Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-1 Chapter 4 Corporate...

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-1

Chapter 4Corporate Governance and

Corporate ComplianceUnderstanding Business Ethics

Stanwick and Stanwick

1st Edition


Ethical Thoughts

• “At this moment, America’s highest economic need is higher ethical standards – standards enforced by strict laws and upheld by responsible business leaders.– George W. Bush, July 9, 2002


Ethical Thoughts

• “Corporate governance is concerned with holding the balance between economic and social goals and between individual and communal goals. The corporate governance framework is there to encourage the efficient use of resources and equally to require accountability for the stewardship of those resources. The aim is to align as nearly as possible the interests of individuals, corporations, and society.”– Sir Adrian Cadbury, 2000


But I Fired You First

• George Perlegos – started Atmel in 1984, the company went public in 1991

• After Sarbanes Oxley, the composition of the board shifted from an ‘insider’ board to a dominated ‘independent’ board

• 2005 – some of the ‘independent’ board members found out that Perlegos and his brother Gust were allegedly misusing company travel funds



• Investigation by the independent board members showed that Atmel had paid $326,000 for personal travel for George and $80,000 for Gust.

• The Perlegos’ stated that the travel issues were the result of the negligent actions of a former employee who had been fired

• The board recommended that George, Gust, and general counsel Michael Ross be fired.



• But, George said the firings were not legal because he had already called a special shareholders’ meeting to fire the independent board members.

• In May 2007, shareholders voted to support the board members and reject George’s proposal to remove the board members who were responsible for his termination


Corporate Governance

• The system that is used by firms to control and direct their operations and the operations of their representatives, the employees.

• Through the corporate governance structure, firms can ensure that the needs of all stakeholders are satisfied.

• Provides a means to measure and validate the ethical vision.


Corporate Governance

• The corporate governance system:– Incorporates the objectives of the

stakeholders– Ensures that the behavior of the employees

within the firm is fair, just, and transparent


Board of Directors

• Designed to represent the interests of the stockholders

• Agency theory – based on the belief that managers are ‘agents’ of the stockholders because they should be making decisions to benefit the stockholders

• The board is a corporate governance mechanism to help ensure that the agents do their job of maximizing returns


Classifications

• Inside Board Member: person who has direct financial ties to the firm– Management team

• Outside Board Member: person who has not direct financial ties to the firm.– President of a University


Responsibilities for Board Members

• Establishing an maintaining internal financial controls

• Communicating financial situations internally and externally

• Establishing and revising the company’s code of ethics and ethical standards

• Selecting the external auditor

• Establishing different board committees


Core Values to Guide board Members’ Behavior

• Honesty

• Integrity

• Loyalty

• Responsibility

• Fairness

• Citizenship

• Note: Stakeholders must be proactive


Typical Decisions Made by Board Members

• Remember that every board of directors is as unique as the firm it represents

• Major Decisions:– The annual business plan of the firm– The hiring and compensation of the board members

and other officials of the firm– The issuance of stock options– The investments in capital structure and level of firm

indebtedness– The issuance of dividends


Typical Decisions Made by Board Members

– Discussions pertaining to risk management and insurance policies

– Acquisitions, divestitures and capital expenditures beyond a certain amount

– Litigation settlements greater than a certain amount– Fines and penalties greater than a stated amount– Restructuring of the firm that may exceed a particular

amount– Tax settlements that are greater than a certain

amount– Contingent liabilities issues greater than a particular

amount– Pension contributions that exceed a stated amount


BOD Committees

• Executive committee• Nominating

committee• Corporate

governance

• Compensation committee

• Succession committee

• Audit committee • Finance committee


Types of Boards of Directors(From Least Involved to Most Involved)

• Passive Board: rubber stamp board• Certifying Board: certifies to shareholders that

the CEO is doing what is expected and that management will make corrective adjustments when needed

• Engaged Board: provides advice and support to the CEO and top management team

• Intervening Board: actively involved in major decisions

• Operating Board: makes key decisions for the firm


Benefits of A Strong Board of Directors

• Stanwick and Stanwick found that having a strong board does have a positive impact on the performance of the firm– Strong board – majority of members are outside

members, large owners of stock in the firm and on only a small number of other boards

– Strong boards yielded a higher level of financial performance than boards that did not have those characteristics

• Having good corporate governance supports not only the ethical requirements established by the stakeholders, but also the financial requirements established by the shareholders


Role of CEO Compensation

• 2003: Estimated that the total compensation of the average CEO was 301 times that of the average employee

• 2004: Ratio increased to 431 to 1

• These compare to 1982 (42 to 1) and 1990 (107 to 1)

• Average CEO pay in 2004 was $11.8 million


CEO Compensation and Ethical Reputation

• Stanwick and Stanwick Study on the relationship among CEO compensation, ethical reputation, and financial performance:– No direct relationship between CEO

compensation and the financial performance of the firm


Sarbanes Oxley Act

• Passed in 2002, in direct response to the scandals at Enron and World Com

• While there was much opposition to the Act when first passed, today many believe that it has had a positive effect on firms and the boards of directors

• Established to increase transparency, integrity, and accountability of public companies


Provisions of SOX

• Established the Public Company Accounting Oversight Board – five members who are considered to be financially literate, two must be CPAs

• Requires that the external auditors who review the financial statements of the firms be restricted to performing audit based functions

• The firm’s audit committee must preapprove all the services provided by the external auditors


Provisions of SOX

• The lead audit partner and the partner responsible for the audit must change at least once every five years

• CEO and CFO must certify all annual and quarterly reports sent to the SEC

• All board members and top executives must report all stock transactions to the SEC within two business days


Provisions of SOX

• Fiduciary duty of the firm’s lawyers to report to the BOD any violations of securities fraud – issuance of personal loans is no longer allowed

• Every publicly traded company must include in its annual report a description of the firm’s internal controls.

