Chapter 3-5 Flashcards
What does a BoD do?
- Primary responsibility is to act in the owners’ interests by formally
monitoring and controlling the corporation’s top-level executives. - Effective representation, however, requires more than integrity.
- Directors who are “dumb but honest” fail to fulfill their obligations.
- also helps to overcome the Principal-Agent Problem
Who is the BoD elected by?
Shareholders\
2 main things that a board does?
Monitor/Advise
what does monitoring on boards entail?
- Hire, evaluate and compensate the CEO
- Approve major operating proposals
- Approve major financial decisions
- Make sure the firm’s activities and financial condition are accurately
reported to its stakeholders
what does advising on boards entail?
- Offer expert advice to management
- Strategic advice
- New product
- New markets and geographies
- M&A
What does a chairman do? (lots)
- Provides leadership for the board
- Responsible for board agenda and work plan
- Presides over meetings of the board of directors
- Ensures the board works effectively
- Ensures good corporate governance practices and procedures are in place
- Ensures all directors are properly briefed on issues arising at board
meeting - Works with board committee chairmen
- Encourages full and active contribution to the board’s affair
- Ensures effective communication between board and the investors,
key stakeholders - Holds annual meetings with non-executive directors
- Ensures constructive relationships between executive and non-
executive directors - Is a principal link between board and CEO/management team
- Involved in selection and induction of new directors
- Counsels individual directors on their performance
why in recent years have boards separated chairman and ceo?
Balance of power at board level to avoid concentration of power in a single individual
Pros of separating the CEO/Chair positions?
- clearer separation of responsibility
- clear authority to one director
- give CEO’s time to focus on strategy completely
- good when a company has a new CEO
Cons of separating the CEO/Chair positions?
- artificial separation
- difficult to recruit a CEO
- create duplication of leadership
- lead to inefficient decision making, especially in turbulent industries
why employ a lead independent director?
- The lead independent director is a compromise when the CEO also chair the board
- Sometimes communicates with shareholders
- Can particularly be important during times of crisis
- Consulted by the Chair/CEO regarding board affairs and coordinates the annual evaluation of the CEO
How are boards most effective?
Through Committees, usually granted full power
What are the 3 required sub-committees?
- Audit committee
- Compensation committee
- Nomination committee
others:
* Executive committee
* Finance committee
* Community relations committee
* Corporate governance committee
* Stock options committee
* Risk committee
* Investment committee
Audit Committee
- Overseeing the financial reporting and disclosure process
- Monitoring the choice of accounting policies and principles
- Overseeing the hiring, performance, and independence of the
external auditor - Overseeing regulatory compliance, ethics, and whistleblower
hotlines - Monitoring internal control processes
- Overseeing the performance of the internal audit function
- Discussing risk-management policies and practices with management
Compensation Committee
- Setting the compensation of the CEO
- Setting and reviewing performance-related goals for the CEO
- Determining an appropriate compensation structure for the CEO,
given these performance expectations - Monitoring CEO performance relative to targets
- Setting or advising the CEO on other officers’ compensation
- Setting board compensation
- Hiring consultants to assist in the compensation process, as
appropriate
Nominating Committee
- Identifying qualified individuals to serve on the board
- Selecting nominees to be put before a shareholder vote at the annual meeting
- Hiring consultants to assist in the director recruitment process, as
appropriate - Determining governance standards for the corporation
- Managing the board evaluation process
- Managing the CEO evaluation process
What is Milton Friedmans philosophy on business?
It should be increasing profits
Shareholder Primacy
- Shareholder primacy is a theory in corporate governance holding
that shareholder interests should be assigned first priority relative
to all other corporate stakeholders. - To date, the courts have interpreted that boards should take into
account non-shareholder interests only to the extent that
shareholder interests are not compromised. - Because the courts have interpreted the board’s obligation to serve
“in the interest of the corporation” to mean “in the interest of
shareholders”, corporate governance in the US is said to be
shareholder-centric.
Stakeholder Primacy
- The company owes a responsibility to a wider group of stakeholders, other than just shareholders.
