MGST 451 chp 1 & 3-5, 7

Agency Problem

When executives are often selfish enough to take opportunities to benefit themselves but can cause shareholders and stakeholders to bear the cost of these actions

Agency Costs

The costs that shareholders and stakeholders have to bear due to selfish executives

Corporate Governance

system of checks and balances that ensures that the interests of various stakeholders, shareholders, employees, customers, and the broader society, are taken into account in decision-making processes.

Moral Salience

knowledge that certain actions are wrong even if they are undetected/unsuspected and left unpunished

Economically Efficient Governance System

decrease agency costs more than costs of implementation

Cost of Implementation

expenses associated with implementing corporate governance policies and practices - can be costly and time-consuming however, it is a worthwhile investment for companies that want to enhance their governance practices and build long-term value for shareholders - ex: hiring outside consultants or legal experts, establishing new policies and procedures, and training employees on the new requirements

Shareholder Perspective

viewpoint that the primary obligation of the organization is to maximize shareholder value

Stakeholder Perspective

viewpoint that the organization has a societal obligation beyond increasing shareholder value

External Forces that Affect Structure of Governance System

"efficiency of local capital markets, legal tradition, reliability of accounting standards, regulatory enforcement, and societal and cultural value, these serve as an external disciplining mechanism on managerial behavior"

External Auditor

hired by a company to review and assess its financial statements and internal controls; provide an objective and impartial assessment of the company's financial reporting, to ensure that the company's financial statements are accurate

Private Equity

"operate with very low levels of independence (almost everyone on the board has a relationship to the company and has a vested interest in its operations); offer extremely high compensation to senior executives"

Activist Investors

investors who seek to influence the management and governance of a company in which they hold shares

Proxy Advisory Firms

use a variety of criteria to evaluate companies, including board composition, executive compensation, and corporate social responsibility, among other factors

Efficient Capital Markets

"prices are expected to be correct based on the information available to both parties in a transaction"

Inefficient Capital Markets

"prices are subject to distortion and corporate decision making suffers"

Capital Markets

financial markets where equity and debt securities are traded, such as stock exchanges, bond markets, and other over-the-counter markets; 2 categories: primary markets and secondary markets -play a crucial role in the economy by facilitating the flow of capital from savers to borrowers

Rules-Based

prescribe detailed rules for how accounting standards should be applied to various business activities

Principles-Based

outline general accounting systems are not always dictate the specific application of these concepts to business activities

Shareholder-Centric View:

primary responsibility of corporation is to maximize shareholder wealth; Actions such as improving labor conditions, reducing environmental impact, and treating suppliers fairly are seen as desirable only to the extent that they are consistent with improving the long-term financial performance of the firm

Stakeholder-Centric View:

"obligations toward constituents such as employees, suppliers, customers, and local communities should be held in equal importance to shareholder returns"

Advisory Capacity

boards expectation to consult with management abt the strategic & operational direction of company

Oversight Capacity

board is expected to monitor management & ensure that it is acting diligently in the interests of shareholders

Directors

expected to advise on corporate strategy but do not develop the strategy, ;expected to ensure integrity of financial statements but do not make the statements

The Board

governing body elected to represent the interests of shareholders

Chairman

responsible for setting the agenda, scheduling meetings, & coordinating actions of board committees

Written Consent

process by which shareholder/board member provides their agreement or consent to particular action of the company in writing; ex: signed doc, email, etc...

Executive Session

independent directors meet at least once a year where executive directors are not present, gives outside directors an opportunity to discuss the performance of management, operating results, internal controls, succession planning privately

Ad Hoc

temporary/one-time group or committee that address a specific issue that falls outside the scope of the regular board or committee structure

Audit Committee

responsible for overseeing company's external audit & is the primary contact btwn auditor; company intended to prevent management manipulation of audit

Obligations of Audit Committee:

1. overseeing financial reporting & disclosure process 2. monitoring choice of acct policies & principles 3. overseeing the hiring, performance, & independence of external auditor 4. overseeing regulatory compliance, ethics, whistleblower & hotlines 5. monitoring internal control processes 6. overseeing the performance of the internal audit function 7. discussing risk-mgmt policies & practices w/ mgmt

