MGST 451 Midterm
Internal Candidates (Heir Apparent) (pros and cons)
- 70-80% of succession - Companies with strong performance od i tmore - Pros and Cons are reverse of External Candidate - Smooth Transistion - Familiar with Company
Principals of Corporate Governance *** (Ask view on Principals of Corporate Governanace)
- Accountability. (Ensure management accountable to Board, and Board accountable to shareholders) - Fairness (Protect shareholder rights, Treat all shareholders equitably, Provide effective redress for violations) - Transparency (timely, accurate disclosure on material matters relating to financial situation, ownership and corporate governance) - Independence (Independent directors and advisers free from influence of others)
Why Boards don't plan for succession
- Awkwards - Reluctant to antagonize CEO
How Board get in trouble?
- Bad performance (sharholders angry) - Lack of leadership - Inapproppraite involvement with management - Entrenchment (High % remain on board too long) - Legal Issues
Why is corporate governance important?
- Better access to finances - Lower Interest Rates - Higher Firm Value (shareholder trust) - Reduce Scandal Risk - Reduce Litigation risk - Good Management
Removal of Directors Process
- Board does not have power to remove a fellow board member. -Either encourage him to resign or Wait to replace at annual meeting - Shareholders may pass special resolution, or vote for removal if election is by majority vote
CEO turnover and Governance
- Boards with high governance more likely to terminate underperforming CEO Evidence; Boards that are not "busy", boards with high outside directors, directors own large shares
What to look for in CEO
- Cognitive Ability (IQ) - Gender - Ability - Height
BOARD EVALUATION TOPICS
- Composition - Accountability - Information - Meetings - Relations
Explain the Principal-Agent problem
- Conflict of interest (Shareholder: increase value of firm, Manager: increase own utility) - Lack of trust from shareholder side
Director-CEO
- Could be poor planning -
blended approach
- Develop Internal Talent and Evaluate External Talent PROS: Internal Candidate develops skills, Levels the field between two types of candidates, External validation assures best CEO is selected CONS: LOts of planning and oversight, Complex Process, BReakdown leads to erosion of twust
Factors of Poor Governance and Good Governance
- Director has no stock - More Inside Directors - Directors with financial ties to management - Unresponsive to investor requests
Cost of Recruiting External Candidates
- Expensive. Cost of hiring search firm, time and effort looking into candidates, engaging in conversation with candidates
Give Real Examples of Agency Problems
- FCF, Managers moral hazard to overdiversify, vs Shareholders may want dividends - Diversification: Managers get increase in firm size, and reduction of top executive employment risk (shareholder don't get anything) - Mergers: Managers don't care much about price of takeover, Shareholders hate it cause managers just throw the excess price above market into goodwill - Refusing to Sell
What is the difference between a successful CEO and failed CEO. (supply side)
- Humble - Feedback Seeking - Unselfish
Interim CEO's
- Indicate lack of succession planning - Temporary Thing One month to two years - can be used to audition the person, groom the candidate, or seat warmer
Other Director Qualifications
- International experience (boards are going international) - Diversity (reduces attendance problems by 10%) - Bankers - Specialized Expertise - Employee Representation
Independence criticism?
- Large number of outsiders can create problems - Limited contact with firm's day-to-day operations and incomplete info about managers - Tough monitoring not always good - Connection improves communications - Ceo's fired too often for out of control reasons
What is a corporation? (Lawyers and Economists)
- Lawers: Seperate entity - Economist: Bundle of Contracts - mechanism to allow different parties to contribute capital, expertise and labor for mutual benefit
Characteristics of public corporations (ONE IMPORTANT)
- Limited liability for investors - Transferability of investers - Legal personality - Seperation of legal ownership and management control
Top Indicators of Fraud
- Living beyond means - Financial Difficultires - Close with vendors
Agency Cost in the Principal-Agent Problem
- Monitoring the Agent is costly, so full monitoring is not optimal - The value forgone due to imperfect monitoring is an explicit agency cost.
Board Governance Trends
- More stock compensation - More outside directors - Smaller Boards - Splitting Chairman/CEO - Diversity
Are CEOs the best directors?
