corporate governance trevor hunter king’s university college

Corporate Governance

Trevor HunterKing’s University College

MOS 4422 Corporate Governance

Professor: Trevor HunterOffice: FB 303Office Hours: Tues. 1:30-3:30pmOffice Phone:519-433-0041 ext. 4338Class Times: Thursdays 1:30-4:30

Teaching MethodologyCombination of lectures and cases

The course will be presented in a seminar format.

Sessions 1-2 will be led by me through lectures where the theory is presented. The rest of the course will be student-led case discussions

Required ReadingsThere is no formal textbook required for this

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

Student EvaluationGroup work – Case write-ups (two) – 40%Individual Consulting Report (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 PurposesCourse Perspective:

Good governance DOES matter

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

Course PurposesQuestions 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 effect of CEO/Board Chair duality?What is the role of the board?

We will examine these questions and others

Course GoalsDeeper understanding of the role of a board

What does it do?

Deeper understanding of the role of a directorWhat is the role and responsibility of an

individual on a board?

Deeper understanding of corporate governance and its executionHow do you “do governance”?

Why Study Corporate GovernanceEvery publicly traded corporation and

every not for profit organization, by law, is governed by a board of directors. This body has many important effects on 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 Board became 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 the 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!


•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


• So much responsibility is given to this process but it is so poorly understood.

•Despite there being no conclusive evidence that good governance leads to better performance :

•Some says yes, some no – really depends upon the research question


• 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


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

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


The 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 organizations’ needs in order to fulfill its role. Forcing either that are not appropriate will lead to failure.


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 ensue

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


The Third Truth:

•If governance is done appropriately, 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


Why even bother?•It matters!

•An imperfect process, system and structure 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

Guiding Principles2

What we need to remember when we think about corporate governance:1. Shareholders, not stakeholders own the company

•The source of ownership authority, therefore the group to whom the Board is directly accountable and with whom the principal-agent relationship exists•In this climate of “occupy” and corporate social responsibility there is a trend to forget this important fact and duty

2The following are adapted from: Carver, J. What continues to be wrong with corporate governance . . .and how to fix it. Ivey Business Journal, September/October 2003.

Guiding Principles

2. The Board is the only shareholder representative and only the Board is accountable to shareholders:

•The Board’s primary obligation is to the shareholders, not the management or the organization itself. In fact, the Board has no obligation to itself either.

•The Board must always do what is in the best interest of the shareholders even if that hurts other stakeholders because the Board exists because of and for the shareholders

Guiding Principles

3. The authority of the Board is group authority, not delegated or fragmented to individuals or committees:

•The work of the Board may be done in committees, and it may be represented by an individual, but all decisions are made by the Board as a whole and it is that group that is responsible and accountable

Guiding Principles

4. The Board is a permanent, active part of the organization that exists to command, not advise:

•The Board is not on standby, it is always actively engaged.

•The board may provide advice to the CEO but that is only a secondary function. Its first job is to “empower, charge and evaluate management”.

•The Board must be engaged or else it is useless

Guiding Principles

5. The CEO works only for the Board:•The CEO does not “manage” the Board.

•The Board sets the agenda, determines CEO performance goals, sets CEO compensation and receives reports from the CEO as determined by the Board.

•Only the Board as a whole tells the CEO what to do – ensures group accountability and reduces risk of malfeasance

Guiding Principles

6. The Chair works for the Board:•The Chair is accountable to the Board.

•Commonly, the Chair is considered to be the “boss” of the Board and therefore the “boss” of the organization – this misinterprets the role of the Chair and gives them special status that effectively and wrongly diminishes the role of the Board.

•Chair aids in smooth operations of the Board but is not “the boss” but has no more importance than any other director

Guiding Principles

7. The Chair and CEO are separate roles:

•These are two different jobs and require different skills.

•Two different jobs that require two different people – one person cannot fill two different and sometimes conflicting requirements

•Absolutely essential to ensure independence and focus on shareholders

Guiding Principles

8. The Board’s job derives from above, not below:

•Governance derives from ownership, not from management. Management is derived from governance.

•The Board’s authority comes from the owners, not the management – that is the primary relationship.

•Must remember that the Board’s ability to govern comes from a legal status as the owners’ representative not because management allows it.

Guiding Principles

9. The Board must add value to ownership not

management:•The Board must make the owners’ property better, not make the managers’ jobs easier.

•Often directors are added based on their ability to help the management or organization when in fact they should be there to help the Board help the owners.

