Notes

Introduction

1. Shleifer and Vishny (1997), p. 737.

2. Cadbury Committee (1992).

3. Centre of European Policy Studies (CEPS; 1995), as reported in Shleifer and Vishny (1997).

4. European Corporate Governance Institute (1992).

5. Organization for Economic Cooperation and Development (OECD; 1999).

Chapter 1

1. “Is One Global Model of Corporate Governance Likely, or Even Desirable?,” Knowledge@Wharton, January 9, 2008.

2. This section is based on Kenneth Holland’s May 2005 review of the book Corporate Governance: Law, Theory and Policy.

3. http://www.sec.gov/about/whatwedo.shtml

4. http://www.investopedia.com

5. On December 20, 2012, the boards of directors of both Intercontinental Exchange and NYSE Euronext approved the $8 billion acquisition of NYSE Euronext. The acquisition is subject to regulatory approval; the deal is not likely to be blocked.

6. This section draws on Edwards (2003).

7. Citigroup paid $400 million to settle government charges that it issued fraudulent research reports; and Merrill Lynch agreed to pay $200 million for issuing fraudulent research in a settlement with securities regulators and also agreed that, in the future, its securities analysts would no longer be paid on the basis of the firm’s related investment-banking work.

8. Coffee (2002, 2003a, 2003b).

9. This section is based on the essay by Hawley and Williams (2001).

10. Thornton (2002, January 14). Hostile takeovers made a dramatic comeback after the 2001–2002 economic recession. In 2001, the value of hostile takeovers climbed to $94 billion, more than twice the value in 2000 and almost $15 billion more than in 1988, the previous peak year.

11. Romano (1994).

12. Holmstrom and Kaplan (2003).

13. Lindstrom (2008).

14. “MCI, Inc.,” Microsoft® Encarta® Online Encyclopedia (2008).

15. Edwards (2003).

16. Angelides et al. (2011).

17. Epstein (2012).

Chapter 2

1. Bernstein (December 2007–January 2008).

2. See Bebchuk (2007, May), p. 675; and Lipton and Savitt (2007, May), p. 733.

3. Lipton and Savitt (2007, May), p. 733.

4. See The American Law Institute (1994), p. 61.

5. See, for example, Bradley, Schipani, Sundaram, and Walsh (1999), pp. 9– 86; and Matheson and Olson (1992), pp. 1313–1391.

6. Reason (2005, October).

7. Friedman (1970).

8. Ibid.

9. Drucker (1974), p. 67.

10. This section draws on Sundaram and Inkpen (2004).

11. Dodge v. Ford Motor Co. (1919).

12. Dodd (1932), pp. 1145–1163.

13. Friedman (1970).

14. For agency theory, see, for example, Alchian and Demsetz (1972); and Jensen and Meckling (1976); and Fama and Jensen (1983a). Agency theory is directed at the dilemma in which one party (the shareholder as the principal) delegates work to another (management as the agent) who performs that work. Agency theory is concerned with resolving two problems that can occur in such a relationship. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principal to verify what the agent is actually doing. The issue here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes toward risk. In this situation, the principle and the agent may prefer different actions because of the different risk preferences.

15. Easterbrook and Fischel (1991). Nexus of contracts theory views the firm not as an entity but as an aggregate of various inputs brought together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm’s inputs. The firm is seen as simply a web of explicit and implicit contracts establishing rights and obligations among the various inputs making up the firm.

16. See the notes for Bainbridge (1993).

17. McTaggart, Kontes, and Mankins (1994), chap. 1.

18. Ellsworth (2002), p. 6.

19. Jensen (2001), pp. 297–317.

20. McTaggart et al. (1994), chap. 1.

21. Freeman (1984), p. 17.

22. Davis (2006, November 1).

23. Henry Schacht, quoted in Fortune, July 7, 2003, and referred to in Martin (2003), p. 1.

24. http://solutions.3m.com/wps/portal/3M/en_US/global/sustainability/management/pollution-prevention-pays/

25. See Jensen and Meckling (1976); Fama (1980), pp. 291–293; and Fama and Jensen (1983b). For a somewhat different view, see Klein (1982).

