BOARDS AND DIRECTORSTHE POLITICAL MECHANISMS OF CORPORAT GOVERNANCE

CHAPTER 2

Outline

Role of Directors

Role of Board

The Agency Problem

Dependent vs Independent Boards

Risk Management

Executive Reward

BOARDS OF DIRECTORS:

THE DNA OF

CORPORATE

GOVERNANCE

WHAT BOARDS DO?

ControlMonitoring the management of the company and ensuring accountability.

StrategyApproving and monitoring the strategic direction of the company.

CounselProviding advice and counsel to the company executives on critical matters.

InstitutionalBuilding institutional relationships with investors, stakeholders and the community

Sources: (Carter & Lorsch (2004:67); Zahra & Pearce (1989); Johnson et al (1996); Daily et al (2003).

The Two Primary Functions of the Board

Outwardlooking

Inwardlooking

Providingaccountability

Strategyformulation

Monitoring andsupervising

Policymaking

Approve and work withAnd through the CEO

Past and present focused Future focused

Source: F. Hilmer and R. I. Tricker (1991).

Outwardlooking

Inwardlooking

Providingaccountability

Strategyformulation

Monitoring andsupervising

Policymaking

Approve and work withAnd through the CEO

Past and present focused Future focused

Source: F. Hilmer and R. I. Tricker (1991).

Levels of Governance (Dawson 2004)

Business Ethics/Principles

Procedures/Processes

Practices/Behaviour

Board Structure and Performance

Independence

Diligence

Competence

Ethics

Board structure

Productive meetings

Succession planning system

Financing reporting/risk management

Strategic information systems

Performance evaluation/compensation systems

Superior strategic guidance

Accountable organisations

High quality senior executives

Long term financial success

Out

com

es

Ou

tpu

ts

Pro

cess

es

Inp

uts

Board Composition

Corporate Performance

Board Performance

Board systems and

structure

Source: Determinants of Board Performance Source: Epstein & Roy 2004, p. 4

OUTWARDLOOKING

INWARDLOOKING

Providing Accountability Strategy Formulation

Monitoring and Supervising Policy Making

PAST AND PRESENT FOCUSED FUTURE FOCUSED

Source: F. Hilmer and R. I. Tricker, 1991.

CONFORMANCE PERFORMANCE

Framework for Analyzing Board Activities

Managed vs the Governed Corporation

The Managed Corporation The Governed Corporation

The board’s role is to hire, monitor and when necessary, replace management

The board’s role is to foster effective decisions and reverse failed policies

Board Characteristics Board Characteristics

Power sufficient to control the CEO and the evaluation process

Independence to ensure that the CEO is honestly evaluated and that directors are not compromised by conflicts or co-opted by management

Board procedures that allow outside directors to evaluate managers dispassionately and effectively

Separate the CEO and chair (or lead outside director)

Board meetings without the CEO present Committee of independent directors to

evaluate the CEO Independent financial and legal advisers to

outside directors Explicit yardsticks for judging the CEO’s

performance

Expertise sufficient to allow the board to add value to the decision-making process

Incentives to ensure that the board is committed to creating corporate value

Procedures that foster open debate and keep board members informed and attuned to shareholders’ concerns

Required areas of expertise that must be represented on the board, such as core industry and finance

Minimum time commitment of twenty-five days per year

Large options package for directors Designated critic to question new policy

proposals Regular meetings with large shareholders Board members free to request information from

any employee

4.5

2.8

2.72.34.0

6.0

4.0

3.0

1.01.0

1.0

1.0

0

2

4

6

8

10

12

14

FTSE 100 FTSE 250 Other Listed Grand Total

Chairman

Executive directors

Non-Exec

Source: Higgs, D. (2003). “Review of the Role and Effectiveness of Non-Executive Directors”. London : Department of Trade and Industry

Average Size and Composition of UK Boards

DIRECTOR’S DUTIES

The UK Company Law Reform Bill (2005)

Act within the powers conferred;

Promote the success of the company for the benefit of its members. Directors must have regard to the long term and wider factors such as relationships with employees, suppliers, customers and the impact of the company’s operations on the community and environment;

Exercise independent judgment;

Exercise reasonable care, skill and diligence;

Avoid conflicts of interest;

Not to accept benefits from third parties;

Declare an interest in a proposed transaction with the company.

Board Judgement

The one element that is absolutely essential in the armoury of directors and boards is judgement:

“Legally, the board is the highest authority in the company, the ‘fountain of power’, yet top management naturally tends to exercise that power…

Board members are expected to provide critical judgement on management performance

– which requires an in-depth knowledge of, and intimacy with the affairs of the corporation

– and at the same time to assure that this judgement is independent – which requires detachment and distance…

Business Judgement Rule

In recognition of the complexity of business decision making, and in order to allow the essential element of risk-taking in business activity, case law in the United States and in many other jurisdictions recognises the business judgement rule that provides directors broad discretion to make decisions in good faith.

