Corporate Governance

Best Practices:
Implications for Commercial Underwriters
Dr. Gail S. Russ
Dr. Meredith Downes
Associate Professors of Management
Illinois State University


2


3
Corporate Governance
Core concern: How do we make sure that
top managers are doing what theyre
supposed to be doing?




4
The Agency Perspective
Separation of ownership & control
Principals & agents
Misalignment of interests
Whats good for the managers may not be what is
good for the owners



5
The Agency Perspective
The Agency Problem:
The misalignment of agents & principals
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).


6
The Agency Perspective
The Agency Problem:
The misalignment of agents & principals
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).
Focus is on protecting shareholder rights



7
The Stakeholder Perspective
The board has broader responsibilities
Focus is on protecting key stakeholder rights
Shareholders
Employees
Vendors
Customers
Society as a whole



8
Best Practices
The board of directors
Executive compensation
Anti-takeover measures



9
The Board of Directors
Role is to monitor & evaluate top
management
But, is the board a complete solution?


10
Best Practices:
Board of Directors
Separate CEO & Chairman of the Board
Role duality gives CEO too much power





11
Best Practices:
Board of Directors
Separate CEO & Chairman of the Board
Role duality gives CEO too much power
Appointment of lead outside director




12
Best Practices:
Board of Directors
Separate CEO & Chairman of the Board
Role duality gives CEO too much power
Appointment of lead outside director
Former CEO does not continue to sit on the
board




13
Best Practices:
Board of Directors
Active board members
Not a rubber-stamp board


14
Best Practices:
Board of Directors
Active board members
Not a rubber-stamp board
Evidence that the directors are in contact
with employees, vendors, & customers


15
Best Practices:
Board of Directors
Active board members
Not a rubber-stamp board
Evidence that the directors are in contact with
employees, vendors, & customers
Board composition
Size
Age
Diversity
Expertise


16
Best Practices:
Board of Directors
Board composition
Insiders versus outsiders


17
Best Practices:
Board of Directors
Board composition
Insiders versus outsiders
Having a board monitor itself is like having
the fox watch the henhouse.



18
Best Practices:
Board of Directors
Board composition
Insiders versus outsiders
Having a board monitor itself is like having
the fox watch the henhouse.
The majority should be independent


19
Best Practices:
Board of Directors
Board composition
Insiders versus outsiders
Having a board monitor itself is like having
the fox watch the henhouse.
The majority should be independent
Should have formal resolution requiring this
AND a written definition of independence


20
Best Practices:
Board of Directors
Board composition
What is meant by independent?
No material relationship with the company, either
directly or as a partner, shareholder or officer of a
firm that has a relationship with the company


21
Best Practices:
Board of Directors
Board composition
What is meant by independent?
Five year cooling off period before can be
considered independent:
Former employees of the firm
If formerly part of an interlocking directorate in which an
executive of the firm sat on the compensation committee
of the firm employing the director
Same applies to directors with immediate family members
in the above categories



22
Best Practices:
Board of Directors
Board members (insiders & outsiders)
Limits on number of other board memberships
Average director spends 176 hours a year for each
board position



23
Best Practices:
Board of Directors
Board members (insiders & outsiders)
Limits on number of other board memberships
Average director spends 176 hours a year for each
board position
CEOs should not serve on each others boards
(interlocking directorates)



24
Best Practices:
Board of Directors
Board members (insiders & outsiders)
Limits on number of other board memberships
Average director spends 176 hours a year for each
board position
CEOs should not serve on each others boards
(interlocking directorates)
Directors & their firms barred from doing
consulting, legal, or other work for the firm



25
Best Practices:
Board of Directors
Board members (insiders & outsiders)
Limits on number of other board memberships
Average director spends 176 hours a year for each
board position
CEOs should not serve on each others boards
(interlocking directorates)
Directors & their firms barred from doing
consulting, legal, or other work for the firm
Significant stock ownership of firm by directors


26
Best Practices:
Board of Directors
Board committees
Key committees at least chaired by outsiders
Audit, compensation, corporate governance
(nominating) committees



