Chapter 4: Corporate Governance: Foundational Issues
Chapter 4: Corporate Governance: Foundational Issues Legitimacy and Corporate Governance Introduction •
Legitimacy helps to explain the role of a corporation’s charter, shareholders, board of directors, management and employees all of which are part of the corporate governance system.
•
Organizations are legitimate to the extent to which their goals and values are congruent with the social system within which they function.
•
Legitimation is a dynamic process by which business seeks to perpetuate its existence
•
Legitimacy has to be considered at both the micro and macro level.
•
At micro level- business achieving and maintaining legitimacy by conforming to societal expectations. This can be done in different ways : o
First, they may adapt its methods of operating to conform to what it perceives to be the prevailing standard.
o
Second, a company may try to change the public’s values and norms to conform to its own practices by advertising and other techniques.
o
Thirdly, an organization may seek to enhance its legitimacy by identifying itself with other organizations, peoples, values, or symbols that have powerful legitimate base in the society.
•
At macro level- refers to the corporate system that is the totality of business enterprises.
•
In comparing both the levels, it is clear that, although specific organizations try to perpetuate their own legitimacy, the corporate system as a whole rarely addresses the issue at all. This is bad because powerful issues regarding business conduct clearly indicate that such institutional introspection is necessary if business is to survive and prosper.
Purpose of Corporate Governance •
Governance comes from the Greek work ‘steering’. The way in which a corporation is governed determines the direction in which it is steered.
•
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.
Components of corporate governance Role of four major groups •
Overarching the groups is a Charter issued by the state. Giving the corporation the right to exist and stipulating the basic terms of its existence.
•
Shareholders are the owners of the corporation. They have control over the corporation. They exercise this control be selecting the board of directors of the company.
•
Large organizations with a large number of shareholders appoint board of directors to govern and oversee the management of the business.
•
The third group is the management, appointed by the board of directors to run the company and manage it on a daily basis. The top management establishes the overall policy. Middle and lower level carry out this policy and conduct daily supervision of operative employees.
•
Employees are those hired by the company to do the actual work.
Separation of ownership from control •
In the precorporate period, the owners were typically the managers themselves; thus the system worked the way it was intended, with the owners also controlling the business.
•
As the public corporation grew and stock ownership became widely dispersed, a separation of ownership from control became the prevalent condition. This being the case, the most effective control the owners could exercise was to appoint the board of directors to look over the management.
•
The problem with this was that the authority, power and control rested with the group that had the most concentrated interest at stake- the management.
•
The corporation did not function according to its designated plan with effective authority, power and control flowing downwards from the owners.
•
Factors that added to the managers power were the corporate laws and traditions that gave the management control over the proxy process ( the method by which the shareholders elected board of directors with like minded people who simply collected their fees and deferred to the management on whatever it wanted).
Problems in Corporate Governance 1. The need for Board Independence
•
Board independence is a crucial aspect in good governance.
•
Outside directors are independent from the firm and its top managers.
•
They have no substantive relation to the firm or it’s CEO.
•
Inside directors have ties with the firm.
•
At times they are the top managers at het firm; at others, insiders are family members or others with a professional or personal relationship to the firm or the CEO.
•
Another problem is managerial control of board processes.
•
CEOs can often control board perks such as director compensation and committee assignments. Board members who rock the boat might find themselves left out in the cold.
2. Issue surrounding Compensation The CEO Pay-Firm Performance Relationship: o
Shareholders observed CEO pay rising when firm performance fell. Many executives received staggering salaries, even while profits were falling, workers were being laid off, and shareholder return was dropping.
o
The SEC introduced stricter disclosure requirements in their effort to monitor CEO pay.
o
The revised compensation rule was designed to provide shareholders with more information about the relationship between firm performance and CEO compensation.
o
Efforts to strengthen this relationship have centered on the use of stock options.
o
Stock options are designed to motivate the recipient to improve the value of the firm’s stock. An option allows the recipient to purchase stock in the future at the price it is today. If stock value rises after granting of the option. The recipient will make money.
o
But this has led to many abuses like:
o
Stock option Backdating that occurs when the recipient is given the option of buying stock at yesterday’s price, resulting in an immediate and guaranteed wealth increase.
o
Spring loading is the granting of a stock option at today’s price but with the inside knowledge that something good is about to happen that will improve the stock’s value.
o
Bullet Dodging is the delaying of a stock option grant until right after bad news.
o
The last two involve the presence of insider trading which is a serious concern.