Compensation Committee

responsible for setting the compensation of CEO & for advising the CEO on the compensation of other senior executives

Obligations of Compensation Committee:

1. setting the compensation of the CEO 2. setting & reviewing performance-related goals for the CEO 3. determining appropriate compensation structure for CEO, given these performance expectations 4. monitoring CEO performances relative to targets 5. setting/advising CEO on other officers' compensation 6. advising the ceo on & overseeing compensation of nonexecutive employees 7. setting board compensation 8. hiring consultants to assist in the compensation process

Governance Committee

responsible for evaluating the companys governance structure & processes & recommending improvements

Nominating Commitee

responsible for identifying, evaluating, & nominating new directors when board seats need to be filled typically in charge of leading CEO succession-planning process

Responsibilities of Nominating + Governance Committees:

1. identifying qualified individuals to serve on the board 2. selecting nominees to be put before a shareholder vote at the annual meeting 3. hiring consultants to assist in the director recruitment process 4. determining governance standards for the corp. 5. managing the board evaluation process 6. managing CEO evaluation process

Specialized Committees

monitor functional areas that the board believes to hold strategic importance for the firm, thus meriting additional oversight

Staggered/Classified Boards

directors who are in charge of making decisions for a company are elected to serve for 3 years at a time. Only one-third of the directors are up for re-election every three years. This means that it would take at least two election cycles for a majority of the board to be replaced. So, the board can't be completely replaced all at once in just one election

Plurality of Votes

directors who get the most votes win, regardless of whether they receive a majority of votes ex: Candidate A receives 45 votes; Candidate B receives 40 votes; Candidate C receives 15 votes Since Candidate A received the most votes (45 out of 100), they would be elected to the board of directors, even though they did not receive a majority of the votes (more than 50%).

Dual-Class Shares

type of stock structure that allows a company to issue multiple classes of shares, each with different voting rights and dividend payouts

Majority Voting

"director is required to get a majority of votes to be elected; even in an uncontested election, a director can fail to win a board seat if over half of all outstanding votes are withheld from him or her"

Cumulative Voting

allows shareholder to concentrate votes on a single board candidate instead of requiring one vote for each candidate

Two Cases Contested Elections Occurs:

occur in two cases: 1. hostile takeover battle 2. activist investor dissatisfied with mgmt & wants to gain influence over company

Contested Elections

multiple parties compete for the control of a company's board of directors through a vote by shareholders

Removal of Directors

done by shareholders voting

Fiduciary Duty

legal obligation that requires individuals to act in the best interest of that party, rather than in their own interests where primary duties of the board are embodied

Three Components of Fiduciary Duty:

1. duty of care 2. duty of loyalty 3. duty of candor

Duty of Care

"requires that a director make decisions with due deliberation & care"

Duty of Loyalty

"addresses conflicts of interest ex: director discovers a business opportunity in the course of his or her service to the company, the duty of loyalty requires that the director refrain from taking the opportunity before first determining whether the company will take it"

Duty of Candor

"requires that management and the board inform shareholders of all information that is important to their evaluation of the company and its management (disclosing info)"

SEC

Securities and Exchange Commission; gov't agency that is responsible for regulating the securities industry, including the issuance and trading of securities such as stocks, bonds, and other financial instruments

3 SEC Filings:

1. filings made when company issues securities 2. annual & quarterly filings 3. filings upon the occurrence of transactions/events (such as, merger, change in auditor, or hiring of CEO)

Material Information

info that an investor would consider important to an investment decision in each SEC filing material info must be included

2 Types of Judicial Intervention to Enforce Fiduciary Duties

1. Injunction 2. Management/Directors to pay damages for losses sustained as a result of violating their duties

Injunction

court order that requires company/individual to stop engaging in an activity, to prevent harm/injury to others ex: might order that company refrain from consummating a pending merger and allow other parties to bid

Business Judgement Rule

court will not second guess a board's decision even if proved to be srsly deficient used when violation of duty of care is involved

Good Faith

"requires that the board act without conflicting interests and that it not turn a blind eye to issues within its responsibility"

Securities Class Action Lawsuit

plantiff's lawyers typically name the company and its CEO as defendants; cases involving financial misstatements, CFO is typically named as well; outside board members are named much less frequently

SEC Enforcement Action

targets members of management who were responsible for violation

Indemnification

process of protecting a company or an individual from financial losses or liabilities arising from legal actions, damages, or other expenses incurred due to their actions

Board of Directors

* centerpiece of the gov’t
* help overcome principal-agent problem
* SH can be BoD & are elected by SH
* Primary Responsibility: monitor/control corp’s execs.

