37. How does the alignment of benefits and interests cause corporate governance issues?
Officers, directors, and shareholders often have competing interests as stakeholders of the corporation. Examples of such conflicts are as follows:
• Officer-Directors – The board of directors is charged with hiring the chief executive officer (and potentially other executives). An inherent conflict exists when the CEO is also a director of the corporation. This conflict is especially evident when the CEO is chairman of the board or a large shareholder. The responsibilities and interests inherent in each of these roles often times conflict.
⁃ Example: Mark is CEO and a director of ABC Corp. He receives several million dollars per year in compensation for his role as CEO. When the corporation receives an offer from a hostile takeover, he opposes the sale of the corporation because he will lose his job. Even though he is charged as director with representing the best interests of shareholders, he votes his personal interest in opposing the merger.
• Officer-Director Compensation – The board of directors is charged with hiring and approving the compensation of officers. Further, members of the board set the compensation of other board members. Compensation for these individuals is generally a mixture of money and stock (or stock options). Executives commonly receive bonuses based upon short-term corporate performance. Incentivizing officers and directors in this fashion often creates incentives toward short-term profits, rather than long-term performance. Further, in the current corporate structure, the selection of a CEO is often influenced by the controlling shareholder(s). In turn, the CEO often influences the selection of director candidates. This reality is much of what SOX and Dodd-Frank seeks to remedy.
⁃ Example: Dillon is CEO and director of a corporation. He is on the nomination committee, which proposes the names of directors for election to the board. Directors receive extensive benefits and membership on the board is highly desirable. He makes it known to all nominees that he supports that he expects to remain as CEO. When it is time to appoint a CEO and select a compensation package, the directors that Dillon nominated support Dillon and propose and very lucrative compensation package.
• Improper Relationships – Officers and directors owe fiduciary duties to the corporation. Particularly, officers and directors owe a duty of loyalty. That is, they cannot usurp corporate opportunities or seek personal gain at the expense of the corporation. Officers and directors are in control of extensive corporate assets and resources. This environment lends itself to the improper receipt of benefits by these individuals.
⁃ Examples: Common examples of improper relationships may include: close personal relationships between officers and directors, personal loans from the corporation to officers or directors, improper use of corporate assets, misallocation of corporate funds, corporate donations to political activities, etc.
• Discussion: Do you believe that the alignment of benefits can create conflicts of interest in the corporation? Why or why not? How do you feel about individuals holding multiple stakeholder positions within the corporation? Does this implicate the duty of loyalty? Why or why not?
• Practice Question: Tammy is a major shareholder, chairman (director), and CEO of ABC Corp. Can you provide examples of the types of incentives that may conflict in each of her roles?