27
Best Practices:
Board of Directors
Board committees
Key committees at least chaired by outsiders
Audit, compensation, corporate governance
(nominating) committees
Preferred: Key committees composed entirely
of independent directors



28
Best Practices:
Board of Directors
Board committees
Compensation committee
Conduct formal evaluation of all company officers
(including CEO) and set compensation


29
Best Practices:
Board of Directors
Board committees
Corporate governance (nominating) committee
Create charter for board


30
Best Practices:
Board of Directors
Board committees
Corporate governance (nominating) committee
Create charter for board
Conduct formal governance review using an
external consultant


31
Best Practices:
Board of Directors
Board committees
Corporate governance (nominating) committee
Create charter for board
Conduct formal governance review using an
external consultant
Nominate board members


32
Best Practices:
Board of Directors
Board committees
Corporate governance (nominating) committee
Create charter for board
Conduct formal governance review using an
external consultant
Nominate board members
Board term limits


33
Best Practices:
Board of Directors
Board committees
Corporate governance (nominating) committee
Create charter for board
Conduct formal governance review using an
external consultant
Nominate board members
Board term limits
Elections
One class of directors
Each director stands for re-election each year


34
Best Practices:
Board of Directors
Board committees
Audit committee
Select independent auditor
Not also employed for consulting work



35
Best Practices:
Board of Directors
Board committees
Audit committee
Select independent auditor
Not also employed for consulting work
Do not seek SEC exemption to do so



36
Best Practices:
Board of Directors
Board committees
Audit committee
Select independent auditor
Not also employed for consulting work
Do not seek SEC exemption to do so
Rotate auditors at least rotate the lead auditor, if
not the entire firm, every 5 years




37
Best Practices:
Board of Directors
Board committees
Audit committee
Select independent auditor
Not also employed for consulting work
Do not seek SEC exemption to do so
Rotate auditors at least rotate the lead auditor, if
not the entire firm, every 5 years
CEO & CFO should not be former employees of the
auditing firm



38
Best Practices:
Board of Directors
Board meetings
Frequency of overall board & committee
meetings



39
Best Practices:
Board of Directors
Board meetings
Frequency of overall board & committee
meetings
Attendance


40
Best Practices:
Board of Directors
Board meetings
Frequency of overall board & committee
meetings
Attendance
Executive sessions
Lead outside director with term limit


41
Best Practices:
Board of Directors
Board meetings
Frequency of overall board & committee
meetings
Attendance
Executive sessions
Lead outside director with term limits
Risk assessment function
Reports identifying risks & methods of addressing



42
Best Practices:
Board of Directors
Board meetings
Frequency of overall board & committee
meetings
Attendance
Executive sessions
Lead outside director with term limits
Risk assessment function
Reports identifying risks & methods of addressing
Access to internal information


43
Best Practices:
Executive Compensation
CEO has substantial stock ownership


44
Best Practices:
Executive Compensation
CEO has substantial stock ownership
Salary, bonuses, & stock options reward
superior performance
not size of the company


45
Best Practices:
Executive Compensation
CEO has substantial stock ownership
Salary, bonuses, & stock options reward
superior performance
not size of the company
AND penalize poor performance


46
Best Practices:
Executive Compensation
CEO has substantial stock ownership
Salary, bonuses, & stock options reward
superior performance
not size of the company
AND penalize poor performance
No modification of performance goals
No re-pricing or swapping stock options


47
Best Practices:
Executive Compensation
CEO has substantial stock ownership
Salary, bonuses, & stock options reward
superior performance
not size of the company
AND penalize poor performance
No modification of performance goals
No re-pricing or swapping stock options
Expense stock options


48
Best Practices:
Anti-takeover measures
Lack of provisions designed to thwart a
hostile takeover
Golden parachutes


49
Best Practices:
Anti-takeover measures
Lack of provisions designed to thwart a
hostile takeover
Golden parachutes
Poison pill provisions



50
Best Practices:
Anti-takeover measures
Lack of provisions designed to thwart a
hostile takeover
Golden parachutes
Poison pill provisions
Greenmail