay for performance), summary comp table, stock awards, stock ownership information ,principle shareholder

The principal elements of executive compensation that came under the most criticism in the Monks and Minow book were..

excessive departure packages, virtually guaranteed bonuses, and Golden Parachutes.

The research on broad-based share plans for employees

shows that paying workers below a fair market wage for their job and region heavily compromises and reduces the effectiveness of such rewards.

Restricted stock

stock that one cannot sell or transfer for a set or restricted period time and the employee does not own it until that period passes.

Privatization as related to a government or a state involves

taking a government entity, determining its value using a valuation/accounting firm, making it a share corporation, and then selling those shares to private investors so it is no longer a government entity and is a private corporation.

The main traditional objection by economists to broad-based equity sharing and profit sharing rewards in corporations has been

that irresponsible workers will "free ride" on the good working behavior of more productive and responsible workers so the rewards will be wasted.

Whose responsibility is it to manage changes in the corporation?

the board of directors

Pump and dump as related to stock options

when execs. force the stock price up and then sell their shares to increase profit

A leveraged ESOP

a retirement plan that borrows money from banking institution in order to buy part or all of the stock of a corporation, pay the loan back out of ongoing profits, and then distribute the stock ownership to the workers without any cost to the workers. An ESOP uses credit made available to an employee trust to buy stock for the benefit of employees.

A proxy fight

allows a group of shareholders or an investor or any group or individual to take over the board of directors and management of a company without buying a majority of the shares be putting two competing board slates against each other in an election.

As a key case study discussed in the class, Southwest Airlines

has traditionally used a similar compensation structure of pay for its executives, its union, and its non-union workers, namely, fixed pay, profit sharing, and employee stock programs.

From a shareholder perspective

mainly, CEOs are principally paid to grow investor money while using a reasonable level of risk, obeying societies laws and regulations.

When a board of directors does not want to exert too much of the board's governance power in a corporation on a day-to-day basis

the reason is that most corporate governance scholars hold that management needs to be entrepreneurial on a day-to day basis and needs strategic direction not micro-management from the board which might depress risk-taking and nimble decision-making.

The First Evidence on Broad-based Shares

"The Captain and the Crew drew one half, and agreed among themselves in what Proportion to divide the fare. Sometimes the Owners hire the men by the Month and give them Common Seaman's wages....they were generally found the most attentive when their Dependence was on a Share of what they caught." --Joseph Anthony, the leading merchant in Philadelphia, Letter to the Assistant Secretary of the United States Treasury

Main sections of Sarbanes-Oxley Act of 2002 as discussed in the textbook

- The most significant provisions of Sarbanes-Oxley are as follows:

How The Board Decides?

-Compensation policy -Compensation consultants -Benchmarking and "peer group" -Compensation committee -history of the committee -essentially deregulated for many years FOCUS ON: In the past - before Enron In the present and the future - after Enron

The Self-interest of Agents Suggests

-More pay -Less performance-based -Less net-of-industry or market correction -Less risk -Structured to de-emphasize performance -BUT some agents like pay for performance

How much of the stock market do institutional investors own?

70-80% - but it hasn't led to much activist corporate governance

How Southwest Airlines handles its compensation system

In the Southwest Airlines case we learned that the firm uses a similar compensation structure of pay for its executives, its union, and its non-union workers.

Financial Crisis

The new corporate governance crisis happens very quickly to a firm Typically leads to a change in CEO Recent Examples are: Have not generally led to a transformation of the board (except for proxy contests) but that is going to change soon Examples: removal of the Fannie Mae and Freddie Mac boards, removal of board members in Home Depot

The Post-Enron President George Bush reforms on executive pay

The reforms say only independent directors could set executive pay, putting them only on the Compensation Committee and giving this committee sole authority (not management) to select compensation consultants.

Portfolio theory

briefly says that a diversified portfolio of the stock market representing different industry groups and asset classes is a responsible approach under most circumstances with a reasonable and prudent percent (generally no more than 10-15% of one's total wealth) in one's own company stock.

Greenmail

involves an investor rapidly acquiring a block of shares (typically then more than 5%) of a company hoping that management - if a takeover is threatened -- will buy the shares from the investor at a large profit.

The main role of the SEC-

(SEC) has a three-part mission: Protect investors. Maintain fair, orderly, and efficient markets. Facilitate capital formation.

