1. Corporate Governance

Corporate Governance

Playlist: 42 Videos: 128 Minutes


Topics: Learning Material

Introduction to Corporate Governance
Corporate governance concerns the procedures and mechanisms associated with administering a business entity. Principles of corporate governance include legal and ethical principles controlling the governance procedures and the conduct of those administering the business. This chapter focus on the corporate entity form. It will examine the internal stakeholders and their roles in the business entity. It will examine the theories of governance applicable to the corporate entity form, the duties and procedural requirements of those administering the business, and the methods by which stakeholders may enforce those duties. Lastly, the chapter will explore numerous laws, organizational requirements, and ethical standards that affect corporate governance practice. For further written and video explanation, discussion and practice questions, see Corporate Governance Law (Intro)

What is “Business Governance”?
Business governance concerns the actions and controls placed on those charged with managing a business entity. Business governance is the subject of extensive legislation and research, particularly as it pertains to the corporate entity form. Corporate governance generally concerns the internal control of a corporation as influenced or controlled by state and federal law, rules of ethics, and industry standards. It specifically focuses on the actions of managers and directors and the observance of procedural safeguards of shareholder rights. For further written and video explanation, discussion and practice questions, see What is "business governance"?

Who are the “Members” of a Corporation?
The corporation is made up of shareholders, directors, officers, and employees. Shareholders are the owners of the corporation. Directors undertake the high-level management and decision-making for the corporation. Officers (and their subordinate employees) run the daily operations of the corporation. Each member of the corporation has specific rights and duties attached to her position. These rights and duties can become confusing when a single individual holds more than one position (such as shareholder, directors, and officer) of the corporation. For further written and video explanation, discussion and practice questions, see Who are the members of a corporation?

What is a “Closely-Held” Corporation
A closely-held corporation is owned and controlled by a small group of owners or shareholders. These shareholders hold the shares of stock necessary to elect most or all of the directors. Often, shareholders in a closely-held corporation will elect themselves to serve as directors and appoint themselves as officers. Family-owned businesses commonly organize as closely-held corporations. In these entities, members of a single family own most or all of the outstanding shares. They also serve as directors and officers of the business. Shareholders generally have limited fiduciary duties to the corporation. With a single or small group of shareholders holding a majority of the voting shares in the corporation, minority shareholders rarely have much influence in the corporation. In such instances, common law generally holds that majority shareholders have fiduciary duties to exercise care and loyalty with regard to the corporation. This is particularly true in closely-held entities. Given the difficulty of enforcing one’s rights, these standards offer little protection to the minority shareholder. For further written and video explanation, discussion and practice questions, see What is a closely-held corporation?

What is a “Private Company”?
A private company is a business whose ownership interest is not openly held or traded by the public at large. Company ownership is not sold in the public market. As such, all ownership interests are acquired via personal transactions with the company or other owners of the company. A public company, on the other hand, is a business whose ownership is openly traded in the market. Often, the ownership interest will be traded on a public “stock exchange”. If the shares are not listed on an exchange, the shares are generally available for purchase through securities brokers in what is known as “over-the-counter” transactions. Public companies are subject to far more extensive regulation than private companies. This reality often leads public companies to repurchase outstanding shares from the public market in a transaction known as “going private”. For further written and video explanation, discussion and practice questions, see What is a "private company" vs a "public company"?

What is the role and purpose of he corporation?
The concept of the corporation originated through governmental charter allowing individuals to carry on business collectively. Basically, the charter gave the corporate entity form legal status that was similar to personhood. The concept of the corporation as a legal person has expanded over time to the point that corporations enjoy many of the same constitutional protections as US citizens. The corporate entity also allows individuals to have a beneficial interest without being actively involved in business operations. That is, it allows for increased division and transfer of ownership interest in a business activity. It allows for the utilization of outside capital from investors (rather than just debt or capital contributions from founders) to grow business operations. The active trading of ownership in corporate entities gave rise to the formation of US stock exchanges and the private equities market. For further written and video explanation, discussion and practice questions, see What is the role and purpose of the corporation?

