Corporate Governance Exam 1
Agency Problem - answer When self-interested executives use their power for personal
gain at the expense of shareholders.
Corporate Governance - answer Monitoring System put in place to mitigate the agency
problem.
Corporate Governance Participants - answer all those involved in management,
monitoring, or operations of the firm
Limitations of Empirical Tests - answer- Average results that cannot be applied to a
specific firm or situation
- correlation doesn't equal causation
- samples may be a selective group, which makes the test inapplicable to different types
of firms
Efficient Capital Markets - answer- Market determines the price of g/s
- when ECMs exist, the price accurately reflects the information held by all parties
- When ECMs don't exist, the inaccurate price can lead to poor decision-making
Market Standard - answerCreated in ECMs and lead to a monitoring system. Any failure
to meet this standard leads to a decrease in stock price.
BOD primary functions - answer1. Advise on corporate strategy
2. Ensure integrity of FS
Board Independence - answerdegree to which a director is free from the company's
influence and removed from conflicts of interest within the firm that could interfere with
monitoring ability and prevent them from acting in the firm's interest
Majority independence required by NYSE
Ensures they can oppose management
Staggered/Classified Board - answerdivided into two-three year terms, with a subset of
directors being up for re-election each year. Prevents hostile takeovers. Unpopular with
shareholders because it insulates BOD from their influence. Has become less common.
Manager/Director Misstatement liability - answerCan be held liable if misstatement was
intended or behaved recklessly to point that behavior approaches intentionality. Also
depends on the severity of the event, i.e. IPO is a very important information event
Pros/Cons of CEOs on the BOD - answerPros:
- Leadership Skills
, - Good stock market reaction
- industry expertise
- business expertise
Cons:
- bossy
- poor collaborators
- busy with their own company
- overly compensated
- may use their own company as a benchmark (not always appropriate industry)
- firm is not their major source of revenue --> may not align interests with firm
Pros/Cons of outgoing CEOs on the BOD - answerPros:
- Company and industry specific knowledge
- Ease transition process
- advise incoming CEO
Cons:
- Make new CEO feel inferior
- Scare off new talent
- Negatively affects firm value (unless CEO=founder)
Purpose/issues of director stock ownership - answer- align interests with shareholders
- minimum amount required to hold = multiple of annual cash retainer
- appears in 78% of firms on average
- Paying directors similar to managers can affect oversight and monitoring ability
- May become risk averse or reject decrease in ST value even if decision could increase
LT value
- Incentivizes directors to make decisions based on personal financial portfolio
- not calibrated for wealth of individual directors
- less likely to oppose low level accounting manipulation
Outside Directors - answer- non-executive/non-employee
- Not major source of income --> removed from company's influence and not invested in
company's performance
- no reporting lines to CEO
- Can draw on diverse background
Social Independence - answerPros:
- Connections or networks between board members
- can make the board mesh well/collaborate
Cons:
- hinder independence
- psychological affinity that can lead to damaging decisions
- higher likelihood of CEO manipulation of earnings
- higher CEO comp
Agency Problem - answer When self-interested executives use their power for personal
gain at the expense of shareholders.
Corporate Governance - answer Monitoring System put in place to mitigate the agency
problem.
Corporate Governance Participants - answer all those involved in management,
monitoring, or operations of the firm
Limitations of Empirical Tests - answer- Average results that cannot be applied to a
specific firm or situation
- correlation doesn't equal causation
- samples may be a selective group, which makes the test inapplicable to different types
of firms
Efficient Capital Markets - answer- Market determines the price of g/s
- when ECMs exist, the price accurately reflects the information held by all parties
- When ECMs don't exist, the inaccurate price can lead to poor decision-making
Market Standard - answerCreated in ECMs and lead to a monitoring system. Any failure
to meet this standard leads to a decrease in stock price.
BOD primary functions - answer1. Advise on corporate strategy
2. Ensure integrity of FS
Board Independence - answerdegree to which a director is free from the company's
influence and removed from conflicts of interest within the firm that could interfere with
monitoring ability and prevent them from acting in the firm's interest
Majority independence required by NYSE
Ensures they can oppose management
Staggered/Classified Board - answerdivided into two-three year terms, with a subset of
directors being up for re-election each year. Prevents hostile takeovers. Unpopular with
shareholders because it insulates BOD from their influence. Has become less common.
Manager/Director Misstatement liability - answerCan be held liable if misstatement was
intended or behaved recklessly to point that behavior approaches intentionality. Also
depends on the severity of the event, i.e. IPO is a very important information event
Pros/Cons of CEOs on the BOD - answerPros:
- Leadership Skills
, - Good stock market reaction
- industry expertise
- business expertise
Cons:
- bossy
- poor collaborators
- busy with their own company
- overly compensated
- may use their own company as a benchmark (not always appropriate industry)
- firm is not their major source of revenue --> may not align interests with firm
Pros/Cons of outgoing CEOs on the BOD - answerPros:
- Company and industry specific knowledge
- Ease transition process
- advise incoming CEO
Cons:
- Make new CEO feel inferior
- Scare off new talent
- Negatively affects firm value (unless CEO=founder)
Purpose/issues of director stock ownership - answer- align interests with shareholders
- minimum amount required to hold = multiple of annual cash retainer
- appears in 78% of firms on average
- Paying directors similar to managers can affect oversight and monitoring ability
- May become risk averse or reject decrease in ST value even if decision could increase
LT value
- Incentivizes directors to make decisions based on personal financial portfolio
- not calibrated for wealth of individual directors
- less likely to oppose low level accounting manipulation
Outside Directors - answer- non-executive/non-employee
- Not major source of income --> removed from company's influence and not invested in
company's performance
- no reporting lines to CEO
- Can draw on diverse background
Social Independence - answerPros:
- Connections or networks between board members
- can make the board mesh well/collaborate
Cons:
- hinder independence
- psychological affinity that can lead to damaging decisions
- higher likelihood of CEO manipulation of earnings
- higher CEO comp
