Chapter 4 Flashcards
MONITOR MANAGEMENT PERFORMANCE AGAINST FINANCIAL AND NONFINANCIAL OBJECTIVES
T 1.1 For which 5 typical questions do Finance (or Audit) Committees tend to provide oversight (and make decisions, based on laws/bylaws)
- borrowing, including levels and composition, resulting leverage
- debt/equity issuance and redemption/repurchase
- cash management (sources and uses of cash)
- capital allocation
- financial aspects of significant transactions
T 1.2 According to various rules (e.g., NYSE, NASDAQ) there are financial literacy requirements for directors (particularly for the Audit Committee). How does the NACD define this term?
as the ability to “read a balance sheet, an income statement, and a cash flow statement, and . . . understand the use of financial ratios and other indices for evaluating company performance.”
T 1.3 Which key question does each of the 3 main financial statements answer?
● B/S: What do we have? (i.e., assets, liabilities, and equity—or, in the case of a nonprofit, assets, liabilities, and net assets)
● I/S: How are we doing? (i.e., sales, operating costs and expenses, operating earnings, and net earnings)
● CF: What can we spend? (i.e., cash flow from operations, investment, and financing)
T 1.4 What are the 5 key types of financial ratios plus one example for each type (w definition)?
- Profitability ratios, e.g., return on sales: (net income)/ sales
- Asset-management ratios, e.g., asset turnover:sales / (total assets)
- Liquidity ratios, e.g. current ratio: (current assets)/ (current liabilities)
- Debt mgmt. ratios, e.g., debt-to-assets ratio: (total debt)/ divided (total assets)
- Market value ratios, e.g., debt-to-equity: (total debt) /(total equity)
T 1.5 What is the definition of “insiders” under U.S. federal securities law (2 buckets plus a callout)?
An insider is any person who
1. owns 10 percent or more of the company’s stock, OR
2. who is a director or officer of the company
Note: under this definition, even independent directors are insiders!
T 2.1 In the NACD’s words, what are the sources of compliance and ethics (and what does that mean for how actions and behaviors are evaluated)?
- Compliance is based on known set of rules, laws, regulations, and/or policies applicable to a group of individuals or entities; evaluations result in a “yes/no”
- Ethics is based on (shared) values; evaluations are more judgmental, subjectives
T 2.2 In the US, what are 5 (legal) sources of the board’s ethics and compliance oversight duties?
- FCPA: “compliance begins with the board of directors”
- Caremark decision: “a director’s obligation includes a duty to attempt in good faith to assure that an adequate corporate compliance information and reporting system exists”
- SEC Section 406 Rule (pertaining to SOX): defines term code of ethics, requires companies to disclose whether it adopted a code for senior officers (if not, explain!)
- NYSE Listed Company Manual (303): whistleblower procedure requirement, directed at the audit committee
- US Sentencing Commission: 2 factors that mitigate punishment are 1) existence of an effective E&C program and 2) self-reporting, cooperation, or acceptance of responsibility
T 2.3 What is the definition of the term code of ethics according to SOX rule 406?
SOX Section 406, defines the term “code of ethics” as “written standards that are reasonably
designed to deter wrongdoing and to promote …”[6 specific types of behavior/ outcomes]
T 2.4 According to SOX Section 406, which 5 specific types of behavior/ outcomes are codes of ethics meant to promote?
- Honest and ethical conduct, including the ethical handling of conflicts of interest
- Full, fair, accurate, timely, and understandable disclosures (to SEC, public)
- Compliance with applicable governmental laws, rules and regulations
- Prompt internal reporting of violations of the code
- Accountability for adherence to the code
T 2.5 According to the NACD, a good code of ethics should contain which 6 elements?
- the organization’s mission and values
- a framework for ethical decision making
- how to handle conflicts of interest
- resources for reporting misconduct
- mechanisms to reinforce accountability
- examples of appropriate and inappropriate behavior
T 2.6 What are 11 forms of director misconduct?
● leaking or otherwise disclosing, without authorization, confidential information
● acting or speaking on behalf of the board or the company without authorization
● entering into a business that competes directly with the company
● acting on and failing to disclose a conflict of interest
● accepting other board seats in disregard of board limits
● trading in the company’s securities without notification or approval
● taking any action that is a breach of fiduciary duty
● violating the law
● failing to abide by the terms of company and board policies
including the company’s code of conduct and ethics
● engaging in disruptive or inappropriate behavior in the boardroom or in with mgmt./employees
● unduly interfering in operations
T 2.7 Overseeing the company’s ethics and compliance program - what are 5 key aspects
- Code of ethics: ensure the company has one
- Boardroom ethics: directors should hold themselves to the highest standards
- Assessing effectiveness of the E&C program
- Establishing clear reporting expectations for mgmt.