What is “Agency Theory”?
Agency theory posits that corporations act as agents of its shareholders. That is, shareholders invest in corporate ownership and thereby entrust their resources to the management of the directors and officers of the corporation. In larger corporations, there is often a sharp divergence between the short and long-term interest of officers and shareholders. This is primarily brought on by short-term demand for profits and the asymmetry of information that officers and directors possess compared with that of shareholders. The divergence of interest between officer, director, and shareholder is thought to influence the actions and decisions of officers and directors who may become detached from shareholder interests. Corporate governance rules seek to establish a legal framework similar to that of the agent-principal relationship. These rules seek to align the incentives of officers and directors with those of shareholders. They seek to establish norms and customs that prevent the adverse results of divergent corporate interests. Further, agency theory lends itself to the duties that officers or director owe to the corporation. For further written and video explanation, discussion and practice questions, see What is the "agency theory" of corporate governance?

What is “Stakeholder Theory”?
The stakeholder theory of corporate governance focuses on the effect of corporate activity on all identifiable stakeholders of the corporation. This theory posits that corporate managers (officers and directors) should take into consideration the interests of each stakeholder in its governance process. This includes taking efforts to reduce or mitigate the conflicts between stakeholder interests. It looks further than the traditional members of the corporation (officers, directors, and shareholders) and also focuses on the interests of any third party that has some level of dependence upon the corporation. Stakeholders are generally divided into internal and external stakeholders. Internal Stakeholders - Are the corporate directors and employees, who are actually involved in corporate governance process. External Stakeholders - May include creditors, auditors, customers, suppliers, government agencies, and the community at large. These stakeholders exert influence but are not directly involved in the process. Key to the stakeholder theory is the realization that all stakeholders engage in some manner with the corporation with the hope or expectation that the corporation will deliver the type of value desired or expected. The benefits may include dividends, salary, bonuses, additional orders, new jobs, tax revenue, etc. For further written and video explanation, discussion and practice questions, see What is the "stakeholder theory" of corporate governance?

What are the role and rights of “Shareholders”?
Shareholders are the owners of the corporation. They have ownership rights in the shares of corporate stock. The role of the shareholder in the corporation is limited, however, as they have neither the right nor the obligation to manage the day-to-day business of the enterprise. Shareholder rights vary pursuant to the type of stock owned and the applicable state law. State law is heavily influenced by authoritative sources, such as the Model Business Corporations Act (Model Act). Common rights afforded corporate shareholders under state law include: Right to Vote, Right to Information, Right to Meetings, Right to Dissent. For further written and video explanation of these concepts, discussion and practice questions, see What is the role & rights of "shareholders" in the corporation?

What is the corporate “Ownership Structure”?
At the time of formation, a corporation authorizes shares to issue to shareholders in exchange for capital. This regards the following concepts: Promoters, Stock Subscription Agreements, Authorized and Issued Shares, Treasury Stock, Equity Compensation, Stock Splits, and Share Transfers. Stock can be divided into categories called “classes”, and these classes can be further divided into subcategories called “series”. Series simply indicate the time of issuance of a certain number of shares. Different classes of stock may have very different rights. For example, a class of preferred stock is different from a class of common stock. All series in a class are fundamentally the same, except for minor distinctions. Classes of stock ownership are generally categorized as follows: Common Stock, Preferred Stock, Stock Options and Warrants. There can be an infinite number of classes of preferred shares — each with unique rights. The most commonly designated special rights associated with preferred shares are as follows: Dividends, Liquidation Preference, Voting Rights, etc. For further written and video explanation, discussion and practice questions, see What are the variations on attributes of "ownership structure"?

Shareholder Fiduciary Duties
Generally, shareholders of a corporation do not owe fiduciary duties to other shareholders. This situation may change in closely-held corporations or in corporations where shareholders also serve as officers or director. State law varies as to the extent that a shareholder owes fiduciary duties to the corporation itself. A state is more likely to recognize shareholder duties to the corporation in closely-held corporations. For further written and video explanation, discussion and practice questions, see What are the fiduciary duties owed by shareholders?

Personal Liability of Shareholders - Piercing the Veil
Generally, corporate shareholders are not liable for the debts or obligations of the corporation, including legal liability for torts or contract actions. Under certain circumstances, however, a court will disregard the corporate protections and hold shareholders personally liable. This situation arises when a plaintiff sues the corporate shareholder(s) alleging that the court should “pierce the corporate veil” of protection and hold shareholders liable for the corporate debts or obligations. This claim involves the “alter ego theory”. Under this theory, a plaintiff must demonstrate that the purpose of the business entity is not to carry on business as a separate entity; rather, the corporate entity is simply a shell and should be considered one in the same with the shareholders. That is, the corporation is the alter ego of the shareholders and the limited personal liability protections should be disregarded. The court will ask the following questions in evaluating whether to pierce the corporate veil: Business Formalities, Business Assets, Business Capitalization, Stakeholder Functions.A negative response in any or all of these situations could be grounds for the court to disregard the limited personal liability protections of the corporate entity. For further written and video explanation, discussion and practice questions, see When is a shareholder personally liable for corporate obligations?