- Number of CEO directors has decreased - Companies adopt guidelines prohibiting outside directorships for their current CEO's Negative Side: CEO's are too busy with their own companies, unable to serve meetings on short notice, poor collaborators, not good listeners Positive Side: Expertise on current issues, Experience with crisis and failure, Good networks
CEO turnover
- Proportionatally inverse to performance - CEO turnover increasing
examples of agency costs
- Reputation and financial damage - Bankrupt - Lawsuits - Massaging earning and financial restatements
Three giving voice to values Reversals (Three GVV flips)
- Reverse what it is we are talking about when we talk about ethics (She focuses on the clear cut issues, not the gray areas because the obvious we all agree if its ethical or not but how do we act upon it?) - Reversed who we think we are talking too (She doesnt focus on the self interested individuals who always act in self interest, or the idealist who always focuses on the collective, she focuses on the pragmatist (the ones who will act correctly if they are sure their is no punishment) - Reversed how we have the conversation. (create muscle memory, rehearse and practice)
Costs of poor succession planning
- Significant Loss of revenues -
Who is responsible for Succession? Explain the process
- Small fraction of companies have CEO succession committee Process: Involves full engagement from Board of directors and senior management. - Requires searchs for 3-4 months - Ongoing activity
Bad Behaviour in the news (Respoonses)
- Statement - Spokesperson - Board Comment - Board Review
Labor Market for CEO Efficient or not?
- Success predection - Size of Market
Why its more challenging to be a CEO
- Technology development pace - Rapid change (long term planning) - Global competition - Overwhelming information - Meeting expectations of shareholders
Reasons boards might not be effective?
- Time Commitement - CEO's pick directors - Directors hold only token stakes (not bought, provided) - CEO is often chairman of board Directors Lack expertise or willingness to ask tough questions: - Roberts Rule of Order (CEO sets agenda) - Be a team player ( dont want confrontation) - CEO is authority figure Directors lack access to fast and appropriate information (Lack of Info or overwhelm with useless Info)
Lead Independent Director
- When CEO/Chair is the same brought in - Evaluates CEO - Eventually "becomes an insider and no longer independent" -has the ability to call meetings of the independent directors, separate from meetings of the full board
Criteria for a good director (Nomination Committee)
- Willingness to challenge management when necessary - Special expertise that is important to the company - Available for outside meetings to advise management - Expertise on global issues - Understands the firm's key technologies and processes
Why Succession is important
- largest potential gains in revenue and profit for business leaders cam from building strengh and looking at talent
chairman of the board. Role? Ensure? ***
- leader of the board of directors - Responsible for Board agenda and work plan - Ensure board effectiveness - Ensures Good corporate governance - Key Link between Board and CEO********
Board of Directors should be
Competent and Honest
Agency Problem
Conflict of interest between principal (shareholder) and agent (management)
Director independence
Degree that director is free from conflict of interest and will act solely in the interest of the firm
Types of Direct and Indirect Agency Costs
Direct: Corporate: Benefit management gets but costs the shareholder Monitoring: Cost to monitor management Indirect: Lost Opportunities: management inaction to protect their jobs
interlocking directorates (two types)
Direct: Two firms share a director OR when an executive of one firm is on the board of another Indirect: When two corporations have directors who serve on the board of a third firm
Directors and Officers have a Fiduciary Duty
Duty of Care: Make decisions with due deliberation, "permitted to rely on managers for information", Duty of Loyalty: Remain loyal to the company Can not make decisions based on personal financial interest or for family. Director should not take opportunities that arise for personal financial gain focus on best interest of corporation. Duty of Candor (America): inform of all information to the shareholders. Transparency
Four models of CEO succesion planning
External Candiditate Heir-Apparent Horse-Race Inside-Outside Model
(demand side) Decision Biases
In-group Bias (In-group vs Out-group) Confirmation Bias Escalation of Commitment:
Fidicuary Duty Enforcement
Injunction: Court orders company to refrain from taking a decisions Pay Damage: For loss sustained as result of board violating their duties These apply if the court deems thee board did not act in good faith and follow a reasonable process
Insiders and Outsiders on the Board
Inside: CEO, CFO, Other executives Outsiders: Investors, Suppliers, Independent
Types of Directors on the Board
Inside: Officers or executives in the corp Outside: may be executives of other firms, not employees of the corp Affiliated: not employed by the corp, used to work for the corporation, partly responsible for past decision, descendant of founder
Special Cases to Succession Planning
Interim CEO Director CEO
Board Committees
Large boards typically create committees that focus on individual subjects (e.g., audit, compensation, litigation, nominating), increasing the board's efficiency. - Most effective to complete work - Usually no Legal Duties, but have full power to act as board
What do boards do?***
Monitor Hire, Evaluate, and Compensate CEO Approve Operation Proposals Approve Financial Decisions Ensure Financial Accuracy Advice Offer Management Advice
Problem with Directors
Not going to worry about the company as if they had invester their own money, less anxious vigilance
Board Size (large vs Small)?
