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McEnally and Kim define corporate governance as
“the system of principles, policies, procedures, and clearly defined responsibilities and accountabilities used by stakeholders to overcome conflicts of interest inherent in the corporate form.”
The lack of an effective corporate governance system
could threaten the existence of a corporation and weaken the trust and confidence that is essential for effective financial markets
The objectives of corporate governance are to
1) Eliminate or reduce conflicts of interest. 2) Use the company’s assets in a manner consistent with the best interests of investors and other stakeholders
An effective corporate governance system will
1) Define the rights of shareholders and other important stakeholders. 2) Define and communicate to stakeholders the oversight responsibilities of managers and directors. 3) Provide clear and measurable accountability for managers and directors in assuming their responsibilities. 4) Provide for fair and equitable treatment in all dealings between managers, directors, and shareholders. 5) Have complete transparency and accuracy in disclosures regarding operations, performance, risk, and financial position
There are three major business forms
1) Sole proprietorship. 2) Partnership. 3) Corporation
Factors causing managers and shareholders confict
Management may act for their own interests include using funds to expand the size of the firm, granting excessive compensation and perquisites, investing in risky ventures, or not taking enough risk
Directors and shareholders conflict
The conflict between directors and shareholders occurs when directors align more with management interests rather than those of shareholders
Factors causing Directors and shareholders conflict
Lack of independence, board members have personal relationships with management, board members have consulting or other business agreements with the firm, interlinked boards, or directors are overcompensated
The board of directors for a corporation has the responsibility to (8 pts)
1) Institute corporate values and corporate governance mechanisms that will ensure business is conducted in a proficient, ethical, and fair manner. 2) Ensure firm compliance with all legal and regulatory requirements in a timely manner. 3) Create long-term strategic objectives for the company that are consistent with the shareholders’ best interests. 4) Determine management’s responsibilities and how they will be held accountable. Performance should be measured in all areas of a company’s operations. 5) Evaluate the performance of the chief executive officer (CEO). 6) Require management to supply the board with complete and accurate information in order for the board to make decisions for which it is responsible. 7) Meet regularly to conduct its normal business, and meet in extraordinary session if necessary. 8) Ensure that board members are adequately trained
Corporate governance best practices includes the following (11 pts)
1) 75% independent board members. 2) CEO and Chairman are separate positions. 3) Directors knowledgeable/experienced, serve on only two or three boards. 4) Annual elections (not staggered). 5) Evaluate/assess board annually. 6) Meet annually without management. 7) Independent directors with finance expertise on audit committee; meet auditors annually. 8) Independent directors on nominating committee. 9) Most senior manager pay is tied to performance. 10) Board use independent/outside counsel. 11) Board approves related-party transactions
Investors and analysts should assess the following policies of corporate governance (7pts)
1) Codes of ethics. 2) Directors’ oversight, monitoring, and review responsibilities. 3) Management’s responsibility to the board. 4) Reports of directors’ oversight and review of management. 5) Board self-assessments. 6) Management performance assessments. 7) Director training
Strong corporate governance increases
profitability and ROE to shareholders
Weak corporate governance systems decrease the value of a company by increasing (risks)
financial disclosure risk, asset risk, liability risk, or strategic policy risk
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