Transcript Title

Chapter 13
Corporate Governance in the
Twenty-First Century
OBJECTIVES
1
Explain what is meant by corporate governance
2
Describe how corporate governance relates to
competitive advantage and understand its basic
principles and practices
3
Identify the roles of owners and different types
of ownership profiles in corporate governance
4
Describe how boards of directors are structured
and the roles they play in corporate governance
5
Explain and design executive incentives as a
corporate governance device
6
Describe how the market for corporate control is
related to corporate governance
7
Compare and contrast corporate governance
practices around the world
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SUNBEAM
Al Dunlap’s mgmt. philosophy
1. Shareholders are most important
corporate constituents
2. Most corporations have bloated
bureaucracies
Results
Early
success
Signs
of problems
5. CEOs should be rewarded like
stars when they perform well
and fired when they do not
6. Board members should have
significant personal investments
in the company
billion to $5 billion
• With R&D budgets cut, new
3. Drastic layoffs are usually needed
to save failing companies
4. Layoffs should be quick,
one-time events
• Costs slashed
• Stock doubled in first month
• Market cap rises from $1.1
Failure
•
•
product development hampered
Growth fails to meet targets
Company accused of “channel
stuffing”
• Board fines Dunlap
• He loses his stock options
• Sunbeam stock is delisted
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CHAINSAW AL
“The last dirty secret in the
corporate world is how directors
live off the fat of a business that
is not their employer. I started a
revolution by insisting that Scott
directors be paid only in stock.”
- Al Dunlap
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CORPORATE GOVERNANCE
In a broader perspective, governance determines how all
stakeholders influence the corporation:
Shareholders
Corporate governance
The system by which
organizations,
particularly business
corporations, are
directed and controlled
by their owners
Board
Management
Corporation
Employees
Society
Environment
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CORPORATE GOVERNANCE IMPACTS PERFORMANCE
The Italian stock
exchange started
a new exchange
called STAR for
small and midsized companies
that followed
strict governance
prescriptions
Companies of the STAR
exchange consistently
out perform their
counterparts on the
regular exchange (e.g.,
during 2004 STAR firms
achieved returns 24.5%
greater than their
counter parts)
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AGENTS AND PRINCIPALS
• When interests are virtually
Principals
Shareholders
of a firm
Agents
Act on behalf
of principals
in managing
the firm
identical, the agency
problem is small: executives
do what is in principals’ best
interests
• However interests often do
not overlap. Then agents
may act to detriment of
principals and visa-versa
(e.g., executives raise
salaries and reduce returns)
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EXAMPLES OF CODES OF GOVERNANCE
What is the
recommendation
on director
independence?
Can the same
executive be both
CEO &
chairperson?
Is auditor rotation
required?
Brazil CVM
Code (2002)
As many as possible
Split recommended
Not addressed
No
Russia CG Code
(2002)
At least one-quarter
Split required by law
Not addressed
No
Singapore CG
Committee
(2001)
At least one-third
Split recommended
Not addressed
Yes
United Kingdom
Cadbury Code1
Majority
Split recommended
Periodic rotation of
lead auditor
Yes
United States
Conference
Board and
CalPers (2003)2
Substantial majority
Separation is one of
three acceptable
alternatives
Recommended3
No
Country
Is disclosure required
if the company does
not comply with the
recommendations?
1. In 2003, a Combined Code made further additions to the code, but these basic principles remain
2. Just one of several codes in existence in the United States
3. The Sarbanes-Oxley Act requires that the lead audit partner be rotated every 5 years; changing audit firm after 10 years of continual relationship or if former audit
partner is employed by the company
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INSTITUTIONAL ACTIVISM ON THE RISE
CalPERS
known for their institutional activism
TIAA-CREF
Corporate Governance Team
8
ROLES AND ACTIONS OF BOARD OF DIRECTORS
9
STAGGERED BOARDS
A
turn over
the entire
are
at once
Board does
not
staggered so
Board
elections
Nearly 2/3 of boards today are
considered staggered.
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BOARD INVOLVEMENT
Phantom
Phantom boards have
no involvement in the
strategic
management process
of the firm.
Active
The public (and major
stakeholders) have
higher expectations
for board involvement
today.
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INCENTIVE ALIGNMENT
Conflicts of interest can arise
Principals
Incentive
alignment can solve
such problems
Agents
Example:
• A company receives a buy-out
offer
• Shareholders (principals) would
benefit because price assures a
good return on investment
• Management (agents) resists
because they may lose their
jobs
Boards can include
“golden parachute”
provisions in
manager’s
compensation
packages
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HOW WOULD YOU DO THAT? – DENDRITE INTERNATIONAL
Dendrite’s challenge:
Dendrite’s solution:
How can Dendrite better align
management
incentives with shareholders?
 20 senior-most executives must
own 15,000 to 100,000 shares of
stock
 Must be common shares
not options
 Must be achieved within 5 years
 Executives may elect to receive
incentive compensation in
stock instead of cash
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EXECUTIVE STOCK OWNERSHIP IN 2004
Largest 250 companies with
stock ownership guidelines
Number of
companies
Percent of
companies
Percent increase
from 2001 to 2004
Executives
142
57
58
Directors
123
49
127
Source: Adapted from Fredrick W. Cook & Co., Inc., “Stock Ownership Policies: Prevalence and design of Executive and Director
Ownership Policies Among the Top 250 Companies,” www.fecook.com/surveys.html (accessed Nov 29, 2005), Sep 2004
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INCENTIVE COMPENSATION
Annual bonus
plans
Oldest form of incentive pay. Board can evaluate executives’
performance along multiple dimensions and allocate a yearend cash award
Stock options
An employee receives the right to buy a set number of shares
of company stock at a later date for a predetermined price
Other longterm
incentives
More recent forms of incentive compensation. Long-term
bonuses linked to performance over several years. May help
executives avoid short-term myopia and focus on long-term
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HIGHEST PAID CEOs
Source: Company annual reports and ExecComp Service of Thomson Financial, www.aflcio.org/Corporate-Watch/CEO-Pay-and-the-99
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EXECUTIVE PAY TRENDS
Source: U.S. Bureau of Labor Statistics, www.aflcio.org/Corporate-Watch/CEO-Pay-and-the-99
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THE MARKET FOR CORPORATE CONTROL
Share holders
Elect
Example:
Corporate control:
The right to choose
the members of the
board of directors
of a company and
to control all major
decisions made
by a company
Board
Hires/fires
Top management
• Corporate raiders such
as T. Boone Pickens,
CarI Icahn, Ted Turner
and Michael Milken
• Oracle engaged in 18month battle to gain
control of PeopleSoft
Directs
Corporation
18
POOR CORPORATE GOVERNANCE, A WORLD-WIDE PROBLEM
Recent examples of scandal-ridden non-U.S. multinationals
• Netherlands Ahold Group (grocery stores)
• Italy’s Parmalat (dairy and food products)
• France’s Vivendi (entertainment)
• French-Belgian Firm ELF (petroleum)
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CORPORATE GOVERNANCE: U.S VS. JAPAN
U.S
Japan
Owner-manager
relationship
Adversarial
Co-operative
Manager and
shareholder
relationship
Through one
company
Through a Keiretsu
(group of interlocking
companies)
Ownership
concentration
Control function
Monitoring function
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