Third Edition

CORPORATE GOVERNANCE

Kenneth A. KimState University of New York at Buffalo

John R. NofsingerWashington State University

Derek J. MohrState University of New York at Buffalo

Boston Columbus Indianapolis New York San Francisco Upper Saddle RiverAmsterdam Cape Town Dubai London Madrid Milan Munich Paris Montreal Toronto

Delhi Mexico City Sao Paulo Sydney Hong Kong Seoul Singapore Taipei Tokyo

CONTENTS

Preface xi

About the Authors xv

Chapter 1 Corporations and Corporate Governance 1Forms of Business Ownership 2

Separation of Ownership and Control 4

Can Shareholders Influence Managers? 5

Monitors 6

An Integrated System of Governance 8

International Monitoring 10

Summary 10

j Review Questions 11

Discussion Questions 11

Exercises 11

Exercises for Non-U.S. Students 11

Endnotes 12

Chapter 2 Executive Incentives 13Potential Managerial Temptations 14

Types of Executive Compensation 14

Base Salary and Bonus 14

Stock Options 15

Stock Grants 17

Does Incentive-Based Compensation Workin General? 17

Potential "Incentive" Problems with Incentive-BasedCompensation 18

Problems with Accounting-Based Incentives 18

Problems with Stock Option Incentives 18

The Debate Over Expensing Executive Options 21

i Other Compensation 22

Crime and Punishment 23

International Perspective—CEO Compensation aroundthe World 23

Summary 24

Web Info about Executive Compensation 25

vi Contents

Review Questions 25

Discussion Questions 25 <•

Exercises 25

Exercises for Non-U.S. Students 26

Endnotes 26

Chapter 3 Accountants and Auditors 27Accounting Functions 27

Accounting for Inside Use 28

Accounting for Outside Use 28

Problems That May Occur in Accounting 29

Auditing 29 <

Internal Auditors 29

External Auditors 30

How the Nature of External Auditing Has Evolved Sincethe Late 1930s 32

Accounting Oversight 33

The Changing Role of Accounting—ManagingEarnings 34

From Manipulation to Fraud 35

Auditors as Consultants 38

International Perspective 38

Summary 39

Web Info about Accounting and Auditing 40

Review Questions 40

, Discussion Questions 40

Exercises 40

Exercises for Non-U.S. Students 41

Endnotes 41

Chapter 4 The Board of Directors 42Overview of Boards 43

The Board's Legal Duties 43

Election of Directors 44

Board Committees 45

Board Structure Regulations Imposed by Exchangesand the Sarbanes-Oxley Act 45

What Is a "Good" Board? 47

Independent Boards 48

Contents vii

< Small Boards 48

Board Structure in the United States and aroundthe World 49

Good for the Goose, Good for the Gander? 49

Can Good Boards Lead to Better FirmPerformance? .50

Potential Problems with Today's Boards 51

International Perspective—Boards in Western Europe 54

Two-Tier Boards 54

Board Regulations on Independence 55

Summary 56

Web Info about Boards of Directors 56

Review Questions 56

Discussion Questions 56

Exercises 57

Exercises for Non-U.S. Students 57

Endnotes 57

Chapter 5 Investment Banks and Securities Analysts 59Investment Banking Activities 60

Criticisms of Investment Banks 62

IPO Problems 62

Structured Deals 64

Securities Analysts 66

Quality of Analysts' Recommendations 68

Potential Conflicts of Interest 69! Analysts and the Firms They Analyze 69

Analysts working at Investment Banks 70

Summary 74

Web Info about Investment Banks and Analysts 74

Review Questions 74

Discussion Questions 75

Exercises 75

Exercises for Non-U.S. Students 75

Endnotes 76

Chapter 6 Creditors and Credit Rating Agencies 78Debt as a Disciplinary Mechanism 79

