MGST 451: Chpt 1, 2 - Intro + BoD

Officers are…

management of corporation

Directors are…

responsible for monitoring and advising the corporation

Shareholders…

own shares in the company

rights of shareholders

• right to vote

• right to dividends

• right to assets after dissolving

directors appoint

officers (CEOs)

shareholders elect

directors

how do officers make money?

by managing corporation

what can directors issue?

dividends (% of $$$ profits) to shareholders

what do shareholders receive?

dividends

what does this demonstrate: the more $$$ spent on salaries, high- rise offices and penthouses, and private planes for officers, the less left for shareholders dividends

information asymmetry and the agency problem

information asymmetry

agents have more information than the principals

Principal

Shareholders, own shares in the company and authorize executives to act on their behalf

• shareholders/stakeholders

Agent

Executives who have a fiduciary duty to act in the best interests of the shareholders

Agency Problem

When there is separation of ownership and management in a corporation, self-interested executives can benefit themselves at the expense of the shareholders and stakeholders

What is one way we can align the interests of shareholders and management?

• Make the managers into shareholders

• Compensate the managers with shares to align their interests with shareholders

Why is it called the “agency” problem?

Arises from the nature of the relationship between an executive and shareholders

• Agents are under a fiduciary duty to act in the best interests of the principal

examples of agency problems

Cooking the books (Enron)

Conflicts of interest (ex: CEO secretly dating the HR Director at Astronomer)

Lying about company value (Theranos, Frank)

Stealing company money (Madoff, Gerald Cotton)

Ignoring safety warnings (OceanGate)

Breaking privacy laws (Meta)

Shoddy engineering (BP Oil – Deepwater Horizon)

Deprioritizing safety and training (Boeing)

Consuming excessive perks (TieCo)

Agency costs

Stock falling in value

Loss of retirement funds

Lawsuits or regulatory action

Bankruptcy

Reputational damage

Plus "externalities" like harm to people,

the environment, democratic

institutions

mitigation strategies: how do we prevent cooking the books, execs stealing company money, fraudulently

representing company value?

independent audit committee

• Independent External Auditor that does not Consult for Corporation

mitigation strategies: How can we prevent execs from shirking (not putting in effort), from taking excessive risks, from taking too little of risks?

compensation committee

• Compensate with bonuses shares, and options

mitigation strategies: how can we prevent nepotism?

Nomination Committee

Public corporations in the United States need what?

all three committees (audit, nominating, and compensation)
- must all be independent directors on committee (do not work for corporation)

public corporation in Canada need what?

Audit committee must be independent

• Compensation and nominating committee do not need to be

risk mitigation measures are known as

corporate governance

why cant we completely mitigate agency costs

• It is not economical to mitigate 100 percent of agency costs

Eventually, the cost of mitigation measures exceeds the agency costs

Prior to the Enron scandal…

There weren’t many rules about who could serve as a director

◦ Boards were “clubby”, conflicted, and management-controlled

Cadbury Commission 1992
Cadbury Commission 1992 - what was it

December 1992: London Stock Exchange commissions a committee to recommend best practices in corporate governance

• London Stock Exchange adopts all of the recommendations

what did the cadbury commission include

Includes:

◦ Separating the role of Board Chairman and CEO

◦ Appointing majority of independent directors

◦ Convening an independent audit committee

Following Enron...

◦ Senator Paul Sarbanes (D-MD) and Congressman Mike Oxley (R-OH) introduce a bipartisan bill to tighten up corporate governance in the United States

◦ This is the Sarbanes-Oxley Act of 2002 (aka SOX) that all US publicly traded companies must follow

key provisions of SOX (US only)

• Audit Committees must be fully independent

• Audit committees directly hire and oversee external auditors

• Restrictions on auditor non-audit services

• CEOs/CFOs must certify financial statements (criminal offence to misrepresent finances)

• Whistleblower protections

what did the NYSE reforms add after SOX (US)

they said that…

• majority of board members have to be independent

• nominating and compensation committee have to be independent

why couldnt canada adopt SOX? (all committees are independent)

• canada doesnt have that many people

• committee members would be on multiple committees (kinda problematic)

what did canada do instead of adopting SOX?

