Chapter 18 Corporate Governance

1. Chapter 18Corporate Governance

2. Mark Hurd • Mark Hurd arrived as the chief executive officer at Hewlett-Packard in 2005 • Hurd got along with the board and got results • On June 29, 2010, Hurd opened a letter from celebrity lawyer Gloria Allred • It accused him of sexually harassing an HP marketing contractor named Jodi Fisher by touching her body suggestively and speaking of intimate personal matters

3. Mark Hurd • Hurd first interviewed Fisher in Los Angeles • Hurd suggested to the board that HP pay to settle the allegations • The board hired a law firm to investigate Hurd’s actions • Early in August, Hurd reached an undisclosed financial settlement with Fisher that prohibited her from discussing the allegations

4. Backdating with Dr. McGuire • SEC regulators told the company they were investigating the matter, but Dr. McGuire seemed untroubled • Dr. McGuire denied that grant dates were picked with the benefit of hindsight • Investigators concluded the grants were “likely backdated” • Dr. McGuire was forced to resign, pay a $7 million fine, and disgorged of wrongful gains

5. What is Corporate Governance? • Corporate governance: The exercise of authority over the members of a corporate community based on formal structures, rules, and processes • The authority is based on a body of rules defining the rights and duties of shareholders, boards of directors, and managers

6. Figure 18.2 - The Power Triangle

7. The Corporate Charter • Corporate charter: A document issued by a state government to create a corporation • Corporate charters specify the purpose of the corporation and basic rights and duties of stockholders, directors, and officers • Fiduciary responsibility: The legal duty of a representative to manage property in the interest of the owner

8. The Corporate Charter • 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 • Bylaws: Rules of corporate governance adopted by corporations

9. The Corporate Charter • States compete to attract the incorporation fees and tax revenues of corporations • For more than a century tiny Delaware has been the victor in this competition

10. Figure 18.3 - Flow of Authority in Corporate Governance

11. Federal Regulation of Governance • 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 • Federal intervention generally comes in reaction to conspicuous failures of governance and imposes mandatory rules and restrictions

12. Enron Corp. • Enron enjoyed admiration and respect among investors, managers of other companies, and the public • Government regulators uncovered multiple instances of : • Juggling accounting records to inflate sales and profits • Hiding debt, concealing excessive CEO perks and compensation in vague footnotes

13. Enron Corp. • Ignoring standard accounting and financial practices • Shredding documents to destroy incriminating records

14. Enron Corp. • 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 • A fundamental cause of the catastrophe was the culture of the company • In 2006 a federal jury found Chairman of the Board Lay and CEO Skilling guilty of conspiracy and fraud

15. The Sarbanes-Oxley Act • It holds management responsible for accurate financial reports and strengthens the power and responsibility of board audit committees • A few of the act’s provisions are: • Creates a five-member oversight board that has authority over practices of accounting firms • Prescribes rules to improve auditing

16. The Sarbanes-Oxley Act • Requires the CEO and CFO to sign and certify the accuracy of annual and quarterly financial statements • Establishes heavy criminal penalties for violating its provisions

17. Lehman Brothers • Lehman Brothers Holdings began in 1850 as a cotton broker and grew into the nation’s fourth-largest investment bank • Since 1994 it had been run by a CEO named Richard S. Fuld, Jr. Intense, intimidating, and impatient • In 2006, Fuld decided that the way to keep share prices rising was to make Lehman grow faster

18. Lehman Brothers • To fund its operations, Lehman depended on borrowing tens of billions of dollars each day in financial markets • Lehman’s bankruptcy caused panic in the markets • During the year preceding bankruptcy the board met eight times and its members earned between $325,038 and $397,538 • Lehman’s management made serious errors of judgment

19. The Dodd-Frank Act • A statute to reform financial regulation and prevent a recurrence of the 2007–2008 financial crisis

20. Boards of Directors • Directors in large corporations are chosen after being nominated by the board and approved by a majority vote of shareholders • Directors who are employees of the company are called inside directors; those who are not employed by the company are outside directors • Boards are divided into committees

21. Duties of Directors • Laws impose two lofty duties on directors: • Represent the interests of stockholders • Exercise due diligence in supervising management • Directors do not make day-to-day decisions • Boards exercise a very broad oversight • Compensation varies substantially among industries

22. Duties of Directors • Some specific board functions: • Approve the issuance of securities and the voting rights of their holders • Review and approve the corporation’s goals and strategies • Select the CEO, evaluate his or her performance, and remove that person if necessary • Give advice and counsel to management

23. Duties of Directors • Create governance policies for the firm, including compensation policies • Evaluate the performance of individual directors, board committees, and the board as a whole • Nominate candidates for election as directors • Exercise oversight of ethics and compliance programs

24. Board Composition • The average board has 11 members and this has not changed for many years • Most state incorporation laws require a minimum of three, but companies typically have between 7 and 15 • Directors are elected by shareholders, usually for terms of one year • Inside directors • Outside directors • Independent directors

25. Board Dynamics • The average board meets eight times a year, although many meet monthly • Agendas include committee reports, mandatory governance matters, and presentations by company executives • The chairman of the board presides over meetings

26. Board Dynamics • Advocates of greater board independence believe that a better solution for strengthening the board is to split the roles of chairman and CEO • Management opposes separation • One fear is compromising clarity in the chain of command

27. Executive Compensation • A compensation committee of the board of directors sets the pay and benefits of top executives • Elements of compensation include a combination of the following • Base salary • Annual cash incentives

28. Executive Compensation • Long-term stock-based incentives • Stock options • Performance shares • Restricted stock • Retirement plans • Perquisites

29. Problems with CEO Compensation • The size of extraordinary payouts • The compensation packages given to some newly hired CEOs • The golden handshakes received by some CEOs when they leave under fire • An alleged bias in favor of boosting CEO compensation due to the composition of the compensation committees

30. Problems with CEO Compensation • Nonconformance with the interests of shareholders • The number and misuse of stock option grants • The spread between executive pay and that of the average worker

31. Concluding Observations • Despite well-defined legal bonds between share owners, boards of directors, and management, there are many tensions between them • Scandals revealed lax oversight of financial strategies and reporting by many boards

32. Concluding Observations • Many shareholders believe that boards have allowed management compensation to exceed reason • The outlook is for more pressures and regulations that tighten board oversight