Case Study: Corporate Governance and Social Responsibility Adoption

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Corporate Governance and Social Responsibility

Adoption of Corporate Governance Principles

Evaluations & Recommendations

Adoption of Corporate Social Responsibility Initiatives

In the United States, corporate governance legislation was initiated mainly directed at listed enterprises requiring executives to confirm financial statements as accurate and requiring increased oversight of boards and auditors. Private unlisted enterprise though, remains free from such regulatory control and protection.

Adoption of Corporate Governance Principles

Evaluations & Recommendations

I would recommend the following Corporate Governance principles; gleaned from the Sarbanes-Oxley Act (2002), OECD (2004), Combined Code (2003) and the Australian Securities Exchange (2007).

Corporate Governance and Managerial Compensation

Being a mining company in today's economic climate, a major responsibility as far as corporate governance goes is for the board of directors is to determine managerial compensation systems. How should managers be compensated? Should pay be tied to performance?

From an accounting perspective, organizing the firm into cost centers and evaluating managers on the basis of costs alone is essentially an input-based monitoring system. For managers, though, output measures are more likely to be used than input measures. These measures are not direct measures of effort but, instead, are what are called instrumental measures. They either measure something that is thought to be closely related to effort or compare outputs to inputs. Historically, such measures have included net income, profit margins, return on assets and return on equity (both measures that compare outputs to inputs), and growth in earnings and sales (Levitt, 2005; pg. 145). In terms of maximizing the wealth of the existing owners of the company, the company's stock price is also assumed to be related to these measures. So, increasingly, more and more companies are using the stock price itself or some compensation scheme that ties rewards to the stock price to finesse the ever-present problem of measuring effort. Still, the problem of separating the contributions management makes to performance from factors that are not under management control (luck, noise) remains (Carroll, 2001; pg. 27). How do we get out of this box?

Measures of relative performance may be one answer. Owners can measure managerial performance relative to the performance of other firms in the industry or some other benchmark. For example, managerial performance can be benchmarked against such industry wide financial ratios as profit margins, return on assets, return on shareholders' equity, and rates of growth in sales and net income. As we will discover, many companies do use such relative performance measures and measure performance against peer groups' With respect to the stock price, managerial performance can be evaluated by adjusting the change in the company's stock price for what happened to the market in general-all companies-during the same period. Suppose the 'per share' price of XYZ Corporation fell by 8% over the year. Was the decline in the share price due to poor management or to factors beyond the control of management, such as an economy wide recession? Some insights into this question can be gained by looking at what happened to a broad-based market index such as the Standard & Poor's 500. If the index fell by 20%, perhaps the managers of XYZ Corporation should be paid a substantial bonus because they were able to guide the company through the recession far better than the managers of other companies. However, if the index rose by 20% during the period, a different story emerges.

Common Pay and Performance Schemes

In the United States, senior managers' pay typically has three components: a fixed or base salary, a short-term or annual bonus payment, and a long-term bonus or performance payment. Both the short-term and long-term bonus payments are tied to performance measures, with the long-term bonus often taking the form of stock options. In 1996, the median CEO pay, inclusive of all forms of compensation, was $3.2 million in mining and manufacturing, $4.6 million in financial services, and, $1.5 million in utilities' (Lunnie, 2007; pg. 189). For U.S. CEOs, the fixed base cash salary represents between 20 and 40% of total compensation, with the fixed salary percentage being lowest among large manufacturing firms and financial services companies (a category that includes investment banks) and highest among utilities. Furthermore, the CEO's base salary as a percentage of total compensation has been dropping since 1990. However, one explanation for the reduction in fixed salaries as a percentage of compensation may be a 1993 change in the U.S. tax code that prohibited firms from deducting as business expenses nonperformance pay over $1 million to executives. Consequently, any compensation in excess of $1 million is likely to be disguised in one form or another as incentive-based pay (Carroll, 2001; pg. 121).

Corporate Governance Dividend Issues

Managers can do two things with present year's earnings: They can hand them out as cash dividends, or they can keep them in the company. If the salary is retained, management can use them to make extra investments or to pay down debt. The choice to pay down debt is part of the financing decision and is associated to the notion of an optimal capital structure and solving governance troubles through the financial structure decision. So, setting aside the ?pay down the debt' alternative, when should management retain earnings and reinvest them in the company, and when should management distribute the earnings as cash dividends ? Arguably, the best reason for paying cash dividends is that management knows that no positive NPV investments exist for the firm. Therefore, rather than keeping cash in the company, where it earns no return, the managers should distribute it to the owners of the company as cash dividends. The owners of the company can then use these cash dividend payments to invest in other companies that have positive NPV projects available to them. Thus, they would be able to create jobs and economic growth for the economy as a whole were they to receive the funds-essentially the public policy objective of a well-functioning corporate governance system . This hypothesis is called the residual theory of cash dividends. If conglomerates were actually following this policy, though, we would detect much more volatility in year-to-year cash bonus payments than we do in reality-volatility that would be more similar to that observed in net income and earnings per share (Drucker, 1984; pg. 156).

The Board of Directors and Shareholders' Rights

The board should have audit, compensation, and nominating committees made up entirely of outside directors. The audit committee ensures that the books aren't being cooked and that shareholders are properly informed of the financial status of the firm (Levitt, 2005; pg. 109). Typically, the audit committee recommends the CPA firm that will audit the company's books, reviews the activities of the company's independent accountants and internal auditors, and reviews the company's internal control systems and its accounting and financial reporting requirements and practices. The compensation committee normally does the following: (1) recommends the selection of the CEO, (2) reviews and approves the appointment of officers who report directly to the CEO, (3) reviews and approves the compensation of the CEO and the managers reporting to the CEO, and (4) administers the stock compensation and other incentive plans (Lunnie, 2007; pg. 256). The nominating committee sets up qualifications for potential directors. It also puts together a list of applicants for board membership for the shareholders to vote on. In all these cases, the point of having only external directors is to stop management from concealing information, deciding on its own pay, and advancing effective control of the company by controlling the board election procedure. Diversity should be a significant factor in building a board. The members should all be capable individuals, but there should be a variety of experience, gender, race, and age.

The corporate scandals of recent years have resulted in a wave of new regulations and legislation. Most prominent among them is the Sarbanes-Oxley Act of 2002 (often referred to as SO). This Act addresses perceived weaknesses in auditing, reporting, and corporate governance of U.S. public companies and has been hailed as the most dramatic change to federal securities laws in over 50 years. In combination with related actions and provisions from the Securities and Exchange Commission (SEC), which administers the laws set forth in the act, and rule changes from the major stock exchanges, notably the New York Stock Exchange (NYSE) and the Nasdaq Stock Exchange (NASDAQ), the Sarbanes-Oxley Act has established enhanced regulations for public company governance and reporting requirements (Pava & Krausz, 2005; pg. 83). The rule changes at the NYSE and NASDAQ came in response to a request from the Chairman of the SEC, who asked the exchanges to examine their listing standards with an emphasis on all those related to corporate governance. In reaction, the NYSE and the National Association of Securities Dealers (NASD) through its subsidiary, the NASDAQ Stock Market, Inc., filed corporate governance reform proposals with the SEC. Specifically, in August of 2002, the NYSE filed the NYSE Corporate Governance Proposal to amend its listed company manual. In October of 2002, the NASD, through… [END OF PREVIEW]

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