Business and Society: Chapter 13
response to cases of overcompensation
"clawback": a process by which executives of failed firms would have to pay back some of their earnings.
Principles of Good Corporate Governance
-Select outside directors to fill most positions: no more than 2 or three current managers. The outsiders should be truly independent. Audits should consist of solely outside directors -hold more open elections for members of the board: in recent years, shareholders have put their candidates on a proxy ballot. Currently candidates need more votes than other candidates, but do not need the majority. -Appoint an independent lead director (non executive chairman): seprarating the duties of the chief executive and the board chairman. (ie. Aruther Levinson at Apple is the nonexcutive chairman will Tim Cook is the cheif executive) can hold meetings without management present. Increases the chances of candid discussion -Align director compensation with corporate performance: 2014 directors earned more than half their pay in stock (ie. Intel compnesates largely through performance based shares) -Evaluate the board's own performance on a regular basis: how competent and how diligently they performed their duties outside of the governance committee of the board who traditionally does this.
objective of stock ownership
-capital appreciation -dividends
U.S. government rules on Compensation
-companies must clearly disclose what their five top executives are paid, and lay out the rationale for their compensation -companies must report the value of various perks, from the use of aircraft to sporting event tickets
compensation for board members
-complex mix of retainer fees, meeting fees, grants of stock and stock options, pensions, and various perks.
cons of high compensation
-hurts the ability of U.S. firms to compete with foreign firms -diverts financial resources that could be used for investment, increasing shareholder dividends, or pay average workers more. -causes resentment in the mid-level employees who receive so much less payment -most empirical evidence shows no true correlation between executive pay and company success.
typical structure of the board
-meet typically six times a year -corporate boards have an average of 12 members -10 or 11 of the 12 are usually outside directors -board members may include chief executives at other companies, major shareholders, bankers, former government officials, academics, representatives of a community, retired executives at other firms.
shareholder legal rights and safeguards
-right to share in the profits of a company through dividends -right to see reporting of annual earnings and company activities, and to inspect corporate books with legitimate reason -right to elect members to the board-->"one share one vote" format -right to hold the board accountable by lawsuit -right to vote on mergers and aquisitions, and changes in by laws -right to sell their stock
major committees
-the compensation committee -the nominating committee -the executive committee -audit committee
reasons why pay is so high
-top managers have so much influence on the pay-setting process -Compensation committees are selected for board membership in part by the CEO, and often have a sense of friendship or loyalty to them -many members on the board are CEOs themselves and are sensitive to the impact of their decisions on their own salaries.
front-running
-traders place buy and sell orders for stock in advance of the moves of big institutional investors -track big trades in real time and act on them quickly.
supporters of high compensation
-well paid managers are being rewarded for outstanding work -high salaries give incentives for innovation and risk-taking -in the era of global competition, restructuring, and financial crisis the role of the CEO has become more challenging and the tenure of the job has become shorter. -job shortage argument: the ability to run such large multinational corporations requires the skill of a very specific group of people, so they can demand high pay. -to retain and attract top talent
disparity of executive pay
CEO In 2014 earned 373 times what the average worker earned
Provision of 2010 Dodd-Frank Act
Required major U.S. firms for the first time to disclose the ratio of their CEO's compensation to the median compenasation of their employees BUT business groups lobbied against this claiming it to be burdensome and it still has not been implemented.
Act that makes insider trading illegal
Securities and Exchange Act of 1934
unusual companies
Some unusual companies voluntarily set caps on executive compensation, and some executives take pay cuts Gravity payments: CEO slashed his own pay and set a minimum pay for employees of 70,000 Whole Foods: set a rule that executive pay cannot be more than 19 times what the average worker makes.
SEC
The Security and Exchange Commission: establish in 1934 in the wake of the stock market crash and the Great Depression mission: to protect shareholder's rights by making sure that stock markets are run fairly and that investment information is fully disclosed. -protects investors against fraud.
bear market bull market progression
The economy falls into a period of recession called a bear market. This is followed by a period of rise in a bull market, which produces gain for investors. Typically bear and bull markets alternate.
evidence suggesting executives are overcompensated
The period leading up to the financial crisis: Merrill Lynch, Stanely O'Neal earned 70 million over his four years as CEO, and then an additional 161 million severance pay when the board fired him. Just a year later Merrill Lynch went under... Disgraced subprime lender Countrywide: Angelo Mozilo the CEO was paid 125 million the year the company collapsed and was taken over by Bank of America.
