FIN 4610 Exam 1- Corporate Governance

According to Shleifer and Vishny (1997), what form of governance is best? (hint: Section VII A)

"Our analysis leads us to conclude that both the legal protection of investors and some form of concentrated ownership are essential elements of a good corporate governance system." p. 769

Succession Planning

-"A board's most important duty is choosing the CEO." p.245 -Every company should have a succession plan

Annual Board Elections

-Annual elections are better than staggered elections -All board members should be individually up for election

Board Size

-Average board has 11 members -Council of Institutional Investors recommends 5-15

Board Over-commitment

-Board should meet at least 4 times per year -In 2000, average board met 8 times -Did members attend 90% of meetings? -How many other boards or positions do members have? -Council of Institutional Investors recommends 5 be the max number of boards one person sits on -Former Senate Majority Leader Mitchell sat on 12 boards, Kemp (vice-presidential candidate) sat on 21

Board Independence

-In 2001, average board had 77% outside members -Be wary of family relationships, previous employment, interlocking directorates, consulting, etc -Does the board ever meet without the CEO?

Board Compensation

-In 2001, average board member was paid $92,452 -In 2013, ave board member at S&P 500 firms was paid $251,000 -Should be at least partially in stock

Board Perks

-Only 6% of firms offer board members retirement plans -Watch for meetings at deluxe resorts, private jets, donations to charities, etc -No perks is probably best

Executive Pay

-Should have clear, performance driven standards -Watch out for executives who were paid bonuses without meeting goals/benchmarks -Should be at least partially stocks or options

Golden Parachute

A golden parachute consists of substantial benefits given to top executives if the company is taken over by another firm and the executives are terminated as a result of the merger or takeover. Golden parachutes are contracts given to key executives and can be used as a type of anti-takeover measure, often collectively referred to as poison pills, taken by a firm to discourage an unwanted takeover attempt. Benefits may include stock options, cash bonuses and generous severance pay.

Hostile Takeover

A hostile takeover is the acquisition of one company (called the target company) by another (called the acquirer) that is accomplished by going directly to the company's shareholders or fighting to replace management to get the acquisition approved. A hostile takeover can be accomplished through either a tender offer or a proxy fight. The key characteristic of a hostile takeover is that the target company's management does not want the deal to go through. Sometimes a company's management will defend against unwanted hostile takeovers by using several controversial strategies, such as the poison pill, the crown-jewel defense, a golden parachute or the Pac-Man defense.

Business Judgement rule

A regulation that helps to make sure a corporation's board of directors is protected from misleading allegations about the way it conducts business. Unless it is apparent that the board of directors has blatantly violated some major rule of conduct, the courts will not review or question its decisions or dealings.

Succession Planning

A strategy for passing each key leadership role within a company to someone else in such a way that the company continues to operate after the incumbent leader is no longer in control. Succession planning ensures that businesses continue to run smoothly after the business's most important people move on to new opportunities, retire or pass away.

Arthur Levitt's governance checklist

Board Independence Board Over-commitment Board Size Board Compensation Board Perks Succession Planning Executive Pay Annual Board Elections Poison Pills

Advantages and disadvantages of the following governance mechanisms: large investors

Concentrated ownership gives large cash flow stake and voting rights Concentrated ownership can be of several types Large shareholders Takeovers/LBOs (leverage buyouts) Large creditors Large investors represent their own interests, which may not always coincide with minority owners' interests Having a majority of voting rights or significant deviation from one-share-one-vote can give large shareholders the ability to vote themselves special privileges Special dividends Greenmail Personally beneficial acquisitions

Problems of Incentive Contracts

Don't work if too small (Jensen & Murphy (1990)—executive pay rises and falls by $3 for every $1000 change in shareholder value) Can't be too big Opportunity for self dealing if executive has too much control over the contract Manipulating performance numbers Accounting numbers, short-term vs long-term Only corporate decisions that courts interfere with deal with executive pay and self dealing (b/c of business judgment rule)

Ways to align manager and owner incentives

Long term Incentive-based -Share ownership -Stock options -Cash bonuses -Threat of dismissal Performance must be verifiable in court

Proxy Statement

Must be sent to every shareholder annually -List of board members with biographies -Which directors are on which committees -If board members attended 75% of meetings -Whether mgmt has reviewed financial statements -Stock performance over past five years -Compensation of at least the top five officers -Shareholder proposals

Advantages and disadvantages of the following governance mechanisms: takeovers/LBOs

Threat of hostile takeover "forces" managers to run firm efficiently in shareholders' best interest Threat of outside control or outright dismissal Not effective enough to be the sole governance mechanism Expensive (in terms of both capital and time) Acquisitions may help shareholders of target firm, but can be detrimental to shareholders of acquiring firm Require liquid capital market (ie certain economic environment) Not legal in every circumstance or every country

Role of Board of Directors

Well-educated, accomplished individuals, elected by shareholders every year or every few years Responsibilities: Oversee mgmt as representative of shareholders Advise mgmt with common sense and expertise Meet regularly to discuss health of firm, mgmt's performance, exec compensation, future outlook, etc Address problems quickly Most important job is to make sure firm has best CEO possible Succession planning Executive compensation Auditing financial statements Rigorous discussion of important matters that may challenge CEO Overseeing CEO

Poison Pill

grant existing shareholders the right to buy additional shares at a deep discount, diluting ownership of corporate raider Prevent shareholders from the right to discipline managers and/or receive a premium for selling their shares during a takeover attempt by making it easier for incumbent management to retain control Often called a "shareholder rights plan"