Holding Shareholders Liable - Direct and Derivative Actions
Shareholders may generally enforce their rights against the corporation (or its officers and directors) in one of two ways. Direct Actions - A shareholder may directly sue the corporation, an officer, or director if one of these individuals takes actions that result in direct harm to the shareholder. This situation is rare, because it’s difficult for a shareholder to demonstrate that she has suffered a specific harm as a result of actions by the officers or directors. Shareholder Derivative Suits - In this type of shareholder litigation, the plaintiffs allege that the corporation itself was harmed by a defendant’s conduct. Shareholders sue the corporation’s directors or officers, alleging a breach of fiduciary duties of loyalty or care to the corporation. Any damages to the shareholders are indirect through the overall negative impact on the corporation. For further written and video explanation, discussion and practice questions, see How can shareholder enforce their rights (direct and derivative actions)?

”Derivative Actions”
A derivative action is a lawsuit against officers or directors brought by shareholders on behalf of the corporation. That is, the shareholders act as representative plaintiff for the corporation and sue the officers or directors for their actions resulting in harm to the corporation. While the objective of such a lawsuit is to halt certain actions by the defendants, any damages recovered in the action belong to the corporation (not the representative plaintiffs). The shareholders benefit indirectly as owners of the corporation. Shareholders begin the derivative action process by making a request to the board of directors to bring a legal action against the alleged wrongdoer. This is called “making demand” on the board. The board will then take one of the following actions: File Suit; Reject the Shareholder Demand; Appoint a Special Litigation Committee (SLC). In certain circumstances, shareholders may file suit without making demand to the board. If they can show that the directors have a conflict of interest, lack the independence to act in the best interest of the corporation, or have otherwise violated the business judgment rule, the court will allow shareholders to bring the derivative lawsuit without the board of directors’ approval. In other words, the court will rule that “demand is futile.” For further written and video explanation, discussion and practice questions, see What is the process for bringing a "derivative action"?

“Corporate Proxies”
Shareholders may vote their shares through a “written consent” or by casting their vote at a shareholder meeting. Written consents avoid the need to call a meeting, but any matter voted upon must receive unanimous written consent to be approved. In corporations with large numbers of shareholders, it is unlikely that all shareholders will attend the meetings and unanimous written consent is not likely. Thus, shareholders have the right to appoint someone to vote for them at a shareholder meeting. Both the appointed individual and the card that the shareholder signs to appoint the substitute voter are often called a “proxy”. For purposes of this material, we will refer to a shareholder proxy as the card used to appoint an individual to vote the shareholder’s interest. The proxy is used to solicit shareholder response and votes on a particular proposal. The shareholder may grant the proxy in favor of a particular action, such as a vote in favor of her desired candidate or corporate action. Under SEC rules, publicly-traded companies are not required to solicit proxies from shareholders, but virtually all of them do. This is the only practical way to obtain the requisite number of shareholders at a meeting to hold a vote and take action. This reaching this minimum number of shareholders present is known as obtaining a “quorum”. The company must accompany all “proxy solicitations” with financial statements and a disclosures statement, known as a “proxy statement”. The proxy statement contains lots of information about the corporation and any proposed actions. Much of this information is disclosed to shareholders in the annual statement and to the public via filing with the Securities Exchange Commission. For further written and video explanation, discussion and practice questions, see What are corporate vote "proxies"?

“Shareholder Activism” and “Institutional Investors”
Shareholder activism refers to the situation where large shareholders of a company exert influence or control over the actions of the directors or officers of the corporation. Activist shareholders are generally concerned with improving returns on their investment through improved corporate performance or other structural changes. They may attempt to influence the company to make certain operational or governance decisions, to adopt goals or causes that the activist investor values, or to undergo a merger, acquisition, divestment or other structural change. Activist investors play an increasingly important role in corporate governance. In the 1920s, approximately 20% of US stocks were owned and held by institutions. Today, nearly 80% of US stocks are held by institutions (mutual funds, pension plans, hedge funds, banks, foundations, endowments, and other investment companies). Individual wealth is largely held by these third-party firms that invest a portion of those funds in corporate shares. Large corporations often directly invest their retained capital in corporate shares of other corporations, or they pay third-parties (such as State Street Corp.) to invest those funds on their behalf. This results in an inordinate amount of corporate stock holdings resting with institutional investors. This model of investment seeks to insulate the underlying investor from the risks associated with investing. More specifically, it spreads risk more evenly across large groups of investors and does not rely solely on one investment class. There is worry, however, that these arrangements place too much authority in the managers of these investment funds with regard to corporate decision-making. For further written and video explanation, discussion and practice questions, see What is "shareholder activism" and the significance of "institutional investors"?

