MOS 4422: Corporate Governance

Trevor HunterKing’s University College

MOS 4422 Corporate Governance

• Professor: Trevor Hunter• Office: FB 303• Office Phone: 519-433-0041 ext. 4338• E-mail: trevor.hunter@uwo.ca• Website: http://thunter.kingsfaculty.ca/• Class Times: Tues. 10:30-11:30

Thur. 10:30-12:30• Office Hours: Wed. 1:00-3:30

Teaching Methodology

• Combination of lectures and cases– Lectures will present the theory. Cases will be

used to apply the theory from the prior lecture(s)• Required Readings– There is no formal textbook required for this

course but there are a number of assigned readings that I will make available to you

– You will need to purchase a case package

Student Evaluation

Individual work – Case write-ups (two) – 40%Group Consulting Presentation (one) – 40%Individual class participation (ongoing) – 20%

• No mid-term test or final exam – poor way to evaluate performance

• Integrative Consulting Report - a much better way of measuring understanding

Course Purposes

• To make students aware of the importance of good governance, and how to do it well– Good governance DOES matter

• There are many questions about governance that have not been definitively answered by academic research, however, anecdotally, there is much evidence that suggests that better governance leads to better organizational performance

Course Purposes

Questions for which definitive answers do not yet exist:

– What is “good governance”?– What is a “good board”?– How does governance (good or bad) influence firm

performance?– What is the role of the board?

• No definitive answers exist because governance is an organization specific activity – however, there are best practices that can be applied across organizations

Course Goals

• Deeper understanding of the role of a board– What does it do?

• Deeper understanding of the role of a director– What is the role and responsibility of an individual

on a board?

• Deeper understanding of corporate governance and its execution– How do you “do governance”?

Why Study Corporate Governance

Every publicly traded corporation and every not for profit organization, by law, is governed by a board of directors. These organizations affect many important aspects of society.

You may encounter a board of directors in many ways. You may volunteer on a not for profit board or you may serve on a for profit board one day.

You should know what they are supposed to do and how to make them work.

Corporate Governance - Historical Perspective

• Relatively recent invention – emergence of publicly owned firms led to the development of professional managers.

• Principal – Agent relationships.

•Required a monitoring body to ensure the goals and interests of the owners were pursued by professional managers.

Corporate Governance – Historical Perspective•To over generalize, over time the Boardbecame a networking opportunity and a way to develop business contacts.• Somewhat of an “old boys club” with

members selected by management based on “patronage.”•There have been many examples of governance failures•Enron• Lehman Brothers

Canada’s Corporate Elite The Gatekeepers of Good Governance1

1Tim Rowley & Matt Fullbrook, Rotman School of Management, 2004

Why Study Corporate Governance•Corporate Governance is the process through which the rights and concerns of shareholders are protected

•The process is carried out by a Board of Directors (a group of people selected by the owners to act on their behalf) and this is the only entity that undertakes this role

•The Board is responsible for EVERYTHING the organization does! This is a big responsibility!

Why Study Corporate Governance•Corporate governance provides oversight for the collective wealth of millions of people as well as the use governmentally allocated funding totaling trillions of dollars:• Corporate stocks and bonds•Mutual funds• Pensions and retirement funds•Government funded human service agencies

Why Study Corporate Governance•So much responsibility is given to this process but it is so poorly understood.

•Despite a lot of research, there is no conclusive evidence that good governance leads to better performance :•Some says yes, some no – really depends upon the research question

Why Study Corporate Governance•Despite the lack of agreement, there is no shortage of research, consultants, books, opinions etc. suggesting ways to improve governance

•Common beliefs:•Smaller boards are better•More independent directors is better•Board chair and CEO should be separate people

Why Study Corporate Governance•Overall belief that things can improve because there are many examples of governance failures and they cause big problems

•Governments and observers react to problems by looking at elements of governance to “explain” why these failures occurred and look to stop them by implementing legislation or theorizing “best practices”

“Truths” about Corporate GovernanceThe First Truth:

•While there are certain commonalities that are in general, operational “best practices” that can and should be applied across most Boards, there is no one right way of doing things – It Depends!

•Every organization is different and therefore its governance needs are different. The process and structure has to fit the organization’s needs in order to fulfill its role. Forcing processes or stuctures that are not appropriate will lead to failure.

“Truths” about Corporate Governance

The Second Truth:

•Governance is done by people and regardless of any regulatory or compliance requirements a government or governing body imposes, if the wrong people are on the Board, bad governance will follow

•Organizations need the right people on the Board at the right time, doing the right things

“Truths” about Corporate Governance

The Third Truth:

• If governance is done properly, because the Board is so removed from the operations of the organization, problems can still result

•The Board does not manage, nor does it operate. People can and will make mistakes or act inappropriately regardless of the oversight provided meaning the extent to which good governance can ensure better performance is limited

“Truths” about Corporate Governance

Why even bother?• It matters!

• Imperfect processes, systems and structures are better than none at all

•By studying and learning about corporate governance we can generate awareness as to why it matters and how it should be done to create an environment of continuous governance improvement.

•This starts with you – creating people who can be good directors

Issues In Corporate Governance

Trevor HunterMOS 4422Corporate GovernanceKing’s University College

22

General Recommendations - Directors

Establish criteria for Board directors:• Directors must be able to exercise independent judgment and be perceived as being able to exercise independent judgment

Independence – unrelated directors:• Anyone who is independent from management and free from any influence due to any special relationship with the business that could interfere with the director’s acting in the best interests of the shareholders.

