Unformatted text preview: 10. Corporate Governance and Board of Directors
1. 2. 3. 4. 5. Outline Board of Directors Audit Committees Compensation Committees Corporate Governance SarbanesOxley Act Bus 424 tenth lecture presentation 1 Board of directors
Shareholders Responsibility Managers Monitor Provide resources Board of Directors Insider/outsider Delegate Authority Bus 424 tenth lecture presentation 2 Board of directors Shareholders, who typically own a portfolio of firms, delegate their authority for internal control to a board of directors. The board is given ultimate control over management. It monitors and approves management decisions, and chooses, dismisses, and rewards managers. Two main control responsibilities: Safeguard the equity investors’ interests by ensuring that management seeks to maximize shareholder value. Protect the interests of other corporate stakeholders (employees, customers, suppliers, competitors, and society at large) by ensuring that the employees in the corporation act in a legally and socially responsible manner. Bus 424 tenth lecture presentation 3 Board of directors (Continued) Duty of care – Duty to make/delegate decisions in an informed way. Duty of loyalty – Duty to advance corporate over personal interests. Duty of good faith – Duty to be faithful and devoted to the interests of the corporation and its shareholders. Duty not to “waste” – Duty to avoid deliberate destruction of shareholder value. All of these duties are defined by, and enforced through, the legal system. Bus 424 tenth lecture presentation 4 Board of directors (Continued) To carry out their responsibilities, boards must ensure that they are independent and accountable to shareholders, and they must exert their authority for the continuity of executive leadership with proper vision and values. – Board independence – Interlocking directorates Bus 424 tenth lecture presentation 5 Board of directors (Continued) Boards are given ultimate control over management: – They are singularly responsible for the selection and evaluation of the corporation’s CEO and must ensure the quality of senior management. – Boards also review and approve the corporation’s longterm strategy and important management decisions, such as the design of equity and compensation policies that motivate management to achieve and sustain superior longterm performance. – Board competence Bus 424 tenth lecture presentation 6 Audit committees Audit committees provide independent oversight over companies’ financial reporting processes, internal controls, and independent auditors. They enhance a board’s ability to focus intensively and relatively inexpensively (without involving the full board) on the corporation’s financial reportingrelated functions. In publiclyheld corporations, audit committees must be comprised solely of financiallyliterate outside (nonemployee) directors.
Bus 424 tenth lecture presentation 7 Compensation committees deal with issues related to the compensation and benefits provided to employees, and particularly top executives. Fiduciary responsibility for ensuring that the company’s executive compensation programs are fair and appropriate to attract, retain, and motivate managers and that they are reasonable in view of company economics and the relevant practices of comparable companies: – Rely on the company’s HR function for staff support. – Because the design of compensation plans can raise many complex issues, compensation committees often employ outside consultants to provide data or expertise that the company does not have internally. Bus 424 tenth lecture presentation 8 Compensation committees Corporate governance The sets of mechanisms and processes that help ensure that companies are directed and managed to create value for their owners while concurrently fulfilling responsibilities to other stakeholders (e.g. employees, suppliers, society at large). Corporate governance deals with controlling the behaviors of top management. Bus 424 tenth lecture presentation 9 Corporate governance and MCSs Corporate governance systems and management control systems (MCS) are inextricably linked. – A corporate governance focus is slightly broader than a MCS focus: A MCS focus takes the perspective of top management and asks what can be done to ensure the proper behaviors of employees in the organization. The corporate governance focus is on controlling the behaviors of top management and, through their direction, those of all the other employees in the firm. Bus 424 tenth lecture presentation 10 Corporate governance regimes Corporate governance approaches and mechanisms vary widely across countries. Generally the world is said to be divided into two corporate governance orientations: – The AngloAmerican system that focuses on the primacy of shareholders as the beneficiaries of fiduciary duties. – The Continental European/Japanese system that has a broader concern for the rights of other stakeholders. Bus 424 tenth lecture presentation 11 Prevalence Primarily because of the major business scandals that were uncovered in the early 2000s, including Enron, WorldCom, Tyco, and other abuses, such as stock option backdating, interest in corporate governance has skyrocketed. – The U.S. SarbanesOxley Act of 2002 – Listing requirements by stock exchanges designed to strengthen corporate accountability – Corporate governance reforms by legislators and regulators in several countries Bus 424 tenth lecture presentation 12 SarbanesOxley Act To improve the transparency, timeliness, and quality of financial reporting. Companies registered with the U.S. Securities and Exchange Commission (SEC) must comply with SarbanesOxley whether their headquarters are based in the U.S. or abroad. In addition, some countries, such as Canada and Japan, are setting regulations very similar to SarbanesOxley. More convergence is expected in the coming years. Bus 424 tenth lecture presentation 13 The external auditing profession, which was formerly self regulated, became highly regulated by the federal government. – The Public Company Accounting Oversight Board (PCAOB) has the authority, with oversight from the SEC, to set auditing standards and to monitor auditors’ actions. Key provisions of Sarbanes Oxley The members of audit committees of companies’ boards of directors are required to be more independent and more financially literate. Bus 424 tenth lecture presentation 14 Key provisions of SarbanesOxley (Continued) Senior company managers (CEO and CFO) are required to certify: – That they have reviewed their company’s quarterly and annual financial statements – That the financial statements are fairly presented, with no untrue statements or omissions of material facts – That they acknowledge responsibility for disclosure controls and procedures and internal controls over financial reporting – That they have evaluated those controls and procedures and disclosed any material changes or deficiencies to the auditors and audit committee. Penalties for fraud and for obstructing an investigation were broadened and made more severe. Bus 424 tenth lecture presentation 15 Section 404 But perhaps the most significant, and most expensive, provision in the Act is the internal controlrelated section of the Act, “Section 404”. Prior to SarbanesOxley, good internal controls were said to be good business practice. – Not only did good controls help ensure fair and accurate financial reporting, they helped ensure that managers would have good information with which to make their business decisions and they helped reduce the incidence of fraud and asset loss. – SarbanesOxley made good internal controls a legal requirement, at least for companies publicly traded in the U.S.. Bus 424 tenth lecture presentation 16 Section 404 mandates an evaluation of the effectiveness of a company’s internal controls by both management and the company’s external auditor and formal written opinions about the effectiveness of those controls. Managers and auditors are required to examine a broad range of internal controls over financial reporting, including: – Policies and procedures – Audit committee effectiveness – Integrity and ethical behavior programs – Whistleblower programs – “Tone at the top” Section 404 (Continued) Bus 424 tenth lecture presentation 17 Section 404 (Continued) Since many internal controls (the auditor’s term) serve management purposes, as well as financial reporting purposes, the SarbanesOxley Act has affected companies’ MCSs in positive ways. Virtually everybody agrees that whether or not the high costs are justified, SarbanesOxley has had positive effects on both the quality of financial reporting and the quality of firms’ MCSs. – e.g., the financial statement restatement rate increased dramatically since the passing of SarbanesOxley, up from 5.7% in 2003 to 14% in 2005. Bus 424 tenth lecture presentation 18 Effectiveness? Will following all the tenets of SarbanesOxley guarantee an infallible control system? Some experts conclude that the extreme examples of fraud and corporate failure that motivated legislators to pass the Act would have occurred even if SarbanesOxley had existed at the time.
Bus 424 tenth lecture presentation 19 Board Evaluation: BSC Approach
Strategy, measures, targets Evaluate firm performance Information input to the board Strategic Contribution Evaluate board performance Information used Strategic contribution Assess/reward performance Information input to the board Enterprise BSC Executive BSC Bus 424 tenth lecture presentation 20 ...
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- Spring '10