Corporate Scandal And System Assignment

 Pick a corporate scandal that happened within the last decade. First, summarize what happened. Then, discuss the corporate governance system of this company that failed to prevent this scandal from happening. Finally, discuss what you would have done differently if you were a decision-maker in this company (director, executive, shareholder, etc.) How would you prevent this scandal from happening? Refer to our lectures and your readings about corporate governance mechanisms. There is not a page limit but your answer should be at least four pages (double-spaced). Let me know if you have any questions. Good luck! 

This compelling finding indicates that senior executives’ interests may be more closely tied to debt holders than is commonly recognized. In- deed, CEOs in Sundaram and Yermack’s sample tended to behave (manage) more conservatively as they aged—not simply to maximize annual bo- nus income, but instead to safeguard the value of their pensions and deferred compensation. But what if their compensation was heavily weighted toward stocks rather than inside debt? A recent study of almost a thousand companies (New Yorker, Nov. 12, 2007, p. 34) found that CEOs whose com- pensation was made up mostly of stock options tended to make investments and acquisitions that were riskier than those made by other executives.

Not surprisingly, Sundaram and Yermack be- lieve that the study of debt-based incentives to senior managers is a fruitful area for further inves- tigation in executive compensation. For instance, do executives with ample inside debt seek mergers that reduce firm risk? Why do some firms have more generous pension formulas than others? Do pension plans influence decisions about CEO suc- cession? These and other important questions re- main to be answered. The fact that our knowledge about the impact of different components of ex- ecutive compensation plans is still limited has both academic and policy implications. If nothing else, it also serves to underscore that deferred compensation schemes for executives ought to be more transparent than is currently the case in the United States.

Source: Sundaram, R. K., & Yermack, D. L. (2007). Pay me later: Inside debt and its role in managerial compensation, Journal of Finance, 62(4), 1551–1588.

How Do Corporate Boards Evolve?

Research Brief by Kathleen Rehbein, Associate Professor of Management, Marquette University

What do we really know about the forces driv-ing board formation? There has been sub-stantial debate about the determinants of board attributes. On one side of the debate are the

researchers who believe that boards evolve effi- ciently so that they address any potential agency problems. According to these researchers, board composition reveals the tendency of corporations to select value-maximizing governance attributes that ensure that managerial interests are aligned with shareholder preferences. Yet other scholars believe that the traits of boards reveal the natural inclination of CEOs to create boards that maxi- mize their discretion at the expense of sharehold- ers. That said, board attributes may also reflect a firm’s stage of growth or its need to acquire certain resources given the demands of the external en- vironment.

Understanding the determinants of board at- tributes is important for addressing concerns about their ability to execute corporate oversight. A recent study by Audra Boone (University of Kan- sas), Laura Field (Penn State University), Jonathan Karpoff (University of Washington), and Charu Raheja (Wake Forest University) be- gins the process of identifying the determinants of board size and independence in young companies. This study examines whether boards are struc- tured efficiently or reflect a manager’s ability to dominate the board for personal gain. Boone and her colleagues depart from previous studies by investigating how boards evolve in young compa- nies that have just gone public. Earlier studies have tended to focus on boards in large, estab- lished firms. Yet corporate governance features may well be affected by a firm’s phase of organi- zational growth.

According to Boone and her colleagues, there are three possible explanations for differences in board structure (i.e., its size and independence). The scope of operations perspective argues that board structure will depend on the complexity of a firm’s operations, stemming from the number of product lines or geographic markets. As a firm’s complexity increases, more specialized board ser- vices are required. Consequently, the demand for independent directors who can provide expertise on a range of business topics increases with firm complexity.

An alternative perspective is that the monitor- ing requirements of a firm’s business affect a board’s attributes. As a manager’s opportunities to

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engage in self-serving activities increase, more monitoring is required by the board to protect shareholder interests. The cost of monitoring will also affect the composition of the board: As mon- itoring costs increase, the number of outside di- rectors will decline along with the overall size of the board.

Finally, the negotiation perspective predicts that board attributes will depend on the bargain- ing power of the CEO. When CEOs have substan- tial influence their preference will be for a board that consists of more insider directors and affili- ated outside directors.

To test these theories, Boone and her col- leagues studied 1,019 industrial firms that went public in the United States between 1988 and 1992 over a 10-year period. To measure the com- plexity of operations, they examined firm size, firm age, and number of business segments. To assess a manager’s potential to extract private ben- efits, they examined measures such as free cash flow, industry concentration, and takeover de- fenses. Monitoring costs were evaluated by exam- ining a firm’s market-to-book ratio, high research and development costs, return variance, and CEO ownership. A CEO’s negotiating influence was determined by his or her tenure and ownership. A CEO’s bargaining constraints were assessed by ex- amining outside director ownership, venture cap- ital presence, and the firm’s underwriter rank.

Interestingly, the results showed that a broad combination of factors affects the composition of the board. In general, the results support the idea that firms select value-maximizing governance features. The significance of the size and age of the firm as well as its number of business segments validates that the complexity of firm operations has a positive impact on the size and indepen- dence of the board. In terms of the monitoring perspective, the measures of monitoring benefits and costs significantly affect the size of a firm’s board. This implies that the number of board members increases in order to constrain managers who have enough discretion to pursue personal benefits. The size of the board also increases if monitoring costs are relatively low, so that board members are in a position to effectively oversee the actions of management. On the other hand,

the results for the negotiation perspective were mixed. While most of the evidence supported the premise that firms structure boards efficiently, the fact that the number of independent directors was not affected by monitoring benefits and/or costs raises questions about the natural development of optimal board features. Likewise, when a CEO had substantial influence and faced few decision- making constraints, the board was less indepen- dent.

This study provides some very important in- sights about board attributes of entrepreneurial firms. But it also raises some questions. Given the finding that corporate governance reflects a firm’s unique competitive environment, Boone and her colleagues question the usefulness of current pol- icies that create broad governance guidelines. They also raise questions about other forces that might be driving the formation of boards. Indeed, resource dependence theory, institutional theory, and social network theories may suggest other factors that may be important in predicting board attributes. And while Boone and her colleagues grouped all outsiders in one category, there can be considerable variation among outside directors in terms of their expertise (general vs. specialized) as well as their relationship with top management. Future studies may want to examine how the characterization of outside directors varies over time. This may also provide insights about the efficiency of a board’s structure. Finally, what are the dynamic aspects of board development? Do board features change as the firm goes through different phases of organizational growth? If boards are structured efficiently, board composi- tion should change as the challenges and oppor- tunities a firm encounters evolve. Alternatively, a board’s composition may persist over time, chang- ing only incrementally despite the changing de- mands in its competitive environment. It will be up to future scholars to answer these important questions.

Source: Boone, A. L., Field, L. C., Karpoff, J. M., & Raheja, C. G. (2007). The determinants of corporate board size and composition: An empirical analysis. Journal of Financial Eco- nomics, 85, 66–101.

64 FebruaryAcademy of Management Perspectives