Board Responsiblity

Monitor, Advise, Hire/Evaluate/Compensate CEO, Approve major operating proposals, approve major financial decisions, offer expert advice to mgmt

Phantom (BoD Continuum)

* Lowest involvement in SGMA

Rubber Stamp

* Lets officers make all decisions
* Low level of SGMA

Minimal Review

* Moderate level of SGMA
* Formally reviews selected issues

Nominal Participation

* Moderate level of SGMA
* Limited involvement in performance/review of selected key decisions

Active Participation

* High level of SGMA
* Approves, questions, and makes final decisions on mission, strategy, policies, and objectives
* Performs Fiscal & Mgmt Audits

Catalyst

* Highest level of SGMA
* Leading role in establishing & modifying mission, objectives, strategy, and policies

Board Independence

directors free from conflict of interest that might compromise their ability to act ONLY in interest of firm

Lead Independent Director

* Usually a non executive
* Acts as link between chair and CEO; COMPROMISE when CEO is also chair of board

Inside Directors

* officers/executives **employed** by corporation

Outsider Directors

* can be executives of other firms

Direct Interlocking Directorate

* two firms that share director

Indirect Interlocking Directorate

* two corporations have directors who serve on a board of a third firm

Audit Committee

* oversee financial reporting, internal controls & audit processes

Compensation Committee

* set executives pay & compensation policies based on performance & industry standards

Nomination Committee

* identifies & selects candidates for the BoD & senior mgmt positions

When Board Actions Take Place

1. board meetings


1. written consent

Uncontested Election

directors elected **as long as they get at least ONE vote**

Cumulative Voting

allows SH to concentrate votes on 1 board candidate

ex: SH w/ 100 shares in company w/ 9 member gets 900 votes

Observer/Advisory Directors

**not** formally elected but still participates in board meetings

Professional Directors

full-time career is being in BoD

ex: retired executives, consultants, lawyers

Pro Bono Basis

provision of **free** professional services/advice typically by lawyers

Ownership Guidelines

* align interests of directors w/ common SH’s
* policy/set of guidelines to encourage executives/directors to maintain ownership in company’s stock

Board Evaluation

* entire board is evaluated for effectiveness
* composition
* accountability
* information
* meetings
* relations

Commercial Bankers

individual & small/mid-sized businesses

Investment Bankers

large corporations

Right of Codetermination

employees right to participate in management of company

Groupthink

prioritizing consensus rather than stating own opinions

* diversity can help overcome this

Tokenism

recruiting underqualified directors to seem diversified (happens w/ women for example)

Labour Market for CEO

process by which the available **supply’s matched with demand**

Pros of External Candidate

* tends to have experience as CEO
* more free to make strategic, operating, & cultural changes

Cons of External Candidate

* expensive
* less familiar with the company
* leads to disruption among operations/staffing
* board has NOT evaluated performance first-hand leadership style might **NOT** translate to new environment

External Candidate

individual who is not currently employed by the company and is being considered for a senior executive position or a position on the board of directors

* mostly hired in poorly-performing firms

Internal Candidate

individual who is currently employed by the company and is being considered for a promotion or other senior role within the organization

* companies w/ strong performance most likely to choose insider

Heir Apparent

means “next in line”, promotion of an internal leading candidate to position of president/COO

Horse Race

promotes **two or more** internal candidates to high-level operating positions who compete to become CEO

Blended Approach: Inside-Outside Model

develops internal talent & at the same time evaluates external candidates

* “inside” = continuity but may resist change
* “outside” = brings **new** ideas

Interim CEO

temporarily appointed to assume role of CEO

Director CEO

director assumes role of CEO

Succession Planning

* ongoing process
* effort to protect organizations capacity to perform key functions, sustain relationships & fulfill commitments during leadership transition