Adopted a hybrid system:

◦ Mandatory independence of audit committees

Voluntary guidelines:

◦ Boards should have majority of independent directors;

◦ Should have independent nominating and compensation committees

What are Independent Directors?

Directors who do not work for the management of the corporation

Regulatory Independence (defined by NYSE)

someone who hasn’t, in the last three years:

• Been employed by the company

• Has made more than $120,000 in direct compensation from the company (other than board fees and committee fees)

• Has worked as an auditor for the company

• Is an executive at another corporation where the listed company’s executives sit on the compensation committee

• Is an executive at another corporation that has done more than $1M in business or 2% gross revenue (whichever is greater)

is regulatory independence the same as actual independence?

No

TORNETTA V. MUSK

Richard Tornetta, who owned 9 shares in Tesla, sued Musk, Tesla, and the Board of Directors in Delaware court

• Elon moved the corporation from Delaware to Texas; a new shareholders vote was

  held and the Court declined to enforce it; in December 2025, the Court (on appeal) reinstated

  the pay package now worth $128 Billion

after SOX was passed, what major event happened

the 2008 financial crash
- SOX didnt workin this situation

what was introduced after SOX and the 2008 crash?

2010 Dodd-Frank

2010 Dodd-Frank Wall Street Reform and Protection Act

• Say on pay - shareholders have a vote on exec pay

• Proxy access - institutional shareholders nominate shareholders

• CEO pay - calculating ratio pay to regular worker

did dodd-frank work?

• no not really:
  Say on pay - advisory: meaning boards aren't legally required to change pay plans after a "no" vote

• Proxy access - struck down in court as capricious and arbitrary

• CEO pay - CEO pay increased, surpassed inflation

Board's Dual Mandate is to

1. advise

2. monitor

what does “advise” mean

• Provided feedback on our strategy to commercialize in the formal education market

• Connected us with their networks

• Approved key hires

• Discuss M&A opportunities

• Advise on regulatory compliance

what does “monitor” mean?

• Held us accountable on our execution of strategy

• Require leadership changes and change of strategy

• Made us cut our budgets

• Evaluate the business model

• Identify key performance measures

• Design executive compensation

• Fire poor-performing CEO

• Ensure integrity of financial statements

• Ensure regulatory compliance

rubber stamp boards

These boards nominally meet, approve management proposals without scrutiny, and provide little independent oversight

active boards will do what?

• challenge management, play an active part in strategy, and trigger corrective changes

what does the board’s fiduciary duty include

• Duty to put the corporation's interest above their own

• Conflicts may happen

• Must disclose conflicts fully and absolve themselves from any vote pertaining to the matter

Canada vs US: US corporate law

• for the stakeholders best interest

• state law for corporate law

• federal common law (SOC, dodd-frank)

• security laws are federal

• audit committee needs to be independent

• need majority independent board

Delaware court also imposes the duties of

• Duty of care: to make informed, prudent decisions

• Duty of loyalty: to put the corporation's interest above their own (no self-dealing)

• Duty of candour: to fully disclose material facts when seeking shareholder action

Canada vs US: Canada corp law

• federal + provincial common law (aka dual jurisdiction)

• security laws are provincial

• criminal laws are federal

• only audit committee needs to be independent

Business judgment rule

Courts won't second guess the business decisions made by boards so long as the decision-making process was sound and informed

boards are made up of

• Insiders: Executives of corporation

• Outsiders: Executives of other corporations, professional directors, retired CEOs, lawyers, and academics

• Affiliated: Banks, investors

• Employees: In Germany, labour representation is required on supervisory board

Active CEOs: pros

• Experienced

• Sharp skills, fresh network

• Stock market responds favourably to appointment of active CEO as director

• Can build trust with CEO

• Not dependent on Board for income

Active CEOs: cons

• Busy directors associated with lower-quality corporate governance

• Bossy, bad listeners, poor collaborators

• Can’t participate in meetings on short notice

• Leads to higher CEO salary

Retired CEOs: pros

• Experienced

• More time on their hands

Retired CEOs: cons

• Network and skills not as fresh

• Might not be as up-to-date on market landscape

Professional Directors: pros

• More time

• Vast network

• Experienced

professional directors: cons

• May be more dependent on board for income or prestige

• May be serving on multiple boards, “busy” director