Chapter 18
Corporate
Governance
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Mark Hurd
o Mark Hurd arrived as the chief executive officer at
Hewlett-Packard in 2005
o Hurd got along with the board and got results
o On June 29, 2010, Hurd opened a letter from
celebrity lawyer Gloria Allred
o It accused him of sexually harassing an HP marketing
contractor named Jodi Fisher by touching her body
suggestively and speaking of intimate personal matters
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Mark Hurd
o Hurd first interviewed Fisher in Los Angeles
o Hurd suggested to the board that HP pay to settle the
allegations
o The board hired a law firm to investigate Hurd’s
actions
o Early in August, Hurd reached an undisclosed
financial settlement with Fisher that prohibited her
from discussing the allegations
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Backdating with Dr. McGuire
o SEC regulators told the company they were
investigating the matter, but Dr. McGuire seemed
untroubled
o Dr. McGuire denied that grant dates were picked with
the benefit of hindsight
o Investigators concluded the grants were “likely
backdated”
o Dr. McGuire was forced to resign, pay a $7 million
fine, and disgorged of wrongful gains
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What is Corporate Governance?
o Corporate governance: The exercise of authority
over the members of a corporate community based on
formal structures, rules, and processes
o The authority is based on a body of rules defining the
rights and duties of shareholders, boards of directors,
and managers
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Figure 18.2 - The Power Triangle
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The Corporate Charter
o Corporate charter: A document issued by a state
government to create a corporation
o Corporate charters specify the purpose of the
corporation and basic rights and duties of
stockholders, directors, and officers
o Fiduciary responsibility: The legal duty of a
representative to manage property in the interest of
the owner
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The Corporate Charter
o Charters include provisions about numbers of shares
and classes of stock authorized, dividends, annual
shareholder meetings, the size of boards, and
procedures for removing directors
o Bylaws: Rules of corporate governance adopted by
corporations
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The Corporate Charter
o States compete to attract the incorporation fees and
tax revenues of corporations
o For more than a century tiny Delaware has been the
victor in this competition
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Figure 18.3 - Flow of Authority in
Corporate Governance
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Federal Regulation of Governance
o Corporate governance laws have been primarily the
province of states, however, the Supreme Court has
said that the Constitution empowers Congress to
regulate corporations if it chooses
o Federal intervention generally comes in reaction to
conspicuous failures of governance and imposes
mandatory rules and restrictions
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Enron Corp.
o Enron enjoyed admiration and respect among
investors, managers of other companies, and the
public
o Government regulators uncovered multiple instances
of :
o Juggling accounting records to inflate sales and profits
o Hiding debt, concealing excessive CEO perks and
compensation in vague footnotes
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Enron Corp.
o Ignoring standard accounting and financial practices
o Shredding documents to destroy incriminating records
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Enron Corp.
o The board’s Special Investigative Committee did not
place sole blame for Enron’s failure on its directors,
but it accused the board of failing to exercise it
oversight responsibility
o A fundamental cause of the catastrophe was the
culture of the company
o In 2006 a federal jury found Chairman of the Board
Lay and CEO Skilling guilty of conspiracy and fraud
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The Sarbanes-Oxley Act
o It holds management responsible for accurate
financial reports and strengthens the power and
responsibility of board audit committees
o A few of the act’s provisions are:
o Creates a five-member oversight board that has
authority over practices of accounting firms
o Prescribes rules to improve auditing
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The Sarbanes-Oxley Act
o Requires the CEO and CFO to sign and certify the
accuracy of annual and quarterly financial statements
o Establishes heavy criminal penalties for violating its
provisions
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Lehman Brothers
o Lehman Brothers Holdings began in 1850 as a cotton
broker and grew into the nation’s fourth-largest
investment bank
o Since 1994 it had been run by a CEO named Richard
S. Fuld, Jr. Intense, intimidating, and impatient
o In 2006, Fuld decided that the way to keep share
prices rising was to make Lehman grow faster
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Lehman Brothers
o To fund its operations, Lehman depended on
borrowing tens of billions of dollars each day in
financial markets
o Lehman’s bankruptcy caused panic in the markets
o During the year preceding bankruptcy the board met
eight times and its members earned between
$325,038 and $397,538
o Lehman’s management made serious errors of
judgment
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The Dodd-Frank Act
o A statute to reform financial regulation and prevent a
recurrence of the 2007–2008 financial crisis
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Boards of Directors
o Directors in large corporations are chosen after being
nominated by the board and approved by a majority
vote of shareholders
o Directors who are employees of the company are
called inside directors; those who are not employed
by the company are outside directors
o Boards are divided into committees
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Duties of Directors
o Laws impose two lofty duties on directors:
o Represent the interests of stockholders
o Exercise due diligence in supervising management
o Directors do not make day-to-day decisions
o Boards exercise a very broad oversight
o Compensation varies substantially among industries
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Duties of Directors
o Some specific board functions:
o Approve the issuance of securities and the voting
rights of their holders
o Review and approve the corporation’s goals and
strategies
o Select the CEO, evaluate his or her performance, and
remove that person if necessary
o Give advice and counsel to management
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Duties of Directors
o Create governance policies for the firm, including
compensation policies
o Evaluate the performance of individual directors,
board committees, and the board as a whole
o Nominate candidates for election as directors
o Exercise oversight of ethics and compliance programs
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Board Composition
o The average board has 11 members and this has not
changed for many years
o Most state incorporation laws require a minimum of
three, but companies typically have between 7 and 15
o Directors are elected by shareholders, usually for
terms of one year
o Inside directors
o Outside directors
o Independent directors
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Board Dynamics
o The average board meets eight times a year, although
many meet monthly
o Agendas include committee reports, mandatory
governance matters, and presentations by company
executives
o The chairman of the board presides over meetings
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Board Dynamics
o Advocates of greater board independence believe that
a better solution for strengthening the board is to split
the roles of chairman and CEO
o Management opposes separation
o One fear is compromising clarity in the chain of
command
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Executive Compensation
o A compensation committee of the board of directors
sets the pay and benefits of top executives
o Elements of compensation include a combination of
the following
o Base salary
o Annual cash incentives
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Executive Compensation
o Long-term stock-based incentives
o Stock options
o Performance shares
o Restricted stock
o Retirement plans
o Perquisites
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Problems with CEO Compensation
o The size of extraordinary payouts
o The compensation packages given to some newly
hired CEOs
o The golden handshakes received by some CEOs
when they leave under fire
o An alleged bias in favor of boosting CEO
compensation due to the composition of the
compensation committees
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Problems with CEO Compensation
o Nonconformance with the interests of shareholders
o The number and misuse of stock option grants
o The spread between executive pay and that of the
average worker
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Concluding Observations
o Despite well-defined legal bonds between share
owners, boards of directors, and management, there
are many tensions between them
o Scandals revealed lax oversight of financial strategies
and reporting by many boards
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Concluding Observations
o Many shareholders believe that boards have allowed
management compensation to exceed reason
o The outlook is for more pressures and regulations that
tighten board oversight
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