As long as there is not evidence of fraud, gross negligence or other misconduct directors will not be held responsible for a business judgement if it proves to be mistaken.

Unless there is evidence of fraud or negligence a court will not second-guess directors by holding them liable for any action attributable to a rational business purpose.

BOARD DUTIES AND FUNCTIONSThe OECD Principles of Corporate Governance (2004)

Reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives, monitoring and implementation and corporate performance; and overseeing major capital expenditure, acquisitions and other divestitures.

Monitoring the effectiveness of the company’s governance practices and making changes as needed.

Selecting, compensating, monitoring and, when necessary, replacing key executives and overseeing succession planning.

Aligning key executives and board remuneration with the longer term interests of the company and its shareholders.

BOARD DUTIES AND FUNCTIONSThe OECD Principles of Corporate Governance (2004)

Ensuring a formal and transparent board nomination and election process.

Monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse of related party transactions.

Ensuring the integrity of the corporation’s accounting and financial reporting systems, including the independent audit and appropriate systems of control are in place, in particular systems for risk management, financial and operational control, and compliance with the law and relevant standards.

Overseeing the process of disclosure and communications (2004:24-5).

Active Boards

Active Boards The ideal portrayal of the board is as an active, deliberative and decisive

forum for the business: “Boards of directors collectively determine, through the decisions they make, the fate of the corporation…The principal work of a board of directors is to make decisions.” Leblance & Gillies (2005).

However boards are inevitably part-time, (due firstly to the necessary extensive external other commitments of directors that enhance the potential contribution they may make to the company; and to the fact that boards that begin to become nearly full-time inevitably stray into operational management, often losing their sense of objectivity and detachment in the process).

Passive Boards

There is much evidence that in the past boards of directors enjoyed a fairly passive existence, carrying out their duties, if at all, in a largely nominal way

Mace (1971); Lorsch & MacIver (1989).

“I served for one fateful year on the board of Penn Central. The education was fast, brutal and highly practical. At each Penn Central directors’ meeting, which only lasted one and a half hours, we were presented with long lists of relatively small capital expenditures to approve, we were shown sketchy financial reports which were rarely discussed in any detail. The reports were not designed to be revealing, and we were asked not to take them away from the meeting. We always had an oral report by the Chief “

(Louis Cabot, Harvard Professor)

The Enron Legacy

Enron Asleep at The Wheel

Fiduciary failure High risk accounting Inappropriate conflicts of interest Extensive undisclosed off the books activities Excessive compensation Lack of independence

Enron’s Rise and Fall

Enron Events vs Closing Stock Price

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

31/0

8/19

98

30/0

9/19

98

31/1

0/19

98

30/1

1/19

98

31/1

2/19

98

31/0

1/19

99

28/0

2/19

99

31/0

3/19

99

30/0

4/19

99

31/0

5/19

99

30/0

6/19

99

31/0

7/19

99

31/0

8/19

99

30/0

9/19

99

31/1

0/19

99

30/1

1/19

99

31/1

2/19

99

31/0

1/20

00

29/0

2/20

00

31/0

3/20

00

30/0

4/20

00

31/0

5/20

00

30/0

6/20

00

31/0

7/20

00

31/0

8/20

00

30/0

9/20

00

31/1

0/20

00

30/1

1/20

00

31/1

2/20

00

31/0

1/20

01

28/0

2/20

01

31/0

3/20

01

30/0

4/20

01

31/0

5/20

01

30/0

6/20

01

31/0

7/20

01

31/0

8/20

01

30/0

9/20

01

31/1

0/20

01

30/1

1/20

01

31/1

2/20

01

Overseas Projects major source of gains

Oct 19, 98 Enron's price at par withindustry

Dabhol Project, India

Mar, 99 Becoming a blue chip. Azurix Acquisition becoming major global water company

Industry Index

Dot Com Boom

Aug. 23, 2000price reaches $90

Energy Crisis

Feb 5, 2001, Andersen discuss dropping Enron as client

Lay dishonestly told employees that Enron stock was a bargain

Oct. 2001 Share price drops to $35. Aannounces a 1.2 bn write off related to trading transactions. Oct. 22, SEC Inquiry begins, Andersen rids of Enron related documents. Details emerge of CFO conflicts of interest, CFO quits

Aug 2001, Lay receives Watkins warning letter and sells 95,000 shares,that earns him 2 million and urges employees to buy

Nov 1, 2001 secures $1bn credit line from JP Morgan Chase & CitigroupNov 8, News that Enron inflated income by $586 million since 1997Nov 9, Dynegy is close to agreeing rescue bid of $8bn but late Nov, Dynegy pulls outNov. 28 last trading $0.61 Dec 2, Chapter 11 Filing