Role of the “Board of Directors”?
Corporate governance procedures under state law and the Revised Model Business Corporation Act regulate the actions of boards of directors. The Organization for Economic Cooperation and Development, Principles of Corporate Governance (2004) describe the responsibilities of the board; some of these are summarized below: Stay Informed; Act Ethically & in Good Faith; Duty of Care; Duty of Loyalty; Provide Planning & Guidance; Hire and Oversee Executives; Oversee Election Process; Ensure Disclosure & Reporting. The amount of board responsibility varies a bit in closely-held firms. State law often allows a heightened role of directors in the daily management of operations. For further written and video explanation, discussion and practice questions, see What is the role of the "board of directors"?

Composition of the Board of Directors
The size of the board and the process for electing directors are laid out in either the articles of incorporation or the bylaws. There are generally few requirements in these governing documents with regard to who can be a director of the corporation. Corporate governance documents generally place few or no requirements with regard to the skill, knowledge, or general competence of board members. There are, however, numerous laws and organizations that control the composition of boards of directors of public companies. These laws and organizational rules include: the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank), the Sarbanes-Oxley Act of 2002 (SOX), the Securities Exchange Act of 1934, as amended (’34 Act), rules of the U S Securities and Exchange Commission (SEC), and the listing standards of the NYSE and NASDAQ.
The most notable requirement of boards imposed either by law or by exchange rules is that a majority of directors on a board be “independent”. The word independent is defined to mean directors who are not officers of the corporation or officers or directors of any parent or subsidiary companies. As such, independent directors are generally chosen from the executive ranks of boards of non-related public or large corporation. Another specific requirement regards corporate committees. Most notably, corporate committee members (particularly special committee members) must be disinterested in their assigned tasks. The objective behind requiring boards to have special committees is to isolate interested directors from controlling the internal workings and decision-making of the entire board. The required types of committee include: Director Nominating Committee; Corporate Audit Committee; and Executive or Director Compensation Committee. For further written and video explanation, discussion and practice questions, see What is the composition of the board of directors?

Standards Governing Actions of the Board
Aside from requirements stated in the articles of incorporation, bylaws, and detailed governance provisions laid out in the previously-referenced laws, boards of directors owe fiduciary duties to the corporation. Fiduciary duties include a duty to "Act in good faith in all actions", a "duty of loyalty", and a "duty of care". The duty of care requires that directors make decisions in line with three principles: Legality, Rational Business Purpose, Informed Decision Making. The "Duty of Loyalty" requires a manager to act in the best interest of the corporation and without personal conflict of interest. I prohibits Self-Dealing (in the absence of Director Approval and Shareholder Approval, and Fairness) or Usurping a Corporate Opportunity. For further written and video explanation, discussion and practice questions, see What standards govern the actions of the board of directors?

What is the “Business Judgment Rule?
The business judgment rule is a principle that applies to officers and directors acting within the scope of their positions. Directors of a corporation have a fiduciary duty to act in the best interest of their stockholders. This includes exercising due care and having a business justification for their decisions and actions. The duty of care requires officers and directors to be informed and avoid acting negligently in the execution of their responsibilities. The business judgment rule applies to further protect directors from liability for their decisions or actions if they acted in good faith. Basically, it raises the standard of care for holding a director liable for actions or decisions that cause a loss to the corporation. A director that takes an action or makes a decision that is negligent or reckless may be shielded from liability if they acted in good faith. Acting in good faith simply means that the officer or director genuinely believed that her decision was appropriate and in the interest of the corporation. The major limitation on the protections of the business judgment rule is when the officer or director either acts to intentionally harm the corporation or breaches her duty of loyalty. For further written and video explanation, discussion and practice questions, see What is the "business judgment rule"?