The Fist Story of Employee Shares in American History

- the founding of the US - The Cod Fishery: 1789 - George Washington - Thomas Jefferson

Methods of Dividing the Pie

-Cash profit sharing -Gain sharing -Stock ownership: ESOP, company stock in 401k plan, open market purchases, Employee Stock Purchase Plan, deferred profit sharing trust -Stock options

HR-ER Implications

-Takeovers are often the endgame of a spiral of failure brought on by the lack of performance of the people management system in a company. -Spin-offs often require strong mobilization on the part of HR-ER staffs especially in creating the new company. -Better corporate governance procedures insulate a company from radical changes in a financial crisis.

Where Did The Share Idea Come From?

-The Founders of the U.S. including Second President John Adams and third President James Madison envisioned a nation of self-employed farmers and artisans who completely owned their own businesses and received the full share of profits from their businesses -They believed that a democracy could not exist without broad-based ownership of business, in this case land and craft shops and shipping. -They believed that owners were more productive and more likely to support a free market economy. -The alternative reminded them of English feudalism where a small group owned everything, however the idea had to be extended to women and minorities.

When two different companies merge, two possibilities are that

1) the acquiring company can buy out all of the shares of the existing shareholders of the target company; and 2) the acquiring company can give its own newly issued shares in exchange for the stock of the target company.

The Mondragon system

A Mondragon is a multinational corporation which has divisions most of which worker-owned cooperatives, it is located in the Basque region of Spain.

% of people who hold employee share ownership

About 20% of all adult workers hold employee share ownership in the company where they work while 7% hold employee stock options. About a third receive profit sharing and about a fifth receive gain sharing.

Elements of executive pay that concern shareholders and the ones that are most criticized by Monks and Minow

The principal elements of executive compensation that came under the most criticism in the Monks and Minow book were excessive departure packages, virtually guaranteed bonuses, and Golden Parachutes. Golden Parachutes: a large payment or other financial compensation guaranteed to a company executive should the executive be dismissed as a result of a merger or takeover.

Institutional investor

a large organization, such as a bank, pension fund, labor union, or insurance company, that makes substantial investments on the stock exchange

A stock option

allows the employee to buy her or his company stock for a set price (the exercise price on the day it is granted) typically for ten years into the future and thus get any upside gain.

A stock option

the right to buy a share of stock at today's price in the future no matter what the price in the future.

Separating the role of the CEO from the role of the Chairperson of the Board of Directors, as a corporate governance reform

was hotly debated after Enron but eventually NOT adopted by the Bush administration and the SEC. They opted for the "lead director" instead.

The main critique of how executive pay was set by boards of directors in the past before Enron and recent President George W. Bush reforms

was that boards of directors and their Compensation Committees often lacked independence from management in many of the mechanics used to set executive pay, in who was on the Compensation Committees, and pay sometimes was a result of management entrenchment.

In the Southwest Airlines case

we learned that the firm uses a similar compensation structure of pay for its executives, its union, and its non-union workers.

Who Has Shares Today?

-A national share census by the U.S. General Social Survey in 2010 -18% of adults own shares in the company where they work or about 19 million citizens -9% hold stock options in the company where they work or about 9 million citizens

What We Found About Shared Capitalism Alone

-As Shared Capitalism increases expected turnover decreases (also in the GSS), willingness to turn down a higher paying job to stay with the firm increases. True separately for profit/gain sharing, employee ownership, higher stock option grant last year, individual bonuses. -As Shared Capitalism increases, absenteeism increases. - True separately for profit sharing and stock options. Why is this the case? -As Shared Capitalism increases workers believe their co-workers work harder, have enough interest to get more involved with the firm, and say that they encourage each other to make extra efforts at work. (This result is powerfully demonstrated by creating a work site score for Shared Capitalism and perception of worker effort.) -As Shared Capitalism increases loyalty to the firm increases. (also in the GSS). True separately for profit/gain sharing, company stock in a 401k plan or open market, or getting a stock option grant last year. -As Shared Capitalism increases workers say they are willing to work harder for the firm. - - True separately for the size of a worker's ESOP stake. -As Shared Capitalism increases workers make more suggestions - True separately for employee ownership. BUT....beware of the behaviorist psychology trap.

Extent in the U.S.

-Based on a random survey of the U.S. working population in 2006 by the General Social Survey -% that own any company stock: 18% -% that got cash profit sharing: 30% -% that got gain sharing: 21% -% that hold stock options: 11% -% that got stock options last year: 6% -% with any combination: 47%

The Evidence on Shares

-Comparing employees in the same situation with shares and without shares in the same company and across companies -Employees with shares: are more loyal, more willing to work harder for the firm, & more willing to innovate. -They make more suggestions, monitor each other more closely, trust the company more, have a special kind of supervision, and participate more in problem-solving. -They have significantly lower turnover. -A supportive company culture is essential. -Fair fixed wages are a precondition to positive outcomes.