- Establish a Compliance Committee (or give this responsibility to the audit committee
T 2.8 Overseeing the company’s ethics and compliance program - what are 3 challenges?
- Responding to emerging issues (example - MeToo):
- Establishing the tone at the top: mgmt. must make sure that the organization’s values and E&C is a top priority
- Designing incentives for mgmt.: make sure incentives don’t accidentally promote bad behavior!
T 2.9 Overseeing the ethics and compliance program - what are 4 recommendations?
- Define the role of the board and its committees in the governance guidelines and committee charters.
- Create written E&C policies such as a code of ethics. Make sure they are written well (plain English, good examples) and communicate and update frequently!
- Incentives: include metrics related to achieving E&C goals and scrub for bad incentives (e.g., re risk, reputation)
- Establish protocols for reporting important E&C-related issues up and make sure that all employees are held to the same standards and disciplinary measures
T 3.1 ESG focus area environment - what are typical considerations? [4 buckets]
- Climate Change
- Resource mgmt and sourcing, e.g., re: energy, water, natural resources
- Waste Management/emissions
- Other aspects of natural resource mgmt,, e.g. biodiversity
T 3.2 ESG focus area social - what are typical considerations? [3 buckets]
- Workforce-related: equal opportunities, health and safety, human capital mgmt.,
- Externally focused:human rights, supply chain mgmt., anti-corruption
- Other: freedom of association
T 3.3 ESG focus area governance - what are typical considerations? [3 buckets]
- Core E&C: Business Ethics, Compliance
- Core corporate governance: Board Structure, Shareholder Rights, Shareholder Structure
- Other: Compensation, Data Privacy
T 3.4 What is a definition of corporate sustainability (based on the Dow Jones World Sustainability Index)?
“Corporate sustainability is a business approach that creates long-term shareholder value by embracing opportunities and managing risks deriving from economic, environmental, and social developments.”
T 3.5 While there are few legal reporting requirements for companies re: ESG, what are 4 emerging reporting standards?
- Global Reporting Initiative (GRI)
- Task Force on Climate-related Financial Disclosure (TFCD)
- International Integrated Reporting Council (IIRC)
- Sustainability Accounting Standards Board (SASB)
T 3.6 ESG reporting/ disclosures - what are proxy advisers Glass Lewis and ISS doing?
- Glass Lewis has integrated SASB guidelines into its proxy voting report and has a partnership with Sustainalytics
- Institutional Shareholder Services (ISS) has its own rating system, the E&S Disclosure Quality Score
T 3.7 How can the term “human capital management” be defined?
“broad range of corporate practices related to the management of employees, including,hiring and retention, employee engagement, training, compensation, fair labor practices, health and safety, responsible contracting, ethics, desired company culture, and diversity, both with respect to a company’s employees and vendors throughout the company’s supply chain”
T 3.8 Human capital - what are relevant SEC disclosure rules (as of August 2020)?
Companies must Include, as a disclosure topic, a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business. This includes disclosure of the number of employees
T 3.9 What are 5 NACD-suggested 5 ideas to incorporate ESG oversight into the boardroom?
- Frame sustainability in the context of the company’s strategy
- Ensure E&S priorities are a regular discussion item in board meetings, either at the full-board or committee level, and that there is an agreed-on escalation mechanism for material ESG matters
- Clarify roles for oversight responsibility of sustainability activities (board, committees)
- Align the board and management on the ESG message and information the company chooses to report publicly
- Engage shareholders on ESG issues
T 4.1 What are 2 factors that have made shareholder engagement (including w institutional investors) more important for the boards of public companies over the last few years (and decades) and how has that played out?
- In 1988, the Department of Labor declared that the same fiduciary duties that apply to managing pension plan assets also apply to how proxies are voted
- The SEC is requiring mutual fund managers to disclose their proxy voting policies and how they voted their shares
- Therefore, institutional investors have become more active as they must have rationales for how they vote
- As result, board engagement (and proxy advisors) have become more important