Excessive CEO pay o
CEO salaries have skyrocketed while worker salaries have waned.
o
The CEO-worker pay ratio has rise from 42 to 1 in 1980 to 319 to 1.
o
The Say on Pay movement that started in UK in 2000, evolved from concerns over excessive executive compensation. It included the requirement to put a remuneration report to a shareholder vote at each annual meeting.
o
When the executive’s high level of pay results from dubious practices such as financial misconducts or the exercising of options in a questionable way, shareholders have a right to recover those funds. It is from a provision called Clawback provisions, which are compensation recovery mechanisms that enable a company to recoup compensation fund, typically in the event of a financial restatement or executive’s misbehavior.
Executive Retirement Plans and Exit Packages o
Executive retirement packages have traditionally flown under radar, escaping the notices of shareholders, employees, and the public. Examples of GE chairman and CEO, CEO of American Bank.
o
Part of public’s frustration is that these CEO retirement packages stand in stark contrast to the workers retirement packages. Many of the workers don’t even have retirement packages today and many who have, are far more likely to have the less lucrative defined contribution (that specify what will be put into the retirement fund).
Outside Director Compensation o
Apart from CEO compensation being an issue, director’s compensation is also a major issue. Paying the board members is relatively a recent idea. A century ago it was illegal to pay nonexecutive board members as they represented the shareholders, paying them out of the company’s (shareholders) funds would be self-dealing.
Transparency o
The SEC rules on complete disclosure are designed to address some of the obvious problems by making the entire pay packages of top executives transparent.
o
Tax Gross-up: reimbursing one for the taxes one would have to pay.
o
Examples of CEO’s giving up their Tax Gross-up perks paid by the companies are given.
o
Some experts express concern that the push for transparency is actually resulting in greater opacity.
o
People argue that CEO’s are not paid excessively; they are paid according to their responsibility and that excessive granting of stock options is clouding the data.
o
Other issues are that transparency has made it easier for executives to compare their pay to that of their peers and that has led these executives to compete for higher pay.
o
Abuses such as backdating and spring loading have also been seen due to stock options given.
3. The Governance Impact of the market for Corporate Control •
Mergers and Acquisitions are another form of corporate governance, one that comes from outside the corporation.
•
The merger, acquisition and hostile takeovers motivated many corporate CEO’s and boards to go to greater lengths to protect themselves from these takeovers. Two controversial practices were Poison pills and Golden Parachutes.
•
Poison Pills- A poison pill is intended to discourage or prevent a hostile takeover. Typically when a hostile suitor acquires more than a certain percentage of a company’s stock, the poison pill provides that other shareholders be able to purchase shares, thus diluting the suitor’s holding and making the acquisition prohibitively expensive.
•
Golden Parachutes- It is a contract in which a corporation agrees to make payments to key officers in the event of a change in the control of the corporation. Advocates argue that these provide top executives with an incentive for not fighting a shareholder wealthmaximizing takeover battle in an effort to preserve their employment. However new rules are requiring more transparent exit packages which are motivating companies to trim down these plans to less lavish terms.
4. Insider Trading Scandals •
It is the practice of obtaining critical information from inside a company and then using that information for one’s own personal financial gains.
•
Statistics showed that suspicious trading occur prior to nearly one third of announced takeover attempts.
•
Insider trading allegations cause the general public to lose faith in the stability and security financial industry.
•
To prop us investor confidence, SEC instituted disclosure rules designed to aid small investors who historically has not had access to the information large investors hold. When companies disclose meaningful information to shareholders and securities professionals, they must now do so publicly so that small investors can enjoy a more level playing field.
Improving Corporate Governance 1. Sarbanes-Oxley Act •
Accounting Reform and Investor Protection Act of 2002 also know as Sarbanes-Oxley Act.
•
It amends the securities laws to provide better protection to investors in public companies by improving the financial reporting of companies.
