Assingment 12 Flashcards
Explain the basic ways in which the SEC is involved with the board of directors
The Securities and Exchange Act sets forth rules and responsibilities for board directors. Also, SEC has a rule requiring companies to bring shareholder resolutions to a vote by all shareholders. SEC determines on a case-by-case basis if a specific shareholder resolution can be excluded from this requirement.
Outline the basic requirements of the Sarbanes Oxley Act of 2002:
- Adoption of or changes to a corporate code of ethics must be disclosed in a timely manner
- CEOs and CFOs must certify in writing their quarterly and annual financial statements
- Material changes in the status of the company’s financial condition must be disclosed in real time
- Publicly traded companies must have only independent directors on their audit committee
- External auditors are barred from providing nonaudit services without express approval of the board
- Publicly traded companies must review their internal control systems, make approriate chagnes and have the results verified by independent audit
- Penalties are increased for fraud and other white-collar crimes, inlcuding destroying records and falsfying documents
- Insiders are prohibited from trading company stock during blackout periods for company stock benefit plans
- Insiders are prohibited from receiving new loans
- Insider trading transactions are to be reported within 2 days
- CEOs and CFOs are to forfeit compensation realized from restatement of financial statements because of misconduct
- Employees are protected from retaliation for whistle-blowing
What is the purpose of an adivsory board to the board of directors?
Some companies find it advantegous to form advisory boards. The most typical reason for their formation is high-level expertise and/or excellent contacts. CEOs can easily acces professional opinions on new ventures or markets, receive assistance in developing needed core competencies and/or reach high-level decision makers.
Advisory board members often find such service more attractive than regualr board service. It requires less of a time commitment and may incur no financial liability.
The CEO must determine needs before reaching out to recruit directors. The first director brough in should should be of sufficient “Star Quality” to attract others to the board. Individuals must clearly know what is expected of them and what they will get in return for their services.
What is the difference between a company’s vision and its mission?
A company’s vision is its long-term objetive that should be motivating, even if unattainable. All plans can be viewed in terms of whether or not they support the vision. The mission consists of the pathway to the vision.
List seven common board committees and briefly describe each of their duties
- Audit Committee- proposing the firm to be made the company’s independent audit, reviewing the results of independ audits and meet separately with outside auditors
- Governance Committee- Proposing canidates to the board for election as officers/directors, reviewing performance of board directors, propsing changes in director pay, and reviewing succession plans for the CEO and other officers
- Compensation Committee- Proposing changes in executive compensation plans and administering those that are approved
- Executive Committee- Acting on behalf of the board to the extent legally permitted
- Finance Committee- Approving capital budgets and proposing dividend action
- Pension Committee- Approving fund managers, setting financial expectations, and reviewing results.
- Strategic planning committee- proposing specific plans, reviewing results and reporting appropraite action to the board
What is a member of the board’s liability?
Directors are expected to exercise prudent judgement, acting in good faith on an informed basis only after obtaining material facts. It is further expected that directors will call on legal and other experts in evaluating alternative actions. Directors must act without conflcit of interest, keeping in mind the best interests of the shareholder and the company.
Possible conflict should be disclosed to other directors. If the directors have acted in this manner the business judgement rule says they should not be held liable for mistakes or decisions that did not turn out as expected. It will be virutally impossible to find individuals willing to serve as directors without a reasonable liability insurance policy in place. Directors facing the burden of paying legal and related expenses will want the company to advance them payments for costs.
The company will want the director to sign a written promise to reimburse the company if indemnification is later denied. However, directors might seek the furthe comfort of an indemnification agreement whereby the company agrees to reimburse the director for any legal actions not covered by liability insurance.
What happens at board meetings?
The key questions about board meetings are:
- How Many?
- Where?
- When?
- What will be discussed at each
- Who gets invited?
There should be a sufficient number of meetings to discharge the governance role of the board. Meetings are typcially held at company headquarters for the convience of the CEO and other memebrs of management. When during the month meetings will be scheduled is a funciton of what will be discussed. A number of boards meet during the second or third week after the close of a financial quarter to review the results before issuing a public statement.
It is also helpful to standardize the meeting agenda so directors know what they can expect. In addition to the directors, the board may allow specified members of management whoa re not board members to sit with them. This provides directors an opportunity to evalaute such individuals based on their behavior. Others prefer that only directors be in attendance.
What is the board book?
In additon to providing directors with a copy of the board meeting agenda in advance of the meeting, it is appropriate that they receive copies of material to be discussed. This material should be in their hands at least a week before the meeting, providing them an opportunity to read it and note their questions. Ideally, the questions should be called in and answered prior to the meeting. This provides maximum amount of time at the meeting for discussion.
