ACCT4007

Corporate Governance

Topic 3
Board of Directors
(Part B) 1
 Agenda

 Board characteristics
 Director compensation
 Board selection
 Board evaluation

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 Board Characteristics
Board leadership
 The board is led by the chairperson.
 Chairperson of the board should be the leader with vision, strategy, busine
ss acumen, motivation, and problem-solving skills.

 Independent chairperson of the board can ensure maximum protect

ion for shareholders.
 The chair is directly responsible for developing a boardroom tha
t facilitates the effectiveness of individual directors.

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 Board Characteristics
Board leadership
 Effectiveness of board meetings depends on the leadership abili
ty of the chairperson to:
 (1) set the agenda of board meeting
 (2) direct discussion

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 Board Characteristics
Board leadership

(1) Setting the agenda of board meeting

 In the case of CEO-chair separation:

◇ The board agenda is usually prepared by the chairperson in close

collaboration with the CEO to ensure its appropriateness.

 In the case of CEO-chair duality:

◇ The CEO should consult with lead director to ensure the agenda is relevant.

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 Board Characteristics
Board leadership

(2) Directing discussion

 Style of discussion:

◇ The meetings will be short or lengthy, formal or informal, friendly or

adversarial, relaxed or tense, efficient or inefficient, productive or
nonproductive, responsive or nonresponsive, relevant or irrelevant, decisive or
indecisive, and predetermined or deliberative.

 Documentation:

◇ Minutes of board meeting should provide a brief description of issues

discussed and the deliberation process, including voting, decisions, and
actions taken by the board.

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 Board Characteristics
Board leadership

Example: Apple’s Proxy Statement

 Who is the chairperson?
 Is he/she an independent director?
 What is the frequency of the board meeting?

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 Board Characteristics
CEO-Chair duality
 Allows the CEO to undertake both managerial and oversight functi
ons.
 Shareholders usually prefer to separate the positions for strengthe
ning the board’s independence and reducing the potential conflicts
of interest.
 If not separated, then it is preferable that the board consists of subs
tantial majority of independent directors.

Example: Walt Disney Company

At the 2004 Disney annual meeting, shareholders with 43% of share
ownership cast their votes to separate the positions of the CEO and
the chairperson of the board by removing Michael Eisner from the
position of the chair, although he continued to be the CEO.
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 Board Characteristics
CEO-Chair duality

Benefits of CEO-chair separation:

 CEO accountability would be improved.
 Potential conflict of interest would be reduced.
 CG and operations would be improved.
 The board responsibility to oversee management for
shareholders’ benefit would be more effective.

Costs of CEO-chair separation:

 Reducing the CEO’s authority when the power is shared with a
nonexecutive director.
 Negative impact on the company if the non-executive chair is less
informed and possibly less experienced in a leadership role.

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 Board Characteristics
CEO-Chair duality

Example: Apple’s Proxy Statement

 Does Apple separate or combine the positions of
chairperson and CEO?
 What is the qualification of the chairperson?

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 Board Characteristics
Board composition
 Board size

Cost of large board size:

 Process of deliberation becomes time consuming and unwieldy

Benefit of large board size:

 More effective in monitoring managerial actions.
◇ As the number of directors involved with monitoring increases,
the opportunity for wrongdoing is decreased and collusion
becomes more difficult.

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 Board Characteristics
Board composition
 Board size
 The board of public companies normally ranges between nine a
nd fifteen directors.
 A board with fewer than nine directors may be viewed as being
dominated and controlled by a small group.
 A board with more than fifteen directors is generally considered
less efficient.

Example: Apple’s Proxy Statement

 What is the board size of Apple?

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 Board Characteristics
Board composition

 Board independence
 Independent director should not have any relationship with t
he company other than his/her directorship that may compr
omise the director’s objectivity and loyalty to shareholders.

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 Board Characteristics
Board composition
 Board independence
A director may not be independent if the director or his/her relative is (or in the past five
years has been):
 employed by the company or an affiliate
 an employee, director, or greater than 20% owner of a corporation that is one of
the company’s or its affiliate’s paid advisors or consultants
 a paid advisor or consultant of the company and receives substantial amount of
revenue (e.g., more than $50,000) for the advisory services
 employed by, or has had a 5% or greater ownership interest in, a third-party that
receives a significant amount of payment from or provides a significant
amount of payment to the company (e.g., the amount is equivalent to 1% of the
annual consolidated gross revenues of the company or the third-party provider)
 an employee or director of a foundation, university, or other nonprofit
organization that receives material grants or endowments (e.g., $100,000 or 1%
of total grants) from the company or one of its affiliates or executive officers.
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 Board Characteristics
Board composition

 Board independence
 Majority of directors should be independent (75% is suggested).
 Quality of directors’ independence, influence, and ability to act
independently is more important than the number or percentage.

Example: Apple’s Proxy Statement

 What is percentage of independent directors on the
board of Apple?

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 Board Characteristics
Interlocking directorships

 Directors sit on other companies’ boards.

Example: Apple’s Proxy Statement

 Does any director of Apple serve on other companies’
board?