The Crash

1. Audit committee told Enron accounting practices “push limits”2. Board Approves Fastow’s Code of waiver for LJM13. Whitewing moved off-balance sheet with $1.5 billion4. Board approves second Fastow waiver for LJM25. LJM2 update: “Q41999: 8 days/ 6 deals/ $125 million”;6. Executive committee approves third Raptor II7. “Project Summer” to sell $6 billion in assets fails; Board approves Raptor III/ IV8. Board approves third Fastow waiver for LJM3; Board told $27 billion in assets off-balance sheet9. Board told total revenues jump from $40 billion in 1999 to $100 billion in 2000: Audit and finance Committees review LJM procedures and for Y2000 transactions

10. Fortune article questions Enron’s earnings and accounting11. Board told 64% of asset portfolio “Troubled” or “Not

performing”; 45 million Enron shares at risk in Raptors & Whitewing

12. Board told of $2.3 billion deficit in market value of Enron’s international assets13. Fastow sells interest in LJM to Kopper14. Skilling resigns; Finance Committee told of $ 6.6 billion in prepays and FAS 125 transactions15. Lay defends use of SPEs in online session with employees16. Finance Committee told of $800 million earnings write-down from Raptors; Audit Committee told of closed investigation into the Watkins letter.

$0

$20

$40

$60

$80

$100

Jan-

99

Mar

-99

May

-99

Jul-9

9

Sep

-99

Nov

-99

Jan-

00

Mar

-00

May

-00

Jul-0

0

Sep

-00

Nov

-00

Jan-

01

Mar

-01

May

-01

Jul-0

1

Sep

-01

Nov

-01

2

3

4

5

6

7

8 9

10 11

1213

14

15

16

1

Source: US Senate Permanent Subcommittee on Investigations, May 2002 2123130 RED FLAGS –GA INVESTIGATIONS

Red Flags Known to Enron’s Board

WorldCom’s Rise and Fall

WorldCom’s Board Didn’t Prevent the Tragedy

As the report prepared for the District Court of New York stated:

‘WorldCom’s board didn’t do many things that might have prevented or limited the tragedy.

On average the board met quarterly, and the meetings were largely filled with formal presentations to the directors and other routine exercises, including CEO Ebber’s opening prayer.

The Audit Committee most vividly exemplified the board’s inadequate time commitment…The Audit Committee spent as little as six hours per year in overseeing the activities of a company with more than $30 billion in revenue, while the WorldCom Compensation Committee met as often as 17 times per year.

‘going through the motions’ rather than developing a thorough understanding of the accounting policies, internal controls and audit programs in use by the Company…

WorldCom’s Board Lack of Independent Members

Despite having a separate Chairman of the Board and independent members, the board did not act like it was in control of the Company’s overall direction.

Rather than making clear that Ebbers served at the pleasure of the Board, and establishing reasonable standards of oversight and accountability, the board deferred at every turn to Ebbers.

Ebbers controlled the board’s agenda, the timing and scope of board review of transactions, awards of compensation, and the structure of management. He ran the Company with an iron control, and the board did not establish itself as an independent force within the Company.

WorldCom’s Board Didn’t have Control of the Agenda

The Chairman of the Board did not have a defined role of substance, did not have control of the board’s agenda, did not run the meetings and did not act as a meaningful restraint on Ebbers…

WorldCom met the formal standards, and yet the board did not take action to limit Ebbers’ power.

Formalities were usually observed, and yet no director said ‘no’ when the Ebers loans of $408 million came before the Board, no director said ‘no’ to grants of massive volumes of stock options, and

No director appears to have questioned Ebbers’ competence and fitness to serve as CEO until the disaster was unavoidable” (Breeden 2003:33-5).

THE REFORM OF BOARDS

Specialized Board Committees Adoption

Country Audit(1995)

Audit(1998)

Remuneration (1985)

Remuneration(1998)

Nomination(1985)

Nomination(1998)

France – CAC 40

0% 90% 0% 70% 0% 43%

France- Privatized firms

- 100% _ 75% _ 66%

Germany – Dax 30

0% 7% 0% 3% 0% 7%

Japan – Top 1,300

0% 0% 0% 0% 0% 0%

UK – FTSE 350

21% 100% 23% 100% 7% 73%

USA –S&P 500

34% 100% 30% 97% 5% 87%

Source: Goyer (2001). “Corporate governance and the Innovation System in France 1985-2000’ Industry and Innovation, 8(2): 135-158

The Transformation from Management Control to Independent Boards

NON- EXECUTIVES

Chairman &

Chief Executive

E X E C U T I V E SInvestorsrelations

Board Appointments

Auditing ofAccounts

Executive Remuneration

Management Controlling the Levels of Power

The Board Controlling the Levers of Power

EXECUTIVES

Investorsrelations

Board Appointments

Auditing ofAccounts

Executive Remuneration

Chairman

ChiefExecutive

N O N - E X E C U T I V E S

Senior Independent

directors

NominationCommittee

Audit Committee

RemunerationCommittee

Source: Taylor (2004)