26. Freeman and McVea (2001), p. 194.

27. Bainbridge (1992).

28. Under the Delaware code, shareholder voting rights are essentially limited to the election of directors and the approval of charter or bylaw amendments, mergers, sales of substantially all of the corporation’s assets, and voluntary dissolutions. As a formal matter, only the election of directors and the amendment of the bylaws do not require board approval before shareholder action is possible. See Delaware Code Ann. tit. 8, § § 109, 211 (1991). In practice, of course, even the election of directors, absent a proxy contest, is predetermined by the existing board nominating the following year’s board.

29. As a practical matter, of course, the sheer mechanics of undertaking collective action by thousands of shareholders preclude them from meaningfully affecting management decisions.

30. Jensen (2001), p. 16.

31. Ibid.

32. Ibid, p. 17.

Chapter 3

1. See Corporate Director’s Guidebook (2004).

2. This book focuses on the most important laws aimed at guiding directors’ behavior. The reader should be aware that the law includes additional duties for directors such as “the duty not to entrench” and “the duty of supervision.”

3. Business Roundtable (2005), p. 2.

4. Millstein, Gregory, and Grapsas (2006, January).

5. Buffett (1993).

6. Ibid.

7. Ibid.

8. Jones (2007).

9. See, for example, Felton and Pamela Fritz (2005) and The State of the Corporate Board (2007, April).

10. Carver (2007, November), pp. 1030–1037.

11. Ibid., p. 1035.

12. Macavoy and Milstein (2003).

13. Deloitte (2012).

14. Heidrick & Struggles (2006).

15. Macavoy and Milstein (2003), pp. 22–23.

16. Carter and Lorsch (2004), p. 93.

17. Coombes and Wong (2004).

18. Ibid.

Chapter 4

1. For a more detailed summary of these and related governance reforms, see, for example, Morgan Lewis, Counselors at Law (2004); or Petra (2006), pp. 107–115.

2. Edwards (2003).

3. The term “earnings mismanagement” is used in the widest sense to include not only reporting that is illegal or inconsistent with accepted accounting standards but also statements that, while within accepted legal accounting standards, are primarily meant to deceive investors about the company’s true financial condition.

4. Hall and Murphy (2002), p. 42.

5. It is now also recognized that a change in tax law—the addition of Section 162(m) to the Internal Revenue Service (IRS) code—was a major contributor to the increased use of stock options. For more on this subject, see chapter 8 in this volume.

6. Edwards (2003).

7. Ibid.

8. See Enron’s proxy statement, May 1, 2001. Subsequent to Enron’s collapse, the independence of some Enron directors was questioned by the press and in Senate hearings because some directors received consulting fees in addition to board fees. Enron had made donations to groups with which some directors were affiliated and had also done transactions with entities in which some directors played a major role.

9. The beneficial ownership of the outside directors reported in the 2001 proxy ranged from $266,000 to $706 million. See Gillan and Martin (2002), p. 23.

10. See Gordon (2003).

11. This subcommittee is administered by the Permanent Subcommittee on Investigations, Committee on Governmental Affairs, United States Senate, July 8, 2002.

12. Warren Buffett’s letter to Berkshire Hathaway shareholders, as quoted in USA Today, March 31, 2003.

13. Edwards (2003).

14. As noted by Edwards (2003), Citigroup paid $400 million to settle government charges that it issued fraudulent research reports; and Merrill Lynch agreed to pay $200 million for issuing fraudulent research in a settlement with securities regulators and also agreed that, in the future, its securities analysts would no longer be paid on the basis of the firm’s related investment banking work. Also see Coffee (2002, 2003a, 2003b); Stewart and Countryman (2002).

