Chap 015

Chapter 15 - Stockholder Rights and Corporate Governance

CHAPTER 15

STOCKHOLDER RIGHTS AND CORPORATE GOVERNANCE

INTRODUCTION

Stockholders occupy a position of central importance in the corporation because they are the company’s legal owners. But the corporation is not always run solely for their benefit, so they contend with management and the board of directors for control of company policies. Recent corporate scandals and debates over executive compensation have challenged companies and government regulators to reform the process of corporate governance to better protect stockholder interests. And individual and institutional investors have demanded greater accountability from those in charge of public corporations.

PREVIEW CASE

The Bankruptcy of WorldCom

What motivated executives at WorldCom to exaggerate the company’s earnings? Why didn’t the board of directors and the company’s accountants exercise greater oversight? Why didn’t government regulators do a better job of protecting stockholders’ interests? Why didn’t stockholders themselves figure out what was going on and sell their shares before it was too late? And, what can be done to prevent such a thing from happening again?

Teaching Tip: IntroductionInstructors, who wish to focus in more detail on the reasons for the bankruptcy of WorldCom, may wish to use a Frontline documentary, first aired on May 8, 2003, “The Wall Street Fix.” A description of the show and ordering information are available at:http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/view/. The documentary emphasizes conflict of interest in the securities industry, which touted WorldCom stock even as it was aware of fundamental problems at the company.

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http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/view/


CHAPTER OUTLINE

I. STOCKHOLDERS

A. Who Are Stockholders?

B. Objectives of Stock Ownership

C. Stockholders Legal Rights and Safeguards

II. CORPORATE GOVERNANCE

i. The Board of Directors

Teaching Tip:Students may be interested to find the latest data on director compensation at: www.execpay.com.

B. Principles of Good Governance

Teaching Tip: Good governance VideoKwame Holman reports on the congressional hearing where HP CEO Mark Hurd and former chairwoman Patricia Dunn testified about HP’s use of pretexting and other possibly illegal and/or unethical methods to investigate boardroom leaks. The segment may be used with a discussion of the role of the board of directors and good corporate governance.* The video segment is from the Public Broadcasting Services’s “News Hour with Jim Lehrer” and is available on the Instructor’s Resource Manual DVD that accompanies the textbook, available upon request from the publisher.

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http://www.execpay.com/


III. EXECUTIVE COMPENSATION: A SPECIAL ISSUE

Teaching Tip: Executive CompensationBoth Business Week and Fortune publish annual surveys of executive compensation, and the Wall Street Journal has an annual executive compensation issue. All three generally appear around the second week of April, before tax filing day. These may be used to update figures given in this section. Executive compensation makes a good topic for a student debate, since compelling arguments can be made on both sides.

Teaching Tip: Executive Compensation VideoPaul Solman reports on the growing scandal surrounding the improper backdating of stock options. Solman explains how stock options work, using the example of a fictitious company. The segment includes interviews with a shareholder advocate, a former federal prosecutor, and a law professor. This segment may be used with the discussion of executive compensation and/or with Exhibit 15.A, “Stock Options: A Controversial Form of Compensation.”* The video segment is from the Public Broadcasting Services’s “News Hour with Jim Lehrer” and is available on the Instructor’s Resource Manual DVD that accompanies the textbook, available upon request from the publisher.

IV. SHAREHOLDER ACTIVISM

A. The Rise of Institutional Investors

B. Social Investment

* Stock Screening

* Social Responsibility Shareholder Resolutions

C. Stockholder Lawsuits

V. GOVERNMENT PROTECTION OF STOCKHOLDER INTERESTS

i. Securities and Exchange Commission

B. Information Transparency and Disclosure

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C. Insider Trading

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Teaching Tip: Insider TrainingStudents may be asked to locate a recent example of insider trading, through an Internet search or review of the business press. They may then be asked to analyze the case to determine if it met the elements of insider trading established by the Supreme Court in U.S. vs. O'Hagen, described in the text.

VI. STOCKHOLDERS AND THE CORPORATIONGETTING STARTED

KEY LEARNING OBJECTIVES

1. Identifying the different kinds of stockholders and understanding their objectives and legal rights.

Stockholders, both individual and institutional, are the legal owners of business corporations. Individuals and institutions own shares of corporations primarily to earn dividends and receive capital gains, although some have social objectives as well. Shareholders are entitled to vote, receive information, select directors, and attempt to shape corporate policies and action.

2. Knowing how corporations are governed and explaining the role of the board of directors in protecting the interests of owners.

In the modern system of corporate governance, boards of directors are responsible for setting overall objectives, selecting and supervising top management, and assuring the integrity of financial accounting.

3. Investigating how recent corporate scandals have affected corporate governance.

The job of corporate boards has become increasingly difficult and challenging, as directors seek to balance the interests of shareholders, managers, and other stakeholders. In the wake of recent corporate scandals, reforms have been proposed to make boards more responsive to shareholders and more independent of management.