The Transformation from Management Control to Independent Boards

Comparative Analysis of Board Structure in 2003 (Selected Countries)

USA (1) S&P 500

USA (2)Biotech

USA (3)Silicon Valley

CAN (4) UK (5)

NL (6) ITALY (7)

SPAIN (8)

SOUTH AFRICA

(9)

Average board size 11 8 7 12.3 10.8 5.1 14 12.6 12

Average annual board meetings 7.8 6.6 7.4 9.4 >8 6.8 (11)

12 9.4 4

Outside directors (%) 80 78 75 77 52.1 91 (12)

57 (13) 36 (16) 34

Separation CEO & Chairman (%) 23 28 - 77 83.3 98 Low 68 88

Average outside directors’ age 60 60.7 56 - 58 60.7 57.9 56 54.1

Have three key committees (%) (10) 80 100 77 92 91.3 89 Low (15) 85

Director’s retirement age 70/72 - 69 70 - - 80 70 69.7

Fully independent audit committee (%)

98 100 96 91 - 94 100 100 50

Fully independent compensation committee (%)

96 100 94 81 86.7 73 (14)

16.7 67 33

Fully independent nominating committee (%)

91 100 88 83 - Low Low 67 28

Average annual director’s pay (cash retainer)

$43,667 $19,630 $24,972 Can $40.000

GBP 35K

E32K E41.4K E45.5K R62K

Lead/Senior Director 36 - 12 - 83 - 0 - -

Formal annual board evaluation 87 - - 86 43 - - - 42

Sources: Data for these Spencer Stuart Board Indexes are taken from the most recent company proxy filings. www.spencerstuart.com

Corporate Governance Quotient Global Rating Criteria

Corporate loans

Option Burn RateCEO Succession Plan

Option ExpensingMeeting of Outside Directors

Pension Plans for Non Employee DirectorsBoard Performance Review

Director CompensationRetirement Age for Directors

Compensation Committee InterlocksRelated Party Transactions

Shareholder Approval of Option PlansBoard Vacancies

Option RepricingBoard Attendance

Cost of Options PlansResponse to Shareholders Proposals

COMPENSATIONBoard Guidelines

Laws – Has Company Opted Out?Chairman/ CEO Separation

Takeover Provision Applicable Under StateFormer CEOs

Capital StructureBoards Served On -other than CEO

Officer and Director Stock OwnershipBoard AmendmentsBoards Served On – CEO

Director Stock Ownership GuidelinesSpecial MeetingsCumulative Voting

Executive Stock ownershipWritten ConsentChanges in Board Size

Director OwnershipVote RequirementsBoard Size

OWNERSHIPFeatures of Poison PillsBoard structure

Auditor RatificationEQUITY STRUCTUREGovernance Committee

Auditor RotationDirector EducationCompensation Committee

Audit FeesDirectors Resign Upon Job ChargeNominating Committee

Audit committee Outside Advisors Available to BoardBoard Composition

AUDITBOARD STRUCTUREBOARD STRUCTURE

Corporate loans

Option Burn RateCEO Succession Plan

Option ExpensingMeeting of Outside Directors

Pension Plans for Non Employee DirectorsBoard Performance Review

Director CompensationRetirement Age for Directors

Compensation Committee InterlocksRelated Party Transactions

Shareholder Approval of Option PlansBoard Vacancies

Option RepricingBoard Attendance

Cost of Options PlansResponse to Shareholders Proposals

COMPENSATIONBoard Guidelines

Laws – Has Company Opted Out?Chairman/ CEO Separation

Takeover Provision Applicable Under StateFormer CEOs

Capital StructureBoards Served On -other than CEO

Officer and Director Stock OwnershipBoard AmendmentsBoards Served On – CEO

Director Stock Ownership GuidelinesSpecial MeetingsCumulative Voting

Executive Stock ownershipWritten ConsentChanges in Board Size

Director OwnershipVote RequirementsBoard Size

OWNERSHIPFeatures of Poison PillsBoard structure

Auditor RatificationEQUITY STRUCTUREGovernance Committee

Auditor RotationDirector EducationCompensation Committee

Audit FeesDirectors Resign Upon Job ChargeNominating Committee

Audit committee Outside Advisors Available to BoardBoard Composition

AUDITBOARD STRUCTUREBOARD STRUCTURE

Source: FTSE ISS CGI SeriesSearch Report April 2005

ISS Corporate Governance Quotient I

Board Board Composition Nominating Committee Compensation Committee Governance Committee Board Structure Board Size Changes in Board Size Cumulative Voting Boards Served On – CEO Boards Served On – Other than CEO Former CEOs Chairman/CEO Separation Governance Guidelines Response to Shareholder Proposals Board Attendance Board Vacancies Related Party Transactions - CEO Related Party Transactions - Other than CEO