15. The popular question, “Do you know anyone who washes a rental car?” is appropriate here.

16. The Securities and Exchange Act of 1934 requires that at least 50% of the value of a fund’s total assets satisfy two criteria: an equity position cannot exceed 5% of the value of a fund’s assets, and the fund cannot hold more than 10% of the outstanding securities of any company.

17. These questions are adapted from Edwards (2003). We also note that the SEC recently made progress on this issue by requiring that a majority of mutual fund boards be comprised of “independent” directors, and by changing the definition of “independence” to be the same as that employed by Sarbanes-Oxley and the New York Stock Exchange.

18. Bosack and Blinka (2010).

19. See Deloitte (2011).

20. Berle and Means (1932), p. 62; Mace (1971), p. 3; Drucker (1974), p. 628; and Gillies (1992), p. 3.

21. Lorsch and MacIver (1989).

22. Leighton and Thain (1997), p. 51.

23. Monks (2005, March), p. 108.

24. Ibid., p. 109.

25. Ibid., p. 109.

26. Ibid., p. 110.

27. In academic terms, reforms enacted to date can be characterized as being primarily focused on addressing the so-called agency problem—the innate conflict that exists between owners (investors) and management, even though managers ostensibly act in the shareholders’ interests. For more on this issue, see chapter 3.

Chapter 5

1. FoxBusiness (September 12, 2012).

2. BusinessWeek (February 7, 2011).

3. See the 2011 Spencer Stuart Board Index at www.spencerstuart.com

4. Mercer Delta Consulting (2006).

5. Khurana and Cohn (2003, Spring).

6. Felton and Fritz (2005).

7. This section draws on “The board of directors’ role in CEO succession” (2006) interview with Heidrick and Struggles, “Building high-performance boards”; and Lucier, Kocourek, and Habbel (2006).

8. Source: the 2011 Conference Board Succession Research Study Report. See also Kane and Lublin (June 20, 2009); Apple Media Advisory, January 14, 2009 (www.apple.com/pr/library/2009/01/14advisory.html), Apple Media Advisory, January 17, 2011 (www.apple.com/pr/library/2011/01/17advisory.html), LIUNA resolution (www.cii.org/UserFiles/file/members%20login/Activism%20Bulletin%20Board/2011/LIUNA%20-%20Apple%20-%20CEO%20succession.pdf), Apple 2011 proxy statement, filed January 7, 2011.

9. This section is based on Lucier et al. (2006) and Charan (2005, February).

10. Charan (2005), p. 75.

11. Ibid., p. 76.

12. “The Role of the Board in CEO Succession,” a best practices study published by the National Association of Corporate Directors (NACD) in collaboration with Mercer Delta Consulting, April 2006.

13. As first reported in the 2011 Conference Board Succession Research Study Report; other sources: “Caterpillar Outlines Leadership Succession Plan; Board Names Doug Oberhelman Vice Chairman and Chief Executive Officer-Elect,” Caterpillar press release, October 22, 2009; “Doug Oberhelman Elected Chief Executive Officer and Caterpillar Board Member; Jim Owens Steps Down as CEO, Remains Chairman Through October 31,” Caterpillar press release, June 9, 2010; “McKinsey conversations with global leaders: Jim Owens of Caterpillar,” McKinsey Quarterly, November 2010; “Guidelines on Corporate Governance Issues,” Caterpillar Inc., February 9, 2011 (www.caterpillar.com/company/governance/governance-documents); Caterpillar proxy statement, filed on April 19, 2010; and Annual Report (Form 10-K), filed on February 2, 2011 (www.caterpillar.com/investors/financial-information).

14. This section draws extensively on the 2011 Conference Board Succession Research Study Report.

15. “Shareholder Proposals,” SEC Staff Legal Bulletin No. 14E (CF), October 27, 2009 (www.sec.gov/interps/legal/cfslb14e.htm).

