Corporate Governance

Acknowledgments xxiii Corporate Governance: A Guide for Students Preface xxiv Chapter 1 Financial Markets, Investor Confidence, and Corporate Governance 1 1. Learning Objectives 1 2. Introduction 1 3. The Free Enterprise System 2 4. Public Trust and Investor Confidence 6 5. Investment Stewardship 9 6. Role of Corporations in Society 11 7. Summary 13 8. Key Points 13 9. Discussion Questions 13 10. Review Questions 14 11. Multiple Choice Questions 14 Chapter 2 An Introduction to Corporate Governance 20 1. Learning Objectives 20 2. Introduction 20 3. Definition of Corporate Governance 21 4. Evolution of Corporate Governance 22 5. Aspects of Corporate Governance 24 o Shareholder Aspect 24 o Stakeholder Aspect 27 o Integrated Aspect 28 6. New Paradigm for Corporate Governance 30 o Commonsense Governance Principles 33 7. Sources of Corporate Governance 34 o State Corporate Laws 34 o The Federal Securities Laws 35 o Listing Standards 36 o Best Practices 37 8. Corporate Gatekeepers 39 9. Corporate Culture and Governance 41 10. Corporate Governance as a Strategic Imperative 42 11. Summary 44 12 Key Points 45 13. Discussion Questions 46 14. Review Questions 46 15. Multiple Choice Questions 47 Chapter 3 Fundamentals of Corporate Governance 52 1. Learning Objectives 52 2. Introduction 52 3. Corporate Governance Theories 52 o Shareholder Theory 53 o Stakeholder Theory 54 o Legitimacy Theory 54 o Signaling Theory 55 o Institutional Theory 55 o Stewardship Theory 56 o Resource Dependence Theory 56 o Other Corporate Governance Theories 57 4. Corporate Governance Structure 58 o Corporate Governance Principles 58 5. Honesty 59 6. Resilience 59 7. Responsiveness 59 8. Transparency 59 9. Practical Guiding Principles of Corporate Governance 60 10. Listing Standards Corporate Governance Principles 64 o Corporate Governance Functions 65 11. Oversight Function 68 12. Managerial Function 69 13. Compliance Function 70 14. Internal Audit Function 71 15. Legal Counsel/Financial Advisory Function 72 16. External Audit Function 72 17. Monitoring Function 73 18. Corporate Governance Mechanisms 74 19. Summary 77 20. Key Points 78 21. Discussion Questions 78 22. Review Questions 79 23. Multiple Choice Questions 79 Chapter 4 Oversight Function 84 1. Learning Objectives 84 2. Introduction 84 3. Role of the Board of Directors 85 4. Fiduciary Duties of the Board of Directors 90 5. Duty of Loyalty 90 6. Duty of Care 91 7. Other Fiduciary Duties 91 8. Duty of Obedience 91 9. Duty of Good Faith 91 10. Duty to Promote Success 92 11. Duty to Exercise Diligence, Independent Judgment, and Skill 92 12. Duty to Avoid Conflicts of Interest 92 13. Duty of Fair Disclosure 93 14. Fiduciary Duties and the Business Judgment Rule 93 15. Board and Corporate Culture 95 16. Director-Shareholder Engagement 97 17. Board Models 98 o One-Tier Board Model 98 o Two-Tier Board Model 99 o Modern Board Model 100 18. Board Attributes, Diversity 102 o Authority 102 o Leadership 103 o Separation of Chair and CEO Roles/ CEO Duality 104 o Lead/Presiding Directors 105 o Resources 107 o Board Independence 108 o Director Compensation/Equity Holdings 109 o Other Attributes of the Board of Directors 110 19. Business Knowledge and Legal and Financial Expertise 111 20. Diversity of the Board of Directors 112 21. Age of the CEO and Directors 115 22. Founding Family CEO 116 23. CEOs as Board Members 117 24. Board Declassification 117 25. Number of Directors 118 26. Who Can Be a Director? 118 27. Number of Directorships 119 28. Number of Meetings 119 29. Board Election 120 30. Board of Directors Education and Evaluation 122 31. Determinants of an Effective Board Best Practices 126 32. Board Accountability 131 o Accountability to Shareholders 132 o Accountability for Board Operation 132 o Accountability for Strategic Decisions and Performance 133 o Succession Planning 133 o Director Liability 133 33. The Board of Directors' Role in Business Sustainability 135 34. Board Emerging Issues 136 35. Board Committees 139 36. Audit Committee 140 37. Audit Committee Relationships With Others in Charge of Governance 142 o Relationship With the Board of Directors 142 o Working Relationships With Management 142 o Working Relationships With External Auditors 143 o Working Relationships With Internal Auditors 144 38. Audit Committee Principles 144 39. Audit