The Market Evidence

-Corporations with significant shares have meaningfully higher Return on Equity when employee empowerment is also high. -Corporations with shares have higher productivity based on definitive governmental studies conducted by the British Treasury. -It appears that lower supervisory costs, more cooperation between workers, and more innovation drive these results.

The Homestead Act: The Principles

-Every citizen should own part of the economy and receive income from this share so that they could be economically and socially independent. -They expected citizens who shared fully in ownership and profits to create a more productive economy. -This independence made small government, low taxes, less corruption, and a healthier civil society possible.

Impact of Corporate Culture and High Performance Work Practices

-Every corporation has these things so they cannot be excluded from the analysis. -As Shared Capitalism increases workers have lower supervision. (Combining SC with high supervision will reduce its effect.) -Shared Capitalism is complementary with having fixed wages above the market rate for the region and the job. (Combining SC with lower fixed wages reduces its effects.) -As shared capitalism increases we observe reduced turnover only when combined with a bundle of high performance work practices. -Shared capitalism effectively reduces absenteeism to zero when combined with a bundle of high performance work practices and low supervision. -Shared capitalism is complementary with high performance work practices, wages above the market, and low supervision in its association with loyalty and willingness to work hard. -As Shared Capitalism increases worker willingness to act against shirkers increases in the presence of complementary HR practices.

The New Idea: Corporate Shares, Once Land Ran Out

-Madison feared the country would run out of land for citizens' shares and worried about the alternative. -Galusha Grow, the Republican Speaker of the U.S. House of Representatives under President Abraham Lincoln said shares of corporations were the way of the future in order to achieve broad-based ownership. -Corporate property would expand without limit.

Issues to Think About

-Research on the level and the management of risk in employee portfolios -Presenting evidence to institutional investors more forthrightly on the benefits of shares -The need to speak up about government policy because huge policy errors by the Federal government are the rule not the exception -Using research fellows to study your company and benchmark your share programs.

The First Legislation on Broad-based Shares

-Signed by President George Washington on February 16, 1792 -Gave tax incentives and tax credits to ships that used broad-based shares in the cod fishery -The tax credits went 3/8th to the shareholders of the ship and 5/8th to the crew to encourage performance

The Founders Pushed Land Shares for a Century

-The Northwest Ordinance of 1787. Encouraged land shares and prohibited slavery in Ohio, Indiana, Illinois, Wisconsin, Michigan, Wisconsin, and Minnesota - "the most important law since the Declaration of Independence" -The Louisiana Purchase of 1803 - Jefferson bought the land making up 15 states from France to encourage land shares and "the empire of liberty." -The Homestead Act of 1862 - Lincoln offered grants of 160 acres including women and extended to the black community after the Civil War.

Studying If Shares Are a Good Idea?

-The three largest studies ever on employee shares. -A study of a representative sample of the entire U.S. population using the U.S. General Social Survey at the University of Chicago -A study of 40,000 employees in 14 corporations of all sizes sponsored by the National Bureau of Economic Research funded by Sage and Rockefeller -A study of 300,000 employees in 800 companies from 2005 to 2006 from the Great Place to Work survey funded by the Alfred P. Sloan Foundation

Why Divide The Pie With Insiders?

-They helped create value. -Align their interests with shareholders. -Align their interests with management and the board. -Evidence this increases performance - this is a causal reason -Efficiency wage theory. -Part of a high performance work bundle of HR practices. -It is the right thing to do - shared capitalism. -It is the essence of capitalism: tying rewards to performance rather than to status.

CG Issue: Dilution

-When companies set aside shares to use as part of a stock option or stock purchase program they are diluting existing shareholders -- illustration of how this works -For example, P&G has 3.034 billion shares outstanding yet 341 million shares set aside for insiders or just over 10% and that does not include their other plans -Shareholders demand that these plans be approved by them in shareholder resolutions -What is the evidence that these plans work?

What did the rise of institutional investors in the American public stock market do?

DID NOT immediately lead to more shareholder activism in the 1980s and 1990s in individual corporations because these institutional investors essentially had computers select a diversified basket of stocks from all the stocks in the stock market and they were not heavily invested enough in any one firm to afford the time, staff, and expense in order to get involved the corporate governance (boards) of one or many firms. Also, the way boards are elected (by being nominated by the previous board did not give institutional investors a clear path to get elected to a board seat.

High Technology Companies

Equity set aside for a broad group of workers is nineteen percent and was responsible for seventy eight billion in cash profits from the mid-nineties to the beginning of this decade.

