CORPORATE GOVERNANCE
READING ASSIGNMENT 1 – August 30:
Corporate Governance Failures in the 21st Century
1. What questions should every corporate director ask every CEO?
Do you have the right CEO?
i. Most important to be sure about this. How do you make the CEO improve? If he’s not the right CEO how will co fix it?
How well is CEO’s compensation linked to actual performance?
i. How is it influencing you?
Do you have a precise understanding of the moneymaking recipe in the chosen strategy?
i. BoD has to understand a co’s strategy and how it translates into profits. How is it distinct from its competitors? How long will advantages last?
Is the mgt team looking at external trends and diagnosing the op/threats presented?
i. Prosperity and survival of the corp is dependent on adjusting to changes in the external environment. Sources of change: Competition within industry, new entrants, technology changes, new distribution channels, regulation/legislation, activists, global economic trends etc. Look also at rival firms’ approaches.
What are the sources of organic growth?
i. Is organic growth good and sustainable, profitable, capital efficient? Although acquisitions play a role, cos with longevity have always used organic growth to create LT shareholder value.
How rigorous is the process for developing the leadership gene pool?
i. A critical success factor for the LT is the qual of co’s human resources
Do you have the right approach to diagnosing financial health?
i. Tracking cash flow is the best way to see how various parts of the business work together. This quickly reveals which business units are performing and which are not. Also, boards need to look at long term obligations to be comfortable that the co will survive should adverse circumstances arise
Are you examining measures that capture the root causes of performance?
i. Instead of focusing on acct figures like inventories, costs, revenue recognition etc, progressive boards identify the physical drivers whose performance today will manifest in accounting figures tomorrow.
Do you get bad news from management, in time and unvarnished?
i. Board members can provide good guidance for mgt if they know of problems, so mgt needs to share them.
How productive are executive sessions?
i. Exec sessions are a critical vehicle for directors to air their feelings, test their hypotheses, and reach a group viewpoint on items that matter.
2. What mistakes do GC’s feel boards are most likely to make?
(1) Not asking questions;
(2) Failing to understand the company and the risks it faces; don’t understand how it works, don’t visit facilities or speak with day managers
(3) Failing to lead on ethics and compliance; must ensure that mgt is implementing correctl; must ensure commitment, follow up, demand training.
(4) Not insisting on a crisis management plan; institute clear protocols and procedures and retainment of appropriate attys and forensic accts… risk identification, risk mitigation, and crisis preparation
(5) Speaking out in a crisis before the facts are in;
(6) Relying on the wrong outside counsel; use counsel with whom the relationship and possible conflicts of interest do not impair advice. Need counsel independent from mgt and with the right expertise for specific issues at hand
(7) Failing to understand attorney-client privilege;
(8) Underestimating regulators and gravity of investigations; Do not think that regulators will simply accept the co’s version of events. Ignoring these things makes them much worse
(9) Giving too much leeway to rainmakers; excessive latitude given to performers, even when it is clear they are dangerously close to compliance lines.
(10) Get caught up in dilemma of false options; always think that they can simply choose to settle or go to court and focus on that decision instead of reality. Or, think that either must settle all cases or defend all cases but not both. Must assess strengths and weaknesses individually
3. What are the common problems that existed among Martha Stewart, Samuel Waksal, Dennis Kozlowski, John Rigas, Ken Lay, and Richard Scrushy?
Like Scott Halliday (Ernst & Young partner) told us in class: we will always be confronted with situations where we will want to act greedily… we should just follow the law… everyone should make a dollar but do it ethically. These are all CEO’s who made money by breaking the law and undermining investor confidence.
Common probs are that many of the execs treated the companies as if they were their own personal property. Felt entitled to huge compensation, borrowed massive sums of money, and improperly used co property. For examples see below: They become disconnected from reality. Money they have and earned is not enough. Failure to appreciate that there are rules, and that even they must follow them. Hubris, ego, greed, sense of entitlement.