The book will contain minutes of the previous meetings as well as the minutes of the board and management committess that have met since the last meeting. The book might also include reports from vairous operating and staff divisions describing their activities sicne the last meeting. A signigicant portion of the book will be focused on the financial performance of the company and its various operating units. The narrative should also include comments on the present and possible future of economic conditions affecting the company by analysts and other experts.
What should be the size of the board?
The number of directors is typically about 12, fewer for smaller companies and a little more for larger companies. One way to determine how many directors are appropriate is to determine the number of board committees and mutiply it by 3. Most of the directors would be outside directors distinuguishing them from inside directors. Typically, at least the CEO sits on the board as an insider. Others may include the COO or CFO.
Outside directors are either dependent or independent. An independent director is one without a professional, financial, or family relationship to the company or CEO or other key officers other than being a memeber of the board of directors. An ouside director who does not meet the independent qualifications is often called an affliated director. Good governance would suggest that independent directors should comprise at least a majority of the board, in addtion to being the only ones to servce as compensation committee members.
Describe the compositon of the board
Having decided how many outside directors to have, what should be their qualificaitons? The most common is an active or retired CEO from another company. Academics, attorneys, bankers and retired governement officials account for most of the rest. The board should reflect diversity of backgrounds, expierences, gender and ethnicity. However, expertise important to the company must be represented on the board. Somes companies require the CEO to leave the board at retirement.
Discuss the election term of a board of directors
When corporate raiders rose to prominence in the 1980s, a number of companies adopted staggered or classified boards. These are boards with starggered terms. Typically, 1/3 of the board of directors are up for election each year. Companies defend the practice as reinforcing continuity. Critics say it makes it more difficult to hold the board accountable, and it is an entrenchment vehicle. Companies aregue that classifed boards put them in better negotiating position during a takeover because the takeover company cannot immediately replace the entire board. Unless a supermajority, or 75% is acquired, it is insufficient to amend the company’s articles of incorporation. In order to thwart this practice, some shareholders are introducing binding resoltuions, whic bind the corporation to act on the voting resutsl.
Cumulative voting is one way to offset the classified board. The number of cotes a shareholder has is determined by multiplying the number of shares owned by the number of directors being elected. Under cumlative voting, it is easier to seat a director if the number of slots up for election is large rather than small.
Discuss director performance appraisal
While most boards have a formal process for appraising the performance of the CEO, few have a similar process to evaluate individual directors. For that reason, more and more companies are rethinking the age and term limit issues.
Of those who do individual director appraisal, many use the less sensitive self-assessment rather than the more obtrusive peer review. Self-assessments are intended to improve performance without threatening the body of directors.
Criticis of individual review point out that the board should be evaluated as a whole rather than by its parts. Staggered boards also make it more difficult to remove a newly elected nonperforming director. With or without formal appraisal, each director is expected to attend each board and committee meeting fully prepared on all issues. Effective boards receive adquate information in time for review prior to the meeting and thoroughly discuss issues during the meeting before taking action.
Boards that do not perform well typically have one of the following problems:
- The CEO is domineering
- Some directors are disruptive at meetings
- Some directors are either not qualified or not performing to potential
- Needed information is either not available or not timely
- Information is voluminous and requires extensive time to evaluate
Explain Pay versus Performance
Pay for executives in general and the CEO in particular is usually viewed in absolute dollars and not in relation to performance. However, a CEO paid a fraction of the pay of a counterpart may be overpaid in relation to performance. Conversly, a CEO paid several times that of a counterpart may be underpaid in realtion to performance.
Furthermore, it is important to view executive pay in relation to that of others in their own peer group. Performance should not simply be company financials, but also total shareholder return, which is stock price plus reinvested dividends.
What is the role of the compensation committee?
Because of their fiduciary role to the shareholder, it is logical to expect members of the compensation committee to be performance oriented in direction but cautious in specific plan design. A plan that is similar to those of other companies is more likely to be acceptable than an innovative creation. In large part, the conservative appraoch is attributable to a lack of knowledge by which to adequately judge the efficacy of a new approach. It is much easier to rely on the judgements of other boards.
In addition to having to absorb a signifigant amount of compensation design and basic accounting and tax considerations, the compensation committee must also be able to see those areas likely to be applicable as well as those that are inappropriate. Thus, it is critical for the compensation committee to have sufficient knowledge of company objectives and compensation desng to be able to judge the efficacy of a specific proposal.
Typically, the commitee makes performance decisions on the CEO and other executives named in the proxy. After making the awards, the committee is responsible for monitoring plan performance and acting upon salary reccomendations for officers. Administration of the actual pay program will focus on all five component’s of the officer’s pay package. inluding their relative mix. This committee would also determine modifications to basic employee benefit plans.