- The board has broader responsibilities and should focus on
protecting key stakeholder rights - Shareholders
- Employees
- Vendors
- Customers
- Society as a whole
Voting for Directors - Dual Class?
different classes of shares each have a different number of votes
per share – approximately 20% of companies in Canada have dual class shares
Voting for Directors - Majority?
the company proposes a slate of Directors. Shareholders vote FOR
or WITHHELD for each Director. Each Director needs more FOR than
WITHHELD votes. If FOR votes are less than 50% of total votes the Director is often asked to resign
Voting for Directors - Cumulative?
each shareholder gets a number of votes equal to the number
of shares they own times the number of Directors up for election. The shareholder allocates the votes however they see fit.
Contested Election - Hostile Takeover?
a hostile bidder makes an offer for the company which
also includes proposing a new Board of Directors
Contested Election - Activist Investor?
an investor unhappy with company performance attempts
to change the Board in order to support their plans
Director Liability (Two forms)
- Indemnification Agreements – entered into between the company and the Director
- D & O insurance – purchased by the company from an insurance company for the benefit of Directors and management
Fiduciary Duty (two/three)
Duty of Care and Loyalty (Candor sometimes)
* The Supreme Court of Canada has ruled that the fiduciary duty is
owed at all times to the corporation.
* The Court has also stated that acting in the best interests of the
corporation is not synonymous with acting in the best interests of
shareholders.
Bill C-97 of the CAN Business Corp Act CBCA
- Stipulates that when acting in the best interests of the corporation,
directors and officers may consider, but are not limited to the
interests of shareholders and certain other stakeholders. - The Canadian government now expressly recognizes stakeholder
interests, and in having done so, moved Canada in the direction of
stakeholder versus shareholder primacy.
Duty of Care?
responsibility that members of a company’s board of directors and senior executives have to act with diligence, prudence, and in the best interests of the company and its shareholders. This duty is a fundamental component of the broader fiduciary duties that corporate officers and directors owe to the organization and its stakeholders.
making sure they are well informed and understand the situation and taking the time to make it so they can make the best decisions in the future.
Duty of Loyalty?
This duty requires them to act in the best interests of the corporation, putting the interests of the company and its shareholders ahead of their personal interests or any conflicting interests.
Duty of Candor?
This duty requires directors, officers, and executives to provide accurate and complete information to shareholders, regulators, and other stakeholders, ensuring transparency and honesty in corporate affairs.
Board size (public/private)
- The size of a board is determined by the corporation’s charter and its by- laws.
- Most corporations have quite a bit of discretion in determining board size.
- The average large, publicly held firm has 10 directors on its board
- The average small, privately-held company has four to five members.
pros and cons of large boards?
Large boards have more resources to dedicate to both oversight and advisory functions. They allow for greater specialization to the board through diversity of director experience and through functional
committees
* Large boards suffer from slow decision making, less candid discussion, diffusion of responsibility, risk aversion and free riding.
* Large boards are associated with lower firm value
* But in complex firm this is not the case
staggered boards
only a portion of board members stand for re-election when directors serve more than one year terms
directors typically are grouped into three classes, each of which is
elected to a three-year term. Only one class of directors stands for
reelection in a given year.
- purpose is for anti-takeover but can say directors are less accountable to shareholders
Who should serve on the board?
Insiders
* CEO
* CFO
* Other executives / employees
Outsiders
* Investors
* Suppliers
* Independent
Codetermination
the inclusion of a corporation’s workers on its board, began only recently in the United States
- europe is doing this more than the US
Criteria for a good director
- Willingness to challenge management when necessary
- Special expertise that is important to the company
- Available for outside meetings to advise management
- Understands the firm’s key technologies and processes
- Works well with others, provides valuable input
- Is alert and inquisitive
- Exercises judgment in best interests of company
- Prepares adequately for meetings, regular attendance
Types of directors (3)
Inside directors
* typically officers or executives employed by the corporation
Outside directors
* may be executives of other firms but are not employees of the board’s corporation
Affiliated directors
* not employed by the corporation, handle legal or insurance work
* used to work for the corporation, partly responsible for past decisions affecting current strategy
* descendants of the founder and own significant blocks of stock
Interlocking directors (2)
Direct interlocking directorate
* when two firms share a director or when an executive of one firm sits on the board of a second
Indirect interlocking directorate
* when two corporations have directors who serve on the board of a third firm
What is board independence
the degree to which a director is free from conflicts of interest that might compromise his or her ability to act solely in the interest of the firm
Is board independence always good?
- Large number of outsiders can create problems
- Limited contact with the firm’s day-to-day operations and incomplete information about managers
- results in ineffective assessments of managerial decisions and initiatives.