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 Board Characteristics
Board authority
 Decision-making authority of the board is granted through shareho
lders’ election.
 The board is authorized to hire, evaluate, compensate, and fire se
nior executives.
 SOX substantially expanded the authority of directors, particularly a
udit committee, which is authorized to:
 Hiring, firing, compensating, and overseeing the work of external
independent auditors.
 Hiring and firing chief audit executive (CAE) and overseeing int
ernal audit function

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 Board Characteristics
Board authority
 Factors affecting board authority
 Nomination and election of directors are influenced by manage
ment.
 Directors may become beholden to the CEO, so as to enjoy the s
tatus, compensation, and other perquisites of directorship.
 Independent outside directors may be influenced by insiders (s
enior executives), due to:
◇ Lack of adequate knowledge and expertise to assess the quality of m
anagerial decisions
◇ Lack of proper incentives to challenge managerial decisions
◇ Possibility that management controls flow of information to the board
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 Board Characteristics
Board resources
 The board should have adequate legal, financial, and information
resources to effectively fulfill its oversight functions.
 Staff support, internal or external advisors, and legal counsel
 Financial resources to compensate directors and officers and to hire exte
rnal auditors, legal counsel, and other advisors
 Information from management, internal auditors, external auditors, legal c
ounsel, and financial advisors.

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 Director Compensation

 Components of director compensation

Retainer for board membership

Fees for being a committee chair
Fees for attending board and committee meetings

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 Director Compensation

 Best practices

 Director compensation consists of a combination of both cash and stocks.

 All directors should own stocks in the company.

 Director compensation should be comparable to a peer market group.

 All unusual compensation should be reviewed and approved by

independent directors and disclosed in the proxy statement.

 Pensions and postretirement benefits should not be granted to outside

directors.

 Director compensation should be approved by shareholders.

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 Director Compensation

 Pros and cons of directors’ stock ownership

Positive side:
 Align directors’ interests with those of shareholders.
 Studies show that corporate performance could be
improved by share ownership as long as it is below 50%.

Negative side:
 Cause directors to perversely use short-term incentives to
artificially boost stock price.

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 Director Compensation

Example: Apple’s Proxy Statement

 What are the components of directors’ compensation in Apple?
 Is the design of director compensation consistent with best
practices?

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 Board Selection
Staggered (Classified) board
 Only a portion of the board is elected each year.

Advantage of staggered board:

 Allow continuity of the board’s monitoring function.

Disadvantage of staggered board :

 Annual reelection of the entire board becomes more difficult.
◇ Under a typical staggered structure, only 1/3 of the board
is elected each year for a three-year term.

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 Board Selection
Staggered (Classified) board

Example: Apple’s Proxy Statement

 Does Apple have the staggered board structure?

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 Board Selection
Voting systems for director election

 (Traditionally) Plurality voting system

 Directors can be elected by the vote of a single share unl
ess they are opposed by a dissident director.
 Give too much power to executive directors and manage
ment to influence election of outside directors.

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 Board Selection
Voting systems for director election

 (Currently preferred) Majority vote system

 Directs are elected when favorable votes exceed 50%.
 Give shareholders the power to hold directors accountable
for their actions and performance, and to elect the most qual
ified directors.

Example: Intel
In January 2006, Intel’s board amended the company’s bylaws to
replace its plurality vote standard with majority vote system.
This move by Intel is viewed positively by its shareholders in
holding its directors more accountable and in bringing democracy to
its boardroom.
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 Board Selection
Voting systems for director election

Example: Apple’s Proxy Statement

 Does Apple use plurality or majority voting system for
director election?

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 Board Evaluation
Evaluation approach

 Performed formally and regularly (at least annually) through:

 Self-evaluation: More in depth
 Outside consulting evaluation: More independent

Example: Apple’s Proxy Statement

 How often does Apple evaluate the board’s performance?

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 Board Evaluation
Evaluation criteria

 Generally accepted benchmarks for board evaluation

 Fulfillment of oversight functions
 Transparency and accountability
 Overseeing of conflicts of interest
 Establishment of goals and strategies
 Assessment of management’s performance

 Individual directors’ evaluation

 Ability, integrity, financial literacy, strategic perspective, decision making
and judgment, teamwork, communication, leadership, and business acu
men.

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 Board Evaluation
Evaluation criteria

Example: Apple’s Proxy Statement

Evaluate the effectiveness of Apple’s board in the following aspects:
(1) Board independence
 There are no more than two inside directors?
 There are no insiders on the audit, nominating, and compensation
committees?
 There are no outside members who directly or indirectly draw
consulting, legal, or other fees from the company?

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 Board Evaluation
Evaluation criteria

Example: Apple’s Proxy Statement

Evaluate the effectiveness of Apple’s board in the following aspects:
(2) Board quality
 Directors sit on no more than four corporate boards?
 The board has at least one outside director experienced in the
company’s core business?
 At least one director is a CEO of a company of similar size?
 All directors attend at least 75% of meetings?

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 Board Evaluation
Evaluation criteria

Example: Apple’s Proxy Statement

Evaluate the effectiveness of Apple’s board in the following aspects:
(3) Board activism
 The board meets regularly without management present?
 The board evaluates its own performance every year?
 Audit committee meets at least four times a year?

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 Board Evaluation
Evaluation criteria

Example: Apple’s Proxy Statement

Evaluate the effectiveness of Apple’s board in the following aspects:
(4) Board accountability
 All board directors own a minimum amount of stock?
 The company does not offer pension benefits to its directors?
 The board stands for election every year?

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