Waksal: ImClone founder and former ceo: heard that his meds were going to be rejected by fda and told his family before news broke, and they all sold their shares. His greed and the vision of making money ruled. Undermines investor confidence in the company
Stewart: lied about reasons she sold shares of ImClone: She got only 45k from the trade!
John Rigas: top exec (along with his son) of cable co Adelphia Communications. Classic greed: execs made up numbers for investors and lenders; regularly withdrew money from co w/o reimbursing; paid a 40k annual salary to a personal masseuse; used co’s plane to fly a Christmas tree to a fam member in NYC costing 6k. Family had crazy lavish spending habits.
Kozlowski: former top exec of Tyco Intl: blatantly looted Tyco of more than 150 million. Among the highest paid executives in America, and found guilty on 22 of 23 charges. Lavish spending: company funds on a 30 million apt, a yacht, 2 million Sardinia bday party for his wife.
Lay: Once enron chairman.. one of the biggest business success stories of the 1990s; its collapse marked a dramatic end to the stock market boom and the beginning of a wave of corporate and regulatory reforms, including the 2002 Sarbanes-Oxley law. Lay quietly sold 70 million dollars worth of Enron stock back to the company without having to report it.
Scrushy: HealthSouth Corp boss; accused of masterminding a 2.7 billion accounting fraud at the Birmingham Al medical concern… acquitted.
READING ASSIGNMENT 2 – September 6 (Part 1):
Nature and Structure of Corporate Boards
1. Describe the power relationships between the board, management, and the shareholders. What can be done to align these three groups?
a. Mgt/Shhldr:
i. Shareholders provide capital, and in return management is responsible for running the company well and delivering timely and accurate financial reports. SEC/NYSE have targeted this relationship with Congress so reporting standards and regulations are in place that promote transparency and are very strong
b. Mgt/BoD:
i. The board monitors performance, counsels management, and hires/fires/sets pay for CEO. In return CEO is responsible for managing the co and keeping the board informed about how things are going.
ii. Board’s allegiance is generally to management, when it should be to shareholders. This skews governance triangle, collapsing one of the sides. Sets stage for cordial consensus driven environment. CEO power is formidable when this happens.
c. Shareholders/BoD:
i. transparency and accountability, which rest at the heart of good governance, are essentially missing in this relationship.
ii. Directors don’t know what shareholders want and shareholders don’t know what directors are doing or if they’re voting in their interest. Shareholders technically elect board but they cannot slate nominees and they don’t know who will vote in their favor.
d. When shareholders fail to engage either in setting direction or holding board members accountable for their behavior, this important link is missing and a director’s allegiance shifts from its proper base (shareholders) to the nearby boardroom where fellow directors and managers fill the void. In such settings the power of the CEO can be formidable. Directors frequently feel an obligation to a CEO who has helped recruit them. Plus CEOs are generally very persuasive people
e. Hard to change things even if independent directors are brought in b/c each director is joining a group with already established norms.
f. Directors’ degree of independence is the most visible driver of director behavior, but other less visible forces are harder to change and present: nomination and recruitment process, board culture and relationship with CEO, level of accountability to shareholders
g. Ways to align:
i. Make directors accountable to shareholders: record individual director votes on key corporate resolutions in proxy stmts; have groups like Institutional Shhldr Services create scorecards
ii. Separate the positions of chairman and CEO: Companies that fuse the roles of CEO and chairman collapse the governance triangle, undermining the system of checks and balances that is essential to responsible corporate governance
iii. Reinvigorate shareholders: In nomination and election process, shareholders could signal their support for candidates the board puts forth and vote accordingly. (Ex: Posting principles and votes on websites). Also if they vote against something they should be able to tell the board why. Urge shareholders to seek each other out and work in concert on issues on which they share common ground
iv. Give Boards Funding: For huge decisions insight from an external perspective could help. (experts). SOX requires that audit committees have their own funds for paying auditors and advisors. Giving budgets to full boards would extend this practice
v. Encourage boards to monitor their own performance
2. What are the key responsibilities of members of boards of directors to the firm they serve?
a. Provide checks and balances on management
b. Provide oversight of the company
c. Properly representing shareholders
d. Determining the culture of the co and how that affects profitability
e. Being informed of the decisions they must make
f. Hire qualified CEO
g. Review CEO’s performance/approve CEO’s compensation
h. Review/approve corporate strategy
i. Review/approve acquisitions
j. Approve hiring and compensation of CEO’s direct reports.