What the research on executive pay shows

From chat with professor: It shows that in some companies pay is connected to performance and in others it is not. Recently, with shareholder activism there has been more downward pressure on executive pay. Also, whenever the stock goes up the pay of executives goes up but that is different than proof that executive pay CAUSED the stock price to go up. That requires a more careful analysis of the connection between pay and performance.

The research on takeovers/mergers and human research management show that many if not most takeovers/mergers fail because of what?

Human Resources/Employment Relations failure to integrate the cultures of the two companies. An well-discussed example of such a failure was the failure of the merger between Time Warner and AOL to achieve most of the expectations communicated to shareholders when they asked for its approval.

Privatization

TWO MEANINGS FIRST, being bought off the stock market and becoming a private company SECOND, also means private owners buying a state -owned company or assets

James Madison's Words

The United States have a precious advantage... in the actual distribution of property, particularly the landed property, and the universal hope of acquiring property.... (It) can generally inspire a like sympathy with the rights of property.

A proxy fight

allows a group of shareholders or an investor or any group or individual to take over the entire board of directors of a company without launching a takeover to actually buy the shares. Once it controls the board, the new board can change the management of a company without buying a majority of the shares. (Note that, as the New York Times article illustrates, some investors will use a proxy fight to only run a few director candidates of theirs and not try to take over the entire board.)

Corporate takeovers and the threat of corporate takeovers on public stock markets are

more common in the US and the UK (and countries with similar corporate governance/ financial systems) because, for example, in these countries: a) a large amount of the value of corporations is traded on the public stock market and accessible easily to acquiring investors; b) an investor wishing to take over a company can typically succeed of they offer the right price; c) there are large pools of money investors can access because of huge pools of pension fund money so potential acquirers can borrow money from investment banks, pension funds, or hedge funds to finance the transaction; and, d) more objective courts are willing to enforce corporate governance laws and are not keen on protecting the existing managers of corporations. One can agree or disagree with these conditions or behaviors, but they are more common in countries where takeovers happen more.

During the takeover era in the late 1980s and 1990s shareholders/investors/principals were very upset when what happened?

the boards and top executives of some companies (where these shareholders owned stock) threw up multiple barriers to considering better offers from outside takeover investors (offering for example to buy shares trading at $10 for a $15 price, what is called a $5 premium on the trading price). In some cases shareholders had to fight management and the board in court to get fair procedures for takeovers and shareholders thought this conflicted with the idea that management and the board were their agents, there to make their investment grow. Many of these lawsuits were won by shareholders and the procedures for considering takeovers significantly had changed by the end of the nineties.

Publicly-traded corporations often encounter what?

the fact or the threat or possibility of mergers, takeovers, proxy fights, spinoffs, or even the opportunity to bid on a former part of the government as a privatized division.

When an investor seeks to initiate a hostile " takeover" of another corporation in a public stock market

the investor hires lawyers and investment bankers and makes an offer to all shareholders to pay them more for their stock than it is currently trading for on the stock market. This is sometimes referred to as the "market for corporate control" meaning that in a public stock market "control of corporations" can be bought or sold on the stock market.

Since many U.S. corporations are incorporated legally in the State of Delaware,

the special Delaware Chancery Court (which only hears corporate governance cases), has an outsize influence in deciding corporate governance policies

What is the main role of the U.S. Securities and Exchange Commission

to serve as a clearinghouse for up-to-date information on corporations for the investing public and for its shareholders in order to insure adequate disclosure of material information on the company is made available to all investors on an even playing field.

Global Reporting Initiative as defined in the textbook

- "The Global Reporting Initiative (GRI) has made vast progress in enlisting companies and institutions to report in a consistent manner on their impact on society." - "It describes itself as: "An international network of thousands from business, civil society, labor, and professional institutions to create the content of the Reporting Framework in a consensus-seeking process". - GRI's vision is that reporting on economic, environmental, and social performance by all organizations is as routine and comparable as financial reporting - the broadest ranging effort to try to account for non traditional financial measures

Stock option

- A stock option allows the employee to buy her or his company stock for a set price (the exercise price on the day it is granted) typically for ten years into the future and thus get any upside gain. - benefits in the form of an option given by a company to an employee to buy stock in the company at a discount or at a stated fixed price

How shareholders have pressed the executive pay issue recently

- Shareholder rights advocates have used their influence to affect executive compensation by: 1. seeking corporate governance grades of exec comp 2. Making lists of the main corporations that have poor executive pay procedures (such as pay not connected to corporate performance) 3.Publicizing this in the press or offering shareholder resolutions to reform executive compensation in particular companies. Sometimes they have informal "breakfasts or lunches" with the companies in order to raise these issues or they have voted against board members whom they believe have supported bad pay plans. From chat with professor: Shareholders have looked at corporate governance grades such as those prepared by ISS Shareholder Services and other firms, they have met informally with management in breakfasts or lunches or meetings to discuss their views and tried to get the company to change its behavior, if not then they have voting against the executive pay programs in the shareholder meeting (they do not always get the support of other shareholders), and at times if very concerned they will do a proxy fight.

