Chapter 13 Corporate Governance in the Twenty-First Century
Dec 21, 2015
Chapter 13Corporate Governance in the Twenty-First Century
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OBJECTIVES
Explain what is meant by corporate governance1
Describe how corporate governance relates to competitive advantage and understand its basic principles and practices
2
Identify the roles of owners and different types of ownership profiles in corporate governance
3
Describe how boards of directors are structured and the roles they play in corporate governance
4
Explain and design executive incentives as a corporate governance device
5
Describe how the market for corporate control is related to corporate governance
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Compare and contrast corporate governance practices around the world
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SUNBEAM
Al Dunlap’s mgmt. philosophy
1. Shareholders are most important corporate constituents
2. Most corporations have bloated bureaucracies
3. Drastic layoffs are usually neededto save failing companies
4. Layoffs should be quick,one-time events
5. CEOs should be rewarded likestars when they perform welland fired when they do not
6. Board members should have significant personal investmentsin the company
Results
• Board fines Dunlap• He looses his stock options• Sunbeam stock is delisted
• With R&D budgets cut, newproduct development hampered
• Growth fails to meet targets• Company accused of “channel
stuffing”
• Costs slashed • Stock doubled in first month• Market cap rises from $1.1
billion to $5 billion
Earlysuccess
Failure
Signsof problems
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CORPORATE GOVERNANCE
Corporate governance
The system by which organizations, particularly business corporations, are directed and controlled by their owners
In a broader perspective, governance determines how all stakeholders influence the corporation:
Board
Employees
Share holders
Corporation
Environment
Management
Society
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CORPORATE GOVERNANCE IMPACTS PERFORMANCE
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)
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EARLY WARNING SIGNS OF PROBLEMS WITH KRISPY KREME
Source: M. Maremont and R. Brooks, “Fresh Woes Batter Krispy Kreme; Doughnut Firm to Restate Results, Delay SEC Filing; Shares Take a 15% Tumble,” Wall Street Journal (Eastern edition), January 5,2005.p.A3
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AGENTS AND PRINCIPALS
• 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)
Agents Principals
Shareholders of a firm
Act on behalfof principalsin managingthe firm
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EXAMPLES OF CODES OF GOVERNANCE
Country
United Kingdom Cadbury Code1
Singapore CG Committee (2001)
Russia CG Code (2002)
Brazil CVM Code (2002)
United States Conference Board and CalPers (2003)2
Can the same executive be both CEO & chairperson?
Split recommended
Split recommended
Split required by law
Split recommended
Separation is one of three acceptable alternatives
Is auditor rotation required?
Periodic rotation of lead auditor
Not addressed
Not addressed
Not addressed
Recommended3
Is disclosure required if the company does not comply with the recommendations?
Yes
Yes
No
No
No
What is the recommendation on director independence?
Majority
At least one-third
At least one-quarter
As many as possible
Substantial majority
1. In 2003, a Combined Code made further additions to the code, but these basic principles remain2. Just one of several codes in existence in the United States3. 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
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SOME NEW COMPLIANCE RULES FROM SARBANES-OXLEY
• Auditors must list the non-audit services they are unable to perform during an audit
• A one-year waiting period for audit-firm employees who leave an accounting firm to become an executive for a former client
• Transactions and relationships that are off the balance sheet but that may affect financial status must now be disclosed
• Personal loans from a corporation to its executives are now largely prohibited
• Research analysts for securities firms must now file conflict of interest disclosures. For instance, analysts must report whether they hold any securities in a company or have received corporate compensation
• Brokers and dealers must disclose if the public company is a client
• Altering, destroying, concealing, or falsifying records or documents with the intent to influence a federal investigation or bankruptcy case is subject to fines and up to 20 years of imprisonment
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OWNERSHIP STRUCTURE VARIES
Source: Company annual reports
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ROLES AND ACTIONS OF BOARD OF DIRECTORS
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EFFECTS OF CEO FIRINGS
Source: M.wiersema, “Holes at the Top: Why CEO Firings Backfire,” Harvard Business Review 80;12 (2002), 70-77
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INCENTIVE ALIGNMENT
Conflicts of interest can arise
Agents Principals
Incentivealignment can solve
such problems
• 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
Example:
Boards can include “golden parachute” provisions in manager’s compensation packages
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HOW WOULD YOU DO THAT? – DENDRITE INTERNATIONAL
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
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EXECUTIVE STOCK OWNERSHIP IN 2004
Largest 250 companies withstock ownership guidelines
Executives
Directors
Number ofcompanies
142
123
Percent ofcompanies
57
49
Percent increase from 2001 to 2004
58
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
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INCENTIVE COMPENSATION
Annual bonus plans
Oldest form of incentive pay. Board can evaluate executives’ performance along multiple dimensions and allocate a year-end cash award
Stock optionsAn employee receives the right to buy a set number of shares of company stock at a later date for a predetermined price
Other long-termincentives
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
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CEO PAY COMPARISON
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HIGHEST PAID CEOs
Source: Company annual reports and ExecComp Service of Thomson Financial
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EXECUTIVE PAY TRENDS
Source: U.S. Bureau of Labor Statistics
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THE MARKET FOR CORPORATE CONTROL
Share holders
Board
Top management
Corporation
Directs
Hires/fires
Elect
The right to choose the members of the board of directorsof a company andto control all major decisions madeby a company
Corporate control: 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
Example:
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POOR CORPORATE GOVERNANCE, A WORLD-WIDE PROBLEM
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)
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CORPORATE GOVERNANCE: U.S VS. JAPAN
Owner-managerrelationship
Manager andshareholderrelationship
Ownershipconcentration
U.S
Adversarial
Through onecompany
Control function
Japan
Co-operative
Through a Keiretsu (group of interlockingcompanies)
Monitoring function
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CORPORATE GOVERNANCE IN GERMANY AND CHINA
Germany
• Two-tier board system
• Management board manages the enterprise
• Supervisory board appoints, supervises, and advises members of the management board
China
• Only recently started a securities market
• Majority of listed companies started off as state-owned enterprises
• State ownership remains high across all industries
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HOW WOULD YOU DO THAT? – CHIQUITA
The Chiquita board set objectives as:
1. Delivery of quality products to consumers
2. Quality returns to shareholders
3. Transform Chiquita into a global player
How should Chiquita compensate its new CEO?
Source: Company annual reports
Chiquita Dole Del Monte
Sales 2004($ millions)
2,613 4,773 2,171
Net income ($ millions)
96 84 134
CEO salary($ thousands)
950 810
CEO bonus($ thousands)
What is appropriate?
1,368 870
CEO total Compensation($ thousands)
4,387 7,394
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SUMMARY
Explain what is meant by corporate governance1
Describe how corporate governance relates to competitive advantage and understand its basic principles and practices
2
Identify the roles of owners and different types of ownership profiles in corporate governance
3
Describe how boards of directors are structured and the roles they play in corporate governance
4
Explain and design executive incentives as a corporate governance device
5
Describe how the market for corporate control is related to corporate governance
6
Compare and contrast corporate governance practices around the world
7