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Reading 40- Corporate Governance

corporate governance
system of internal controls and procedures by which individual companies are managed

checks, balances, & incentives a company needs in order to minimize & manage the conflicting interests between insiders & external shareowners

independence
a board member must not have a material business or other relationship with:
-the company or subsidiaries
-controlling individuals, families, or governments
-executive managers
-company advisers

7/10 board members are from the management team= not a good board (anyone who can benefit from transactions of a company)

p. 195*

good corporate governance: the Board– investors and shareowners have authority to:

-majority of independent board members
-board members have qualifications for challenges
-board members have authority to hire independent third-party consultants without having to receive approval from management
-board members are *elected annually*
-outside business relationships
-audit committee
-setting executive remuneration/ compensation committee
-nominations committee= recruits board members
-committee for overseeing management activities (M&A, legal, risk, environmental, & safety issues)
-evaluate the communications the board has with shareowners
good corporate governance: Management– investors and shareowners should:
-code of ethics
-insiders, use company assets for personal reasons
-compensation is appropriate
-share repurchase & price stabilization programs
-evaluation communications
-long-term strategic plans
-how management is handling risk
good corporate governance: Shareowner Rights:
-different classes of common shares that separate voting rights
-confidential voting & vote tabulation
*cumulative voting= vote all 300 votes for candidate A
-simple majority voting (NOT supermajority) to elect directors
-binding or advisory “say on pay”?
-proxy ballot= shareowners should be able to vote by mail even without being present at shareholder meeting
-legal & regulatory action to protect/ enforce shareholder rights
-takeover defense (BAD)= investors take over the company, get rid of the management to run the company better, and drive the share prices back up
cumulative voting
enhances likelihood that shareowners’ interests are represented on the board
takeover defense
suppress a hostile bid
Shareowner proposals
-shareowner sponsored board nominations
-shareowner-sponsored resolutions
-advisory or binding shareowner proposals
-ownership structure= class A voting rights + economic benefit; class B economic benefit. NOT a good structure
prefer a company where such a segmentation does not exist
All of the following practices constitute good corporate governance, EXCEPT:

A)
there are proper procedures and controls covering management’s day-to-day operations and the firm acts lawfully in dealings with shareholders.

B)
the board of directors protects shareholder interests, and the shareholders have a voice in governance.

C)
the firm’s financial, operating, and governance activities are reported to shareholders in a fair, accurate, and timely manner, and management acts independent of the board of directors.

C

The board of directors must be able to act independent of management, not vice versa. Both of the remaining practices are examples of good corporate governance.

Which of the following statements related to corporate governance is least accurate?

A)
It is desirable for the chairman of the board to be the firm’s current CEO or former CEO.

B)
Board members should not have any material relationships with the firm’s advisers, auditors, and their families.

C)
It is desirable for board members to have board experience with other boards.

A

The willingness of independent board members to express opinions that are not aligned with managements’ may be impaired when the chairman is the firm’s current CEO or a former CEO.

A properly qualified board member is of vital importance to proper corporate governance within a firm. Board members who lack the requisite skills, knowledge and expertise to conduct a thorough review of the firm’s activities are:

A)
more likely to defer to management when making decisions.

B)
less likely to participate fully in decision-making matters during board meetings.

C)
more likely to consult with outside interests to assist in decision-making.

A

Board members must be properly qualified, having the knowledge and experience which is required to advise management in light of the firm’s specific situations encountered. Both remaining answers are incorrect.

Which of the following might be an undesirable trait of a member of the board of directors?

A)
Lack of legal or regulatory problems as a result of working with other firms.

B)
Service on the board for more than 10 years.

C)
Experience with the technologies, products, and services the firm offers.

B

Service on the board for more than 10 years may indicate knowledge and experience, but may result in a member becoming too close to management.

A strong corporate code of ethics is vitally important. Which of the following statements concerning a firm’s code of ethics is least likely accurate?

A)
A firm’s code of ethics should require clear disclosure of any advantages given to the firm’s insiders that are not also offered to shareholders.

A

The firm’s code of ethics should prohibit practices that give advantages to company insiders that are not also offered to shareholders.

The audit committee of a company’s Board of Directors is most likely to act in the interests of shareholders when:

A)
the committee has authority to prevent the company from engaging in non-audit business relationships with its external auditors.

B)
a company officer other than the CEO controls the audit budget.

C)
a reliable communication “firewall” is in place between the committee and the company’s internal auditors.

A

The audit committee is responsible for evaluating the financial information that the company provides to shareholders. This committee should be able to approve or reject the company’s proposed non-audit engagements with its external auditing firm. The audit committee, not management, should control the audit budget, and there should be no restrictions on communication between the committee and the company’s internal auditors.

A special-purpose board committee with which of the following responsibilities would be least likely to act in the best interests of the shareholders?

A)
Takeover defense.

B)
Corporate governance.

C)
Mergers and acquisitions.

A

A committee responsible for takeover defense would most likely be acting in the interests of the company’s current management rather than in the interests of shareholders.

Investors have a duty to determine whether the board has properly established committees of independent board members to help carry out various board functions. Which of the following statements about the “audit committee” is least accurate?

