Corporate Governance Flashcards
Outside Directors
Directors who have no involvement with the entity other than in their capacity as a director
Inside Director
Has some significant involvement in the entity, often as a member of management, in addition to being a director
Disadvantages of Bonus Incentives
Often easy to manipulate profits in the short run by deferring or accelerating expenses or revenues through capitalization and depreciation policies as well as various other means.
Role of Corporate Governance
To make certain that the objectives of the entity are met while the legitimate needs and concerns of all stakeholders are being addressed
Cadbury Report
Suggested a voluntary code for corporate governance which all companies listed on the London Stock Exchange are required to comply with or explain:
(1) Extent to which they don’t comply
(2) Areas where they don’t comply
(3) Reasons for any noncompliance
Principles of Cadbury Report
(1) Clear division of responsibility at the top - primarily position of chairman of the board separated from CEO
(2) Majority of board members should be outside directors
(3) Remuneration of board members should be determined by non-executive directors
(4) Board should select an audit committee that includes at least 3 non-executive directors
OECD
Organization for Economic Co-operation and Development
OECD Principles of Corporate Governance 6 Key Areas
(1) Effective corporate governance framework
(2) Shareholder rights and ownership functions
(3) Stakeholders role in corporate governance
(4) Disclosure and transparency
(5) Board responsibilities
(6) Equitable treatment of shareholders
What do Articles of Incorporation Become when Approved
Corporate Charter
Where are Articles of Corporation Filed
With secretary of state
What’s Included in Corporate Charter
(1) Name of company
(2) Address at the time of filing
(3) Company’s purpose
(4) Name of the registered agent of the corporation
(5) Name and address of each incorporater
(6) Number of authorized shares of stock and types of stock
What Are Bylaws
Internal rules of corporation
Information Included in Bylaws
(1) Minimum and maximum number of directors
(2) How directors are to be selected and compensated
(3) How often directors are to meet
(4) Nature of directors responsibilities
BOD Fiduciary Duties
(1) Act loyally and in the best interest of the corporation and shareholders - including not putting their interest above company’s and acting without personal economic conflict
(2) Act with duty of care and be diligent when making company decisions
(3) Act with due diligence
Typical BOD Duties
(1) Determining or revising the entity’s mission and bylaws
(2) Strategic planning and the development of broad objectives
(3) Selection and oversight of CEO
(4) Securing availability of financial resources
(5) Budget approval and approval of major operating and financial proposals
(6) Accounting to stakeholders including making certain reliable financial information is reported by the entity
(7) Providing advice to management and determining it’s compensation
(8) Establishing dividend policies
(9) Reacquiring treasury stock
Who Established Requirements Related to BOD of Listed Companys
NYSE and NASDAQ
Requirements for BOD of Listed Companies
(1) Majority of directors are required to be independent and information regarding independence must be provided to investors
(2) Non-management directors required to meet on a regularly scheduled basis
(3) Directors must adopt and publish a code of conduct applicable to all parties within the entitiy
(4) Must maintain an independent committee
(5) Entity must identify relationships that automatically indicate a director isn’t independent
A Board Director isn’t Independent if:
(1) They were recently an employee or affiliate of the entity, former partner or employee of the external auditor, or if a family member was recently an officer of the entity (5 years for NYSE, 3 years for NASDAQ)
(2) Director or a family member received more than $120k from the corporation, excluding director fees, for any 12 month period within the last 3 years
(3) Director is an executive of another entity that receives significant amounts of revenue from the entity
Committees Public Companies are Required to Maintain
(1) Nominating committee
(2) Audit committee
(3) Compensation committee
Nominating Committee
Responsible for overall corporate governance of an organization
Primary Duty of Nominating Committee
Determine who is suitable for service on BOD
Other Responsibilities of Nominating Committee
(1) Charged with developing and suggesting governance principles and policies to the board
(2) Oversee CEO succession
(3) Enhancing quality of nominees to the board
(4) Making certain of integrity of nominee process
Required Characteristics of Those Serving on Audit Committee
Made up of independent directors and at least one “financial expert” per SOX title IV
Audit Committee Responsibilities
(1) Overseeing financial reporting process
(2) Make certain that information useful to stakeholders available on a timely basis
(3) Responsible for appointment, compensation, and oversight of entity’s auditors
(4) Auditors report directly to audit committee
(5) Internal control responsibilities
SOX Section 404 Title IV
Audit Committee must
(1) Oversee establishment of appropriate control, including programs for the prevention and detection of fraud