On average large firms have 10 directors on board Small firms have 4-5
Board of Directors Continuum
Phantom - No Involve Rubber Stamp - Permits officers decisions Minimal Review- Review what is brought up Nominal Participation - Some participation Active Participation - Actively involved Catalyst - Huge active role
"Tainted" CEO's as directors (Pros and COns)
Pros: - May only know what they were presented - Learn missed flaws (Don't drop the ball twice) - If they have integrity, valuable perspective Cons: - Ethical problems caused by character flaw, not lack of knowledge - Reputational risks and credibility - Oversight in the past resulting in issues - Tone at the Top
Chair / CEO Seperation Pro's and Cons
Pros: Good when company has new CEO, Clear seperation of responsibility Cons: Recruiting new CEO is hard, Inefficient decision making in turbulent industries
"tainted" directors as new directors
Pros: learned valuable lesson, misled by management? Cons: Character issues, Trust?, how engaged are they really?
benefits of succession planning
Reduce costs •Loss of business/pay for desperation Reduce anxiety/fear •By internal and external stakeholders Prepare for CEO retirement situations •Prevent lawsuits/create transparent transitions/groom new leadership Prepare for crises situations •Unexpected loss of CEO (death/termination/departure for better opportunity) •Lack of succession planning can result in a post transition meltdown
Horse Race
Simialr to Internal Canditate Heir Apparent but with multiple candidates.
Giving voice to values seven pillars (Most important one is?)
The fifth one (Self-Knowledge and Alignment) - Ask people when have you been effective in the past? (look at your strengths). Ex. Can you persaude people?
board of directors
a group of persons elected by the stockholders to manage a corporation
Staggered boards
only a portion of board members stand for re-election when directors serve more than one year terms. Effective anti-takeover method in the past. Now under criticism that it prevents shareholder influence.
Giving Voice to Values is about
Basically how you deal with challenges and values conflict - Found that it is very common that people who actually act efficiently in a values conflict are people who spoke out loud and replayed this situations as a young adult either with a mentor, or adults or senior. (Rehearsed) - At the cognitive level they names the values that mattered tothem outloud - "Act a specific way until you think that way, rather than think some way until you act that way" - Reasoning is that when we are faced with a conflict we don't sit down and think what would aristotle say or do instead we just act unconsciousl, so similar to reflexes you train we should rehearse
Advantages of large boards?
Advantages: More resources to dedicate, greater specialization and greater diversity Disadvantages: slow decision making, less candid discussion, risk averse/risk free.
Two things caused by information asymmetry**
Adverse Selection: Insurance pool of two people, one lies and says they are fit. Increases likelhood of selecting ifnerior alternative Moral Hazard: Give insurance, person takes undue risks and shirks other responsibilitty, costs incur to another party.
Retired CEO's as directors
As seen with Lehman brothers might be a time where experience is outdated
Three Most Common Board Committees and their Roles ******
Audit - Oversee Financial Reporting, Monitor choice of accounting policies and principles. Oversee Compliance and whistleblower hotlines Compensation- Setting CEO compensation and goals, Setting and monitoring CEO performance, Board compensation Nomination - Identify individuals to serve on board, manage board evaluation process, select nominees to be put before a shareholder vote at the annual meeting.
information asymmetry (Principal-Agent)
The concept that the manager generally has more information about the true financial position and results of operations of the entity than the shareholder does.
Professional Directors (Pros and Cons)
individuals who have retired from their primary profession but are serving as board directors primary career Pros: Experience, Time available, Network Cons: Busy (if multiple boards), not effective if they consider directorship as active retirement
External Candidates Pros and Cons
job candidates who are individuals from outside of the organization. Pros: Experience as CEO, More Free to make changes Cons: Less familiar with company, Disruption among operations, Board not evaluated performance First hand, Leadership style might not translate to new environment
Agency Costs
the costs of the conflict of interest between stockholders and management. These are the costs that come with a separation of objectives between the agent and principle
Codetermination
the inclusion of a corporation's workers on its board
Corporate Governance ( WATCH VIDEO ON D2L FOR GUEST SPEAKER)
the system (rules policies etc) of governing a company so that the interests of corporate owners and other stakeholders are protected. Monitoring system consists of board of directors and an external auditor and many more. (Pg 8 Textbook Diagram)
Six Critical Questions for Directors
•Do I believe I have all the information? •Have I the necessary skills to make this decision? •Do I have any conflict in this matter? •Objectively, is this a rational business decision? •Can I explain this in a transparent manner? •Is it a responsible discharge of my duties?