k. Nominate (select) new directors
l. Review financial reports
m. Promote the “Best Interest” of the firm
n. Act without conflict of interest
o. Act in good faith to further the best interests of co and stockholders
3. How does the business judgment rule protect directors? Explain.
which fall along a continuum from least to most involved.
b. Passive Board: Functions at the discretion of the CEO, limits its activities and participation, limits its accountability, ratifies mgt prefs
c. Certifying Board: certifies to shareholders that the ceo is doing what the board expects and that mgt will take corrective action when needed; emphasizes the need for independent directors and meets without CEO; Stays informed about current performance and designates external board members to evaluate the CEO. Establishes an orderly succession process; is willing to change mgt to be credible to shareholders
d. Engaged Board: Provides insight, advice and support to CEO and mgt team; recognizes its ultimate responsibility to oversee CEO and company performance; guides and judges the CEO; Conducts useful two way discussions about key decisions facing the company; Seeks out sufficient industry and financial expertise to add value to decisions; takes time to define the roles and behaviors required by the board and boundaries of CEO and board responsibilities
e. Intervening Board: Becomes intensely involved in decision making around key issues; convenes frequent, intene meetings, often on short notice
f. Operating Board: Makes key decisions that mgt then implements; fills gaps in mgt experience
3. What steps can be taken to improve the performance of corporate boards?
“Everyone knows what most boards have been: gentleman’s-club-era relics characterized by ceremony and conformity. And everyone knows what boards should be: seats of challenge and inquiry that add value without meddling and make CEOs more effective but not all-powerful.”
Have the right mindset.
i. Realize that boards can constantly be improved.
ii. Create and implement a process of board evaluation that helps to monitor progress and concerns as well as to lay out future goals.
Choose the right role.
i. Determine the level of involvement the board will have in the influencing management decisions and the company’s direction. (Look at #2 above.)
ii. Set out the board’s responsibilities (as compared to those that belong exclusively to management.)
Choose the right directors.
i. Capable, qualified individuals who exhibit the characteristics described in #7 below.
Manage agendas to control the work of the board.
i. Make sure to allow the board to shape the agenda; do not allow the CEO to overload the agenda and stifle debate or conversation when needed.
Present directors with the right information.
i. Give directors the information they need to make an informed decision; don’t weigh them down with useless information and stacks of insignificant numbers.
Promote the right board culture.
i. “Engaged cultures are characterized by candor and a willingness to challenge, and they reflect the social and work dynamics of a high-performance team.” (Building Better Boards)
ii. As board members start to act as a team, they can move closer to creating an engaged culture.
4. Why are more CEO’s saying “no thanks” to board seats?
a. Since the fall out from Enron and WorldCom, directorships have become increasingly risky and time-consuming.
a. 10 former directors at those two companies had to use personal finances to settle shareholder lawsuits.
b. Hours have increased, liability has increased and compensation has remained the same.
b. Further, a growing number of companies limit the number of outside boards on which their CEOs may serve.
5. How should a lead director interact with management and the board?
a. A lead director should act as an intermediary between the CEO, the chairman and the board.
b. He or she should have the authority to call meetings of the independent directors and to set the agendas for those meetings.
c. He or she should also be able to suggest to the chairman and CEO when its appropriate to call a full meeting of the board and to participate in setting the agenda for that meeting after soliciting the views of the other board members.
d. He or she should facilitate discussion among other independent directors and pass their views along to the CEO.
e. “In other words, this role calls for the soft skills, diplomacy and judgment, plus the courage to raise tough issues.” (What It Takes to Be a Lead Director)
