Corporate Governance Matters

David Larcker is James Irvin Miller Professor of Accounting at Stanford Graduate School of Business; Director of the Corporate Governance Research Initiative; and Senior Faculty, Arthur and Toni Rembe Rock Center for Corporate Governance. David’s research focuses on executive compensation, corporate governance, and managerial accounting. He has published many research papers and is frequently quoted in both the popular and business press. He received his BS and MS in engineering from the University of Missouri–Rolla and his PhD in business from the University of Kansas. He previously was on the faculty of the Kellogg Graduate School of Management at Northwestern University and The Wharton School at the University of Pennsylvania. Professor Larcker presently serves on the Board of Trustees for the Wells Fargo Advantage Funds.  Brian Tayan is a member of the Corporate Governance Research Program at the Stanford Graduate School of Business. He has written broadly on the subject of corporate governance, including boards of directors, succession planning, executive compensation, financial accounting, and shareholder relations. Previously, he worked as a financial analyst at Stanford University's Office of the CEO and as an investment associate at UBS Private Wealth Management. He has actively managed a private investment partnership since 2006, specializing in long-term, conservative growth through equity investments. Tayan received his MBA from the Stanford Graduate School of Business and his BA from Princeton University.

• Acknowledgments     xvAbout the Authors     xviiPreface      xviii  Chapter 1. Introduction to Corporate Governance      1Self-Interested Executives       4Defining Corporate Governance       8Corporate Governance Standards      9Best Practice or Best Practices? Does “One Size Fit All”?       12Relationship between Corporate Governance and Firm Performance      13Endnotes       16  Chapter 2. International Corporate Governance       21Capital Market Efficiency       21Legal Tradition      24Accounting Standards       25Enforcement of Regulations      27Societal and Cultural Values      28Individual National Governance Structures       30Endnotes       46Interlude      52  Chapter 3. Board of Directors: Duties and Liability      53Board Responsibilities      53Board Independence     54The Operations of the Board       55Duration of Director Terms      63Director Elections       63Removal of Directors      66Legal Obligations of Directors      66Endnotes       78  Chapter 4. Board of Directors: Selection, Compensation, and Removal      83Market for Directors      83Director Recruitment Process      91Director Compensation       93Removal of Directors      100Endnotes      104  Chapter 5. Board of Directors: Structure and Consequences       111Board Structure      112Summary       143Endnotes       144Interlude      153  Chapter 6. Strategy, Performance Measurement, and Risk Management      155Organizational Strategy       156Strategy Implementation Process      158Business Model Development and Testing      160Key Performance Measures      163How Well Are Boards Doing with Performance Measures and Business Models?       166Risk and Risk Management       168Risk and Risk Tolerance      169Risk to the Business Model      170Risk Management      173Oversight of Risk Management      176Assessing Board Performance on Risk Management       178Cybersecurity       180Endnotes       182  Chapter 7. CEO Selection, Turnover, and Succession Planning      187Labor Market for Chief Executive Officers       187Labor Pool of CEO Talent       190CEO Turnover       193Newly Appointed CEOs      196Models of CEO Succession       198The Succession Process       201How Well Are Boards Doing with Succession Planning?       205Executive Search Firms       207Endnotes       209  Chapter 8. Executive Compensation and Incentives       217The Controversy over Executive Compensation       218Competing Theories of CEO Pay       219Components of Compensation      220Determining Compensation       225Compensation Consultants       227Compensation Levels       228Ratio of CEO Pay to Other Top Executive Pay       233Ratio of CEO Pay to Average Employee Pay       235Compensation Mix      236Short-Term Incentives       239Long-Term Incentives      241Benefits and Perquisites       244Compensation Disclosure       245Say-on-Pay       247Competing Theories of CEO Pay       249Endnotes       250  Chapter 9. Executive Equity Ownership      259Equity Ownership and Firm Performance      259Equity Ownership and Risk      262Equity Ownership and Agency Costs       268Accounting Manipulation       268Manipulation of Equity Grants      269Equity Sales and Insider Trading      272Rule 10b5-1      275Hedging       278Pledging      282Repricing and Exchange Offers      284Endnotes       286  Chapter 10. Financial Reporting and External Audit      295The Audit Committee      296Accounting Quality, Transparency, and Controls       296Financial Reporting Quality      298Financial Restatements      302Models to Detect Accounting Manipulations       307The External Audit      309Audit Quality      312Structure of Audit Industry      313Impact of the Sarbanes–Oxley Act      315External Auditor as CFO      317Auditor Rotation       318Endnotes       320  Chapter 11. The Market for Corporate Control       329The Market for Corporate Control       330Stock Market Assessment of Acquiring and Target Firms       334Antitakeover Protections       340Antitakeover Actions       341Warding Off Unwanted Acquirers      351Endnotes       354  Chapter 12. Shareholders and Shareholder Activism       361The Role of Shareholders      361Blockholders and Institutional Investors       364Institutional Investors and Proxy Voting      367Activist Investors      369The Rise of Index Investing       379Shareholder Democracy and Corporate Engagement       380Proxy Advisory Firms       384Endnotes       389  Chapter 13. Stakeholders and Stakeholder Activism       399Pressure to Incorporate Stakeholder Interests      400Legal and Economic Implications       404Director and CEO Views on Stakeholders       408ESG Metrics and Disclosure      409External Assessment of ESG       413Endnotes       421  Chapter 14. Corporate Governance and ESG Ratings      429Third-Party Ratings       429Credit Ratings      430Commercial Corporate Governance Ratings      432Governance Rating Systems by Academic Researchers       437The Viability of Governance Ratings       442ESG Ratings      443Endnotes       448  Chapter 15. Alternative Models of Governance      451Family-Controlled Corporations      451Venture-Backed Companies       454Special Purpose Acquisition Companies       461Private Equity–Owned Companies      462Nonprofit Organizations      465Endnotes       469  Chapter 16. Summary and Conclusions       475Testing Remains Insufficient      476The Current Focus Is Misdirected      476Important Variables Are Clearly Missing       478Context Is Important       479Rights of Shareholders and Stakeholders       479Endnotes       480  Index 481