Corporate Governance Matters

David Larcker is James Irvin Miller Professor of Accounting (Emeritus) 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 Funds. Brian Tayan is a member of the Corporate Governance Research Initiative at Stanford Graduate School of Business. He has written broadly on the subject of corporate governance, including studies and other materials on boards of directors, succession planning, executive compensation, financial accounting, and shareholder relations. Previously, Brian worked as a financial analyst at Stanford University's Office of the CEO and as an investment associate at UBS Private Wealth Management. He received his MBA from the Stanford Graduate School of Business and his BA from Princeton University.

• Preface     xviii Chapter 1  Introduction to Corporate Governance     1 Self-Interested Executives    4 Defining Corporate Governance     8 Corporate Governance Standards     9 Best Practice or Best Practices? Does “One Size Fit All”?     12 Relationship between Corporate Governance and Firm Performance     13 Endnotes     15 Chapter 2  International Corporate Governance     19 Capital Market Efficiency     19 Legal Tradition     22 Accounting Standards     23 Enforcement of Regulations     25 Societal and Cultural Values     26 Individual National Governance Structures     28 United States     29 United Kingdom     31 Germany     35 Japan     37 South Korea    40 China    41 India    43 Brazil    44 Russia    46 Endnotes    47 Interlude     53 Chapter 3  Board of Directors: Duties and Liability     55 Board Responsibilities     55 Board Independence     56 The Operations of the Board     57 Board Committees     60 Duration of Director Terms     64 Director Elections     64 Removal of Directors     66 Legal Obligations of Directors     66 Fiduciary Duty     67 Environmental, Social, and Governance (ESG)     70 Disclosure Obligations under Securities Laws     71 Legal Enforcement of State Corporate Law (Fiduciary Duties)     72 Legal Enforcement of Federal Securities Laws     73 Director Indemnification and D&O Insurance     73 Endnotes     75 Chapter 4  Board of Directors: Selection, Compensation, and Removal     79 Market for Directors     79 Criteria for Director Recruitment     80 Active CEOs     81 International Experience     82 Special Expertise     82 Diverse Directors     84 Professional Directors     85 Disclosure Requirements for Director Qualifications     86 Director Recruitment Process     87 Director Compensation     90 Ownership Guidelines     95 Board Evaluation     96 Removal of Directors     98 Endnotes     102 Chapter 5  Board of Directors: Structure and Consequences     109 Board Structure     110 Chairman of the Board     113 Lead Independent Director     116 Outside Directors     119 Board Independence     122 Independent Committees     125 Bankers on the Board     126 Financial Experts on Board     127 Politically Connected Boards     127 Employee Representation     129 Boards with “Busy” Directors     131 Interlocked (or Connected) Boards     134 Committee Overlap     135 Board Size     136 Board Diversity     136 Female Directors     138 Summary     139 Endnotes     141 Interlude     150 Chapter 6  Strategy, Performance Measurement, and Risk Management     151 Organizational Strategy     151 Strategy Implementation Process     154 Business Model Development and Testing     156 Example 1: Fast-Food Chain and Employee Turnover     156 Example 2: Financial Services Firm and Investment Advisor Retention     158 Key Performance Measures     159 How Well Are Boards Doing with Performance Measures and Business Models?     162 Risk and Risk Management     164 Risk and Risk Tolerance     165 Risk to the Business Model     166 Risk Management     169 Oversight of Risk Management     172 Assessing Board Performance on Risk Management     174 Cybersecurity     175 Endnotes     177 Chapter 7  CEO Selection, Turnover, and Succession Planning     181 Labor Market for Chief Executive Officers     181 Labor Pool of CEO Talent     184 CEO Turnover     186 Newly Appointed CEOs     191 Models of CEO Succession     193 External Candidate     193 President and/or Chief Operating Officer     195 Horse Race     196 Inside–Outside Model     197 The Succession Process     197 How Well Are Boards Doing with Succession Planning?     