Business & Society Ethics, Sustainability & Stakeholder Management PDF

Business & Society Ethics, Sustainability & Stakeholder Management 10th Edition © 2018 Cengage 1  Chapter 4 Corporate Governance...

Business & Society Ethics, Sustainability & Stakeholder Management 10th Edition © 2018 Cengage 1  Chapter 4 Corporate Governance : Foundation al Issues © 2018 Cengage 2  Learning Outcomes (1 of 2) 1. Link the issue of legitimacy to corporate governance. 2. Discuss the problems that have led to the recent spate of corporate scandals and problems in corporate governance. 3. Discuss the principal ways in which companies can improve corporate governance. 4. Discuss the role of shareholders and the idea of strengthening shareholder voice. What are some of the mechanisms that enable this? © 2018 Cengage 3  Learning Outcomes (2 of 2) 6. Discuss the principal way in which shareholder activists exert pressure on corporate management to improve governance. 7. Discuss investor relations and the concept of shareholder engagement. 8. Compare and contrast the shareholder- primacy and the director-primacy models of corporate governance. What are their strengths and weaknesses? Which do you prefer and why? © 2018 Cengage 4  Chapter Outline Legitimacy and Corporate Governance Problems in Corporate Governance Improving Corporate Governance The Role of Shareholders The Role of the SEC Shareholder Activism Investor Relations and Shareholder Engagement An Alternative Model of Corporate Governance Summary © 2018 Cengage 5  Legitimacy and Corporate Governance Legitimacy - A condition that prevails when there is a congruence between an organization’s activities and society’s expectations. Legitimation - A dynamic process by which a business seeks to perpetuate its acceptance. © 2018 Cengage 6  Legitimacy Micro Level of Macro Level of Legitimacy Legitimacy Adapt operational Focus is on the methods to perceived corporate system, the societal expectations. totality of business enterprises. Attempt to change Business has a fragile societal expectations mandate, subject to or norms to conform to ratification. firm’s practices. Seek to enhance its Business exists solely legitimacy by because society has identifying itself with given others that have a it that right. powerful legitimate base in society. © 2018 Cengage 7 Corporate Governance - Refers to the method by which a firm is being governed, directed, administered, or controlled, and to the goals for which it is being governed. Is concerned with the relative roles, rights, and accountability of such stakeholder groups as owners, boards of directors, managers, employees, and other stakeholders. © 2018 Cengage 8  Roles of Four Major Groups - Shareholders - Own stock in the firm, giving them ultimate control (the shareholder-primacy model). Board of Directors - Govern and oversee management of the business. Managers - The individuals hired by the Board to manage the business on a daily basis. Employees - Hired to perform actual operational work. © 2018 Cengage 9 Separation of Ownership from Control © 2018 Cengage 10  The Corporation’s Hierarchy of Authority © 2018 Cengage 11  Problems in Corporate Governance The Need for Board Independence: Outside directors – are independent from the firm Inside directors – have some tie to the firm Board independence from management is crucial to good © 2018 Cengage 12 Issues Surrounding Compensation CEO Pay–Firm Performance Relationship Excessive CEO Pay Executive Retirement Plans & Exit Packages Outside Director Compensation Transparency; SEC Rules © 2018 Cengage 13  CEO Pay– Firm Performance Relationship Stock Options - Allows the recipient to purchase stock in the future at the price it is today. Backdating - Allows the recipient to purchase stock at yesterday’s price, resulting in immediate wealth increase. Spring-loading - Granting of a stock option at today’s price, but with the inside knowledge that stock’s value is improving. Bullet Dodging - Delaying of a stock option grant until right after bad news. © 2018 Cengage 14  Excessive CEO Pay Ratio of CEO pay to that of average worker - 1950, 20 to 1 2014, 216 to 1 Say on Pay Evolved from concerns over excessive executive compensation. Clawback provisions Compensation recovery mechanisms that enable a company to recoup CEO pay, typically in the event of a financial restatement or executive’s misbehavior. © 2018 Cengage 15  Executive Retirement Plans and Exit Packages Retirement packages – have come under scrutiny. $210 million to Robert Nardelli when he was ousted from Home Depot. $125 million to outgoing Bank of America CEO Ken Lewis. In contrast, many of today’s workers do not have a retirement plan. Those who do generally have a defined contribution plan, rather than a defined benefit plan. © 2018 Cengage 16  Outside Director Compensation - Paying board members is a recent idea. Today, outside board members are paid. From 2003-2015, their median pay rose about a third, from $175,800 to $258,000. © 2018 Cengage 17  Transparency - SEC Rules require disclosure of executive compensation. Such disclosures may have a moderating impact prior to implementation. © 2018 Cengage 18  Governance Impact of the Market for Corporate Control Mergers and acquisitions - Expectation is that the threat of a possible takeover will motivate top managers to pursue shareholder, rather than self-interest. But many corporate CEOs and boards go to great lengths to protect themselves from takeovers, using: poison pills (discourages a hostile takeover by making the firm difficult to take on) golden parachutes (firm agrees to pay key officers in the event of a change in control of the corporation) © 2018 Cengage 19  Insider Trading - The practice of buying or selling a security by someone who has access to material information that is not available to the public. “Material Information” is information that a