Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-1 Chapter 4 Corporate Governance and Corporate Compliance Understanding Business Ethics Stanwick and Stanwick 1 st Edition

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-2 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-3 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

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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-5 But I Fired You First 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.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-6 But I Fired You First 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-7 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.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-8 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-9 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-10 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-11 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-12 Core Values to Guide board Members’ Behavior Honesty Integrity Loyalty Responsibility Fairness Citizenship Note: Stakeholders must be proactive

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-13 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-14 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-15 BOD Committees Executive committee Nominating committee Corporate governance Compensation committee Succession committee Audit committee Finance committee

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-16 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-17 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-18 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-19 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-20 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-21 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-22 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-23 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-24 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-25 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?

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-26 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-27 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-28 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-29 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-30 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-31 Common Criminal Charges Under the Federal Sentencing Guidelines: –Fraud –Environmental waste discharge –Violations of taxation –Antitrust violations –Food and drug criminal violations

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-32 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-33 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-34 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-35 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-36 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-37 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-38 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

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-39 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.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 4-40 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.