Business and society ethics sustainability and stakeholder management 9e chapter 4

Part I: BUSINESS, SOCIETY, AND STAKEHOLDERS. 1. The Business and Society Relationship. 2. Corporate Citizenship: Social Responsibility, Performance and Sustainability. 3. The Stakeholder Approach to Business, Society, and Ethics. Part II: CORPORATE GOVERNANCE AND STRATEGIC MANAGEMENT ISSUES. 4. Corporate Governance: Foundational Issues. 5. Strategic Management and Corporate Public Affairs. 6. Issue, Risk, and Crisis Management. Part III: BUSINESS ETHICS AND MANAGEMENT. 7. Business Ethics Fundamentals. 8. Personal and Organizational Ethics. 9. Business Ethics and Technology. 10. Ethical Issues in the Global Arena. Part IV: EXTERNAL STAKEHOLDER ISSUES. 11. Business, Government, and Regulation. 12. Business Influence on Government and Public Policy. 13. Consumer Stakeholders: Information Issues and Responses. 14. Consumer Stakeholders: Product and Service Issues. 15. Sustainability and the Natural Environment. 16. Business and Community Stakeholders. Part V: INTERNAL STAKEHOLDER ISSUES. 17. Employee Stakeholders and Workplace Issues. 18. Employee Stakeholders: Privacy, Safety, and Health. 19. Employment Discrimination and Affirmative Action. Cases.

Chapter 4

Corporate Governance: Foundational

Issues

Learning Outcomes

1 Link the issue of legitimacy to corporate governance.

2 Identify the best practices boards of directors can follow.

3 Discuss the problems that have led to the recent spate of corporate

scandals and the efforts that are currently underway to keep them from happening again.

4 Discuss the principle ways in which shareholder activism exerted

pressure on corporate management groups to improve governance.

5 Discuss the ways in which managers relate to shareholders and the

issues arising from that relationship.

6 Compare and contrast the shareholder-primacy and

director-primacy models of corporate governance What are their respective strengths and weaknesses? Which do you prefer and why?

Chapter Outline

• Legitimacy and Corporate Governance

• Problems in Corporate Governance

• Improving Corporate Governance

• The Role of Shareholders

• The Role of the SEC

• Shareholder Activism

• Investor Relations

• An Alternative Model of Corporate Governance

•

Legitimacy and Corporate Governance

Legitimacy

-•A condition that prevails when there is a

congruence between an organization’s

activities and society’s expectations.

Legitimation

-•A dynamic process by which a business seeks

to perpetuate its acceptance.

Legitimacy

Corporate Governance -

• Refers to the method by which a firm is

being governed, directed, administered, or controlled, and to the goals for which it is being governed

• Is concerned with the relative roles, rights,

and accountability of such stakeholder

groups as owners, boards of directors,

managers, employees, and other

stakeholders.

Roles of Four Major Groups -

Shareholders

-• Own stock in the firm, giving them ultimate

control (the shareholder-primacy model)

Board of Directors

-• Govern and oversee management of the

business

Managers

-• The individuals hired by the Board to manage

the business on a daily basis

Employees

-• Hired to perform actual operational work

Separation of Ownership from Control Contributes to Governance Problems

Precorporate Period

Owners (ownership)

Managers (control)

Owners (ownership)

Managers (control)

Corporate Period

Shareholders (ownership)

Shareholders (ownership)

Board of Directors

Board of Directors

Management (control) Management (control)

The Need for Board Independence

Outside directors –

•are independent from the firm

Inside directors –

•have some tie to the firm

Board independence from management is crucial

to good governance.

Issues Surrounding Compensation

Excessive CEO Pay

Outside Director Compensation

CEO Firm Performance Relationship

Pay-Stock Options -

•Allows the recipient to purchase stock in the future

at the price it is today

Excessive CEO Pay

Ratio of CEO pay to that of average worker

CEO Pay Controversy

1 Shareholder push to link pay to

conditions

2 Increasing use of “clawback” provisions where executives must return pay under some

conditions

Say on Pay

Movement

Executive Retirement Plans and

Exit Packages Retirement packages –

•have come under scrutiny.

• $210 million to Robert Nardelli when he

was ousted from Home Depot

• $125 million to outgoing Bank of America

CEO, Ken Lewis

•In contrast, many of today’s workers do not have a retirement plan.

•Those who do generally have a defined

contribution plan, rather than a defined

Outside Director Compensation

-• Paying board members is a recent idea.

• Today, outside board members are paid.

• From 2003-2010, their median pay rose

about a third, from $175,800 to $233,800.

• Controversy over whether directors should

be paid at all, and whether they are paid

enough.

Transparency -

Exec compensation packages may include deferred pay, Severance, pension benefits, & other perks over $10,000.

