Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

What is Corporate Governance?  The rules of corporate governance define how power is distributed among shareholders, boards of directors, and managers and how disputes are settled.  The nature of corporate governance has changed dramatically over time.  Boards of directors evolved to perform the critical role of monitoring hired managers for the shareholders. Corporate Governance The exercise of authority over the members of a corporate community based on formal structures, rules, and processes.

The Corporate Charter  The corporate charter is the document that authorizes formation of a corporation. It specifies the rights and responsibilities of stockholders, directors, and officers.  Directors have a fiduciary responsibility to the shareholders.  U.S. corporations are chartered by the state in which they incorporate.  States compete with one another to attract the incorporation fees of large corporations.

Flow of Authority in Corporate Governance

Boards of Directors  The average corporate board had 11 members although there is no set number.  Directors in large corporations are chosen after being nominated by the board and approved by a majority vote of shareholders.  Directors who are employees of the company are called inside directors; those who are not employed by the company are outside directors.  Boards are divided into committees.

Duties of Directors  Laws impose two lofty duties on directors:  Represent the interests of stockholders  Exercise due diligence in the oversight of corporate activity  Directors do not make day-to-day decisions.  Boards exercise a very broad oversight.  Compensation varies substantially among industries.

Duties of Directors (continued)  Some specific board functions:  Review and approve the corporation’s goals and strategies.  Select the CEO, evaluate his or her performance, and remove the CEO if necessary  Give advice and counsel to management.  Create governance policies for the firm, including compensation policies  Nominate candidates to be presented to the stockholders for election as directors  Exercise oversight of ethics and compliance programs.

Institutional Investors and Governance  The growth of pension and mutual fund assets has given institutional investors new power in corporate governance.  Jesse Unruh formed the Council of Institutional Investors (CII).  The CII endorsed a Shareholders Bill of Rights demanding a voice in “fundamental decisions which could affect corporate performance and growth.  Since then, institutional investors have been more active in corporate governance issues.

Percent of Equity Held by Institutions

Shareholder Resolutions  Shareholder resolutions cover a wide range of topics and their focus has changed over time.  In the 1970s and 1980s they focused on corporate social responsibilities such as automobile safety and doing business in apartheid South Africa.  In recent years they focused on corporate governance issues, especially the methods for the election of directors and limits on executive compensation.  Resolutions are voted on by all shareholders at the annual meeting, by mail, or by Internet.

Executive Compensation  A compensation committee of the board of directors sets the pay and benefits of top executives.  Elements of compensation include a combination of the following.  Base salary  Annual cash incentives  Long-term stock-based incentives  Stock options  Performance shares  Restricted stock  Retirement plans  Perquisites

Suggested Compensation Reforms  Suggestions for compensation reform include:  The SEC should require more data on compensation in reports to shareholders.  Pay and performance relationship should be revealed.  Bonuses should be tied to long-term performance.  Shareholders should be able to vote on executive compensation.