201 Executive Search Firms     203 Endnotes     205 Chapter 8  Executive Compensation and Incentives     211 The Controversy over Executive Compensation     212 Competing Theories of CEO Pay     213 Components of Compensation     214 Determining Compensation     218 Compensation Consultants     221 Compensation Levels     221 Ratio of CEO Pay to Other Top Executive Pay     226 Ratio of CEO Pay to Average Employee Pay     229 Compensation Mix     230 Short-Term Incentives     233 Long-Term Incentives     235 Benefits and Perquisites     237 Compensation Disclosure     238 Say-on-Pay     239 Competing Theories of CEO Pay     242 Endnotes     243 Chapter 9  Executive Equity Ownership     251 Equity Ownership and Firm Performance     251 Equity Ownership and Risk     254 Equity Ownership and Agency Costs     259 Accounting Manipulation     260 Manipulation of Equity Grants     261 Other Examples of Value Extraction through Timing     263 Equity Sales and Insider Trading     264 Rule 10b5-1     267 Hedging     269 Pledging     273 Repricing and Exchange Offers     274 Endnotes     277 Chapter 10  Financial Reporting and External Audit     285 The Audit Committee     285 Accounting Quality, Transparency, and Controls     286 Financial Reporting Quality     288 Non-GAAP Reporting     290 Financial Restatements     291 Models to Detect Accounting Manipulations     297 The External Audit     299 Audit Quality     302 Structure of Audit Industry     302 Impact of Sarbanes–Oxley     305 External Auditor as CFO     307 Auditor Rotation     308 Endnotes     310 Chapter 11  The Market for Corporate Control     319 The Market for Corporate Control     320 Stock Market Assessment of Acquiring and Target Firms     324 Who Gets Acquired?     324 Who Gets the Value in a Takeover?     327 Antitakeover Protections     330 Antitakeover Actions     331 Poison Pills     333 Staggered Board     335 State of Incorporation     337 Dual-Class Shares     339 Warding Off Unwanted Acquirers     341 Endnotes     344 Chapter 12  Shareholders and Shareholder Activism     351 The Role of Shareholders     351 Blockholders and Institutional Investors     354 Institutional Investors and Proxy Voting     357 Activist Investors     359 Pension Funds     361 ESG and Socially Responsible Investing     363 Individual Activist Investors     364 Activist Hedge Funds     366 The Rise of Index Investing     370 Shareholder Democracy and Corporate Engagement     371 Majority Voting in Uncontested Director Elections     371 Proxy Access     372 Proxy Voting     372 Corporate Engagement     374 Proxy Advisory Firms     375 Endnotes     381 Chapter 13  Stakeholders and Stakeholder Activism     391 Pressure to Incorporate Stakeholder Interests     392 Legal and Economic Implications     397 Director and CEO Views on Stakeholders    401 ESG Metrics and Disclosure    402 External Assessment of ESG    407 Endnotes    417 Chapter 14  Corporate Governance and ESG Ratings    425 Third-Party Ratings    425 Credit Ratings    426 Commercial Corporate Governance Ratings    428 ISS: Corporate Governance Quotient    428 ISS: Governance Risk Indicators    430 ISS: QualityScore    430 MSCI ESG Governance Metrics    431 Testing the Predictability of Corporate Governance Ratings    432 Governance Rating Systems by Academic Researchers    433 The Viability of Governance Ratings    438 ESG Ratings    439 MSCI ESG    440 Sustainalytics    441 Vigeo Eiris    442 HIP (Human Impact + Profit)    442 ISS E&S Disclosure QualityScore    442 TruValue Labs    443 Evaluation of ESG Ratings    443 Endnotes    444 Chapter 15  Alternative Models of Governance    449 Family-Controlled Corporations    449 Venture-Backed Companies    452 Private Equity-Owned Companies    458 Nonprofit Organizations    462 Endnotes    466 Chapter 16  Summary and Conclusions    473 Testing Remains Insufficient    474 The Current Focus Is Misdirected    475 Important Variables Are Clearly Missing    476 Context Is Important    477 Rights of Shareholders and Stakeholders    478 Endnotes    478 Index    481