What is “D&O Insurance”?
Directors (and officers) of corporations often have a layer of protection from personal liability beyond the business judgment rule. Many corporations purchase “director and officer insurance” (D&O insurance) that provides the corporation (and possibly the director or officer) with indemnification for liability for actions or decisions made in its official capacity. D&O insurance generally only applies to breaches of the duty of care. The irony of this situation is that shareholder funds are used to purchase insurance protecting officers and directors from personal liability to shareholders. For further written and video explanation, discussion and practice questions, see What is D&O insurance?

What is the role of “Executives of the Corporation
Managers control the daily operations of the corporation. The senior managers are the officers of the corporation. The most senior positions are often directly chosen by the board of directors. The board then defers to the judgment of these officers with regard to all decision making and actions taken on behalf of the corporation. This includes allowing officers to fill the subordinate management positions in the corporation. The corporate management structure generally includes any of the following senior-level positions: Chief Executive Officer, Corporate Secretary, Chief Financial Officer, and Chief Operating Officer. Other executive positions may be in charge of marketing, information or communication, technology, innovation, etc. For further written and video explanation, discussion and practice questions, see What is the role of "managers" of the corporation?

What standards govern Executive Actions
Officers of the corporation, like the corporate directors, owe fiduciary duties to the corporation. Officers must demonstrate loyalty and care in carrying out their responsibilities. The standard of care that an officer must observe in carrying out her duties varies considerably given the wide array of officer responsibilities; but, the officer must generally be informed and not act negligently. Similarly to corporate directors, officers are protected in their actions by the business judgment rule. Further, most corporation purchase insurance to indemnify officers and directors for any personal liability for actions taken on behalf of the corporation. For further written and video explanation, discussion and practice questions, see What standards govern manager actions?

State and Federal Corporate Governance Laws
Regulation of corporate governance practices is a mixture of state and federal law and organizational requirements. Below is a list of the primary state and federal laws and stock exchange rules contributing to corporate governance: state-specific corporate laws (particularly Delaware law and Model Business Corporation Act states); the Securities Exchange Act of 1934 (’34 Act) and SEC Rules; the Sarbanes-Oxley Act of 2002 (SOX); the Foreign Corrupt Practices Act (FCPA); the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank); the listing standards of the NYSE and NASDAQ; the advisor rules from Proxy Advisory Firms. Each of the above sources of regulation are discussed in detail below. For further written and video explanation, discussion and practice questions, see What are the primary state and federal corporate governance laws?

Role of the State in Corporate Governance
State corporate law is the primary law governing corporate governance and operations. Each state passes its own statutory corporate laws and develops its own common law surrounding those statutes. Shareholders seeking to bring actions to enforce their rights must generally do so under state law. Many state legislatures, rather than independently drafting corporate statutes, adopt the Model Business Corporations Act (MBCA) as the default corporate law in that state. The MBCA is a model set of laws prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association. Twenty-four states have chosen the wholesale adoption of the MBCA. This practice has added a degree of uniformity to state statutory law across state borders. A corporation may incorporate in any state, whether or not the corporation carries on business in that state. This is a common practice when a corporation wishes to take advantage of a state’s favorable legal environment for businesses operations. The most common state for incorporation by businesses that operate primarily outside of that state is Delaware. That is, many corporations (particularly public corporations) incorporate in Delaware but establish their headquarters in other locations. Delaware does not follow the MBCA, and corporations organizing in Delaware do so with the purpose of availing themselves with Delaware’s corporate governance provisions and court system. Delaware allows for several legal benefits that make it a popular choice for companies headquartered in other states, including: Developed Corporate Law, Legislative Responsiveness, Chancery Court. All of the factors provide greater degrees of certainty and comfort to corporate managers and directors. For further written and video explanation, discussion and practice questions, see What is the role of the state in corporate governance?

Securities Law - Corporate Governance
Federal securities laws are generally concerned with corporate compliance. The primary federal securities laws are the Securities Act of 1933 (’33 Act) and the Securities Act of 1934 (’34 Act). State law also governs the sale or exchange of securities, but state law largely mimics or piggybacks upon federal securities law. The ’33 Act primarily controls the initial issuance of securities. In private corporations, the ’33 Act places numerous governance requirements on corporate stakeholders during the issuance process. The ’34 Act places significant requirements on the reporting and disclosure of information by publicly-held corporations. These provisions include mandatory reporting to the Securities and Exchange Commission, as well as disclosure requirements to corporate shareholders. The corporate directors and officers are primarily tasked with making and ensuring the accuracy of all securities-related disclosures. Notably, the ’33 and ’34 Acts allow for a cause of action by shareholders against the corporation or its agents for failure to make disclosures, omissions, or material inaccuracy in a disclosure. These causes of action are based upon negligent misrepresentation and fraud (intentional misrepresentation) in connection with the purchase or sale of corporate securities. The causes of action available to shareholders under the ’33 Act and ’34 Acts are discussed in greater detail in a separate chapter. For further written and video explanation, discussion and practice questions, see What is the role of "securities laws" in corporate governance?