•
Some of the ways the act works is that it limits the non-auditing services an auditor can provide, requiring auditing firms to rotate auditors who work with a specific company, and making it unlawful for accounting firms to provide auditing services where conflict of interest exists.
•
The act enhances financial disclosure with requirements such as reporting of offbalance-sheet transactions, the prohibiting of personal loans to directors and executives and the requirements that auditors assess and report upon the internal controls employed by the company.
•
The act requires audit committees to have one financial expert approved by CEO and CFO to certify and be held responsible for financial representation of the company.
•
The act also makes it necessary for firms to adopt a code of ethics for senior financial officers.
•
Punishments are harsh if the provisions of the act aren’t adopted.
•
Whistle-blower protection is also given by the act.
•
Benefits of the act were that there was evidence that executives and directors were being more diligent in their reporting to shareholders.
•
But there has been an increase in the number of firms turning private to avoid regulations.
•
The cost of compliance can be as much as three times the cost prior to the act’s implementation.
•
The requirements of SOX made it far less attractive to sit in the CFO position.
2. Changes in Board of Directors •
See figure 4-3 on page 142.
3. Board Diversity •
Prior to 1960’s, boards were composed primarily of white, male inside directors.
•
After 1960’s the scenario changed. But the progress in the diversity of Women in the boards has been less.
•
The diversity of African-Americans has not changed according a study conducted.
•
This is the case only in US. In other countries the statistics say otherwise. Norway leads in having women on corporate boards.
•
Diversity of boards makes a difference because a diverse board is better able to hear their concerns and respond to their needs.
•
Diverse boards are also less likely to fall prey to groupthink because they would have the range of perspectives necessary to question the assumptions that drive group decisions.
4. Outside Directors •
The difference outside directors make are :
•
A study showed that having outside directors is associated with fewer shareholder lawsuits.
•
It is found that outside directors correlated positively with dimensions of social responsibility associated with both people and product quality.
•
The most important characteristic for outside directors is the ability to ask difficult questions and speak truthfully about concerns, without letting ties to the firm get in the way.
5. Use of Board Committees •
The audit committee is responsible for assessing the adequacy of internal control systems and the integrity of financial statements.
•
Nominating committee, which should be composed of outside directors, has the responsibility of ensuring that competent, objective board members are selected.
•
Compensation committee, which also should be composed of outside directors, has the responsibility of evaluating executive performance and recommending terms and conditions of employment.
•
Public issues committee or Public policy committee is responsible for responding to public or social issues, provide policy leadership, and monitor management’s performance on these issues.
6. The Board’s Relationship with the CEO •
Boards of directors are responsible for monitoring CEO performance and dismissing poorly performing CEO’s.
•
Because of the above stated changes, CEO’s are dropping like flies. They have no security of employment.
•
Due to global recession the turnover of CEO has reduced.
7. Board Member Liability
•
Concerned about the increasing legal hassles, directors have been quitting or rejecting board positions.
•
Hence the Business judgment rule prevailed.
•
The rule holds that courts should not challenge board members who act in good faith, making informed decisions that reflect company’s best interests instead of their own selfinterest.
•
It gives directors the freedom to take risks without fear of liability.
The Role of Shareholders Shareholders are the owners of the corporation. 1. Shareholder Democracy •
The shareholder democracy movement stems from the lack of power shareholders have felt, particularly in board elections.
•
Proponents of shareholder democracy contend that increased shareholder power and involvement will lead to improved firm performance.
•
Opponents say that shareholders are not owners in the traditional sense of the word because they can exit their ownership relatively easily by simply selling their shares. They contend that increased shareholder power will lead to inefficient and short term oriented decision making, as well as infighting among competing interests.
•
The movement however has raised three key issues that are :
•
Majority vote- it is the requirement that board members be elected by a majority of votes cast. This is in contrast to the previously prevailing norm of plurality.
•
Classified Boards- they are those that elect their members in staggered terms. For example, in a board of 12 members, 4 might be elected each year, and each would serve a three-year term. It would then take three years for the entire board slate to be replaced.
