Topic 8

Corporate Governance, Disclosure, and

Executive Compensation
 Corporate Governance
 The corporate scandals at the beginning of
the new century were almost exclusively
scandals about corruption at the top.
 In case after case, management was not
responsible to their boards, and the boards
were not accountable to their shareholders.
 The reaction of the U.S. government was not
only to condemn the abuses but to attempt
to legislate remedies.
 The Sarbanes-Oxley Act served as a good
start to addressing issues of corporate
governance. The law, which took effect in
July 2002, was the most sweeping law
governing corporations since the 1930s
.
 Top Management
 Frequently members of the top management of
corporations have acted as if the code of their
companies applied to lower members within the
firm, but not to them.
 Sarbanes-Oxley addresses this issue in Section 406
by directing the SEC to require that a company
disclose whether it has a code of ethics for its
senior financial officials.
 If it does, the company must disclose the contents
of the code, and any waiver of or change in the
code that it may make. If it does not have a code,
the company must explain why it does not.
 Corporate Board
 Corporate boards vary considerably from
company to company.
 One function of a board is to oversee the
management of the corporation by its
executives.
 Sarbanes-Oxley attempts to give investors some
assurance that the board is able to act
independently.
 Under the new rules, the independent members
of the board are required to hold regularly
scheduled meetings without management.
 Corporate Disclosure
 The information that a corporation is morally
obliged to disclose coincides with much that is
legally required.
 The moral basis for disclosure of corporate
information rests primarily on two second-order,
substantive moral principles:
each person has the right to access the
information he needs to enter into a transaction
fairly, and
each person has the right to know those actions
of others that will seriously and adversely affect
him.
 A transaction is fair if those who are a party to it
have access to the appropriate information and
freely enter into it.
 Parties Entitled to Disclosure
 A corporation has the moral obligation to disclose appropriate
information to those with whom it enters into transactions and to
those whom its actions affect seriously and adversely.
 In broad terms, those affected are:
 the shareholders and potential shareholders of the
corporation,
 the board of directors,
 the workers,
 government,
 the corporation’s suppliers and agents,
 the consumer of the corporation’s product, and
 the general public, whether or not they are consumers of the
product.
 Parties Entitled to Disclosure
Disclosure of information to stockholders and to potential stockholders
 The right of shareholders to information about the company is a right
that no one denies.
 Shareholders have a right to financial information.
 Shareholders are legally represented by members of the board
of directors of a corporation. Shareholders, therefore, should be
informed about the operation of the board and the actions of its
members.
 Shareholders have a right to know not only for whom they are
voting who nominated the members of the proposed slate, how
the board functions, who sets agendas, how often the board
meets, who serves on the committees of the board, the number
of meetings each board member has attended in the previous
year, and the reasons for the resignation of any board members.
 Parties Entitled to Disclosure
 The members of the board of directors are the legal
representatives of the shareholders, so they owe the
shareholders appropriate information, as well as honest service
in their interests. Yet board members need not make public
everything they learn.
 Workers have a right to know the conditions of work, including
their rights, benefits, and obligations. Workers also have a right
to know the general policy of the corporation in the areas in
which they have moral concerns. Workers also have the right
to know, in ample time, about decisions made by
management that will directly and adversely affect them.
 Government has the right to know that corporations are
complying with the law.
 Parties Entitled to Disclosure

 The corporation, from a moral point of view,

should disclose to its suppliers whatever is
necessary to make the contracts between
them fair.
 Consumers should be informed of any dangers
posed by the use of the product they
purchase.
 The general public is also entitled to
information about the corporation and its
operations.
 Form of Disclosure
 The appropriate channels for reporting information
concerning the moral dimensions of some of a
corporation’s actions have yet to be decided upon, much
less standardized.
 Corporations have typically been reluctant to disclose
information about their activities.
 If left to themselves, some of them would consider all their
internal operations trade secrets.
 Shareholders’ meetings are only one forum for raising and
discussing these questions.
 Sarbanes-Oxley has moved toward greater disclosure and
transparency. There is room for much more of both.
 Insider Trading
 Insider information is information that someone within a company has
but that is not available to those outside the company.
 This includes not only trade secrets, but company strategy and plans.
 The moral problems connected with insider information concern the
use individuals may make of such information while they are still
members of a firm. Two aspects of the question raise special
problems.
 One is that of someone within the firm using information for his or
her own private gain, at the expense of the firm. This is called
conflict of interest.
 The other is the use of insider information by someone within a firm
to secure personal advantage over those not in the firm. The most
serious instance of this concerns inappropriate insider trading.
 Insider Trading

 The SEC considers an “insider” anyone who has pertinent

information that is not publicly available and that gives the
trader an advantage over the public.
 The SEC argues that insider trading will dampen the public’s
interest in investing in what people feel is an unfair market, one
in which insiders have all the advantages.
 Critics of the SEC claim that the practice of insider trading is so
widespread that the SEC investigations barely scratch the
surface and are not worth the money or effort poured into
attempts to stop such trading.
 Furthermore, critics claim, insider trading has not discouraged
investor interest in the stock market, and hence the SEC’s fears
are unfounded.
 Executive Compensation
 One of the responsibilities of a corporate board is the
appointment and evaluation of the corporation’s CEO, and
the determination of his or her compensation.
 We should ask what background institutions are appropriate
to keep income differentials from skewing our society in
undesirable ways, robbing those less well off of their dignity
and personal or social esteem.
 In 1992 the SEC, partially in response to public demand,
issued new executive compensation rules, under which
appropriate data must be publicly stated in a standard form,
all compensation is to be disclosed, and the firm’s
compensation committee is to disclose the factors on which
the compensation decision was made.
 Executive Compensation
 The term “golden parachute” refers to a practice of
guaranteeing that the chief officers of a company are
given a certain set of benefits in the case of voluntary or
involuntary severance. The justification given for such a
practice is threefold.
 First, it makes it easier to hire a new CEO in a climate of
corporate takeovers, where one may lose one’s job
through no fault of his or her own.
 Second, it increases the cost to the predator company.
 Third, it gives the chief executives an incentive to work
toward the interests of the shareholders in case of a
takeover threat.
 Executive Compensation
 Critics of the “golden parachute” object that this is an
inappropriate use of a company’s money.
 First, many doubt that well-paying CEO positions would
go begging without golden parachutes.
 Second, given the scale of large takeovers, the cost of
golden parachutes is unlikely to prevent a takeover.
 Third, and most important, CEOs are already very well
compensated in their jobs, and they are paid precisely
to manage the company as best they can for the
benefit of—among others—the shareholders, even at
some possible detriment to themselves.