Corporate Governance

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CHAPTER 3

• Corporate Governance

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Corporate Governance

• Corporate governance is the formal systemof
  oversight, accountability, and control for
  organizational decisions and resources.
• Major issues
• Shareholder rights
• Executive compensation
• Organizational ethics programs
• Board composition and structure
• Auditing, control and risk management
• CEO selection and executive succession plans

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Corporate Governance Framework

• Most businesses operate under the belief that the
  purpose of business is to maximize profits for
  shareholders.
• The stakeholder model places the board of
  directors in a position to balance the interests
  and conflicts of various constituencies.
• Directors and officers of corporations are placed
  in positions of trust and must exercise a duty of
  diligence and a duty of loyalty in decision
  making.

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History of Corporate Governance

• 1932U.S. Securities Exchange Commission (SEC)
  is formed, requiring corporations to allow
  shareholder resolutions to be brought to a vote
  of all shareholders.
• Mid-1900sThe goal of business is to align the
  interests of principals and agents so that
  organizational value and viability are
  maintained.

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History of Corporate Governance (cont.)

• Mid-1990sBoards of directors play a greater
  role in strategy formulation, andthere is
  movement toward corporate governance committees.
• 2002Sarbanes-Oxley Act brought sweeping changes
  in corporate governance.
• 2008-2009 Collapse of U.S. financial system
  discloses corruption and need for greater
  oversight and control.

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Fortunes Best and WorstCompanies for Social
Responsibility
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Models of Corporate Governance

• Shareholder model
• Maximizes wealth for investors and owners
• Develops and improves the formal system of
  performance accountability between management and
  the firms shareholders
• Makes decisions based on what is ultimately best
  for investors
• Focuses on aligning investor and management
  interests

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Models of Corporate Governance (cont.)

• Stakeholder model
• Considers the interests of employees,suppliers,
  government agencies, communities, and other
  groups with which the firm interacts
• Assumes a collaborative and relationalapproach
  to business
• Focuses on continuous improvement,
  accountability, and engagement with internal and
  external constituents

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Issues in Corporate Governance Systems

• Boards of directors
• Independence
• Quality and experience
• Performance
• Shareholders and investors
• Shareholder activism
• Social investing
• Investor confidence

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Issues in Corporate Governance Systems (cont.)

• Internal control and risk management
• Internal and external audits
• Control systems
• Risk management
• Financial misconduct
• Executive compensation

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Boards of Directors

• Assume legal responsibility for firms resources
  and decisions
• Appoint top executive officers
• Maintain a fiduciary duty
• Monitor decisions made by managers on behalf of
  the company
• Growing interest in hiring outside directors to
  bring in more independent thought and action

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Shareholders and Investors

• Shareholders are concerned with ownership
  investment in publicly traded firms.
• Greater input on company strategy and decisions
• Investor is a general term for any individual or
  organization that provides capital to another
  firm.
• Financial
• Human
• Intellectual

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Characteristics of a Successful Shareholder
Activism Campaign
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General Issues in Social Investing

• Environmental
• Workplace equity and safety
• Product safety and testing
• Global operations
• Human rights

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Corporate Governanceas an Investment Criterion
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Internal Control and Risk Management

• Controls are used to safeguard corporate assets
  and resources, protect the reliability of
  organizational information, and ensure compliance
  with regulations, laws and contracts.
• Limit employee and management opportunism
• Ensure that board members have access to timely
  and quality information
• Implement internal and external audits to link
  risk, controls, and corporate governance
• Anticipate and remedy organizational risks
• Minimize negative situations
• Uncertainty needs to be hedged

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Financial Misconduct

• The failure to understand and manage ethical
  risks played a key role in the financial crisis
  of 2008-2009.
• Complex financial schemes, inappropriate risk
  levels, opportunity for personal gain, financial
  incentives, and a lack of effective corporate
  governance led to the financial crisis.
• Subprime lending created thousands of mortgage
  foreclosures and delinquencies.
• Derivatives, a financial trading instrument, have
  been called financial weapons of mass
  destruction.

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Executive Compensation

• The average executive makes 344 times the average
  workers salary.
• Up from 40 times the average salary in the 1960s
• Two contrasting perspectives
• Executives assume a great deal of risk and
  therefore deserve great rewards.
• No executive is worth millions of dollars
  regardless of investor return.
• Plans that base achievement on several
  performance goals are growing in popularity.

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OECD Principles of Corporate Governance

• 1. Basis for an effective corporate governance
  framework
• 2. Rights of shareholders and key owners
• 3. Equitable treatment of shareholders
• 4. Role of stakeholders in corporate governance
• 5. Disclosure and transparency
• 6. Responsibilities of the board

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Implementing OECD Principles of Corporate
Governance

• Create systems that articulate divisions of
  responsibilities and are consistent with the rule
  of law.
• Ensure the rights of shareholders to vote and
  influence corporate strategy.
• Recruit greater number of skilled, independent
  members on boards of directors.
• Eliminate techniques that protect failing
  management and strategy.
• Promote wider use of international accounting
  standards.
• Promote better disclosure of executive pay and
  remuneration.

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Future of Corporate Governance

• Boards will be held responsible fordeveloping
  company purpose statementsthat cover stakeholder
  interests.
• Annual reports will include more nonfinancial
  information.
• Boards will be required to perform
  self-assessments.
• Board member selection process will become
  increasingly formalized.
• Boards will need to work more as teams.

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Future of Corporate Governance (cont.)

• Board membership will require more time.
• Focus will move from a shareholder model to a
  stakeholder model.
• Systems will ensure greater organizational- level
  accountability and control.
• General support for corporate governancewill
  rise.
• Governments will play a more significant role.