U.S. executive comp. in comparison to other countries
Top managers in other countries earn much less.
insider trading
a person gains access to confidential information about a company's financial condition and then uses that information before it becomes public to buy/sell stock. -most common occurrence: information about mergers and aquisitions
Council of Institutional Investors (CII)
an organization that represents institutions and pension funds with investments collectively exceeding 3 trillion. -developed a shareholder bill of rights and has urged its members to view their proxies as assets, voting on behalf of shareholders not with management
ISS and Glass Lewis
analyze shareholder resolutions and advise institutions how to vote.
compensation committee
approves salaries and benefits of high level management
Shareholder Activism
arises because it is more difficult for them to sell their holdings if they become dissatisfied with management performance -selling a large block of stock could seriously depress its price, and therefore the value of holdings -strong incentive for activism
how directors are selected
board members are elected at the annual shareholder's meeting, where absent owners may vote by proxy. The system is formally democratic. However typically, the nominating committee working with the CEO and chairman develops a list of possible candidates to be presented to the board for consideration. The shareholders either approve or disapprove of these candidates, but since alternate candidates are rarely presented, the vote has little significance. (self-perpetuating system)
strategy of both hedge funds and private equity firms
both funds often invest in public companies with the intention of intervening to dramatically improve returns .
drivers of either a bear or bull market
driven by the health of the economy, interest rates, world events, and other unpredictable factors.
board of directors
elected group with the legal duty to establish corporate objectives, policy, and select top-level personnel to carry out objectivies/policy. The board also reviews management's performance to make sure the company is well run and stakeholder needs are protected.
pay-for-performance
executives will work to improve the company because if the stock goes up, so does their compensation 54 percent of executive pay was performance-based as of 2014. Critique: managers will do ANYTHING ethical or not to improve stock value like cooking the books.
nominating committee
finds and recommends candidates for officers and directors
social screens
for those following social criteria, weeding out companies that have a negative social impact.
agency problem
if managers are simply hired as agents, what will guarantee that they act in the interests of shareholders rather than simply helping themselves?
shareholders
individuals shareholders: directly own stock, usually purchased through a stockbroker and are held in brokerage accounts. institutions: pensions, mutual funds, insurance companies, university endowments. More money to invest
shareholder lawsuits
initiated to check many abuses by a company ie. insider trading, inadequate price obtained for stock, failure to disclose material.
private equity firms
managed pools of money invested by very wealthy individuals and instituitions
companies and dividends
most companies pay dividends, but some--particularly new companies hoping for rapid growth do not. In this case, investors buy stock with the goal of appreciation only.
outside directors
not managers of the company
audit committee
perhaps the most important committee: required by law to be completely outside directors and be "financially literate" it reviews financial reports, and recommends the appointment of outside auditors, and observes the integrity of internal financial controls.
hedge funds
pools of private capital; use aggressive strategy to ear high returns for their investors
corporate governance
process by which a company is controlled/governed
say-on-pay
provisions on the Dodd-Frank act: public companies must hold their shareholder votes on executive compensation at least once every. three years. Most do so annually on a voluntary basis.
dividends
receiving their share of the company's earnings.
The Organization for Economic Cooperation and Development (OECD)
representing 34 nation, has issued a set of principles for corporate governance that stands as a benchmark for companies and policy makers worldwide.
social responsibility shareholder resolutions
resolution on an issue of corporate social responsibility place before shareholders for a vote. -The Security and Exchange Commission (SEC) allows resolutions to be placed in proxy statements.
executive compensation
setting this is one important function of the board of directors
proxy access
shareholders have increasingly demanded the right to nominate their own candidates to break the current often self-perpetuating system.
capital appreciation
shareholders make money when the value of a stock increases
bullmarket
stocks create gains for many investors (rise)
bearmarket
stocks losing value as the economy falls
stock options
the right to buy a company's stock at a set price (strike price) for a certain period. The option becomes valuable when, and if, the stock price rises about this price.
divestment
the sale of stock from companies that have a negative social impact.
Social investment (SRI)
the use of stock ownership as a strategy for promoting social, environmental, and governmental objectives. 1. Selecting stocks according to social criteria 2. using the corporate governance process to raise issues of concern.
institutional investors
typically have more money to invest account for 63 percent of the values of all equities.
proxy
vote by an absentee ballot
executive committee
works closely with top managers on important business matters
