Corporate Governance Best Practices: Implications for Commercial Underwriters

1. Corporate Governance Best Practices:Implications for Commercial Underwriters Dr. Gail S. Russ Dr. Meredith Downes Associate Professors of Management Illinois State University

3. Corporate Governance • Core concern: How do we make sure that top managers are doing what they’re supposed to be doing?

4. 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

5. 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).

6. 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

7. The Stakeholder Perspective • The board has broader responsibilities • Focus is on protecting key stakeholder rights • Shareholders • Employees • Vendors • Customers • Society as a whole

8. Best Practices • The board of directors • Executive compensation • Anti-takeover measures

9. The Board of Directors • Role is to monitor & evaluate top management • But, is the board a complete solution?

10. Best Practices:Board of Directors • Separate CEO & Chairman of the Board • Role duality gives CEO too much power

11. Best Practices:Board of Directors • Separate CEO & Chairman of the Board • Role duality gives CEO too much power • Appointment of lead outside director

12. 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

13. Best Practices:Board of Directors • Active board members • Not a rubber-stamp board

14. Best Practices:Board of Directors • Active board members • Not a rubber-stamp board • Evidence that the directors are in contact with employees, vendors, & customers

15. 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

16. Best Practices:Board of Directors • Board composition • Insiders versus outsiders

17. Best Practices:Board of Directors • Board composition • Insiders versus outsiders • “Having a board monitor itself is like having the fox watch the henhouse.”

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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)

24. 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

25. 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

26. Best Practices:Board of Directors • Board committees • Key committees at least chaired by outsiders • Audit, compensation, corporate governance (nominating) committees

27. 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

28. Best Practices:Board of Directors • Board committees • Compensation committee • Conduct formal evaluation of all company officers (including CEO) and set compensation

29. Best Practices:Board of Directors • Board committees • Corporate governance (nominating) committee • Create charter for board

30. Best Practices:Board of Directors • Board committees • Corporate governance (nominating) committee • Create charter for board • Conduct formal governance review using an external consultant

31. 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

32. 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

33. 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

34. Best Practices:Board of Directors • Board committees • Audit committee • Select independent auditor • Not also employed for consulting work

35. 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

36. 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

37. 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

38. Best Practices:Board of Directors • Board meetings • Frequency of overall board & committee meetings

39. Best Practices:Board of Directors • Board meetings • Frequency of overall board & committee meetings • Attendance

40. Best Practices:Board of Directors • Board meetings • Frequency of overall board & committee meetings • Attendance • “Executive” sessions • Lead outside director with term limit

41. 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

42. 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

43. Best Practices:Executive Compensation • CEO has substantial stock ownership

44. Best Practices:Executive Compensation • CEO has substantial stock ownership • Salary, bonuses, & stock options reward superior performance • not size of the company

45. 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

46. 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

47. 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

48. Best Practices:Anti-takeover measures • Lack of provisions designed to thwart a hostile takeover • Golden parachutes

49. Best Practices:Anti-takeover measures • Lack of provisions designed to thwart a hostile takeover • Golden parachutes • Poison pill provisions

50. Best Practices:Anti-takeover measures • Lack of provisions designed to thwart a hostile takeover • Golden parachutes • Poison pill provisions • Greenmail