•
Proxy access- it provides shareholders with the opportunity to propose nominees for the board of directors. In the prevailing system, shareholders must file a separate ballot if they want to nominate someone. So now they are asking for the ability to place their candidates directly on proxy material.
The Role of the SEC •
The SEC is responsible for protecting investor interests.
•
But many argue that SEC often appears more focused on the needs of the business that on that of investors.
•
A ponzi scheme lures investors in with the fake promise f profit but actually pays earlier investors with later investors’ money until the scheme collapses.
•
The SEC failed to stop a major ponzi scheme that cost the investors around the world tens of billions of dollars even though they were warned of the scheme a decade before.
Shareholder Activism •
Shareholder activists have historically been socially oriented; that is, they want to exert pressure to make the companies in which they own stock more socially responsive.
•
The growth of shareholder activism shows no signs of abating. Activist shareholders, known also as corporate gadflies, are no longer dismissed as nuisance and are instead viewed as credible, powerful and a force with which to be reckoned.
Shareholder Resolutions •
One of the major ways by which shareholder activists communicate their concerns to management groups is through the filing of shareholder resolutions.
•
To file a resolution, a shareholder or a shareholder group must obtain a stated number of signatures to require management to place the resolution on the proxy statement so that it can be voted on by all the shareholders.
•
Although individuals could initiate a shareholder resolution, but he or she may not have the resources or means to obtain the required signatures.
•
The issues on which shareholder resolutions are filed vary widely, but the typically concern some aspect of a firm’s social performance. Few examples are executive compensation, animal testing, board structure, sustainability reporting, board diversity and climate change.
Shareholder Lawsuits •
Shareholders sued the board of directors for a decision that’s against their interests.
Investor Relations •
Over the years, it has been seen that corporate managements have been neglecting their owners because they have been too pre-occupied to fulfill their own self-interest. But now, the scene has changed. Corporations are beginning to realize that they have a responsibility to their shareholders that they cannot neglect further. Owners are demanding accountability, and it appears that they will be tenacious until they get it.
•
Public corporations have obligations to existing shareholders as well as potential shareholders. Full disclosure (transparency) is one of these responsibilities.
•
Another responsibility of management is to communicate with shareholders.
Legitimacy helps to explain the role of a corporation’s charter, shareholders, board of directors, management and employees all of which are part of the corporate governance system.
•
Organizations are legitimate to the extent to which their goals and values are congruent with the social system within which they function.
•
Legitimation is a dynamic process by which business seeks to perpetuate its existence
•
Legitimacy has to be considered at both the micro and macro level.
•
At micro level- business achieving and maintaining legitimacy by conforming to societal expectations. This can be done in different ways : o
First, they may adapt its methods of operating to conform to what it perceives to be the prevailing standard.
o
Second, a company may try to change the public’s values and norms to conform to its own practices by advertising and other techniques.
o
Thirdly, an organization may seek to enhance its legitimacy by identifying itself with other organizations, peoples, values, or symbols that have powerful legitimate base in the society.
•
At macro level- refers to the corporate system that is the totality of business enterprises.
•
In comparing both the levels, it is clear that, although specific organizations try to perpetuate their own legitimacy, the corporate system as a whole rarely addresses the issue at all. This is bad because powerful issues regarding business conduct clearly indicate that such institutional introspection is necessary if business is to survive and prosper.
Purpose of Corporate Governance •
Governance comes from the Greek work ‘steering’. The way in which a corporation is governed determines the direction in which it is steered.
•
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.
Components of corporate governance Role of four major groups •
Overarching the groups is a Charter issued by the state. Giving the corporation the right to exist and stipulating the basic terms of its existence.
•
Shareholders are the owners of the corporation. They have control over the corporation. They exercise this control be selecting the board of directors of the company.
•
Large organizations with a large number of shareholders appoint board of directors to govern and oversee the management of the business.
•
The third group is the management, appointed by the board of directors to run the company and manage it on a daily basis. The top management establishes the overall policy. Middle and lower level carry out this policy and conduct daily supervision of operative employees.
•
Employees are those hired by the company to do the actual work.
Separation of ownership from control •
In the precorporate period, the owners were typically the managers themselves; thus the system worked the way it was intended, with the owners also controlling the business.