reasonable investor might want to use, and is likely to affect the price of the firm’s stock. A “tipper” provides that information. A “tippee” receives the information. Executives and others who work for a firm may have inside information. Also those in relationships that include a duty of confidentiality may have inside information, including spouses, parents, children, friends. © 2018 Cengage 20  Improving Corporate Governance (1 of 2) Legislative Efforts: Sarbanes-Oxley Act of 2002 (SOX) - Amends securities laws to protect investors in public companies Enhances public disclosure to require reporting of off-balance sheet transactions, and personal loans to executives Limits the nonauditing services an auditor can provide to a firm it audits Makes it unlawful for accounting firms to provide services where conflicts of interest exist CEOs and CFOs must certify financials, and are held responsible for financial representations © 2018 Cengage 21  Improving Corporate Governance (2 of 2) Changes in boards of directors - More Board diversity A greater ratio of outside board members to inside board members Use of board committees to: Ensure that financials are not misleading Ensure that internal controls are adequate Follow-up allegations of irregularities Ratify the selection of an external auditor © 2018 Cengage 22  Red Flags Signaling Board Problems Ranking of Red Flags- 1. Company has to restate earnings. 2. Poor employee morale. 3. Adverse Sarbanes-Oxley 404 opinion 4. Poor customer satisfaction track record. 5. Management misses strategic performance goals. 6. Company is target of employee lawsuits. 7. Stock price declines. 8. Quarterly financial results miss analysts’ expectations. 9. Low corporate governance quotient rating. © 2018 Cengage 23  Steps to Take for Board Repair Steps to Take - 1. Spread risk oversight among multiple committees 2. Seek outside help in identifying potential risks 3. Deepen involvement in corporate strategy 4. Align board size and skill mix with strategy 5. Pick compensation committee members who will question the status quo 6. Use independent compensation consultants © 2018 Cengage 24 The Board’s Relationship with CEO Boards are responsible for monitoring CEO performance and dismissing poorly performing CEO Formerly, CEOs were protected; no more; firings of CEOs are up significantly If CEO also serves as Chairman of the Board, this duality can offer some protection Activists have moved to separate CEO and Board functions © 2018 Cengage 25  Board Member Liability - The Business Judgment Rule protects board members if: they act in good faith making informed decisions that reflect the company’s best interests, and not their own interests. Good Faith is central to the defense The argument in favor of the Business Judgment Rule is that board members © 2018 Cengage need to be free to 26  The Role of Shareholders The Shareholder Democracy Movement arises from the fact that although they are owners, shareholders may find that their votes are not counted. They seek: A Majority Vote The requirement that board members be elected by a majority of votes cast, rather than by a plurality. Banning Classified or Staggered Boards Electing members in staggered terms means that it might take 3 or more years to replace a board. Proxy Access© 2018 Cengage 27  The Role of the SEC - The SEC is responsible for protecting investor interests. Critics argue that the SEC is more focused on the needs of businesses than on that of investors. The SEC failed to stop the Bernard Madoff Ponzi scheme before investors lost billions, although they had been warned of the scheme a decade earlier. © 2018 Cengage 28 Shareholder Activism History of Shareholder activism Shareholder resolutions Shareholder lawsuits © 2018 Cengage 29  Investor Relations and Shareholder Engagement A majority - of corporate boards now communicate with their major investors Public corporations have obligations to current and potential shareholders, including Full disclosure (Transparency), and the duty to provide information that might affect investment decisions. Management is also responsible for communicating with shareholders. CEO Warren Buffett calls his annual shareholder meeting a “Woodstock © 2018 Cengage 30  An Alternative Model of Corporate Governance The Anglo-American model of corporate governance is one of shareholder primacy A emerging perspective is a director-primacy model of corporate governance A director-primacy model is based on the concept of a corporation that is not owned, but is an independent legal entity that owns itself. Boards are mediating hierarchs, responsible for balancing competing interests of stakeholders Boards©have a duty to shareholders, but 2018 Cengage 31  Key Terms (1 of 2) Accounting Reform Corporate and Investor responsibility Protection Act of committee 2002 Corporate Agency problems sustainability Anglo-American committee model Council of Audit committee Institutional Backdating Investors (CII) Board of directors Director-primacy Bullet-dodging model Business judgment Dodd-Frank Wall rule Street Reform and CEO duality Consumer Protection Charter Act Classified boards Employees Clawback provisions Fragile mandate Compensation Full disclosure committee Golden parachute Continental- Information © 2018 Cengage 32 European Model asymmetry  Key Terms (2 of 2) Majority vote Say on Pay Management movement Material information Separation of Nominating ownership from committee control Out-of-pocket Shareholder liability activism Outside directors Shareholder Pay-ratio disclosure democracy rule Shareholder-Director Personal liability Poison pill exchange Ponzi scheme Shareholder Private Securities engagement Litigation Reform Act Shareholder lawsuit of 1995 Shareholder Proxy access resolutions Regulation FD (fair Shareholders disclosure) Spring-loading Restricted stock © 2018 Cengage Stock options 33