4. Analyzing the function of executive compensation and debating if top managers are paid too much.

Some observers argue that the compensation of top U.S. executives is justified by performance, and that high salaries provide a necessary incentive for innovation and risk-taking in a demanding position. Critics, however, believe that they are too high. In this view, high pay hurts firm competitiveness and undermines employee commitment.

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5. Knowing how investors organize to promote their economic and social objectives.

Shareholders have influenced corporate actions by forming organizations to promote their interests and by filing lawsuits when they feel they have been wronged. They have also organized under the banner of social investment. These efforts have included screening stocks according to social and ethical criteria, and using the voting process to promote shareholder proposals focused on issues of social responsibility.

6. Understanding how the government protects against stock market abuses, such as fraudulent accounting and insider trading.

Recent enforcement efforts by the Securities and Exchange Commission have focused on improving the accuracy and transparency of financial information provided to investors. They have also focused on curbing insider trading, which undermines fairness in the marketplace by benefiting those with illicitly acquired information at the expense of those who do not have it.KEY TERMS AND CONCEPTS USED IN THE CHAPTERB.board of directors, 324

corporate governance, 324

executive compensation, 328

institutional investors, 322

insider trading, 337

proxy, 323

Securities and Exchange Commission (SEC), 335

shareholder lawsuits, 334

social investment, 333

social responsibility shareholder resolutions, 333

stockholders, 321

stock option, 328

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INTERNET RESOURCES

www.nyse.com New York Stock Exchange

www.irrc.org Investor Responsibility Research Center

www.cii.com Council of Institutional Investors

www.socialinvest.org Social Investment Forumwww.socialfunds.comSite for socially responsible individual investorswww.ecgi.org

European Corporate Governance InstituteDISCUSSION CASE

TURMOIL IN THE MAGIC KINGDOM

Discussion Questions

1. In your view, did the behavior of top managers and the board of directors at Walt Disney Co. fall short of the standards of good corporate governance described in this chapter, and if so, how? What evidence supports your opinion?

The behavior of top managers and the board of directors at Walt Disney Co. fell far short of the standards of good corporate governance described in this chapter. The judge in a lawsuit brought by institutional shareholders concluded that the board’s practices fell “significantly short of the best practices of ideal corporate governance.” Eisner’s compensation was, by most measures, excessive, even though he led the company through a very successful period early in his tenure. The case also implies that his compensation and performance were not appropriately aligned. He also exercised virtual total control over the board, which the judge called his “personal Magic Kingdom.” Most directors were friends and acquaintances who were totally loyal to him; they were not truly independent, as required by good governance standards. He held the positions of both CEO and chairman of the board, another practice not recommended by governance experts. He pushed through important decisions, such as the one to hire Ovitz as president (and later to fire him), without sufficient board debate and discussion.

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http://www.ecgi.org/

http://www.socialfunds.com/

http://www.socialinvest.org/

http://www.cii.com/

http://www.irrc.org/

http://www.nyse.com/


2. Do you believe the compensation received by Michael Eisner and Michael Ovitz was appropriate? Why or why not?

Both Michael Eisner and Michael Ovitz were highly compensated. The discussion case reports that Eisner Along the way, Eisner was one of the highest-paid executives ever, drawing more than $1 billion in total compensation over two decades. Ovitz worked for Disney for just 14 months, but received a severance package worth $140 million. Some would defend Eisner’s compensation, saying that he boosted the stock value very significantly during the early years of his tenure; however, others would argue that it was excessive, particularly during the latter years of his tenure. For Ovitz’s part, his defenders would say that his payout was necessary to compensate him for giving up his lucrative talent agency to take his position with Disney. Others would say that $140 million is grossly excessive for just over a year’s work.

3. What steps did institutional shareholders at Disney take to protect their rights and promote their interests? What additional steps, if any, could or should they have taken?

In 2004, Roy E. Disney and Stanley Gold, two dissident members of the board, mounted a campaign to convince institutional shareholders to withhold their votes from Eisner. They also called for greater accountability to shareholders and a clearer link between executive pay and performance. Many institutional shareholders supported them; several major state pension funds, mutual funds, and the proxy advisory firm Institutional Shareholder Services withheld their support from Eisner. As a consequence, the board stripped Eisner of his chairmanship and gave the post to an independent director (George Mitchell). Arguably, institutional shareholders could have done more, including suing the company.4. Do you believe that the changes in corporate governance that have been made at Disney are sufficient? Why or why note? If not, what additional changes should be made?

In addition to separating the roles of chairman and CEO (see #2), the board also adopted a new procedure for director elections. If a majority of shareholder votes were withheld from any director, that individual would be required to resign. The board’s governance committee would then have to recommend to the full board if the resignation should be accepted. Other reforms they could have made might include: 1) setting a minimum number or proportion of outside directors; 2) establishing compensation policies that clearly linked pay to performance; 3) requiring regular meetings of independent directors; and 4) evaluating the board’s own performance on a regular basis.

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Chap 015

Documents

Transcript of Chap 015