Foreign Corrupt Practices Act – Corporate Governance
The Foreign Corrupt Practices Act (FCPA) places limitations on the ability of the corporation to pay incentives or bribes to foreign governments and corporate officials to secure business advantages.The regulations place specific requirements on corporate accounting departments to account for foreign payments and on corporate directors and managers to adequately disclose those payments to regulators and shareholders. Failure to do so may result in criminal and civil penalties. For further written and video explanation, discussion and practice questions, see What is the role of the "Foreign Corrupt Practices Act" in corporate governance?

Sarbanes-Oxley Act – Corporate Governance
The Sarbanes-Oxely Act (SOX) is the primary federal law governing corporate governance and accountability across multiple aspects of corporate business practice. SOX specifically regulates markets, brokers, dealers, accounting and auditing, on-going government and shareholder disclosure by reporting companies, insider trading, anti-fraud, proxy regulation and so forth. SOX established a new regulatory body, increased the authority of existing regulators, as well as imposed regulations beyond those of the self-regulating, industry organizations. The primary objectives of SOX are to promote: Fairness to Shareholders; Fairness to Stakeholders; Heightened Director and Board Responsibilities; Director and Officer Ethics; Disclosure and Accountability; Accounting and Disclosure Procedures; The Public Company Accounting Oversight Board (PCAOB); External Auditing Firms; Securities Regulations. For further written and video explanation, discussion and practice questions, see What is the "Sarbanes-Oxley Act" (SOX) effect on corporate governance?

Dodd-Frank Act – Corporate Governance
Dodd-Frank was passed in response to the financial downturn beginning in 2007. While Dodd-Frank imposed extensive controls on banks and other lending institutions, it also prescribed corporate governance procedures designed to protect shareholder interests. Notable provisions of Dodd-Frank include: Proxy Rights - Requires corporations allow shareholders have greater ability to nominate directors for election to the board in corporate proxy material. Proxy Disclosures - Requires corporations to make more extensive shareholder disclosures in all corporate proxies. Shareholder Voting Rights - Entitles shareholders to a non-binding vote on certain corporate governance issues. For further written and video explanation, discussion and practice questions, see What is the "Dodd-Frank Wall Street Reform and Consumer Protection Act effect on corporate governance?

Industry Standards Affecting Corporate Governance
Public securities exchanges have extensive governance requirements for companies listing securities for sale with the exchange. Perhaps the most known US exchanges are the New York Stock Exchange (“NYSE”) and NASDAQ Stock Market (“NASDAQ”). Common exchange provisions require:
Director Independence; Committees; Shareholder Votes; Equity Structure; Management Restrictions; Public Disclosures. The regulatory authority of exchanges comes from the exchange’s ability to control which companies are listed on the exchange. Exchanges may reprimand, suspend, or bar companies from listing their shares for violations of exchange rules. For further written and video explanation, discussion and practice questions, see What industry organization standards affect corporate governance?

Proxy Advisory Firms – Corporate Governance
Recent changes to corporate governance laws allow shareholders increased ability to add information to corporate proxies. As a result, proxy advisory firms have assumed an important role in the shareholder proxy solicitation and notification process. These firms propose governance standards for corporations. They encourage corporations to adopt and comply with those standards by sending information to all corporate shareholders about the corporation’s governance. These standards will indicate when directors adhere to or deviate from the proposed governance standards. They may also include a recommendation for director elections. This practice pressures directors to conform to governance standards or face a recommendation from the advisory firm against election or re-election. These firms serve a very important function by informing shareholders who otherwise lack the ability or motivation to learn about directors proposed by the nomination committee of the corporation. For further written and video explanation, discussion and practice questions, see How do "proxy advisory firms" affect corporate governance?