A)
The audit committee should ensure that the audit is conducted consistent with generally accepted auditing standards (GAAS).

B)
Firm management is responsible for hiring and supervising the independent external auditors, but the audit committee has strict oversight responsibilities.

C)
The audit committee should ensure that the independent auditors have authority over the audit of the entire corporate group, which includes foreign subs and affiliates.

B

The audit committee is responsible for hiring and supervising the independent external auditors, in order to ensure that the auditors’ priorities are consistent with the best interests of shareholders. Both remaining statements are correct.

Which of the following statements concerning Board committees is least accurate?

A)
The nominations committee is responsible for recruiting qualified board members and preparing an executive management succession plan.

B)
Members of the audit committee should be independent experts in accounting and finance.

C)
The audit committee has authority over the procedures used to audit the entire corporate group including subsidiaries and affiliates.

C

The independent auditor has authority over the audit procedures. The audit committee is responsible for hiring and supervising the independent auditor.

Shareholder-sponsored resolutions are something investors can consider in order to be “heard”. These resolutions do have implications for investors. Which of the following statements regarding shareholder-sponsored resolutions is least accurate?

A)
The right to propose initiatives for consideration at the firm’s annual meeting is one way for shareholders to send a message that they are dissatisfied with the way the board is handling one or more firm matters.

B)
The ability shareholders have to propose needed changes in a firm can serve to erode shareholder value.

C)
The right to propose initiatives for consideration at the firm’s annual meeting is one way for shareholders to send a message that they are dissatisfied with the way management is handling one or more firm matters.

B

The ability to bring issues in front of the board and/or management can serve to prevent erosion of shareholder value.

Which of the following is least likely to be considered a “best practice” regarding corporate governance?

A)
Use of a third party to tabulate votes and retain voting records.

B)
A code of ethics that is audited and improved periodically.

C)
Board members are limited to a six-year term.

C

Anything beyond 2- or 3-year term limits on board membership has the potential to restrict the ability for shareholders to change the composition of the board if its members are not acting in the shareholders’ best interest.

The most likely outcome of adopting a golden parachute, poison pill, or greenmail is a:

A)
negative impact on the stock price and a greater possibility for a successful takeover bid.

B)
reduced possibility for a successful takeover bid and a positive impact on the stock price.

C)
reduced possibility for a successful takeover bid and a negative impact on the stock price.

C

Adopting a golden parachute, poison pill, or greenmail are all take-over defenses used to frustrate an acquisition attempt. The barriers created by such defenses are likely to decrease the value of the stock.

Which of the following would NOT be a good source for information about a company’s proxy voting rules?

A)
Company’s articles of organization and by-laws.

B)
Firm’s corporate governance statement.

C)
Firm’s annual report.

C

The annual report would typically not contain this detailed information.

Which of the following actions would most likely have a positive influence on shareholder value?

A)
Executive board members regularly attend the board meetings.

B)
Only one class of common equity has been issued.

C)
Adopting a poison pill.

B

Firms with dual classes of equity can have a negative effect on shareholder value as the shareholder may have inferior voting rights. Takeover measures such as poison pills, golden parachutes, and greenmail typically have a negative effect on shareholder value. Annual elections are preferred for board members as it increases accountability. Executive board members regularly attending the meetings can potentially prevent free discussion among the independent members.

Which of the following statements regarding company takeover defenses is CORRECT?

A)
Newly created anti-takeover provisions may or may not require stakeholder authorization/approval.

B)
The firm’s annual report contains pertinent details concerning takeover defenses.

C)
A firm’s proxy is the most likely place to find information about present takeover defenses.

A

These provisions may or may not require such approval. In either case, the firm may have to, at a minimum, provide information to its shareholders about any amendments to existing takeover defenses. A firm’s articles of organization are the most likely places to locate information about present takeover defenses.

When examining a firm’s ownership structure, it is imperative to examine any super-voting rights by certain classes of shareholders. Which of the following statements concerning these voting rights is most accurate?

A)
If a company has a significant minority shareowner group, such as a founding family, cumulative voting to elect board members can be a positive factor for shareholders.

B)
Super-voting rights by certain classes of shareholders impair the firm’s ability to raise capital for the future.

C)
Firms with a single class of common equity could encourage prospective acquirers to only deal directly with shareholders with the supermajority rights.

B

Firms with dual classes of common equity could encourage prospective acquirers to only deal directly with shareholders with the supermajority rights. If the firm has a significant minority ownership group, such as a founding family, use of cumulative voting to elect board members can favor specific interests at the expense of the interests of other shareholders.

Which of the following firms is most likely to have a board of directors that considers the best interest of all shareholders?

A)
Firms that assign a single vote to each share, but not firms with different classes of common equity with supermajority rights given to one class.

B)
Firms that assign a single vote to each share, and firms with different classes of common equity with supermajority rights given to one class.

C)
Neither firms with different classes of common equity with supermajority rights given to one class, nor firms that assign a single vote to each share.

A

Firms that assign one vote to each share are more likely to have a board that considers the best interest of all shareholders. Firms with dual classes of common equity where supermajority rights are given to one class are likely to have boards that focus on the interests of the supermajority shareholders.

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