•
As the public corporation grew and stock ownership became widely dispersed, a separation of ownership from control became the prevalent condition. This being the case, the most effective control the owners could exercise was to appoint the board of directors to look over the management.
•
The problem with this was that the authority, power and control rested with the group that had the most concentrated interest at stake- the management.
•
The corporation did not function according to its designated plan with effective authority, power and control flowing downwards from the owners.
•
Factors that added to the managers power were the corporate laws and traditions that gave the management control over the proxy process ( the method by which the shareholders elected board of directors with like minded people who simply collected their fees and deferred to the management on whatever it wanted).
Problems in Corporate Governance 1. The need for Board Independence
•
Board independence is a crucial aspect in good governance.
•
Outside directors are independent from the firm and its top managers.
•
They have no substantive relation to the firm or it’s CEO.
•
Inside directors have ties with the firm.
•
At times they are the top managers at het firm; at others, insiders are family members or others with a professional or personal relationship to the firm or the CEO.
•
Another problem is managerial control of board processes.
•
CEOs can often control board perks such as director compensation and committee assignments. Board members who rock the boat might find themselves left out in the cold.
2. Issue surrounding Compensation The CEO Pay-Firm Performance Relationship: o
Shareholders observed CEO pay rising when firm performance fell. Many executives received staggering salaries, even while profits were falling, workers were being laid off, and shareholder return was dropping.
o
The SEC introduced stricter disclosure requirements in their effort to monitor CEO pay.
o
The revised compensation rule was designed to provide shareholders with more information about the relationship between firm performance and CEO compensation.
o
Efforts to strengthen this relationship have centered on the use of stock options.
o
Stock options are designed to motivate the recipient to improve the value of the firm’s stock. An option allows the recipient to purchase stock in the future at the price it is today. If stock value rises after granting of the option. The recipient will make money.
o
But this has led to many abuses like:
o
Stock option Backdating that occurs when the recipient is given the option of buying stock at yesterday’s price, resulting in an immediate and guaranteed wealth increase.
o
Spring loading is the granting of a stock option at today’s price but with the inside knowledge that something good is about to happen that will improve the stock’s value.
o
Bullet Dodging is the delaying of a stock option grant until right after bad news.
o
The last two involve the presence of insider trading which is a serious concern.
Excessive CEO pay o
CEO salaries have skyrocketed while worker salaries have waned.
o
The CEO-worker pay ratio has rise from 42 to 1 in 1980 to 319 to 1.
o
The Say on Pay movement that started in UK in 2000, evolved from concerns over excessive executive compensation. It included the requirement to put a remuneration report to a shareholder vote at each annual meeting.
o
When the executive’s high level of pay results from dubious practices such as financial misconducts or the exercising of options in a questionable way, shareholders have a right to recover those funds. It is from a provision called Clawback provisions, which are compensation recovery mechanisms that enable a company to recoup compensation fund, typically in the event of a financial restatement or executive’s misbehavior.
Executive Retirement Plans and Exit Packages o
Executive retirement packages have traditionally flown under radar, escaping the notices of shareholders, employees, and the public. Examples of GE chairman and CEO, CEO of American Bank.
o
Part of public’s frustration is that these CEO retirement packages stand in stark contrast to the workers retirement packages. Many of the workers don’t even have retirement packages today and many who have, are far more likely to have the less lucrative defined contribution (that specify what will be put into the retirement fund).
Outside Director Compensation o
Apart from CEO compensation being an issue, director’s compensation is also a major issue. Paying the board members is relatively a recent idea. A century ago it was illegal to pay nonexecutive board members as they represented the shareholders, paying them out of the company’s (shareholders) funds would be self-dealing.
Transparency o
The SEC rules on complete disclosure are designed to address some of the obvious problems by making the entire pay packages of top executives transparent.
o
Tax Gross-up: reimbursing one for the taxes one would have to pay.
o
Examples of CEO’s giving up their Tax Gross-up perks paid by the companies are given.
o
Some experts express concern that the push for transparency is actually resulting in greater opacity.
o
People argue that CEO’s are not paid excessively; they are paid according to their responsibility and that excessive granting of stock options is clouding the data.
o
Other issues are that transparency has made it easier for executives to compare their pay to that of their peers and that has led these executives to compete for higher pay.
o
Abuses such as backdating and spring loading have also been seen due to stock options given.
