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The Political Environment Part II

Corporate Governance
Prof. A. Contu
The Enron Scandal:
The CEO: Jeff Skilling
The Enrons version of the free market
The Cost of Enron

Outline of the Lecture
What is Governance:
Mapping the terrain of corporate governance
Key actors, key features and key issues
Current trends
Shareholder activism
From responsibility to accountability

the processes and institutions, both formal and
informal, that guide and restrain the collective activities
of a group (Keohane & Nye 2000) .
steering and coordination of interdependent (usually
collective) actors based on institutionalized rule
systems (Benz 2004) .
Thus, governance mechanisms are how institutions
govern, i.e. regulate, their members behaviour and
are able to reproduce themselves over time.

Definition of Corporate Governance

Usually understood as the process by which
shareholders seek to ensure that their corporation is
run according to their interests.
It includes processes of goal definition, supervision,
control and sanctioning.
BUT: In the broader sense it includes all actors who
contribute to the achievements of the stakeholders
goals inside and outside of the corporation and their
control and monitoring.
Different forms of governance
Anglo-Saxon systems

Rhine Capitalism systems: eg Germany, Netherlands

Key actors
Board of Directors
Inside/executive directors: Chief Executive Officer charters the strategy of
the company. It is desirable for the For the Chair of the Board to be separate
from the CEO
Outside/ non-executive directors
Aim of the board is to propose key strategic decisions for the company,
including M&A and compensation levels.
Non for profit organization also have a board.

A USA Example

Apples Board of Directors:
Apples Corporate Governance
Apples Corporate Governance Guidelines:

In continental Europe: two tier system of co-determination

Upper-tier, Supervisory Board
Lower-tier : executive board overseeing the daily activities
Some members decided by workers; inclusion of direct
representatives of stakeholders (e.g. workers and banks)

External actors
Auditors: accounting firms

Credit Rating Agencies

Stock Analysts & Brokers in the major investment financial institutions

They are to produce:
True and fair view of a company financial situation or a judgment of the
trustworthiness of an investment opportunity
Those who own the company shares
They invest to have a return either by increase share price or by getting dividends if paid
Individual/household shareholders/institutional shareholders: pension funds, college
endowments, hedge funds, mutual funds, commercial banks, insurance companies,
Changing landscape:
Lower regulations of share transactions
Information & Communication Technology Changes
More professional brokers rather than individual, lone investors: brokers have incentives to
trade shares more frequently than individuals do
1. in the 50s: household/individual shareholders owned 90% of the shares
2. Now (article published in 2009) institutional shareholders own 50% of the US stock and if one
includes hedge funds and and foreign shareholders the figure is probably closer to 65-70%
Short-termism: An equity traded in the New York Stock Exchange in the 50s was held on
average for about 7 years. Now it is held for about 6 months!
(see Fox and Lorsch, 2009)
Locus of control: The myth that shareholders own the corporation
and directors work is to maximise shareholders value Prof. Lynn
Stout, Cornell Law School

General Issues
Shareholders rights
They have the right to the dividends if dividend are issued
They have claim on firms residual asset after all creditors are satisfied
The have the right to sell their shares
They have the right to vote at the general assembly
They have the right to submit shareholders resolutions
The by-laws in corporate charters will specify others
An issue of discipline:
Potential Conflict of Interest: how shareholders can check/control that directors are not
following their own interest rather than the corporation & shareholders' interest
Informational Asymmetry

Discipline issue
Executive power:
Against hostile takeovers, i.e. bid to buy control of the corporation
(start to be worried if above 20%) without consent of the Board
(i.e. the Board does not agree with such change in stock
Poison Pills are shareholders rights plans (to buy & sell) included
in the by-laws designed to make the stock less attractive
If over 20% concentration then all other shareholders have option to
buy at discounted prices or for
Golden Parachutes severance packages worth millions.
Movement to take back the control of the board and address the
principal agency dilemma:
High executive pay and share options

BUT : unintended consequences of fuelling short term logic
and favoring financialization
rather than economic and financial longevity of the corporation
( profitable; pay dividend and sell stock when return is
As Fox and Lorcsh put it:
The statistical correlation between CEO pay and corporate
performance at S&P 500 companies is zero reports Baruch
Lev in his 2012 book Winning Investors Over.

