Chapter 13 Corporate Governance in the Twenty-First Century - PowerPoint PPT Presentation

Chapter 13Corporate Governance in the Twenty-First Century

1

• Explain what is meant by corporate governance

2

• Describe how corporate governance relates to competitive advantage and understand its basic principles and practices

3

• Identify the roles of owners and different types of ownership profiles in corporate governance

4

• Describe how boards of directors are structured and the roles they play in corporate governance

5

• Explain and design executive incentives as a corporate governance device

6

• Describe how the market for corporate control is related to corporate governance

7

• Compare and contrast corporate governance practices around the world

• Corporate Governance in Action:
• A new business term is coined –
• Pretexting: approaching a company under the pretext of being someone else.

Results

• Costs slashed
• Stock doubled in first month
• Market cap rises from $1.1billion to $5 billion

• Earlysuccess

• With R&D budgets cut, newproduct development hampered
• Growth fails to meet targets
• Company accused of “channel stuffing”

• Signsof problems

• Board fines Dunlap
• He looses his stock options
• Sunbeam stock is delisted

• Failure

• Al Dunlap’s mgmt. philosophy

• Shareholders are most important corporate constituents
• Most corporations have bloated bureaucracies
• Drastic layoffs are usually neededto save failing companies
• Layoffs should be quick,one-time events
• CEOs should be rewarded likestars when they perform welland fired when they do not
• Board members should have significant personal investmentsin the company

• “The last dirty secret in the corporate world is how directors live off the fat of a business that is not their employer. I started a revolution by insisting that Scott directors be paid only in stock.”
• - Al Dunlap

Corporate governance

• Share holders

• The system by which organizations, particularly business corporations, are directed and controlled by their owners

• Board

• Management

• Corporation

• Employees

• Society

• Environment

• In a broader perspective, governance determines how all stakeholders influence the corporation:

• The Italian stock exchange started a new exchange called STAR for small and mid-sized companies that followed strict governance prescriptions

• Companies of the STAR exchange consistently out perform their counterparts on the regular exchange (e.g., during 2004 STAR firms achieved returns 24.5% greater than their counter parts)

Agents

• Principals

• Shareholders of a firm

• Act on behalfof principalsin managingthe firm

• When interests are virtually identical, the agency problem is small: executives do what is in principals’ best interests
• However interests often do not overlap. Then agents may act to detriment of principals and visa-versa (e.g., executives raise salaries and reduce returns)

As many as possible

• Split recommended

• Not addressed

• No

• At least one-quarter

• Split required by law

• Not addressed

• No

• At least one-third

• Split recommended

• Not addressed

• Yes

• Majority

• Split recommended

• Periodic rotation of lead auditor

• Yes

• Substantial majority

• Separation is one of three acceptable alternatives

• Recommended3

• No

• What is the recommendation on director independence?

• Can the same executive be both CEO & chairperson?

• Is disclosure required if the company does not comply with the recommendations?

• Is auditor rotation required?

• Country

• Brazil CVM Code (2002)

• Russia CG Code (2002)

• Singapore CG Committee (2001)

• United Kingdom Cadbury Code1

• United States Conference Board and CalPers (2003)2

• In 2003, a Combined Code made further additions to the code, but these basic principles remain
• Just one of several codes in existence in the United States
• The Sarbanes-Oxley Act requires that the lead audit partner be rotated every 5 years; changing audit firm after 10 years of continual relationship or if former audit partner is employed by the company

CalPERS

known for their institutional activism

TIAA-CREF

Corporate Governance Team

• A

• turn over
• at once

• the entire
• Board does not

• are
• staggered so

• Board
• elections

• Nearly 2/3 of boards today are
• considered staggered.

Phantom

• Active

• Phantom boards have no involvement in the strategic management process of the firm.

• The public (and major stakeholders) have higher expectations for board involvement today.

Incentivealignment can solvesuch problems

• Conflicts of interest can arise

• Agents

• Principals

• Example:

• A company receives a buy-out offer
• Shareholders (principals) would benefit because price assures a good return on investment
• Management (agents) resists because they may lose their jobs

• Boards can include “golden parachute” provisions in manager’s compensation packages

• Dendrite’s challenge:

• Dendrite’s solution:

• How can Dendrite better align managementincentives with shareholders?

• 20 senior-most executives must own 15,000 to 100,000 shares of stock
• Must be common sharesnot options
• Must be achieved within 5 years
• Executives may elect to receive incentive compensation in stock instead of cash

• Largest 250 companies withstock ownership guidelines

• Number ofcompanies

• Percent ofcompanies

• Percent increase from 2001 to 2004

• Executives

• 142

• 57

• 58

• Directors

• 123

• 49

• 127

Source: Adapted from Fredrick W. Cook & Co., Inc., “Stock Ownership Policies: Prevalence and design of Executive and Director Ownership Policies Among the Top 250 Companies,” www.fecook.com/surveys.html (accessed Nov 29, 2005), Sep 2004

Oldest form of incentive pay. Board can evaluate executives’ performance along multiple dimensions and allocate a year-end cash award

• Annual bonus plans

• An employee receives the right to buy a set number of shares of company stock at a later date for a predetermined price

• Stock options

• More recent forms of incentive compensation. Long-term bonuses linked to performance over several years. May help executives avoid short-term myopia and focus on long-term

• Other long-termincentives

Source: Company annual reports and ExecComp Service of Thomson Financial

Source: U.S. Bureau of Labor Statistics

Share holders

• Elect

• Example:

• Example:

• Corporate raiders such as T. Boone Pickens, CarI Icahn, Ted Turner and Michael Milken
• Oracle engaged in 18-month battle to gain control of PeopleSoft

• Board

• Corporate control:

• Hires/fires

• The right to choose the members of the board of directorsof a company andto control all major decisions madeby a company

• Top management

• Directs

• Corporation

• Recent examples of scandal-ridden non-U.S. multinationals

• Netherlands Ahold Group (grocery stores)

• Italy’s Parmalat (dairy and food products)

• France’s Vivendi (entertainment)

• French-Belgian Firm ELF (petroleum)

• U.S

• Japan

• Owner-managerrelationship

• Adversarial

• Co-operative

• Manager andshareholderrelationship

• Through a Keiretsu (group of interlockingcompanies)

• Through onecompany

• Ownershipconcentration

• Control function

• Monitoring function