3. The Governance Impact of the market for Corporate Control •
Mergers and Acquisitions are another form of corporate governance, one that comes from outside the corporation.
•
The merger, acquisition and hostile takeovers motivated many corporate CEO’s and boards to go to greater lengths to protect themselves from these takeovers. Two controversial practices were Poison pills and Golden Parachutes.
•
Poison Pills- A poison pill is intended to discourage or prevent a hostile takeover. Typically when a hostile suitor acquires more than a certain percentage of a company’s stock, the poison pill provides that other shareholders be able to purchase shares, thus diluting the suitor’s holding and making the acquisition prohibitively expensive.
•
Golden Parachutes- It is a contract in which a corporation agrees to make payments to key officers in the event of a change in the control of the corporation. Advocates argue that these provide top executives with an incentive for not fighting a shareholder wealthmaximizing takeover battle in an effort to preserve their employment. However new rules are requiring more transparent exit packages which are motivating companies to trim down these plans to less lavish terms.
4. Insider Trading Scandals •
It is the practice of obtaining critical information from inside a company and then using that information for one’s own personal financial gains.
•
Statistics showed that suspicious trading occur prior to nearly one third of announced takeover attempts.
•
Insider trading allegations cause the general public to lose faith in the stability and security financial industry.
•
To prop us investor confidence, SEC instituted disclosure rules designed to aid small investors who historically has not had access to the information large investors hold. When companies disclose meaningful information to shareholders and securities professionals, they must now do so publicly so that small investors can enjoy a more level playing field.
Improving Corporate Governance 1. Sarbanes-Oxley Act •
Accounting Reform and Investor Protection Act of 2002 also know as Sarbanes-Oxley Act.
•
It amends the securities laws to provide better protection to investors in public companies by improving the financial reporting of companies.
•
Some of the ways the act works is that it limits the non-auditing services an auditor can provide, requiring auditing firms to rotate auditors who work with a specific company, and making it unlawful for accounting firms to provide auditing services where conflict of interest exists.
•
The act enhances financial disclosure with requirements such as reporting of offbalance-sheet transactions, the prohibiting of personal loans to directors and executives and the requirements that auditors assess and report upon the internal controls employed by the company.
•
The act requires audit committees to have one financial expert approved by CEO and CFO to certify and be held responsible for financial representation of the company.
•
The act also makes it necessary for firms to adopt a code of ethics for senior financial officers.
•
Punishments are harsh if the provisions of the act aren’t adopted.
•
Whistle-blower protection is also given by the act.
•
Benefits of the act were that there was evidence that executives and directors were being more diligent in their reporting to shareholders.
•
But there has been an increase in the number of firms turning private to avoid regulations.
•
The cost of compliance can be as much as three times the cost prior to the act’s implementation.
•
The requirements of SOX made it far less attractive to sit in the CFO position.
2. Changes in Board of Directors •
See figure 4-3 on page 142.
3. Board Diversity •
Prior to 1960’s, boards were composed primarily of white, male inside directors.
•
After 1960’s the scenario changed. But the progress in the diversity of Women in the boards has been less.
•
The diversity of African-Americans has not changed according a study conducted.
•
This is the case only in US. In other countries the statistics say otherwise. Norway leads in having women on corporate boards.
•
Diversity of boards makes a difference because a diverse board is better able to hear their concerns and respond to their needs.
•
Diverse boards are also less likely to fall prey to groupthink because they would have the range of perspectives necessary to question the assumptions that drive group decisions.
4. Outside Directors •
The difference outside directors make are :
•
A study showed that having outside directors is associated with fewer shareholder lawsuits.
•
It is found that outside directors correlated positively with dimensions of social responsibility associated with both people and product quality.
•
The most important characteristic for outside directors is the ability to ask difficult questions and speak truthfully about concerns, without letting ties to the firm get in the way.
