Corporate Governance & Ethics

Public Company Hierarchy of Authority

State Charter

Shareholders

Board of Directors

Management

Employees

Friedman’s Philosophy

“social responsibility of business is to increase profits”

Shareholder primacy

shareholders—the providers of the necessary risk capital and the legal owners of public companies—have the most legitimate claim on profits

Shared Value Creation Framework

Economic value for shareholders

Social value by addressing society’s needs and challenges

Stakeholder primacy

Corporate Governance

A system of mechanisms to:

• Direct and control and enterprise

• Ensure it pursues strategic goals successfully….and legally

Offer checks and balances

Ask the tough questions when needed

Try to address principal-agent problem

Agency Problem: Manifestations

Excess compensation (even decoupled from firm performance

Unrelated diversification (empire-building)

On-the-job consumption

Insider trading

Board of Directors

The centerpiece of corporate governance

• Helps overcome principal-agent problems

Inside and outside directors

• Inside = CEO, COO, CFO, etc.

• Outside = often senior execs from other firms

Elected by shareholders

• votes

Board of Directors: Responsibilities

General strategic oversight and guidance

Selecting, evaluating, and compensating the CEO

• Hire/fire the CEO

• Succession plan

Providing guidance for executives’ compensation

Reviewing, monitoring, evaluating, and approving strategic initiatives

Risk assessment & mitigation

Ensure the firm’s audited financial statements represent a true and accurate pic of the firm

Ensure the firm’s compliance with laws and regulations

Other Mechanisms for align principal & agent incentives

Executive Compensation Design

The market for Corporate Control

Auditors, Government Regulators, and Industry Analysts

Executive Compensation Design

Internal mechanism

Cash + Performance linked compensation

~ 2/3 pay linked to performance

Example: stock options

• Incentivize the CEO to work in the best interest of shareholders

The Market for Corporate Control

External mechanism

Activist investors who:

• Seek to gain control of underperforming corp

• Buy shares in open market

Example: hostile takeover, leveraged buyout (LBO), poison pill, institutional investor activism

Auditors, Government Regulators, and Industry Analysts

External mechanism

Avoid misrepresentation of financial results

• GAAP

• Audits

Example: analysts’ forecast and recommendations (buy, sell, hold)

Business Ethics

Agreed-upon code of conduct in business, based on societal norms

Lay foundation and provide training for:

• “behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society”

Can differ around the globe

• Universal norms = fairness, honesty, reciprocity

Law is the minimum acceptable standard

“most internal of control mechanisms”

What to do when facing an ethical dilemma

Ask whether intended course of action falls within acceptable norms of professional behavior

• Outlined by organization (code of conduct)

• Outlined by profession at large

Would you feel comfortable explaining and defending decision to public?

• How would media report?

• How would stakeholders feel?