• External auditor must review the internal control procedures of the firm


Provisions of SOX

• Each firm must develop and make a corporate code of ethics applicable to the firm’s top executives at a minimum

• Firms are required to hold separate directors meetings where the CEO is not present

• In direct response to the events at Enron, the act requires the firm to report, in detail, all off balance sheet transactions


Cost of SOX Compliance

• Most resistance has come from Section 404 – Internal Controls; companies are required to test internal controls on a regular basis

• Complaints have come from many saying that SOX is to costly, too time consuming and uses too many employee resources

• Are companies taking the ACT to its extreme? Should they?


Least Expensive Aspects of SOX that firms can adopt

• CEO/CFO certification of financial statements

• Developing an internal code of ethics

• Appointing independent board members and an audit committee

• Creating processes for reporting concerns and protecting informants from retaliation for complaints made in good faith


Least Expensive Aspects of SOX that firms can adopt

• Insisting on true independence for outside professionals

• More clearly defining the client as the organization as a whole

• Splitting audit and nonaudit services between separate accounting firms


The Cadbury and Combined Code

• Cadbury Committee was established in 1991 in the United Kingdom– To develop and recommend changes in the

corporate governance system

• Replaced the Cadbury and Greenbury Codes of Corporate Governance with the Combined Code


Ethics and Corporate Compliance

• Deloitte & Touche argues that corporate compliance should not be considered a penalty of doing business, but an opportunity to incorporate a value-based approach to compliance issues– Step 1: risk/cultural assessment– Step 2: review of current compliance program– Step 3: review the current ethical policies and procedures– Step 4: review and revise if necessary the communication,

training, and implementation phases of the compliance program– Step 5: develop ongoing self-assessment of the compliance

program


US Federal Sentencing Guidelines for Organizations

• Difficult to completely eliminate unethical behaviors in all people.

• Passed in 1991 and revised in 2004• Organizations, like individuals, can be

charged with and convicted of federal crimes– Cannot be sent to prison, but can be fined,

sentenced to probation for up to five years, and ordered to pay restitution to their victims


Common Criminal Charges

• Under the Federal Sentencing Guidelines:– Fraud– Environmental waste discharge– Violations of taxation– Antitrust violations– Food and drug criminal violations


Effective Compliance Program under the US Federal Sentencing Guidelines for

Organizations• The firm must establish appropriate standards

and formal procedures to not only detect, but also prevent criminal conduct

• Oversight by a high ranking employee within the organization

• Implementing due care when assigning delegation responsibilities

• Having an effective means of communicating the compliance system to everyone within the organization


Effective Compliance Program under the US Federal Sentencing Guidelines for

Organizations• Implementing ‘reasonable’ steps to ensure

compliance, which would include systems for monitoring, auditing, and reporting and illegal activity without any fear of reprisal

• Having a consistent level of enforcement of the compliance standards including disciplinary procedures when necessary

• Showing a good faith effort to respond to and prevent future illegal actions after the violations have been filed


The Challenge of Compliance

• Pricewaterhouse Coopers global survey:– Business persons feel they will receive from

Section 404 compliance:• better information, better informed management.

Greater reliance on audited accounts, greater transparency, reduction of overall risk, fewer frauds, more predictable earnings and greater confidence


Corporate Compliance Systems and Global Corruption

• Corruption: the conscious abuse of public roles and resources for the private benefit of a firm and/or the individuals of the firm; the use of bribery, extortion and/or embezzlement for the benefit of one’s own interests– Bribery: giving a financial benefit in return for

influencing the decision of a person in a position of trust

– Extortion: the use of intimidation or power in return for financial benefit

– Embezzlement: the taking of money illegally from a firm or other source


Corruption

• Petty Corruption: occurs when private individuals give illegal financial incentives to non-elected public officials in exchange for favorable dealings with certain government transactions

• Grand Corruption: occurs when illegal financial incentives are given to higher ranked public officials

• Influence Peddling: occurs when illegal transactions take place along with legal transactions


US Foreign Corrupt Practices Act

• Passed into law in 1977 and amended in 1988

• Prohibits any US firm and its foreign subsidiaries from giving foreign government officials any financial incentives in exchange for either obtaining or retaining any government business in that country


Corporate Governance and Stakeholders

• Employees, suppliers, and communities want and expect an honest and transparent relationship with the firm

• Stockholders expect the firm to perform at the maximum financial performance level


Questions for Thought

1. A variety of board committees are discussed in this chapter. Search the Web pages of five companies to see if you can identify any other types of committees.

2. Explain how the Sarbanes-Oxley Act has changed public reporting of financial information.

3. Evaluate the impact corporate governance issues have on the stakeholders identified in Figure 4-2.


All rights reserved. No part of this publication may be reproduced, stored in a retrieval system,

or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of

America.

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