5. Use of Board Committees •
The audit committee is responsible for assessing the adequacy of internal control systems and the integrity of financial statements.
•
Nominating committee, which should be composed of outside directors, has the responsibility of ensuring that competent, objective board members are selected.
•
Compensation committee, which also should be composed of outside directors, has the responsibility of evaluating executive performance and recommending terms and conditions of employment.
•
Public issues committee or Public policy committee is responsible for responding to public or social issues, provide policy leadership, and monitor management’s performance on these issues.
6. The Board’s Relationship with the CEO •
Boards of directors are responsible for monitoring CEO performance and dismissing poorly performing CEO’s.
•
Because of the above stated changes, CEO’s are dropping like flies. They have no security of employment.
•
Due to global recession the turnover of CEO has reduced.
7. Board Member Liability
•
Concerned about the increasing legal hassles, directors have been quitting or rejecting board positions.
•
Hence the Business judgment rule prevailed.
•
The rule holds that courts should not challenge board members who act in good faith, making informed decisions that reflect company’s best interests instead of their own selfinterest.
•
It gives directors the freedom to take risks without fear of liability.
The Role of Shareholders Shareholders are the owners of the corporation. 1. Shareholder Democracy •
The shareholder democracy movement stems from the lack of power shareholders have felt, particularly in board elections.
•
Proponents of shareholder democracy contend that increased shareholder power and involvement will lead to improved firm performance.
•
Opponents say that shareholders are not owners in the traditional sense of the word because they can exit their ownership relatively easily by simply selling their shares. They contend that increased shareholder power will lead to inefficient and short term oriented decision making, as well as infighting among competing interests.
•
The movement however has raised three key issues that are :
•
Majority vote- it is the requirement that board members be elected by a majority of votes cast. This is in contrast to the previously prevailing norm of plurality.
•
Classified Boards- they are those that elect their members in staggered terms. For example, in a board of 12 members, 4 might be elected each year, and each would serve a three-year term. It would then take three years for the entire board slate to be replaced.
•
Proxy access- it provides shareholders with the opportunity to propose nominees for the board of directors. In the prevailing system, shareholders must file a separate ballot if they want to nominate someone. So now they are asking for the ability to place their candidates directly on proxy material.
The Role of the SEC •
The SEC is responsible for protecting investor interests.
•
But many argue that SEC often appears more focused on the needs of the business that on that of investors.
•
A ponzi scheme lures investors in with the fake promise f profit but actually pays earlier investors with later investors’ money until the scheme collapses.
•
The SEC failed to stop a major ponzi scheme that cost the investors around the world tens of billions of dollars even though they were warned of the scheme a decade before.
Shareholder Activism •
Shareholder activists have historically been socially oriented; that is, they want to exert pressure to make the companies in which they own stock more socially responsive.
•
The growth of shareholder activism shows no signs of abating. Activist shareholders, known also as corporate gadflies, are no longer dismissed as nuisance and are instead viewed as credible, powerful and a force with which to be reckoned.
Shareholder Resolutions •
One of the major ways by which shareholder activists communicate their concerns to management groups is through the filing of shareholder resolutions.
•
To file a resolution, a shareholder or a shareholder group must obtain a stated number of signatures to require management to place the resolution on the proxy statement so that it can be voted on by all the shareholders.
•
Although individuals could initiate a shareholder resolution, but he or she may not have the resources or means to obtain the required signatures.
•
The issues on which shareholder resolutions are filed vary widely, but the typically concern some aspect of a firm’s social performance. Few examples are executive compensation, animal testing, board structure, sustainability reporting, board diversity and climate change.
Shareholder Lawsuits •
Shareholders sued the board of directors for a decision that’s against their interests.
Investor Relations •
Over the years, it has been seen that corporate managements have been neglecting their owners because they have been too pre-occupied to fulfill their own self-interest. But now, the scene has changed. Corporations are beginning to realize that they have a responsibility to their shareholders that they cannot neglect further. Owners are demanding accountability, and it appears that they will be tenacious until they get it.
•
Public corporations have obligations to existing shareholders as well as potential shareholders. Full disclosure (transparency) is one of these responsibilities.
•
Another responsibility of management is to communicate with shareholders.