Audit Audit Committee Audit Fees Auditor Ratification Financial Expert

Charter/Bylaws Poison Pill Adoption Poison Pill - Shareholder ApprovalPoison Pill - TIDE Provision Poison Pill - Sunset Provision Poison Pill - Qualified Offer Clause Poison Pill - Trigger Vote Requirements - Charter/Bylaw Amendments Vote Requirements - Mergers & Business

Combinations Written Consent Special Meetings Board Amendments Capital Structure – Dual class Capital Structure – Blank check preferred

ISS Corporate Governance Quotient II

State of Incorporation State Anti-takeover Provisions Control Share Acquisition Provision Control Share Cash-out Provision Freeze-out Provision Fair Price Provision Stakeholder Law Poison Pill Endorsement  

Executive and Director Compensation Cost of Option Plans Option Repricing Shareholder Approval of Option PlansCompensation Committee Interlocks Director Compensation Option Burn Rate Performance-Based Compensation Option Expensing  

Board Performance Reviews Individual Director Performance Reviews Meetings of Outside Directors CEO Succession Plan Outside Advisors Available to Board   Director Ownership Executive Stock Ownership Guidelines Director Stock Ownership Guidelines Officer & Director Stock Ownership Mandatory Holding Period for Options Mandatory Holding Periods for Restricted

Stock  

Director Education Director Education

The Learning Board Model

ACCOUNTABILITY POLICY FORESIGHT

• To owners• To regulators & • Legislators• To stakeholders• Ensuring Directoral• audits

• Purpose• Vision & Values• Emotional

Climate & culture• Monitoring external

environment

• Overseeingmanagementperformance

• MonitoringBudgetarycontrol

• Reviewing keyBusiness results

• Ensuring organi -zational capability

• Positioning in thechanging markets

• Setting corporatedirection & processes

• Reviewing & decidingkey resources

• Assessing risks• Implementing strategy

EXTERNAL

INTERNAL

SHORT TERM LONG TERM

Envisioning

Au

dit

ing

Co

mm

un

ica

tio

n

Se

nsitizin

gP

ositio

nin

g

ImplementingSource: Garratt (2003)

Key Risks Areas

Business risk Legislative risk People risk Disaster risk

Asset management &

resource

planning.

Business interruption.

Change: organisational/

technical/ political.

Construction activity.

Feasibility studies.

Foreign exchange operations.

Information systems/ computer

networks investments.

Operations & maintenance

systems .

Transport (air, sea, road, rail).

Project Management

Purchasing contract mgmt

Treasury and finance

Design & product liability

Directors’ & officers’

Liability.

Employment procedures,

training, discrimination &

Harassment.

Environmental issues.

Fraud prevention/

detection/ management.

Legislative requirements

Occupational Health &

Safety

Public risk & general liability

Ethics & probity

Issues.

Human, animal &

plant health.

Professional

Advice.

Reputation & image

Issues.

Security

Contingency, disaster

&emergency planning

Fire detection/ fire

prevention

Strategic Role of the Board

Single plant,Single product

Verticalintegration

Horizontalintegration

DiversificationRelated or unrelated

Diversificationgeographic

Internal Organicgrowth

Mergers andAcquisitions,Spin-off anddivestitures

Inter-organizationale.g. joint ventures,Franchising, Alliances.

Equity –Public and/or private

Debt-Bank, public

Retainedearnings

Trade creditand networks

U- form

M- formGeography,Product.

H- form

Matrix

Direction

Method Finance Structure

Typology of Directors

Source Kirkpatrick (2004)

Conflict -Sensitive Functions

Perspective; Objectivity

“Independent” Directors

Long -Term Planning; Oversight of Key Risk Areas

Strategy; Continuity; Expertise

Non -Executive (“Outside”) Directors

Management Nexus -Focused

Knowledge of Day -To Day Operations; Communicate Implement Decisions

Executive Directors

Conflict -Sensitive Functions

Perspective; Objectivity

“Independent” Directors

Long -Term Planning; Oversight of Key Risk Areas

Strategy; Continuity; Expertise

Non -Executive (“Outside”) Directors

Management Nexus -Focused

Knowledge of Day -To Day Operations; Communicate Implement Decisions

Executive Directors

Studies on Strategic Involvement of the Board

Strength of Involvement

Description Studies

Passive Statutory boards Pro-forma (Pahl & Winkler 1974)Minimalist (Pettigrew & McNulty 1995)Statutory (Aram & Cowan 1986)Managerial control (Molz 1985)Ratifying (Wood 1983)Legalistic (Zahra & Pearce 1989)First-level Board (Ferlie et al 1994)