- emphasizes financial, as opposed to strategic, controls to gather performance information to evaluate performance of managers & business units, which could reduce R&D investments, increase diversification, and pursue higher compensation to offset their employment risk
- In fast-moving industries requiring significant R&D (e.g., IT), outside directors are found to have a negative impact on firm performance
is board independence always good? p2
- Boards not only monitor, but also advise the board. Tough monitoring is not always good.
- Survey evidence that CEO-director friendship ties improve communication.
- Evidence that director independence worsens performance in some firms.
- CEOs are fired too often for reasons outside their control.
does professional experience matter in being on a board?
Yes, relative to the industry,
- most need 10-20 years of business experience in a leadership role
Are CEO’s the best directors?
- More companies adopt guidelines prohibiting outside directorships
for their current CEOs.
Are active-CEO directors better than average director?
* Yes – 21%; No – 79%
Are retired-CEO directors better than active-CEO directors?
* Yes – 55%; No – 45%
Are retired-CEO directors better than average director?
* Yes – 47%; No – 54%
How many years before CEO experience is outdated?
* < 5 years – 26%
* 5-10 years – 20%
* >10 years – 16%
* Never - 38%
Pros and cons of a CEO Director
On the negative side
* 87% believe that active CEOs are too busy with their own companies to be effective
* Unable to serve on time-consuming committees or participate in meetings on short notice
*Active CEOs are too bossy, poor collaborators, and not good listeners
On the positive side
* Strategic and managerial expertise, current knowledge of business issues
* Experience dealing with crisis or failure
* Extensive personal and professional networks
* Can build trust with CEO, prioritize challenges
Retired vs. Active CEOs
Although retired CEOs might have similar strategic and leadership
experience as current CEOs without time demands of the current
CEOs, as we saw in the Lehman Brothers case, there might be a time
after which executive experience becomes so far outdated that it is
no longer relevant.
Are CEOs the best directors?
- Research finds no evidence that the appointment of an outside CEO positively contributes to future operating performance, decision making, or the monitoring of management by the board.
- At the same time, research suggests that the appointment of an active CEOs as directors might lead to increased CEO compensation.
Director qualifications
- International Experience
- Diversity (ethic and women)
- Bankers
- Politically connected – (Al Gore in Apple)
- No direct evidence of benefits
- Specialized expertise
-High tech
-Turnaround and restructuring
-Regulations and law - Employee representation
Professional Director pros and cons as a primary career
- Professional directors serve on boards as their primary career.
(+) Considerable experience; have witnessed multiple successes and
failures.
(+) More time to dedicate to boardroom responsibilities.
(+) Extensive personal and professional networks.
(-) Might be too “busy” if they serve on many boards concurrently.
(-) Might not be effective monitors if they view directorship as a form
of “active retirement.”
Can tainted CEOs be good firectors?
On the positive side
* The CEO may only know what he/she has been presented
* A good CEO learns why he missed the flaws and does not drop the ball twice
* As long as their integrity is not compromised, experience can be
valuable/add a new perspective
* Assuming the board member was not involved in the irregularities, he/sheshould have learned a valuable lesson
* Board members can be misled by the management and learning to be skeptical from such experience can make a better board member
On the negative side
* Ethical problems are not caused by a lack of knowledge, they are caused by character flaws (and character doesn’t change)
* Even if they learned valuable lessons the reputational risks are too high and their credibility is a problem
* As the CEO, he or she clearly must have had some lapse in leadership and oversight for there to be a substantial accounting or ethical issue in his/her tenure
* Tone at the top is a key driver of corporate culture, and the CEO is the most influential person in setting tone. Accounting and ethical issues are usually the result of problems with CEO performance
* At the end of the day it is the board that shareholders place trust in, and they must have and show understanding of the company’s accounts
* If it happens on their watch, you have to question how engaged they are in good governance
Is being a director worth it?
shareholders have become increasingly more demanding of directors and, as a result, directors have been working longer hours, taking more stock ownership in the firm to ensure a vested interest, challenging CEO more often, and taking their duties more seriously.
60% of nominated directors are turning down appointments.
* Nonetheless, directorships remain quite lucrative and prestigious.
What is director compensation?
- Compensation must be sufficient to attract, retain, and motivate
qualified directors. - Compensation covers time directly spent on board matters, cost to
keeping schedule flexible to address urgent issues, and financial and
reputational risk from corporate scandal or lawsuit. - Companies also pay fees for serving on committees.