(2) Responsible for maintaining code of ethics for officers and making it publicly available
(3) Required to establish procedures for dealing with complaints about accounting, internal control, or audit matter
(4) Facilitate a process for employees to anonymously and confidentially express concerns about accounting related matters
Financial Expert Definition
Individual Who Has:
(1) An understanding of GAAP and financial statements
(2) Experience preparing or auditing comparable financial statements and experience in applying financial statement or audit knowledge to the accounting for estimates, accruals, and reserves
(3) Experience with internal accounting controls
(4) An understanding of the function of the audit committee
* Need not be a CPA
Compensation Committee
Made up of independent directors; responsible for establishing compensation policies for directors and executives of the corporation
Charged with assuring policies are both appropriate and supportable as well as consistent with mission and objectives of entity
Compensation Committee Responsibilities as Required by NYSE, NASDAQ, and SEC
(1) Developing a compensation approach or philosophy
(2) Establishing compensation for CEO and other executive officers
(3) Use outside expertise as appropriate
(4) Receive and evaluate proposals regarding executive compensation put forth by shareholders
Say-on-Pay
Stockholders required to be allowed to decide by vote whether:
(1) They approve of the compensation of executive officers
(2) The vote on compensation should occur every 1, 2, or 3, years
(3) In the even of a merger they approve any compensation related to a “Golden Parachute”
Wall Street Reform and Consumer Act
Dodd-Frank
SOX Section 906
CEO and CFO must certify that reports filed with the SEC comply with relevant security laws and present fairly the financial conditions and results of operations of company. If found criminally liable for certifying false and defective financial statements could be imprisoned for 10-20 years and fined $1-5 million
Executive Oversight
One of the most significant responsibilities of the BOD - oversight of management. Accomplished through management compensation policies and monitoring of management
Goal of Management Compensation Policies
Find balance between different forms of compensation that may motivate management to strive to perform at the utmost level or may cause management to find ways to maximize their own compensation at the detriment of or without considering benefit to the entity
If Compensation Package Includes too High Proportion of Fixed Compensation and too Low Proportion Incentive Compensation
Management won’t have incentives to take risks that may be appropriate and necessary for achievement of entity’s objectives
If Compensation Package Includes too High Proportion of Incentive Compensation and too Low Proportion Fixed Compensation
Management may take risks that are inconsistent with entity’s risk appetite
Fixed Compensation
Consists of salary and perks
Bonuses
Compensation generally based on some version of accounting profit
Types of Share Based Compensations
(1) Stock options
(2) Shared appreciation rights
(3) Restricted shares
(4) Performance shares
Stock Options
Give ability to buy shares at a fixed price for a specific period of time
Disadvantages of Stock Option Compensation
(1) May cause management to focus too heavily on short term stock price rather than long term objectives
(2) Decline in stock price may make it appear that the option won’t pay off negating incentive
Shared Appreciation Rights
Operate similarly to stock options with same advantages and disadvantages but also provides cash payments resulting from increases in stock rather than opportunity to buy shares at potential bargain
Restricted Shares
Shares of stock that may not be disposed of for a specific period of time
Advantages of Restricted Shares Compensation
Don’t have to pay for shares and gives management incentive to increase stock price at least during period of restriction
Performance Shares
Issued to management if specific objectives are met
Chief Auditing Executive
Responsible for internal audit function within the entity and report to audit committee
Components of Internal Auditors International Professional Practices Framework (IPPF)
(1) Definition of internal auditing
(2) Code of ethics
(3) Attribute and Performance standards
IPPF Code of Ethics Principles
(1) Integrity
(2) Objectivity
(3) Confidentiality
(4) Competence
IPPF Attribute Standards
(1) Purpose, authority, and responsibility
(2) Independence and objectivity
(3) Proficiency and due professional care
(4) Quality assurance and improvement program
IPPF Performance Standards
(1) Managing internal audit activity
(2) Nature of work
(3) Engagement planning
(4) Performing the engagement
(5) Communicating Results
(6) Monitoring progress
(7) Communicating the acceptance of risks
Fiduciary
One who holds a position of trust with respect to another party or it’s property. It’s the fiduciary’s duty to act selflessly for the benefit of another, with undivided loyalty, obedience, and diligence - with due care and in good faith
SOX Section 302
Requires that CEOs and CFOs certify accuracy of the financial statements and reliability of internal control prior to statements being signed.
Audit Committee of BOD Oversees
(1) Financial reporting
(2) Financial disclosure
(3) Compliance with standards