Review boards Review and approve (Molz 1985)Review and analysis (Zahra 1990)Second stage board (Ferlie et al 1994)Third party (Herman 1981)

Active Partnership Collegial (Vance 1983)Shared leadership (Herman 1981)Participative (Wood 1983)Normative/strategic (Molz 1985)Maximalist (Pettigrew & McNulty 1995)Partnership (Zahra 1990)

Source: Stiles & Taylor (2002)

Red Flags for Investors

24. A company that restates its results

23. The use of one time earnings gains ( or aggressive pension fund assumptions) to reach earning targets

22. Companies that always meet or beat earning expectations

21. Big payments are made to executives for their work on takeovers

20. When top executives own very little of their company’s stock

19. When stock options are handed to executives like there is no tomorrow

18. When CEO pay is not linked to performance

17. When senior management includes the company’s former auditor

16. A CEO is built up as the new star who is going to fix everything

15. A company is facing a large number of large class action law suits

14. The SEC launches a full-scale probe into possible securities fraud

13. don’t get caught up in the latest fad; it probably won’t last

12. Beware of accountants who are promoters of the latest business fad

11. When net profit is raising but cash flow is declining or negative

10. Companies dipping in and out of cookie-jar reserves

9. A company hides behind anti-takeover devices and ignores votes to change

8. cross-Board memberships can lead to conflicts of interest

7. If a company rewards failure by repricing stock options

6.-A CEO is known as a serial acquirer rather than a builder

5. Beware the worst combination of all: an aggressive CEO and a compliant CFO

4. The Quitter: When a CEO leaves without explanation.

3. When money is easy to raise, be alert to companies doomed to fail.

2. Is a technology stock is said to transform the world, it is being over-hyped

1. When you find the big lie, everything else crumbles

24. A company that restates its results

23. The use of one time earnings gains ( or aggressive pension fund assumptions) to reach earning targets

22. Companies that always meet or beat earning expectations

21. Big payments are made to executives for their work on takeovers

20. When top executives own very little of their company’s stock

19. When stock options are handed to executives like there is no tomorrow

18. When CEO pay is not linked to performance

17. When senior management includes the company’s former auditor

16. A CEO is built up as the new star who is going to fix everything

15. A company is facing a large number of large class action law suits

14. The SEC launches a full-scale probe into possible securities fraud

13. don’t get caught up in the latest fad; it probably won’t last

12. Beware of accountants who are promoters of the latest business fad

11. When net profit is raising but cash flow is declining or negative

10. Companies dipping in and out of cookie-jar reserves

9. A company hides behind anti-takeover devices and ignores votes to change

8. cross-Board memberships can lead to conflicts of interest

7. If a company rewards failure by repricing stock options

6.-A CEO is known as a serial acquirer rather than a builder

5. Beware the worst combination of all: an aggressive CEO and a compliant CFO

4. The Quitter: When a CEO leaves without explanation.

3. When money is easy to raise, be alert to companies doomed to fail.

2. Is a technology stock is said to transform the world, it is being over-hyped

1. When you find the big lie, everything else crumbles

Source: Martin Howell, Predators and Profits ( Upper saddle River, N>J>: Reuters Prentice Hall,2003).

Board Defences

Limitations of action by written consent, for establishment of majority thresholders, unanimous consent, elimination of the right to take action.

Written Consent

They limit the voting rights of some shareholders and expand those of othersUnequal Voting

Charter provision for approval of mergersSupermajority

They increase or decrease the level of shareholder support required to call a special meeting

Special Meeting

Similar to golden parachutes but on behalf of employeesSilver Parachutes

Agreements to assure executives of their positions or some compensation, but they are not contingent upon a change in control

Executives Severance

Limitations of action by written consent, for establishment of majority thresholders, unanimous consent, elimination of the right to take action.

Written Consent

They limit the voting rights of some shareholders and expand those of othersUnequal Voting

Charter provision for approval of mergersSupermajority

They increase or decrease the level of shareholder support required to call a special meeting

Special Meeting

Similar to golden parachutes but on behalf of employeesSilver Parachutes

Agreements to assure executives of their positions or some compensation, but they are not contingent upon a change in control

Executives Severance

Source: Gompers, Ishii and Metrick (2001)

Independent third party or employees sworn to secrecy are used to proxy votes and the management agrees not to look at individual proxy cards

Secret Ballot

Securities that provide their holders with special rights in the case of a triggering event such as a hostile takeover bid

Poison Pills

Surplus funds are required to remain the property of the pension fund and this prevents an acquire from using these funds to finance an acquisition

Pension Parachutes

It limits the director’s personal liability, mainly for breaches of the duties of care but not for breaches of the duty of loyalty or for intentional misconduct