Basic elements of executive pay

- The range of basic elements of executive pay are a fixed salary, profit/gain sharing, employee stock ownership (maybe in the form of stock options or restricted stock), Long-Term Incentive Plans (that often include equity and profit/gain sharing) , and various retirement benefits; - excessive departure packages, virtually guaranteed bonuses, and Golden Parachutes.

Role of Compensation Consultants

-Before and after Enron -They are paid by the company. -Typically hired by SVP of HR or CFO in spite of recent reforms. -Provide legitimacy and peer data on one hand. -Can lead to racheting on the other hand through benchmarking. -Choice of peer groups can be manipulated.

Sign of Some Changes

-Committees are more independent. -Committee members are being challenged. -More CEOs are losing their jobs after poor performance. -CEO pay is going down. -Ratings firms are evaluating the process.

The Problem of Hidden Exec Pay

-Companies allowed their own format before 1992. -Standard 1992 format had many loopholes. -New format actually still hides a lot. -Payments on the way out: often not related to performance and even negatively related to performance: forgive loans, accelerate stock options, increase pensions, lump-sum payments, consulting agreements; often payments when fired. -Payments from acquiring firms: can be viewed as kickbacks but are called retention bonuses, are beyond employment contract, may help get transaction approved but this is proof of managerial power. -Special retirement payments: golden good-byes,, change stock options, alter retirement plan, use of special nonqualified retirement plans, perks, consulting, tax gross-ups, all of little cost to directors. -Inputed years of service. -Executive loans (now prohibited) -Special consulting arrangements and grants to charities. -All of these are evidence of power of agent over principal and failure of objective governance.

The critique of executive pay by some shareholder groups

-Critics argue that sometimes the rise in the stock price for stocks that executives hold is a result of a general rise in the market and may not be something that the management team did uniquely for that corporation. -As a result some reformers of executive compensation wish to have executive pay indexed to the market. This means that certain executive pay elements (equity grants and stock options) would only be available to executives if their company's stock price outperformed that of its industry peers. From chat with professor: Some shareholder groups attempt to provide evidence and analysis that pay is not connected to performance. They are often most critical, as the book says, of golden parachutes and payments to retiring executives.

History of Regulation

-Essentially no regulation or transparency before 1930s SEC Act -Very minimal disclosure from 1930s to 1992 -Odd effect of Clinton-Gore $1m. reform -Major reform in 1993 lead to use of tables (see example) -There were many loopholes -New reform in 2006 -Reforms did not connect pay and performance as financial collapse shows

Basic Mechanisms

-Fixed annual pay -Stock options -Long-term incentive plans -Restricted Stock -Bonuses -Forms of profit sharing and gain sharing -Retirement Benefits -Post-retirement benefits of other types

Bad Governance and Inefficient Pay: How Board Structure and Processes Affect Managerial Power

-Lack of real board elections -Ongoing influence of CEO in choosing board members -Lack of separation of CEO from Chair of the Board position -Self-perpetuation of boards by closed nomination committees -Bigger boards are less effective boards -Lack of large blockholders -Lack of board seats for institutional investors -Ineffective boards: lack of necessary skills, time, desire to be truly independent, training, or focus (membership on multiple boards) -Social and psych factors (loyalty, reputation, obligation) -Insiders on boards -Fewer institutional investors Insulation of shareholder resolution process from pay -Poor organization of compensation committee -Anti-takeover arrangements that insulate CEO

Influence of Shareholder Activism

-Major shareholder collaboration was viewed as collusion before 1990s. -Pro-mgt. SEC view on shareholder resolutions. -Institutional shareholders largely index their holdings and do not have time/staff/money to have seats or be involved. -CALPERS and other campaigns do influence pay but it is after the fact. -Publicity also has an after the fact influence. -More on this when discussing the SEC and regulation. -Lack of willingness to take corporate governance seriously in an up market. -*Shareholder outrage and publicity has had some effect but in just a few cases: if focus on directors and the board; if can influence reputation of the company; if can increase risk of takeover; if a major drop in stock price; if managers are concerned about future careers.

