Corporate Governance
Best Practices:
Implications for Commercial Underwriters
Dr. Gail S. Russ
Dr. Meredith Downes
Associate Professors of Management
Illinois State University
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Corporate Governance
• Core concern: How do we make sure that
top managers are doing what they’re
supposed to be doing?
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The Agency Perspective
• Separation of ownership & control


Principals & agents
Misalignment of interests
• What’s good for the managers may not be what is
good for the owners
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The Agency Perspective
• The Agency Problem:

The misalignment of agents & principals’
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).
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The Agency Perspective
• The Agency Problem:


The misalignment of agents & principals’
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).
Focus is on protecting shareholder rights
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The Stakeholder Perspective
• The board has broader responsibilities

Focus is on protecting key stakeholder rights
•
•
•
•
•
Shareholders
Employees
Vendors
Customers
Society as a whole
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Best Practices
• The board of directors
• Executive compensation
• Anti-takeover measures
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The Board of Directors
• Role is to monitor & evaluate top
management
• But, is the board a complete solution?
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Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board

Role duality gives CEO too much power
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Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board

Role duality gives CEO too much power
• Appointment of lead outside director
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Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board

Role duality gives CEO too much power
• Appointment of lead outside director
• Former CEO does not continue to sit on the
board
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Best Practices:
Board of Directors
• Active board members

Not a rubber-stamp board
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Best Practices:
Board of Directors
• Active board members

Not a rubber-stamp board
• Evidence that the directors are in contact
with employees, vendors, & customers
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Best Practices:
Board of Directors
• Active board members

Not a rubber-stamp board
• Evidence that the directors are in contact with
employees, vendors, & customers
• Board composition




Size
Age
Diversity
Expertise
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Best Practices:
Board of Directors
• Board composition

Insiders versus outsiders
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Best Practices:
Board of Directors
• Board composition


Insiders versus outsiders
“Having a board monitor itself is like having
the fox watch the henhouse.”
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Best Practices:
Board of Directors
• Board composition



Insiders versus outsiders
“Having a board monitor itself is like having
the fox watch the henhouse.”
The majority should be independent
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Best Practices:
Board of Directors
• Board composition




Insiders versus outsiders
“Having a board monitor itself is like having
the fox watch the henhouse.”
The majority should be independent
Should have formal resolution requiring this
AND a written definition of independence
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Best Practices:
Board of Directors
• Board composition

What is meant by “independent”?
• No material relationship with the company, either
directly or as a partner, shareholder or officer of a
firm that has a relationship with the company
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Best Practices:
Board of Directors
• Board composition

What is meant by “independent”?
• Five year “cooling off” period before can be
considered independent:
– Former employees of the firm
– If formerly part of an interlocking directorate in which an
executive of the firm sat on the compensation committee
of the firm employing the director
– Same applies to directors with immediate family members
in the above categories
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Best Practices:
Board of Directors
• Board members (insiders & outsiders)

Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position
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Best Practices:
Board of Directors
• Board members (insiders & outsiders)

Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position

CEOs should not serve on each other’s boards
(interlocking directorates)
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Best Practices:
Board of Directors
• Board members (insiders & outsiders)

Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position


CEOs should not serve on each other’s boards
(interlocking directorates)
Directors & their firms barred from doing
consulting, legal, or other work for the firm
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Best Practices:
Board of Directors
• Board members (insiders & outsiders)

Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position



CEOs should not serve on each other’s boards
(interlocking directorates)
Directors & their firms barred from doing
consulting, legal, or other work for the firm
Significant stock ownership of firm by directors
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Best Practices:
Board of Directors
• Board committees

Key committees at least chaired by outsiders
• Audit, compensation, corporate governance
(nominating) committees
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Best Practices:
Board of Directors
• Board committees

Key committees at least chaired by outsiders
• Audit, compensation, corporate governance
(nominating) committees

Preferred: Key committees composed entirely
of independent directors
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Best Practices:
Board of Directors
• Board committees

Compensation committee
• Conduct formal evaluation of all company officers
(including CEO) and set compensation
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Best Practices:
Board of Directors
• Board committees

Corporate governance (nominating) committee
• Create charter for board
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Best Practices:
Board of Directors
• Board committees

Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
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Best Practices:
Board of Directors
• Board committees

Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members
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Best Practices:
Board of Directors
• Board committees

Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members
• Board term limits
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Best Practices:
Board of Directors
• Board committees

Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members
• Board term limits
• Elections
– One class of directors
– Each director stands for re-election each year
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Best Practices:
Board of Directors
• Board committees

Audit committee
• Select independent auditor
– Not also employed for consulting work
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Best Practices:
Board of Directors
• Board committees

Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so
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Best Practices:
Board of Directors
• Board committees

Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so
• Rotate auditors – at least rotate the lead auditor, if
not the entire firm, every 5 years
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Best Practices:
Board of Directors
• Board committees

Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so
• Rotate auditors – at least rotate the lead auditor, if
not the entire firm, every 5 years
• CEO & CFO should not be former employees of the
auditing firm
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Best Practices:
Board of Directors
• Board meetings

Frequency of overall board & committee
meetings
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Best Practices:
Board of Directors
• Board meetings


Frequency of overall board & committee
meetings
Attendance
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Best Practices:
Board of Directors
• Board meetings



Frequency of overall board & committee
meetings
Attendance
“Executive” sessions
• Lead outside director with term limit
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Best Practices:
Board of Directors
• Board meetings



Frequency of overall board & committee
meetings
Attendance
“Executive” sessions
• Lead outside director with term limits

Risk assessment function
• Reports identifying risks & methods of addressing
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Best Practices:
Board of Directors
• Board meetings



Frequency of overall board & committee
meetings
Attendance
“Executive” sessions
• Lead outside director with term limits

Risk assessment function
• Reports identifying risks & methods of addressing

Access to internal information
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Best Practices:
Executive Compensation
• CEO has substantial stock ownership
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Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance

not size of the company
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Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance

not size of the company
• AND penalize poor performance
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Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance

not size of the company
• AND penalize poor performance
• No modification of performance goals

No re-pricing or swapping stock options
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Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance

not size of the company
• AND penalize poor performance
• No modification of performance goals

No re-pricing or swapping stock options
• Expense stock options
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Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover

Golden parachutes
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Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover


Golden parachutes
Poison pill provisions
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Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover



Golden parachutes
Poison pill provisions
Greenmail
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