Ethics in Corporate Governance
Corporate codes of ethics are internal measures aimed at ensuring fair and honest conduct by members of the corporation. The corporate law objective to promote openness of information is echoed in codes of ethics. The main problems with codes of ethics are that they do not force compliance and there is very little consequences for individuals failing to adhere to their provisions. As such, corporate actors routinely avoid these provisions in favor of self-interested actions. For further written and video explanation, discussion and practice questions, see What is the role of ethics in corporate governance?

Major Causes of Corporate Governance Issues
The primary characteristics of the corporate governance regime that cause issues or conflicts between shareholders and the corporation are as follows: Access to Information, Decision-Making Procedure, Competition for Authority, Interest and Benefit Misalignment. Each of these drivers of corporate governance issues is discussed below. For further written and video explanation, discussion and practice questions, see What are the major causes of corporate governance issues?

Governance Issues - Shareholder Access to Information
Shareholders own the corporation and control the election of directors. While this structure should effectively check the decision making and actions of directors, the lack of shareholder information about the actions and decisions of directors prevents them from making accurate decisions and often causes apathy with regard to exercising their voting rights. The lack of information is amplified by the fact that nomination committees within the corporation often have unilateral authority to recommend a director for election to the board. Couple this with the fact that shareholders have limited access to proxy material to make shareholder proposals, it makes it unlikely shareholders will be effective in influencing director actions. In light of this reality, shareholders must either possess a large share of corporate ownership or assemble into voting groups to have any real influence on the actions and decision-making of directors. A large shareholder or large voting block has the ability to pass resolutions and control the election of directors. It is often difficult, however, for shareholders to effectively aggregate into a strong voting block in the corporation. One reason is the lack of available information and the high cost of obtaining and monitoring that information. For this reason, increased shareholder access to proxy material, additional shareholder voting rights, and the role of proxy advisory firms has become very important. For further written and video explanation, discussion and practice questions, see What are the "access to information" issues?

Governance Issues - Decision-Making Authority
The structure and process for decision making within the corporation can lead to conflicts between officers and directors and shareholders. Below are common decisions or processes that give rise to conflict: Corporate Approvals, Capital Distribution, Proxy Statements, Written Consents, Supermajority and Unanimity Requirements. For further written and video explanation, discussion and practice questions, see What are decision-making structure issues?

Governance Issues – Benefit Alignment
Officers, directors, and shareholders often have competing interests as stakeholders of the corporation. Examples of such conflicts are as follows: Officer-Directors Authority, Officer-Director Compensation, Improper Relationships. For further written and video explanation, discussion and practice questions, see What are benefit-alignment issues?

Governance Issues - Power Struggles
The corporate structure is designed to establish limited authority in shareholders, directors, and officers. While the general responsibilities of each are clearly established, the strength of influence on decision making is often distorted by the amount of authority demanded or exercised by each stakeholder. Internal Power Struggles - The most notable power struggles come between the board of directors and shareholders. These matters are often settled through shareholder votes or derivative actions by shareholders against the board. In this process, shareholders may seek to assert additional control over director decision making; while directors often seek to diminish shareholder input. Friendly Takeovers - A common point of conflict may arise between the existing board of directors and prospective acquirers (purchasers of a controlling percentage of outstanding shares) of the corporation. This transaction is known as a corporate “takeover” or “buyout”. A takeover is where third parties purchase the outstanding shares of corporate stock and thereby gain control of the corporation. The prospective acquirer(s) may be unrelated third parties, managers, or existing shareholders. The acquirer may petition the board of directors to accept a takeover bid. If the board endorses the offer, it will submit the proposal to existing shareholders. If a majority (or supermajority) of shareholders approve the purchase, the board will repurchase all of the outstanding shares from shareholders at the proposed price. The shares are then surrendered to the acquiring firm. If, however, the board or shareholders reject the acquirer’s offer, the acquirer may seek alternative methods to acquire control over the corporation, such as through a “hostile takeover”. For further written and video explanation, discussion and practice questions, see What are the power struggle or competition issues?