What The Research Shows

-Most executive pay is in variable rewards - especially stock options and restricted stock - and special benefits and is not connected to performance -Yes, as stock price rises, stock-based compensation also rises but causality? -But there are many examples of CEO and top executive pay rewarding leaders when the company has done poorly

The Mechanics of Rewards When the Company Does It Poorly

-Poor definition of bonus and Long Term Incentive Plans -Paying out stock option rewards that do not control for market or industry increases -"Pump and dump" effects -Use of public relations or poor accounting to artificially lift up stock price -The size of the firm predicts "total pay" -Pay for dismissal or being acquired -Retirement benefits and perks not performance- related

How Society Cooperates With This?

-Popular media identification with CEO as principal rather than agents -Flows from aristocratic power and reputation given to CEOs by the press. -Public relations function and power and wealth of CEOs helps create this social power. -Corporations imitating the compromise between royalty, aristocracy, and democracy in the compromises of our founding documents.

Is It The Amount or the Process?

-The piece of the pie cut and given to executives belongs to shareholders -The amounts are staggering but the process is probably equally important. -Why? Bad incentive contracts create bad executive decision-making and that is really what hurts shareholders. -Examples: taking on too much risk, making the firm too large. -Compromising the governance process.

Friendly Takeovers

-the target board is interested, accepts the offer, or is willing to negotiate -a friendly takeover allows the potential acquirer to look more closely at the company, understand it business, and work with fuller information in order to work on financing -recent events -- such as shareholder dissatisfaction with the performance of the company - may have created pressure on the board -because a takeover is friendly this does not mean that it is in the best interests of shareholders -Example: the merger between AOL and Time Warner .combined value of AOL and Time Warner was $280. Billion at time of merger .shareholders of both companies voted FOR the merger, 99% of Time and 97% of AOL .AOL's stock was trading at about $74. a share and Time Warner's at about $102. a share in 1/2000 .the merger resulted in the angry departure of both Ted Turner (of CNN and TBN) and Steve Case, one of the founders of AOL .AOL significantly lost its edge as an Internet company which had been the "Google" of its day .the company has had to continuously sell its parts to raise money to operate and regularly downsize .in 2002 it had a $99. B loss the largest of any company to date .finally, AOL was spun off again as a separate company .the Time Warner stock today is trading at about $70.08 a share and the company's market value is about $65. billion whereas AOL's stock is trading at $37.29 and its market value is about $3. billion .THIS MERGER HAS HAD TO AN ALMOST $210 billion REDUCTION IN market value of the combined companies and destroyed one of the first premiere Internet brands .the transaction is viewed as a terrible mistake, the "worst merger in history," even by Steve Case

Why professional managers emerged in the early 20th century

A Because founders often family founders of companies like Carnegie and Rockefeller who were executives AND owned big ownership stakes did not have relatives to take over from them. Thus, boards hired professional managers where ownership and control became disconnected, separated. But now major corporations were no longer managed by owners/principals and the principal-agent problem became more pronounced.

The pros and cons of the debate on separating the role of the CEO from the Chairperson in the Bush post-Enron reforms and how that proposed reform ended up

A Pro for separating is that the board hires and fires and evaluates the CEO so they should not be the same person to allow objectivity. Argument against separating them is that there will be more unitary power in the role of the CEO-Chair and it may lead to the board being more collegial.

The pros and cons of employees being more involved in managing their companies through decentralized decision-making

A Yes this could be a problem although most employee participation in decisions is at the job or department level where employees actually have a lot of knowledge about what is going on. Most employees recognize that middle and upper management has an important role to play. Even in democratic worker-owned cooperatives employees elect representatives to get involved in making decisions, and all employees do NOT get involved in making all decisions, that would be ridiculous.

Spinoffs

A direct outgrowth of mergers that failed to improve business or shareholder value in the short and long-term. Companies may be worth more separately than together. Response to the view that it does not matter what the portfolio of companies is -- what matters is the numbers. It is now widely believed that top management cannot focus on multiple businesses and discern winning strategies in each of them. Spinoffs may have to do with competition. E.g. Employee-owned spinoffs are fairly common. Example: Robert Monk's break-up of Sears. The role of ESOPs in spinoffs

Proxy Fights

Allows a group of shareholders or an investor or any group or individual to take over the board of directors and management of a company without buying a majority of the shares One of the few cases in U.S. corporate governance where competing slates of directors run against each other. A major defense against proxy fights are staggered boards or different classes of stock. Threatened proxy fights have substantial power and low expense. E.g. Home Depot

What is an Employee Stock Ownership Plan

An organization contributes money to a trust, to purchase shares for its employees. Enables employees to acquire meaningful ownership interest in the companies they work for. An ESOP is a type of retirement plan that invests primarily in company stock and holds its assets in a trust, in accounts earmarked for employees. Plan participants do not directly own the stock and are, for the most part, paid out after they leave the company. Most ESOPs are in privately held companies, not companies that trade on the stock markets.