Board evaluation topics (5)
- Evaluations can address a variety of topics, including:
– Composition
– Accountability
– Information
– Meetings
– Relations
Removal of Directors
- There are a variety of reasons why a director might leave a
corporate board.
– (+) Director wishes to retire.
– (+) Director reaches mandatory retirement age.
– (–) Director has irresolvable disagreement with other directors or management.
– (+) Company requires new skills and capabilities on the board.
– (+) Company wants to “refresh” the board.
– (–) Company feels director is negligent or performing below expectations. - Shareholders often do not know the real reason a director
leaves the board.
Process to remove a director
- The process for removing a director is complicated.
- The board does not have the power to remove a fellow board member. It must either:
– Encourage him/her to resign
– Wait to replace the director at the annual meeting. - Shareholders, too, have limited rights to remove directors.
– Pass special resolution, if they can demonstrate cause.
– Vote for removal, if election is by majority voting. - In fact, directors are rarely unwillingly removed from office.
Why might boards be ineffective
Time commitment
- spend more time than before
- even those hours are not productive
- they have other loyalties
CEOs pick directors
- Directors hold only token stakes in their companies
- Most directors receive more compensation as directors than gain as stockholders. Share ownership is increasing, but they receive shares from the firm (rather than buy them).
Directors lack the expertise (and the willingness) to ask the necessary
tough questions..
* Robert’s Rules of Order? In most boards, the CEO continues to be the chair. Not surprisingly, the CEO sets the agenda, chairs the meeting and controls the information provided to directors. ̈
* Be a team player? The search for consensus overwhelms any attempts at confrontation. ̈
* The CEO as authority figure: Studies of social psychology have noted that loyalty is hardwired into human behavior. While this loyalty is an important tool in building up organizations, it can also lead people to suppress internal ethical standards if they conflict with loyalty to an authority figure. In a board meeting, the CEO generally becomes the authority figure.
Access to pertinent information:
* There are two ways to keep the board in the dark: provide very little
information or overwhelm with irrelevant information
How do boards get in trouble?
- Poor business performance – hence the wrath of shareholders;
- Lack of Board leadership;
- Inadequate or inappropriate involvement in management;
- Entrenchment (high % of members remaining in the Board too long);
- Internal political or personal conflicts;
- Ineffective Board organization and process; and
- Conspiring in or tolerating legal violations.
Good board practices
- continually vigilant
- poor board does not = poor management
- good counselling
- Clearly defined roles and authorities
- Board is well structured
- Creation of a “lead director” role that has strong agenda-setting and
oversight powers - Appropriate work and mix of skills
- Balanced composition of executive and non-executive directors
- Non-executive directors should be of sufficient caliber
- Increased diversity in board members’ backgrounds.
- Appropriate Board procedures
- Sufficient notice for board meetings
- Freedom to include items on agenda
- Regular meetings and active participation
- Director compensation in line with best practice
six critical questions for directors
- Do I believe I have all the information?
- Have I the necessary skills to make this decision?
- Do I have any conflict in this matter?
- Objectively, is this a rational business decision?
- Can I explain this in a transparent manner?
- Is it a responsible discharge of my duties?
Trends in board governance
- Institutional investors active on boards
- Shareholder demands that directors and top management own
significant stock - Directors are increasingly compensated with stock and options in the company, instead of cash.
- There are fewer insiders on the board.
- More directors are identified and selected by a nominating committee rather than being chosen by the CEO of the firm.
- Boards have become smaller over time.
- Splitting the Chairman and CEO positions
- Increased representation of women and minorities
- Society expects boards to balance profitability with social needs of
society
do boards matter?
- Sudden deaths of some directors affect stock prices.
- Directors of firms that experience proxy contests find it difficult to
obtain additional board appointments. - In China, the hiring of directors with foreign experience improves
their firms’ performance.
BoD Continuum
Low
Phantom
- never knows what to do, no involvement
Rubber Stamp
- permits officers to make all decisions, votes on what they rec
Minimal Review
- formally reviews selected issues
Normal Participation
- involved to a limited degree in perf review/key decisions/mgmt programs
Active Participation
- approves/questions and makes final decisions on mission/strategy/policies/objectives, active board committees and audits
Catalyst
- takes the leading role in establishing and modifying the mission/obj/strat/policies, very active in strategy