“Hostile Takeovers” and “Defense to Takeover”
A hostile takeover is where a third-party acquirer seeks to purchase a controlling number of outstanding shares without the endorsement or approval of the target company’s board of directors. Prospective shareholders can carry out their objectives through a number of methods. Strategies for a Hostile Takeover, Tender Offer, Proxy Contest, Creeping Tender Offer, Bear Hug. Examples of Defenses to hostile takeovers include: Shark Repellants, Poison Pills, Greenmail, Legal Lockups, and White Knight Defenses. The above list is not exhaustive, but it provides larger categories for types of defenses employed by boards of directors to thwart takeovers. In some cases, these takeover attempts are directed against existing shareholders or managers that seek to gain control of the corporation. A management takeover is generally carried out as a ‘leveraged buy-out’. A leveraged buyout is when managers use a combination of debt and private investment capital to purchase a controlling interest of the corporation. Generally, debt used to purchase the corporate shares is secured by assets of the corporation. For further written and video explanation, discussion and practice questions, see What are "hostile takeovers"?

“Shark Repellant” Defenses
Anti-takeover Measures - When an acquirer attempts a hostile takeover, boards of directors commonly institute measures to thwart the acquirer’s attempts to gain control of the corporation. Some common measures employed are as follows: Shark Repellants - These provisions strengthen the board and make it increasingly difficult for the acquirer to effectuate its plan of replacing current directors. Staggered Boards - The election of directors is staggered over a multi-year period. A certain number of directors will be elected at each annual meeting. This will lengthen the amount of time it would take a bidder to gain full control over the board. Super-majority Voting - This means that the proposed action requires a higher number of shareholder votes than a simple majority. This will mean that the hostile acquirer must purchase or obtain a proxy from a larger number of shareholders in order to effectuate the takeover. For further written and video explanation, discussion and practice questions, see Shark Repellant Defenses?

“Poison Pill” Defenses
Poison Pills - These provisions have the objective of raising the cost of acquisition to the acquirer in hopes of making the acquisition prohibitively expensive. Preferred Share Issuances - The board may approve a preferred class of shares that grant extensive rights to existing shareholders. The preferred shareholder may generally exercise her rights in the event of a takeover offer or a purported acquirer obtains a controlling block of shares. Dual Class Recapitalization - The board distributes a new class of equity to stockholders with superior voting rights but inferior dividends or marketability. The new shares allow shareholders to exchange these shares for some multiple (2x, 3x, etc.) of ordinary common stock. This will augment the voting power of existing managers and make it more difficult for an acquirer to obtain a controlling block of shares. Employee Stock Ownership Plans - This plan may allow employee (particularly executive) stock plans to vest at an accelerated rate. These types of plans are known as “golden parachutes”. They force the acquirer to purchase far more shares at a higher valuation. For further written and video explanation, discussion and practice questions, see Poison Pill Defenses?

“Delay-Tactic” Defenses
Buying Off Acquirer - Often the corporation will attempt to provide benefits to the acquirer that will incentivize it to give up its efforts. These efforts are generally not in the best interest of existing shareholders and can lead to litigation. Target Share Repurchase Plans (Greenmail) - In some cases the corporation will attempt to repurchase of block of shares held by an intended acquirer. The acquirer heavily profits from the repurchase. This effectively eliminates the acquirer from continuing with the acquisition plan. Standstill Agreements - The board may offer to pay an acquirer to halt the acquisition of additional shares for a state period of time. The provision may also require the acquirer to vote its shares for the current board of directors. This will give the corporation time to implement additional anti-takeover measures. For further written and video explanation, discussion and practice questions, see Delay-Tactic Defenses?

“Legal Lockup” Defenses
Legal Lockups - The corporation may be able to halt or delay the acquisition by making it less lucrative to the acquirer or making it illegal under existing law. Asset Restructuring - The corporation may be able to acquire assets that the acquirer does not want or that will create antitrust problems. Alternatively, the corporation could sell valuable assets that the acquirer desires, thus making the acquisition less valuable. Litigation - The corporation may seek a legal action through the FTC or SEC alleging that a merger or takeover violates antitrust or securities laws. For further written and video explanation, discussion and practice questions, see Legal Lockup Defenses?

“White Knight & Pac Man” Defenses
Alternative Acquisition Defenses - In some cases, a corporation may seek to acquire or be acquired in an alternative arrangement that thwarts the acquirer’s efforts. White Knight Defense - In some cases the board may go so far as to endorse acquisition by a different acquirer. The endorsed acquirer does so to avoid the corporation falling into the hands of the original intended acquirer. This process is known as a “white-knight” defense to a hostile takeover. Pac-Man Defense - The target corporation may seek to acquire the acquirer, if the acquirer is a public corporation with stock available for purchase. This is a sort of counter attack that may thwart the takeover effort. For further written and video explanation, discussion and practice questions, see White Knight and Pac Man Defenses?


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