How corporate takeovers operate in general

As you see with the proposed takeover TODAY that is all over the business news of Qualcomm by Broadcom, the investor/acquirer(in this case Broadcom) tells the target company ( in this case Qualcomm) it wishes to purchase all of its shares. If it is accepted by the target's board it is a friendly takeover, if not accepted it is a hostile takeover. Then the investor/acquirer makes an offer that is higher than the target's shares are trading for and all shareholders vote on the investor's offer. Sometimes the target company makes a competing offer so the vote is a choice between the two. Whoever win 5-% plus one vote or more wins. If the investor/acquirer wins, in the US they must purchase ALL the shares of ALL the shareholders at the price offered.

Why board members might not want to exert too much control over managers

Basically the answer to this is that everyone in the corporation has a job to do and they ought to do it by themselves. The Board doesn't need to be so overbearing upon managers and micromanage them because this would interfere with management's ability to do a good job. Why hire managers if you want to do their job for them?

What are Rents?

Economics term for extra returns agent gets from principal by using her or his positional advantages. Concept of "rent extraction"

Corporate governance reforms to address the problems the takeover era and resultant court cases raised

From chat with professor: The answer is that a series of court cases required that only independent (non-blockholder, non-family founder, non-reports to the CEO or management) directors decide on the takeover. Another was that names and addresses of shareholders had to be shared with the takeover investor. Another was that if employees voted their shares through a company employee ownership plan, like an ESOP, the vote tally had to be by a third party outside firm that protected the confidentiality of the workers' votes in case they decided to vote FOR the takeover and against their managers' expected recommendations. The class does not have to memorize specific legal cases.

Why broad-based employee ownership and profit sharing became an issue as a result of principal-agent theory

From chat with professor: Well, for two reasons. First, broad-based employee ownership and profit sharing are an example of the incentive solution to the principal-agent problem; and second, shareholders in the US have to vote to support the use of more than an additional 1% of the company's shares for employee ownership plans for execs or other employees. Outside shareholders will want the possible incentive effect and motivation effect of the employee ownership plans to be more than the dilution to their shares and their governance power. That is it in a nutshell.

Why institutional investors have not lived up to the promise of leading corporate governance activism

From chat with professor: there was a view that with 70-80% of the market in their hands that they would ask for board seats and become active investors but they mainly invested their shares using computer investing which bought an index of the entire stock market. They did not have a lot of time to devote to individual company corporate governance reform. Only recently did they start using corporate governance grades to focus on companies they viewed as having less than optimal corporate governance.

The impact setting aside more shares for stock options on the dilution of company dividends and the voting power of other shareholders

Governance dilution: if you double the number of shares of a company, a previous shareholder will have less voting power than before. Example: If they controlled 10% of the shares they would have half as much voting power now, namely 5%, when they cast their vote on shareholder resolutions or other issues at the shareholder meeting. (seen with equity plans designed for employees) Dividend dilution: same concept as governance dilution but instead that shareholder would receive half of the dividends they received before the dilution.

Hostile Takeovers

It often starts as a letter or offer to the board of directors saying that a price higher than the market price for the stock will be paid to shareholders. It may start with the public release of news of a 5% stake through an SEC filing or media word that someone is accumulating shares. Remember the board is there to act as the agent of the principal - the owners, the shareholders, and an immediate agreement can mean an immediate increase in shareholder wealth. Remember also that the board is also there to represent the role of the different stakeholders in the firm such as workers and the local community. A hostile takeover bid allows the potential acquirer to go around the target board and make the offer directly to the shareholders in the stock market. Shareholders "vote" for the deal by agreeing in writing to tender their shares to the acquirer - if a majority agree the company is sold and the new owners may change management and the board. There is suspicion that a negative answer by a target management and board results from an attempt to protect the agents' interests. Hostile takeovers often try to wear down management and the board until they agree to a friendly takeover (that is, no tender of shares but it may require a shareholder approval). The goal of most takeovers is to change the strategy of the company in order to increase its value. Sometimes it means selling off parts of the company.

Why Hostile Takeovers Take Place Mainly in The U.S. and the U.K.?

Most large companies are traded on their public stock markets. Public markets mean quick easy PUBLIC access to the shares of any company. The market for corporate control can overcome most corporate governance systems except for different classes of stock. Other countries have smaller public stock markets and large often family blockholders (or government stakes) that can control a majority of shares/votes. Courts in some jurisdictions are less objective about takeovers. Potential acquirers can borrow money from investment banks, pension funds, or hedge funds to finance the transaction.