Liability

To indemnify directors and executives from legal expenses and law suits pertaining their conduct. This provision uses the bylaws and charter of the company

Director Indemnification

Severance agreements which provide cash and non cash compensation to senior executives upon a triggering event such as termination, demotion or resignation following a change in control

Golden Parachutes

These requirements limit the range of prices a bidder can play in two-tier offersFair Price

They allow directors to consider constituencies other than shareholders when considering a merger (employees, host communities, suppliers)

Director’s Duties

A shareholder can allocate his total votes in a manner desired, to elect favoured directorsCumulative Voting

Laws that enable shareholders to sell their stakes to a controlling shareholder at a fair priceControl-Share Cash Out

Indemnification contracts from legal expenses and lawsuits pertaining their conductContracts

Allowing participants to cash out options or accelerate the payout of the of bonuses should there be a change in control

Compensation Plans

The directors are placed into different classes and serve overlapping terms. It prevents an outsider from gaining control of a board in a short-term horizon

Classified Board

See bylawsCharter

They are amendment limitations to change governing documents of the corporationBylaws

Laws that impose a delay of certain transactions (asset sales, mergers)Business Combination

Preferred stock over which the board determine voting, dividend, conversion and rightsBlank Check

To prevent that a company could agree with a large shareholder to buy back his stock at a high price for the shareholder’s promise not to seek control for a period of time

Anti-greenmail

DescriptionProvision

Independent third party or employees sworn to secrecy are used to proxy votes and the management agrees not to look at individual proxy cards

Secret Ballot

Securities that provide their holders with special rights in the case of a triggering event such as a hostile takeover bid

Poison Pills

Surplus funds are required to remain the property of the pension fund and this prevents an acquire from using these funds to finance an acquisition

Pension Parachutes

It limits the director’s personal liability, mainly for breaches of the duties of care but not for breaches of the duty of loyalty or for intentional misconduct

Liability

To indemnify directors and executives from legal expenses and law suits pertaining their conduct. This provision uses the bylaws and charter of the company

Director Indemnification

Severance agreements which provide cash and non cash compensation to senior executives upon a triggering event such as termination, demotion or resignation following a change in control

Golden Parachutes

These requirements limit the range of prices a bidder can play in two-tier offersFair Price

They allow directors to consider constituencies other than shareholders when considering a merger (employees, host communities, suppliers)

Director’s Duties

A shareholder can allocate his total votes in a manner desired, to elect favoured directorsCumulative Voting

Laws that enable shareholders to sell their stakes to a controlling shareholder at a fair priceControl-Share Cash Out

Indemnification contracts from legal expenses and lawsuits pertaining their conductContracts

Allowing participants to cash out options or accelerate the payout of the of bonuses should there be a change in control

Compensation Plans

The directors are placed into different classes and serve overlapping terms. It prevents an outsider from gaining control of a board in a short-term horizon

Classified Board

See bylawsCharter

They are amendment limitations to change governing documents of the corporationBylaws

Laws that impose a delay of certain transactions (asset sales, mergers)Business Combination

Preferred stock over which the board determine voting, dividend, conversion and rightsBlank Check

To prevent that a company could agree with a large shareholder to buy back his stock at a high price for the shareholder’s promise not to seek control for a period of time

Anti-greenmail

DescriptionProvision

The Incident of Board Entrenchment and Related Provisions in US Corporations (%)

YEAR

200220001998199519931990

59%59.9%55.4%56.6%57.6%54.4%Poison pill

70.2%67.4%56.9%55.2%55.7%53.3%Golden parachutes

32.3%34.1%34.1%38.4%39.5%39%Supermajority

2.5%3.3%3.0%3.1%3.4%3.3%Limits to amend charter

23.2%20.2%18.2%16.1%16.2%14.5%Limits to amend bylaws

61.9%60.5%59.5%61.8%60.5%59.2%Staggered Board

Entrenchment index provisions:

YEAR

200220001998199519931990

59%59.9%55.4%56.6%57.6%54.4%Poison pill

70.2%67.4%56.9%55.2%55.7%53.3%Golden parachutes

32.3%34.1%34.1%38.4%39.5%39%Supermajority

2.5%3.3%3.0%3.1%3.4%3.3%Limits to amend charter

23.2%20.2%18.2%16.1%16.2%14.5%Limits to amend bylaws

61.9%60.5%59.5%61.8%60.5%59.2%Staggered Board

Entrenchment index provisions:

1.7%2%2.4%3.5%4.9%4.1%Silver Parachutes

1%1.5%2.2%4%5.3%4%Pension parachutes

15%15.8%17.1%20.1%20.8%19.7%Anti-green mail

90.889%88.4%87.4%87.5%84.1%Business combination law

10.8%10.2%9.9%10.9%11.1%10.4%Director Duties

2.5%2.7%3.1%3.6%3.7%4.1%Cash out law

44%48.5%49.4%57.6%59.1%58%Fair price

90.8%89.4588%85.9%80.1%76.7%Blank check

1.6%1.5%1.7%1.9%2%2.4%Unequal vote

6.1%9.2%11.2%10.2%5.5%13.1%Severance Agreements

74%72.6%63.2%72.8%66.1%45.3%Compensation plans

33.9%43.1%47.2%65.5%69.2%72.7%Director liability

8.1%9.1%11.2%12.6%15.3%16.6%Director Indemnification contracts

19.1%23.6%24.5%38.5539.5%40.8%Director indemnification

88.8%89.1%90.4%87.8%90.5%97.1%No secret ballot

90.4%89%87.8%85%83.6%81.6%No cumulative vote

46.4%36.2%33.3%32.1%29.3%24.8%Limits to written consent

61.9%38.3%34.8%32%30%24.8%Limits to special meeting

All other provisions

1.7%2%2.4%3.5%4.9%4.1%Silver Parachutes

1%1.5%2.2%4%5.3%4%Pension parachutes

15%15.8%17.1%20.1%20.8%19.7%Anti-green mail

90.889%88.4%87.4%87.5%84.1%Business combination law

10.8%10.2%9.9%10.9%11.1%10.4%Director Duties

2.5%2.7%3.1%3.6%3.7%4.1%Cash out law

44%48.5%49.4%57.6%59.1%58%Fair price

90.8%89.4588%85.9%80.1%76.7%Blank check

1.6%1.5%1.7%1.9%2%2.4%Unequal vote

6.1%9.2%11.2%10.2%5.5%13.1%Severance Agreements

74%72.6%63.2%72.8%66.1%45.3%Compensation plans

33.9%43.1%47.2%65.5%69.2%72.7%Director liability

8.1%9.1%11.2%12.6%15.3%16.6%Director Indemnification contracts

19.1%23.6%24.5%38.5539.5%40.8%Director indemnification

88.8%89.1%90.4%87.8%90.5%97.1%No secret ballot

90.4%89%87.8%85%83.6%81.6%No cumulative vote

46.4%36.2%33.3%32.1%29.3%24.8%Limits to written consent

61.9%38.3%34.8%32%30%24.8%Limits to special meeting

All other provisions

Source; Bebchuk,L., Cohen A., and Ferrell A. (2004). What Matters in Corporate Governance?. Harvard Law School Working paper No. 491, November.

93 98 92 86 68 63 60 61 46 42 40 44 40 32 37 38 38 42 34 3899

6266

58626263

68

6056

6058

5440 43373224

Source: Data up to 2001, compiled from Hall B. (2003). ‘Six Challenges in Designing Equity-Based Pay’. Journal of Applied Corporate Finance, 15(3): 21-23. From 2002, compiled from Salmans, C (2007). ‘Mercer Issues Annual Study of CEO Compensation at Large US Firms’. Mercer LLC 2009; Towers Perrin ‘2009 Proxy Statements Highlight the New Realities in Executive Compensation’; Institute for Policy Studies ‘Executive Excess Report 2008 and 2007’.

38

62

Composition of Median CEO Pay in the US (1980-2008)

Executive Pay as a multiple of Worker Pay US (1990-2008)

Source: United for a Fair Economy: CEO Pay; Institute for Policy Studies: Executive Excess Report 2008.

-50%

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Average CEO pay 409.2 %

S&P 500 Index

326.6% 296.2%

260.6%

106.7%

4.3%

-9.3%

Corporate Profits

Average worker pay

Minimum wage

Source: Institute For a Fair Economy (2006) “Executive Excess”, Washington D.C. Institute For Policy Studies.

Comparison of CEO and Worker pay in the US1990-2005 ( in 2005 USD)

Conclusions

The analysis of the political mechanisms of boards and directors reveals a great divide between the legal duties and functions of the board, and the actual performance of those duties and functions.

Passive boards were prevalent in the past, and the more recent

failures at Enron, WorldCom, Tyco and other major corporations, indicate boards completing the formalities rather than the substance of their office.

Whether boards can be effectively reformed remains an open question: greater effort is now being made to achieve board independence and best practices but fundamental tensions still exist.

Can boards adequately fulfill both the monitoring role and the strategic leadership role that is expected of them?

Conclusions

To whom is the board ultimately responsible – simply shareholders or a wider constituency of stakeholders?

How can boards offer support for CEOs at the same time as ensuring they do not run out of control?

In the Anglo-American world boards have patently failed to restrain the inflation in executive remuneration which poses a serious question regarding the authority and integrity of boards.

Perhaps though, the era of the all-powerful CEO was a temporary

phase born out of the longest bull market in history.

The institutions are now playing a more pivotal role in corporate governance, and the implications for corporate governance of this new development are presently playing out.