Issues 2
Autonomy and Independence of Board of Directors,
especially the Non-Execs
Autonomy and independence of external agents:
Auditors, Stock Analysts impartiality
Regulatory bodies
Issues 3
Corruption and Scandals: For example,
Insider trading

Accounting Frauds

1) Regulatory reforms

1) Shareholder activism

2) From Responsibility to Accountability
Regulatory changes to reform corporate governance
In the USA: Sarbanes-Oxley (SOX) Act 2002 or
Public Company Accounting and Investor Protection Act:
Higher responsibilities for the role of board of directors on the accuracy of
financial statements
Senior management must sign the accounts taking individual personal
responsibility for their accuracy (e.g. could not say I did not know!)
Higher independence of auditors (e.g. rotation, restriction on consulting
contracts, reporting requirements and certifications) and securities
analysts (requires disclosures of conflict of interest)
Tougher penalties for those found guilty
In Europe and other countries: new, constantly updated codes for
corporate governance

Shareholder Activism
If one refuses the option to Exit by selling the shares can
choose the option of Voice
Voice involves a direct engagement with the board
decisions which is within the owners of the shares
prerogatives and rights.
It can also involves class action lawsuits: way to counter
corporate fraud or potentially unlawful conduct that
damages their interest
Shareholders Resolutions

Mostly for internal corporate governance issues:
For example, challenge anti-sharks measures, conflict
of interests, Exec Remuneration packages and links
with performance, etc.
But also used for raising social concerns and raise
social and environmental issues:
Climate change issues
Suppliers issues
Equal opportunity issues

Latest Trends
Development of socially responsible investment funds and
Investments in sustainable firms
Quality and reliability of information
Dubious criteria
Mostly based on management policies not actual results and activities
So growing demand for accountability at all levels not only financial but also broadly
economic, environmental and social ------- Global Governance Issues and growing
financial and non financial reporting
Accountability: a system that guarantees clarity of rules, structures and due process that
clarifies who is responsible for what and that shows in clear, traceable ways (i.e.
accounts) corporate results on financial, social and environmental performance &

Case Study
Preparation and Required Reading Prior to Class: In March
2014 Exxon agreed to publish a report on the risk of carbon
assets. This came as a response to the shareholder resolution
presented by You Sow and Arjuna Capital. You must find reliable
information on this event putting together a brief case study for
class discussion. This includes:
Who are the stakeholders involved?
What is the issue at stake?
When did this occur?
What was the content of the proposal?
Why was it issued?
What was Exxon response?
In what ways is this related to corporate governance?
What is your opinion of the case specifically (did shareholder
activism work? Did it achieve its aims? Why are such actions
important?) and of corporate governance more generally?

Some reputable sources on the issue
As You Sow | Engaging Corporations. Protecting People and Planet.." As You Sow. N.p., n.d. Web. 13 May 2014.
Landmark Agreement with Shareholders: ExxonMobil Agrees to Report on Climate Change and Carbon Asset Risk." www.arjuna- As You Sow/Arjuna Capital, n.d. Web. 10 May 2014. http://arjuna-
IHS Energy 50 | IHS." IHS Energy 50 | IHS. IHS Inc., n.d. Web. 10 May 2014. <>.
Arjuna Capital." Arjuna Capital. N.p., n.d. Web. 10 May 2014.
Exxon Report on Climate change:
Fahey, Jonathan. "Exxon: Highly unlikely world limits fossil fuels." Saloncom RSS. N.p., 31 Mar. 2014. Web. 10 May 2014.
"Congressional Attacks on the Clean Air Act." US Climate Action Network. USCAN Climate Action Network, n.d. Web. 10 May 2014.
"Shareholder Resolutions." Ceres. N.p., n.d. Web. 10 May 2014.
Davenport, Coral. "Justices Back Rule Limiting Coal Pollution." The New York Times. The New York Times, 29 Apr. 2014. Web. 10 May
Vlasic, Bill. "U.S. Sets High Long-Term Fuel Efficiency Rules for Automakers." The New York Times. The New York Times, 27 Aug.
2012. Web. 10 May 2014.
Naik, Gautam. "U.N. Climate Change Report Says Worst Scenarios Can Still Be Avoided." The Wall Street Journal. Dow Jones &
Company, 13 Apr. 2014. Web. 13 May 2014.

Academic References
Hond, Frank Den, and Frank G. A. De Bakker. "Ideologically Motivated
Activism: How Activist Groups Influence Corporate Social Change Activities.."
Academy of Management Review 32.3 (2007): 901-924. Print.
Newell, Peter. "Civil Society, Corporate Accountability and the Politics of
Climate Change." Global Environmental Politics 8.3 (2008): 122-153. Print.
Reid, Erin M., and Michael W. Toffel. "Responding to public and private
politics: corporate disclosure of climate change strategies." Strategic
Management Journal 30.11 (2009): 1157-1178. Print.
"Carbon asset risk." ExxonMobil. N.p., n.d. Web. 10 May 2014.

Corporate Governance is of extreme significance because
of the agency problem
Failures in corporate governance can have serious
consequences for investors, workers, suppliers and local
and global communities
The trends are in:
higher regulation either rule-based and mandatory or
best-practice based.
Rising shareholder activism
And demands to move from responsibility to accountability