The general issue that entities before the corporation and including the corporation had to figure out how to divide up the profit or equity pie with insiders

Well this is the theme that we have covered as lot that the board of directors is always, every year, considering whether to grant stock or stock options to employees, often top executives but sometimes all employees. Think of it that there is a pie of stock or equity or ownership and it belongs to YOU THE OUTSIDE SHAREHOLDERS. The board is deciding what pieces of this pie to give to inside executives and employee to incentivize them. Grants of stock and stock options to workers dilutes outside shareholders but they will likely support it if the positive effect on corporate performance will be more than the dilution. Google and Southwest Airlines have persuaded their shareholders this is true. The same is true with profits. In a corporation that pays out all profits or some profits as dividends the board decides annually whether to share profits with execs and other employees and this they are dividing up the profit sharing pie. Profit sharing reduces outside shareholders dividends.

Greenmail

What it is: Investing in a company not to take it over but rather to temporarily lift up the price and get bought out or cash out How it engendered the corporate governance debate -the practice of buying enough shares in a company to threaten a takeover, forcing the owners to buy them back at a higher price in order to retain control.

Response to Hostile Takeovers II

White knight defense: a friendly buyer takes over the firm, e.g. Bayer takes over Schering to compete with Merck (Note: a white squire takes a minority stake.) Poison pill: shareholder rights plan that kicks in at 20-30% Stock options: vest if the company is taken over. Greenmail: greenmailer gets a stake in the company to make money not because they really want to take it over Leveraged recapitalization: the company borrows money to do stock buybacks or pay dividends to shareholders in order to fend off a takeover

While the overall amount of executive compensation can be considered a social issue as a result of economic inequality, the main economic argument against executive compensation not tied to corporate performance is that

bad incentives interfere with rational and economical decisions and use of capital appropriately while rewarding behavior and performance that might not optimal on the part of corporations. According to this argument it is the linkage to performance not the amount that is the principal issue.

Depending on their size, the employee share plans of corporations

can dilute the ownership stake, the governance power, and the dividends of existing shareholders. The key decision my the board and the key judgment by outside shareholders is whether the potential for aligning shareholders and employees and enhancing the performance of the company is greater than this dilution.

There are several main types of employee share ownership:

company stock can be purchased within a 401k plan often with matching contributions, company stock can be purchased at a discount in an Employee Stock Purchase Plan, stock can be granted through an ESOP (Employee Stock Ownership Plan), stock can be granted through a restricted stock or performance shares plan. You should be aware of the mechanics and basic structure of each.

The term "pump and dump"

describes an unethical practice of insider behavior towards stocks where insiders use accounting or public relations to increase the stock price, then sell their shares at a profit, and shareholders lose when the stock goes down, as reality sets in.

A general example of how dilution works with equity plans designed for employees is that

if you double the number of shares of a company, a previous shareholder who, for example, controlled 10% of the shares would have half as much voting power now, namely 5%, when they cast their vote on shareholder resolutions or other issues at the shareholder meeting. Once can call this governance dilution. Another example is dividend dilution where that shareholder would receive half of the dividends they received before the dilution.

Employee stock ownership first emerged

in American corporations in a major way during the welfare capitalism movement of the 1920s when corporations were concerned about giving workers a stake in American capitalism and were worried about socialist and Communist movements.

The President George Bush Post-Enron reforms of executive compensation involved saying only

independent directors could set executive pay, putting them only on the Compensation Committee and giving this committee sole authority (not management) to select compensation consultants.

Socially responsible investing

is generally used today to describe investing in corporations that meet certain criteria for broad social and environmental goals

The main reason why shareholders might want to divide the share ownership or profit sharing pie with broad groups of employees inside the company

is that if shareholders do well then insiders will do well and their interests will be aligned.

Shareholder rights advocates have used their influence to affect executive compensation by

seeking corporate governance grades of exec comp, by making lists of the main corporations that have poor executive pay procedures (such as pay not connected to corporate performance), by publicizing this in the press or offering shareholder resolutions to reform executive compensation in particular companies. Sometimes they have informal "breakfasts or lunches" with the companies in order to raise these issues or they have voted against board members whom they believe have supported bad pay plans.

Critics of executive compensation argue

that sometimes the rise in the stock price for stocks that executives hold is a result of a general rise in the market and perhaps and perhaps may not be something that the management team did uniquely for that corporation. As a result some reformers of executive compensation wish to have in executive pay indexed to the market. The means that certain executive pay elements such as equity grants and stock options would only be available to executives if their company's stock price out performed that of its industry peers.