business ethics_chapter 5

8/10/2019 Business Ethics_Chapter 5

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CHAPTER 5

CORPORATE GOVERNANCE


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Earnings can be as pliable as puttywhen a charlatan heads the company

reporting them.Warren Buffet


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OBJECTIVESAfter studying this chapter, you should be able to:

1. Explain the term corporate governance.2. Explain the roles of the Chief Executive Officer(CEO), Chief Financial Officer (CFO), and ChiefOperating Officer (COO).

3. Understand the roles and responsibilities of theBoard of Directors.4. Understand the different responsibilities of thefollowing committees:5. Audit Committee,

6. Compensation Committee, and7. Corporate Governance Committee8. Understand the differences between the followingtwo governance methodologies: comply or explainand comply or else.

9. Identify an appropriate corporate governance model


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FRONTLINE FOCUS


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Corporate governanceis the process bywhich organizations are directed andcontrolled.

In addition to the interests of their

owners, it is argued that managers carryan accountability to thepublicinterest or, more specifically, to their stakeholderstheir customers, their vendor partners,state and local entities, and thecommunities in which they conduct theirbusiness operations.

Corporate Governance is concerned withhow well organizations meet their

obligations to all these people.


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Corporate Governance is about the way in whichboards oversee the running of a company by itsmanagers, and how board members are in turnaccountable to shareholders and the company. Thishas implications for company behavior towards

employees, shareholders, customers, and banks.Good corporate governance plays a vital role inunderpinning the integrity and efficiency offinancial markets. Poor corporate governanceweakens a companys potential and at worst can

pave the way for financial difficulties and everfraud. If companies are well governed, they willusually outperform other companies and will beable to attract investors whose support can finance

further growth.


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WHAT DOES CORPORATE

GOVERNANCE LOOK LIKE?

The Board of Directors, in theory, is elected bythe owners to represent their interests in theeffective running of the corporation.

The board is typically made up of inside andoutside members inside members holdmanagement positions in the company,whereas outside members do not. The termOutside Directorcan be misleading becausesome outside members may have directconnections to the company as creditors,suppliers, customers, or professionalconsultants.


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WHAT DOES CORPORATE


The Board of Directorsis a group ofindividuals hired to oversee governance of anorganization. Elected by vote of theshareholders at the annual general meeting(AGM), the true power of the board can varyfrom institution to institution from a powerful

unit that closely monitors the management ofthe organization, to a placeholder body thatrubber-stamps the decisions of the chiefexecutive officer (CEO) and executive team.


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WHAT DOES CORPORATE


The audit committeeis an operatingcommittee staffed by members of theboard of directors plus independent oroutside directors. The committee isresponsible for monitoring the financialpolicies and procedures of the

organization specifically the accountingpolicies, internal controls, and the hiringof external auditors.


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Owners

Board of Directors

CEO, CFO, COO

Managers and

employees

Stakeholders

Creditors

Corporate

Governance

committee

Compensation

committee

Audit

committee


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IN PURSUIT OF CORPORATE

GOVERNANCE

Which two scandals greatly increasedthe attention paid to the 1992Cadbury Report?

Explain the right balance thatCadbury encourages companies topursue.

Explain the difference between theKing I and King II reports.


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COMPLY OR EXPLAIN

OR COMPLY OR ELSE?

Comply or explainis a set ofguidelines in which companies are

expected to abide by a set ofoperating standards or explain whythey choose not to.

Comply or elseis a set of

guidelines in which companies abideby a set of operating standards orface stiff financial penalties.


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IN THE KNOW OR IN THE DARK?

One cannot say that the checks andbalances against excessive powerwithin the old WorldCom didnt work

adequately. Rather, the sad fact isthat there were no checks andbalances.

R. C. Breedon


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EXAMPLES OF ETHICAL DILEMMAS

CASE 5.1

A Tale of Two Boards


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THE CHAIRMAN AND THE CEO

The argument in favor of merging thetwo roles is one of efficiencyby puttingthe leadership of the board of directors

and the senior management team in thehands of the same person, the potentialfor conflict is minimized and, it is argued,the board is given the benefit of

leadership from someone who is in touchwith the inner workings of theorganizationrather than an outsider whoneeds time to get up to speed.


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THE CHAIRMAN AND THE CEO The argument against merging the two roles is an ethical

one. Governance of the corporation is now in the hands ofone person, which eliminates the checks and balancesprocess that the board was created for in the first place.

As time passes, as we have seen with the Disneyexample, the CEO slowly populates the board with

friends who are less critical of the CEOs policies and

more willing to vote larger and larger salary and benefitspackages. With a rubber-stamp board in place toauthorize his every wish, the CEO now becomes a lawunto himself. The independence of the board iscompromised, and the power of the stockholders isminimized.

The CEO can pursue policies that are focused onmaintaining a high share price in the short term (tomaximize the price he will get when he cashes in all theshare options that his friends on the board gave him inthe last contract) without any concern for the long-term

stability of the organizationafter all, there will probablybe another CEO by then.


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EFFECTIVE CORPORATE GOVERNANCE

To be truly effective, boards should followthe following six steps:

1. Create a climate of trust and candor.

2. Foster a culture of open dissent.3. Mix up roles.

4. Ensure individual accountability.

5. Let the board assess leadership talent.6. Evaluate the boards performance


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22 QUESTIONS FOR

DIAGNOSING YOUR BOARD

Select your top six from WalterSalmons 22 Questions for

Diagnosing Your Board and defendyour selection.


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EXAMPLES OF ETHICAL DILEMMAS

CASE 5.2

Richard Grasso and the NYSE


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DANGERS OF A CORPORATE

GOVERNANCE CHECKLIST

There is more to effective corporate governancethan simply maintaining a checklist of items to bemonitored on a regular basis. Simply having themechanisms in place will not, in itself, guarantee

good governance. Enron, for example, had alltheir governance boxes checked:

They separated the roles of Chairman (KennethLay) and Chief Executive Officer (Jeffrey

Skilling)at least until Skillings surpriseresignation. They maintained a roster of independent

directors with flawless rsums. They maintained an audit committee consisting

exclusively of nonexecutives.


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DANGERS OF A CORPORATE

GOVERNANCE CHECKLIST

However, once you scratched beneath thesurface of this model exterior, the true picturewas a lot less appealing:

Many of the independent directors wereaffiliated with organizations that benefiteddirectly from Enrons operations.

They also enjoyed substantial benefits thatcontinued to grow as Enrons fortunes grew.

Their role as directors of Enron, a Wall Streetdarling, guaranteed them positions as directorsfor other companiesa career package that wouldbe placed in jeopardy if they chose to ask toomany awkward questions and gain reputations as

troublemakers.


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A FIDUCIARY RESPONSIBILITY

Examples of evidence that good corporate governance can

pay off for organizations: A study of Standard & Poor 500 firms by Deutsche Bank

showed that companies with strong or improving corporategovernance outperformed those with poor or deterioratinggovernance practices by about 19 percent over a two-year

period. A Harvard/Wharton study showed that if an investor

purchased shares in U.S. firms with the strongestshareholder rights, and sold shares in the ones with theweakest shareholder rights, the investor would have earnedabnormal returns of 8.5 percent per year.

The same study also found that U.S.-based firms with bettergovernance have faster sales growth and were moreprofitable than their peers.

In a 2002 McKinsey survey, institutional investors said theywould pay premiums to own well-governed companies.

Premiums averaged 30 percent in Eastern Europe and Africaand 22 percent in Asia and Latin America.


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FRONTLINE FOCUS

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