23

General Recommendations - Directors

Problems:• Board decides who is unrelated – “unrelated” is in the eye of the beholder

• Majority of independent directors does not guarantee independent judgment – if Board does not adhere to guiding principles, familiarity breeds compliance and passivity

• Conflicting evidence as to whether unrelated directors provide better oversight

24

General Recommendations - Directors

The nominating committee:• Process of filling members is central to enhanced governance

• Should be composed of outside directors

• Should seek candidates with skills/experience the Board needs

25

General Recommendations - Directors

Orienting new directors• Crucial to ensure understanding of expectations

• Manuals, two-day seminars, etc.

Size of the board:• Average in Canada 10-16 members,

• No one perfect size, but in general, if they are too big effective decision-making is difficult

• If size goes beyond 20, board effectiveness decreases

26

General Recommendations - Directors

Management participation on the board:• The fewer the better, one is usually enough

• Board members should interact outside of meetings to verify information provided by management

Maximum terms for members:• Suggests 6 – 7 years

Limit to the number of directorships•Conflict of interest avoidance

27

General Recommendations - DirectorsRemuneration of directors:• Remuneration should reflect responsibility and commitment levels – Average director compensation in 2011: $87,9085 but norm for larger firms is ~ $200,000

• High director risk, thus, higher expected return

• Much compensation in shares or RSUs (restricted stock units) – reduces agency risk

Source: Korn/Ferry Institute

28

General Recommendations - DirectorsPersonal liability of directors:• Directors are personally liable for many potential misdeeds

• Personal liability is an acceptable technique for influencing corporate conduct

• Laws tend to cause risk averse directors to act more conservatively – could mean missed opportunities

• Fear of liability limits the number of qualified candidates – fewer people willing to take on the risk

29

General Recommendations – Who Should be a Director?

Recognition of the Importance of Diversity:•Encourages awareness of cultural, gender-related and other social nuances for strategy development:• Better sensitivity to business environmental change through diverse perspectives – broader base of insight.

•Reflects corporate culture of social justice:• Stance against racism, sexism.• Role models for executive development

•Reality: Only about 10% of directors are women6

6Source: http://www.cbc.ca/news/business/women-on-corporate-boards-companies-need-to-open-their-minds-1.2711186

30

General Recommendations – Who Should be a Director?

Recognition of the Importance of Diversity:•Greater investor confidence in Boards that will grasp and appreciate their full range of interests and the interests of the market:• Diverse board should better reflect a diverse marketplace and group of shareholders (particularly important for global firms).

• Reputational effects.

31

General Recommendations – Who Should be a Director?

Recognition of the Importance of Diversity (cont.):• Access to diverse networks for contacts ranging from new business development to government regulation to social movements.

•No wasted resources:• Difficulty in finding talented, skilled, effective Board Members as pool shrinks.

32

General Recommendations – Who Should be a Director?

Source: The resource dependence roles of directors. Hillman, Cannella & Paetzold, Journal of Management, 2000

Category

Area of resource needs provided Types of directors

Insiders

Expertise on the firm itself as well as general strategy and directionSpecific knowledge in areas such as finance and law

Current and former officers of the firm

Business

Experts

Expertise on competition, decision making and problem solving for large firmsServe as sounding boards for ideasProvide alternative viewpoints on internal and external problemsChannels of communication between firmsLegitimacy

Current and former senior officers of other large for-profit firmsDirectors of other large for profit firms

33

General Recommendations – Who Should be a Director?

SupportSpecialists

Provide specialized expertise on law, banking, insurance, and public relationsProvide channels of communication to large and powerful suppliers or government agenciesEase access to vital resources, such as financial capital and legal supportLegitimacy

LawyersBankers (commercial and investment)Insurance company representativesPublic relations experts

CommunityInfluentials

Provide non-business perspectives on issues, problems and ideasExpertise about and influence with powerful groups in the communityRepresentation of interests outside company product of supply marketsLegitimacy

Political leadersUniversity facultyMembers of clergyLeaders of social or community organizations

34

General Recommendations – Who Should be a Director?

Creating the Board “character”:•Underpins all decisions about composition, structure, and selection process

•Passive vs. active – extremes vs. the right balance?• Ambitious goals and difficult constraints• Passive board would makes CEO job easier on one hand – can pass directives without objection – but harder on the other – less advice and poorer governance from weak board

•Firm image dependent upon Board character

35

General Recommendations – Who Should be a Director?

Selection Process:•Creation of candidate pool – where to start?• Annual reports

•Consultants•Advice from shareholders, analysts•Nominating committee• Members?• How should it be formed?• Process?

•Order of solicitation• One at a time or after list is made

36

General Recommendations – Who Should be a Director?•Does the candidate have the skills, experience, commitment to be an effective Board member?

•Does she/he have a proven successful track-record?

•Do the candidate’s skills compliment or add to those of the current directors?

•Will the candidate be active or passive?

37

General Recommendations – Who Should be a Director?•How will the candidate’s personality interact with those of the other members?

•What are the legal requirements and shareholder obligations that need to be considered in creating the Board?

38

Corporate Governance•We will study the roles of the Board and the directors more closely in the coming sessions•Your job is to take the lessons from the lectures and readings and apply the them to the cases and your project to show how governance can be improved