•If management needs help they can ask the Board but this must not compromise the directors’ primary responsibility

Doing Corporate Governance

Structure:•Main board often divided into various committees – dependent upon needs and type of organization

Directors:•Individuals who have related experience •Prominent •Leaders•Competency


Committees:•Where the real work of the BOD gets done•Audit•Governance•H/R, nominating, recruitment•Finance•Risk


Objectives:•Provide oversight of the corporation’s management to ensure and enhance shareholder wealth maximization

Principal Parties:•Shareholders, directors, and management

Other stakeholders:•Employees, the community, suppliers, creditors and customers


Limitations:•Corporate governance not an end to itself•Good corporate governance will not guarantee good performance•Different perspectives as to what a BOD should do, what a director should do and what governance is•Often, people think they can be a director when really they should not be one

Board Responsibilities

Stewardship of the corporation•Oversee the conduct of the business and supervise management, not run the business.•Ensure adherence to corporate mission – established by owners


Specific responsibilities:•Approve strategic planning process and strategic plan•Manage risk•Appoint, monitor and evaluate CEO•Create and foster a shareholder communication policy•Maintain the integrity of corporate internal control and management information systems


•Balance the interests of the shareholders and corporation and act in accordance with what is best for shareholders.

•Difficult to do sometimes•In general the shareholders and board members are far removed from each other despite the fact that the board is supposed to represent their interests


•Shareholder /corporation lines of communication:

•Boards are responsible for ensuring that accurate and timely information regarding the operations of the corporation are communicated to shareholders•Shareholders are becoming proactive in communicating with boards

•Institutional investors and shareholder activism raising the bar of BOD performance expectations

Relationship between BOD and Management

Relationship of the board to management:

•Board should not participate in the day-to-day operations of the firm – oversight not management•Board must be engaged and proactive regarding Board-level activities, not be passive or reactive

Relationship between BOD and Management

Board should function independently of management:

•Separate chair and CEO positions•Audit committee composed of outside directors•Problem – The Board is dependent upon management for information

Developments in Corporate Governance

Recognition that status quo is not appropriate - high-level reports recommended changes to Canadian Boards:

•The Dey Report (1994)•Five Years to the Dey (1999)•Saucier Report (2001)

•In general, the Dey report found that Canadian corporate governance was in poor shape.•Unfortunately, years later, subsequent reports found that although there was some improvement, much more was still needed.


Sarbanes/Oxley Act – USA (2002)2

•Intended to "deter and punish corporate and accounting fraud and corruption, ensure justice for wrongdoers, and protect the interests of workers and shareholders" (Quote: President G.W. Bush).

2Source: http://www.sarbanes-oxley-forum.com/


Sarbanes/Oxley Act – USA (2002)2

•Signed into law on 30th July 2002, and introduced highly significant legislative changes to financial practice and corporate governance regulation. It introduced stringent new rules with the stated objective: "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws". 2Source: http://www.sarbanes-oxley-forum.com/


Sarbanes/Oxley Act – USA (2002)•Applicable to all companies with shares traded on American stock exchanges•Includes Canadian companies due to cross-listing

•Of the 100 largest firms on the TSX, 90 are cross-listed in the USA4

•Focuses mainly on financial oversight role of Board •Led to BOD becoming more compliance oriented than strategy oriented• Not producing better governance

4 http://www.tfmsl.ca/docs/V4(3A)%20Nicholls.pdf


Typical cost of Sarbanes/Oxley compliance in US firms (by revenue), 20103

3http://www.protiviti.com/en-US/Insights/Browse-by-Content/Surveys/Documents/2011-SOX-Compliance-Survey-

Protiviti.pdf

$100 million - $499.9 million

$500 million - $999.9 million

$1 billion - $4.99 billion

$5 billion - $9.99 billion

Less than $100,000

30% 13% 16% 5%

$100,000-$500,000

58% 50% 50% 30%

$500,000-$1,000,000

5% 30% 19% 17%

$1 000,000-$1,500,000

7% 0 9% 28%

$1,500,000-$2,000,000

0 7% 3% 14%

Greater than $2,000,000

0 0 3% 6%

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.


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


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


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


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

General Recommendations - DirectorsRemuneration of directors:

•Remuneration should reflect responsibility and commitment levels – Average director compensation in 2011: $112,6515

•High director risk, thus, higher expected return•Much compensation in shares or RSUs (restricted stock units) – reduces agency risk

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

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


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.


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.


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


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


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


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

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?

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?

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

Corporate Governance

Trevor HunterKing’s University College

corporate governance trevor hunter king’s university college

Documents

governance good

better governance

corporate governance

good board

gatekeepers of good

profit board

board of directors

better firm performance