Chapter 6

1. This section is based on “Audit Committee: Leading Practices and Trends,” Ernst & Young, 2012.

2. Waller, Lansden, Dortch, and Davis (2005).

3. Keinath and Walo (2004), p. 23.

4. This section is based on The Institute of Internal Auditors (2006) http://www.theiia.org

5. Buffett (2002).

6. This section is based on Wood (2005).

7. For a more detailed discussion of this subject, see Waller et al. (2005).

8. Web site of Berkshire Hathaway, available at http://www.berkshirehathaway.com.

Chapter 7

1. Bart (2004), pp. 111–125.

2. Felton and Fritz (2005).

3. de Kluyver and Pearce (2009), chap. 1.

4. Bart (2004).

5. Carey and Patsalos-Fox (2006).

6. Korn/Ferry International (2007).

7. Nadler (2004).

8. Ibid.

9. Ibid.

10. Ibid.

11. This section is based on de Kluyver and Pearce (2008), chap. 9; and Rérolle and Vermeire (2005, April 29).

12. Usually, such opinions are prepared by the company’s financial advisers or other consultants hired by management (who naturally hope to gain repeat business). The board must ensure that this expert appraisal is carried out in a truly independent manner. The board must therefore verify the independence and skills of the expert(s), and, when the report is submitted, it must ensure that the work was carried out properly, in accordance with the professional standards in force. This assumes that at least one member of the board has adequate, relevant experience or that the board is assisted by another expert to help it in this task of supervision.

13. Rérolle and Vermeire (2005, April 29).

14. This section is based on McKinsey & Company (2006, March).

15. This section is based on Nadler (2004).

16. Carey and Patsalos-Fox (2006).

Chapter 8

1. This section is based on Rivero and Nadler (2003).

2. Ibid.

3. Ibid.

4. Ibid.

5. Ibid.

6. http://www.sec.gov/answers/execomp.htm

7. Krantz and Hansen (March 29, 2012).

8. Crystal (1992).

9. Rose and Wolfram (2002, pp. S138–S175) document a “spike” in base salaries at $1 million that did not exist before the new tax rules.

10. This argument ignores possible inside information held by the employee about the prospects of the firm, and the potential incentive benefits accruing to shareholders when employees hold options.

11. Murphy and Zabojnik (2004).

Chapter 9

1. World Investment Report (2004).

2. The International Chamber of Commerce, a global advocacy group for the private sector, observed in 2000 that “non-governmental organizations have gained an enormous influence” over corporate decision making, as quoted in Barrington (2000, January–June).

3. “Civil society” is sometimes described as the part of society that exists between the state and the market. A more formal definition is “the voluntary association of citizens, promoting their values and interests in the public domain,” according to Saxby and Schacter (2003, p. 4). Kaldor, Anheier, and Glasius (2003, p. 2) estimate that there are approximately 48,000 international NGOs, and that total membership in international NGOs grew by about 70% between 1990 and 2000.

4. Coggin (2004, October 18).

5. This section is based on Nadler (2004) and Nadler, Behan, and Nadler (2006).

Chapter 10

1. Bridging Board Gaps (2012).

2. Ibid, p. 17.

3. Ibid, p. 19.

4. Ibid, p. 22.

5. Ibid, p. 25.

6. Ibid, p. 28.

7. Ibid, p. 31.

8. Ibid, p. 34.

9. Spencer Stuart (2008).

10. Ibid.

11. For more on formal versus informal rules in the boardroom, see Carter and Lorsch (2004), chap. 8. See also Khurana and Pick (2005), pp. 1259–1285.

12. Carter and Lorsch (2004), chap. 7.

13. Directorship, (July 11, 2008).

14. Brancato and Plath (2004). Many CEOs have historically followed a practice that all communication of information to the board from senior managers would flow first through the CEO, who would then relay that information to the board. This has the potential to obstruct information flow to the board. See also Ide (2003, March), p. 838.

15. Heidrick and Struggles (2006).

16. Bird, Buchanan, and Rogers (2004).