SEC Rules require disclosure of executive compensation

Such disclosures may have a moderating impact

prior to implementation

Governance Impact of the Market

for Corporate Control

Mergers and acquisitions -

•Expectation is that the threat of a possible

takeover will motivate top managers to pursue

shareholder, rather than self-interest

•But many corporate CEOs and boards go to

great lengths to protect themselves from

takeovers, using:

• poison pills (discourages a hostile takeover

by making the firm difficult to take on)

• golden parachutes (firm agrees to pay key

officers in the event of a change in control of the corporation)

Insider Trading -

• The practice of buying or selling a security by

someone who has access to material information that is not available to the public

• “Material Information” is information that a

reasonable investor might want to use, and is

likely to affect the price of the firm’s stock

• A “tipper” provides that information

• A “tippee” receives the information

• Executives and others who work for a firm may

have inside information

• Also those in relationships that include a duty of

confidentiality may have inside information,

Improving Corporate Governance (1 of 2)

• Sarbanes-Oxley Act of 2002 (SOX) -

• Amends securities laws to protect investors in public companies

• Enhances public disclosure to require reporting

of off-balance sheet transactions, and personal loans to executives

• Limits the nonauditing services an auditor can provide to a firm it audits

• Makes it unlawful for accounting firms to provide services where conflicts of interests exist

• CEOs and CFOs must certify financials, and are held responsible for financial representations

Improving Corporate Governance (2 of 2)

Changes in boards of directors -

• More Board diversity

• A greater ratio of outside board members

to inside board members

•Use of board committees to:

• Ensure that financials are not misleading

• Ensure that internal controls are adequate

• Follow-up allegations of irregularities

Red Flags Signaling Board Problems

Ranking of Red Flags-

2 Poor employee morale

1 Company has to restate earnings

3 Negative risk assessment from auditor

4 Poor customer satisfaction track record

5 Management misses strategic performance goals

6 Company is target of employee lawsuits

7 Stock price declines

8 Quarterly financial results miss analysts’ expectations

9 Low corporate governance quotient rating

Steps to Take for Board Repair Steps to Take -

1.Spread risk oversight among multiple committees2.Seek outside help in identifying potential risks

3.Deepen involvement in corporate strategy

4.Align board size and skill mix with strategy

5.Revamp executive compensation

6.Pick compensation committee members who will question the status quo

7.Use independent compensation consultants

8.Evaluate CEO on grooming potential successors

The Board’s Relationship with CEO

• Boards are responsible for monitoring

CEO performance and dismissing poorly performing CEO

• Formerly, CEOs were protected; no more;

firings of CEOs are up significantly

• If CEO also serves as Chairman of the

Board, this duality can offer some

protection

• Activists have moved to separate CEO and

Board Member Liability -

board members if:

• they act in good faith,

• making informed decisions

• that reflect the company’s best interests,

and not their own interests.

• Good Faith is central to the defense

• The argument in favor of the Business

Judgment Rule is that Board members

need to be free to take risks without fear

The Role of Shareholders

The Shareholder Democracy Movement rises

from the fact that although they are owners,

shareholders may find that their votes are not counted They seek:

A Majority Vote

•The requirement that board members be elected by a majority of votes cast, rather than by a plurality

Banning Classified or Staggered Boards

•Electing members in staggered terms means that it

might take 3 or more years to replace a board

Proxy Access

•Would provide shareholders with the opportunity to

The Role of the SEC

-• The SEC Is responsible for protecting investor

interests.

• Critics argue that the SEC is more focused on

the needs of businesses than on that of

investors.

• The SEC failed to stop the Bernard Madoff

Ponzi scheme before losing investors billions, although they had been warned of the

scheme a decade earlier.

Shareholder Activism

Investor Relations -

• A majority of corporate boards now

communicate with their major investors

• Public corporations have obligations to current

and potential shareholders, including Full

disclosure (Transparency), and the duty to

provide information that might affect

investment decisions.

• Management is also responsible for

communicating with shareholders

• CEO Warren Buffet calls his annual shareholder

meeting a “Woodstock weekend for capitalists.”

An Alternative Model of

Corporate Governance

• The Anglo-American model of corporate

governance is one of shareholder primacy

• A emerging perspective is a director-primacy

model of corporate governance

• A director-primacy model is based on the

concept of a corporation that is not owned, but

is an independent legal entity that owns itself

• Boards are mediating hierarchs, responsible for

balancing competing interests of stakeholders

• Boards have a duty to shareholders, but boards are

Key Terms (1 of 2)

• Accounting Reform and

Investor Protection Act of

• Sarbanes-Oxley Act (SOX)

• Say on Pay movement