Corporate Governance Matters

Preface xviii

Chapter 1 Introduction to Corporate Governance 1

Self-Interested Executives 4

Defining Corporate Governance 8

Corporate Governance Standards 9

Best Practice or Best Practices? Does "One Size Fit All"? 12

Relationship between Corporate Governance and Firm Performance 13

Endnotes 15

Chapter 2 International Corporate Governance 19

Capital Market Efficiency 19

Legal Tradition 22

Accounting Standards 23

Enforcement of Regulations 25

Societal and Cultural Values 26

Individual National Governance Structures 28

United States 29

United Kingdom 31

Germany 35

Japan 37

South Korea 40

China 41

India 43

Brazil 44

Russia 46

Endnotes 47

Interlude 53

Chapter 3 Board of Directors: Duties and Liability 55

Board Responsibilities 55

Board Independence 56

The Operations of the Board 57

Board Committees 60

Duration of Director Terms 64

Director Elections 64

Removal of Directors 66

Legal Obligations of Directors 66

Fiduciary Duty 67

Environmental, Social, and Governance (ESG) 70

Disclosure Obligations under Securities Laws 71

Legal Enforcement of State Corporate Law (Fiduciary Duties) 72

Legal Enforcement of Federal Securities Laws 73

Director Indemnification and D&O Insurance 73

Endnotes 75

Chapter 4 Board of Directors: Selection, Compensation, and Removal 79

Market for Directors 79

Criteria for Director Recruitment 80

Active CEOs 81

International Experience 82

Special Expertise 82

Diverse Directors 84

Professional Directors 85

Disclosure Requirements for Director Qualifications 86

Director Recruitment Process 87

Director Compensation 90

Ownership Guidelines 95

Board Evaluation 96

Removal of Directors 98

Endnotes 102

Chapter 5 Board of Directors: Structure and Consequences 109

Board Structure 110

Chairman of the Board 113

Lead Independent Director 116

Outside Directors 119

Board Independence 122

Independent Committees 125

Bankers on the Board 126

Financial Experts on Board 127

Politically Connected Boards 127

Employee Representation 129

Boards with "Busy" Directors 131

Interlocked (or Connected) Boards 134

Committee Overlap 135

Board Size 136

Board Diversity 136

Female Directors 138

Summary 139

Endnotes 141

Interlude 150

Chapter 6 Strategy, Performance Measurement, and Risk Management 151

Organizational Strategy 151

Strategy Implementation Process 154

Business Model Development and Testing 156

Example 1: Fast-Food Chain and Employee Turnover 156

Example 2: Financial Services Firm and Investment Advisor Retention 158

Key Performance Measures 159

How Well Are Boards Doing with Performance Measures and Business Models? 162

Risk and Risk Management 164

Risk and Risk Tolerance 165

Risk to the Business Model 166

Risk Management 169

Oversight of Risk Management 172

Assessing Board Performance on Risk Management 174

Cybersecurity 175

Endnotes 177

Chapter 7 CEO Selection, Turnover, and Succession Planning 181

Labor Market for Chief Executive Officers 181

Labor Pool of CEO Talent 184

CEO Turnover 186

Newly Appointed CEOs 191

Models of CEO Succession 193

External Candidate 193

President and/or Chief Operating Officer 195

Horse Race 196

Inside-Outside Model 197

The Succession Process 197

How Well Are Boards Doing with Succession Planning? 201

Executive Search Firms 203

Endnotes 205

Chapter 8 Executive Compensation and Incentives 211

The Controversy over Executive Compensation 212

Competing Theories of CEO Pay 213

Components of Compensation 214

Determining Compensation 218

Compensation Consultants 221

Compensation Levels 221

Ratio of CEO Pay to Other Top Executive Pay 226

Ratio of CEO Pay to Average Employee Pay 229

Compensation Mix 230

Short-Term Incentives 233

Long-Term Incentives 235

Benefits and Perquisites 237

Compensation Disclosure 238

Say-on-Pay 239

Competing Theories of CEO Pay 242

Endnotes 243

Chapter 9 Executive Equity Ownership 251

Equity Ownership and Firm Performance 251

Equity Ownership and Risk 254

Equity Ownership and Agency Costs 259

Accounting Manipulation 260

Manipulation of Equity Grants 261

Other Examples of Value Extraction through Timing 263

Equity Sales and Insider Trading 264

Rule 10b5-1 267

Hedging 269

Pledging 273

Repricing and Exchange Offers 274

Endnotes 277

Chapter 10 Financial Reporting and External Audit 285

The Audit Committee 285

Accounting Quality, Transparency, and Controls 286

Financial Reporting Quality 288

Non-GAAP Reporting 290

Financial Restatements 291

Models to Detect Accounting Manipulations 297

The External Audit 299

Audit Quality 302

Structure of Audit Industry 302

Impact of Sarbanes-Oxley 305

External Auditor as CFO 307

Auditor Rotation 308

Endnotes 310

Chapter 11 The Market for Corporate Control 319

The Market for Corporate Control 320

Stock Market Assessment of Acquiring and Target Firms 324

Who Gets Acquired? 324

Who Gets the Value in a Takeover? 327

Antitakeover Protections 330

Antitakeover Actions 331

Poison Pills 333

Staggered Board 335

State of Incorporation 337

Dual-Class Shares 339

Warding Off Unwanted Acquirers 341

Endnotes 344

Chapter 12 Shareholders and Shareholder Activism 351

The Role of Shareholders 351

Blockholders and Institutional Investors 354

Institutional Investors and Proxy Voting 357

Activist Investors 359

Pension Funds 361

ESG and Socially Responsible Investing 363

Individual Activist Investors 364

Activist Hedge Funds 366

The Rise of Index Investing 370

Shareholder Democracy and Corporate Engagement 371

Majority Voting in Uncontested Director Elections 371

Proxy Access 372

Proxy Voting 372

Corporate Engagement 374

Proxy Advisory Firms 375

Endnotes 381

Chapter 13 Stakeholders and Stakeholder Activism 391

Pressure to Incorporate Stakeholder Interests 392

Legal and Economic Implications 397

Director and CEO Views on Stakeholders 401

ESG Metrics and Disclosure 402

External Assessment of ESG 407

Endnotes 417

Chapter 14 Corporate Governance and ESG Ratings 425

Third-Party Ratings 425

Credit Ratings 426

Commercial Corporate Governance Ratings 428

ISS: Corporate Governance Quotient 428

ISS: Governance Risk Indicators 430

ISS: QualityScore 430

MSCI ESG Governance Metrics 431

Testing the Predictability of Corporate Governance Ratings 432

Governance Rating Systems by Academic Researchers 433

The Viability of Governance Ratings 438

ESG Ratings 439

MSCI ESG 440

Sustainalytics 441

Vigeo Eiris 442

HIP (Human Impact + Profit) 442

ISS E&S Disclosure QualityScore 442

TruValue Labs 443

Evaluation of ESG Ratings 443

Endnotes 444

Chapter 15 Alternative Models of Governance 449

Family-Controlled Corporations 449

Venture-Backed Companies 452

Private Equity-Owned Companies 458

Nonprofit Organizations 462

Endnotes 466

Chapter 16 Summary and Conclusions 473

Testing Remains Insufficient 474

The Current Focus Is Misdirected 475

Important Variables Are Clearly Missing 476

Context Is Important 477

Rights of Shareholders and Stakeholders 478

Endnotes 478

Index 481