Institutional Lenders as Corporate Monitors 80

viii Contents

' Why Didn't Lenders Raise a Red Flag during the RecentCorporate Scandals? 80

Do Creditors Influence Corporate Governance inBankruptcy? 81

Credit Rating Agencies 82

A Brief Historical Perspective 82

The Ratings 84

Criticisms 86

International Perspective 89

Japan's Main Bank System 89

Creditor Rights around the World 90

Summary 92

Web Info about Credit Rating Agencies 92

Review Questions 92

Discussion Questions 93

Exercises 93

Exercises for Non-U.S. Students 93

Endnotes 93

Chapter 7 Shareholders and Shareholder Activism 95What is Shareholder Activism? 96

Activism by Individual Shareholders 96

Monitoring by Large Shareholders 97

Institutional Shareholders: An Overview 98

Types of Shareholder Activism 100

Shareholder Proposals 100

Contested Election of Directors (Proxy Fights) 103

Shareholders Lawsuits 104

Does Institutional Shareholder Activism Work? 107

Potential Roadblocks to Effective Shareholder Activism 107

International Perspective 109

Summary 109

Web Info about Shareholder Activism 110

Review Questions 110

Discussion Questions 110

Exercises 110

Exercises for Non-U.S. Students 111

Endnotes 111

Contents ix

Chapter 8 Corporate Takeovers: A GovernanceMechanism? 113Brief Overview of Mergers and Acquisitions 115

The Target Firm 116

The Notion of the Disciplinary Takeover 118

Takeover Defenses 120

Firm-Level Pre-Emptive Takeover Defenses 121

Firm-Level Reactionary Takeover Defenses 121

State-Level Anti Takeover Laws 122

Assessments of Takeover Defenses 123

Are Takeover Defenses Bad for the GovernanceSystem? 123

International Perspective 124

Summary 126

Web Info about Mergers and Acquisitions 126

Review Questions 126

Discussion Questions 126

Exercises 126

Exercises for Non-U.S. Students 127

Endnotes 127

Chapter 9 The Securities and Exchange Commission and theSarbanes-Oxley Act 129The Securities Acts 130

Summary of the Acts 131

Organization Structure of the Securities and ExchangeCommission 131

Need for the Acts and the Securities and ExchangeCommission 134

Securities and Exchange Commission Problem Areas 135

Reporting 135

Punishment 135

Securities and Exchange Commission Resources 137

Sarbanes-Oxley Act of 2002 138

The 2002 Act's Effect on Accounting Oversight 139

Public Company Accounting Oversight Board 139

Auditor Independence 139

Corporate Responsibility 140

Enhanced Financial Disclosures 140

Contents

Analysts Conflicts of Interests 141

Securities and Exchange Commission Resourcesand Authority 141

Corporate and Criminal Fraud, Accountability,and Penalties 141

Willthe Act Be Beneficial? 141

Other Regulatory Changes 142

The New York Stock Exchange 142

NASDAQ Stock Market 143

International Perspective 143

Summary 145

WEB Info about the Securities and Exchange Commissionand the Sarbanes-Oxley Act 145

Review Questions 145

Discussion Questions 146

Exercises 146

Exercises for Non-U.S. Students 146

Endnotes 146

Chapter 10 Moral Hazard, Systemic Risk, and Bailouts 148History of Systemic Risk and Bailouts 149

The Financial Crisis of 2007 to 2009 152

Corporate Governance Failures in the MortgageIndustry 154

The Overreliance of Banks on AIG and Credit DefaultSwaps 158

International Perspective 161

Summary 162

WEB Info about Moral Hazard, Systemic Risk,and Bailouts 163

Review Questions 163

Discussion Questions 163

Exercises 163

Exercises for Non-U.S. Students 164

Endnotes 164

Chapter 11 Corporate Citizenship 166Stakeholder View of the Firm 167

Legal Foundations 169

Corporate Social Responsibility 169

Contents xi

Governance and Stakeholder Theory 172

Criticisms 172

International Perspective 175

Summary 177

Web Info about Corporate Citizenship 178

Review Questions 178

Discussion Questions 178

Exercises 178

Exercises for Non-U.S. Students 178

Endnotes 179

Index 181