Committee Composition 145 40. Committee Size 146 41. Independence 146 42. Member Qualifications 146 43. Member Attributes 146 44. Authority/Resources 147 45. Audit Committee Responsibility 147 46. Audit Committee Effectiveness 149 47. Audit Committee Meetings/Agendas 149 48. Whistleblowing Policies and Procedures 153 49. Audit Committee Reporting 154 50. Legal Liability of Audit Committees 155 51. Audit Committee Performance Evaluation 156 52. Compensation Committee 156 53. Compensation Committee Guiding Principles 157 54. Compensation Committee Responsibilities 158 o Evaluation and Compensation of Directors 158 o Evaluation and Compensation of Senior Executives 159 55. Compensation Committee and Consultants 162 56. Compensation Committee Report 162 57. Determinants of Effective Compensation Committees 164 58. Nominating Committee 165 59. Responsibilities of Nominating Committees 166 60. Selection and Nomination of New Directors 166 61. Election of Directors 167 62. Reelection of Incumbent Directors 168 63. Succession Planning Process 168 64. Nominating Committee Disclosures 168 65. Other Board Standing Committees 169 66. Governance/Strategic Committee 169 67. Corporate Governance Reporting/Disclosures 172 68. Outside Independent Directors' Committee 173 69. Executive Committee 173 70. Disclosure Committee 173 71. IT Committee 174 72. Compliance/Risk Committee 174 73. Ethics Committee 175 74. Sustainability Committee 175 75. Special Committees 176 76. Summary 177 77. Key Points 178 78. Discussion Questions 179 79. Review Questions 180 80. Multiple Choice Questions 180 Chapter 5 Managerial Function 191 1. Learning Objectives 191 2. Introduction 191 3. Management Responsibilities 192 4. Operating Process 194 5. Corporate Reporting Process 195 6. Initiatives to Improve Corporate Reporting 196 7. Forward-Looking Information 196 8. Comprehensive Business Reporting Model 196 9. Integrated Financial and Internal Control Reporting 197 10. Integrated Sustainability Reporting 199 11. Compliance Process 200 12. Corporate Executives/Officers 200 13. Chief Executive Officer 201 14. Fiduciary Duties 202 15. Pay and Skill 202 16. Self-Serving and Self-Dealing CEOs 202 17. Succession Planning 203 18. CEO Duality 203 19. Financial Knowledge and Understanding 204 20. Diversity 205 21. Chief Financial Officer 205 22. CFO Transition to CEO 206 23. Corporate Development Officer 206 24. Chief Risk Officer (CRO) 208 25. Chief Governance Officer (CGO) 209 26. Chief Internal Control Officer (CICO) 210 27. Chief Ethics and Compliance Officer (CECO) 210 28. Chief Sustainability Officer (CSO) 211 29. Chief AI Officer 212 30. Other C-Suite Officers 213 31. Executive Compensation 213 32. Components of Executive Compensation 216 33. Salary 216 34. Annual Incentive Compensation 217 35. Long-Term Compensation 217 36. Stock Option Awards 217 37. Stock Ownership 218 38. Employment Contracts, Severance, and Change-of-Control Payments 218 39. Retirement Arrangements 219 40. Compensation Policies 221 41. Executive Compensation Disclosure 222 42. Executive Compensation and Claw-Back 223 43. Say-on-Pay 224 44. Financial Reporting Requirements 226 45. Internal Control Reporting and Executive Certification 228 46. Management's Responsibility Under Section 302 of SOX 228 47. Management Responsibilities for Section 404 Compliance of SOX 229 48. Auditor Report on Internal Control Over Financial Reporting (ICFR) 229 49. Lessons Learned 230 50. Small Businesses and Section 404 231 51. Risk Assessment and Management 231 52. Cybersecurity 232 53. Summary 234 54. Key Points 234 55. Discussion Questions 235 56. Review Questions 236 57. Multiple Choice Questions 236 Chapter 6 Compliance Function 244 1. Learning Objectives 244 2. Introduction 244 3. Regulatory Reforms in the United States 246 o State Regulation 247 o Federal Securities Regulation 249 o Foreign Corrupt Practices Act of 1977 (FCPA) 250 o Sarbanes-Oxley Act of 2002 251 4. Provisions of SOX 252 o Corporate Governance Provisions 253 o Financial Reporting Provisions 254 o Audit Function Provisions 254 o Enforcement of the Federal Securities Laws 255 o Provisions Addressing Conduct of Other Individuals 255 o Whistleblower Provisions 256 5. Evaluation of the Sarbanes-Oxley Act 256 6. SOX Efficacy 257 7. Global Reach of SOX 258 8. Financial Reform and Consumer Protection Act of 2010 (Dodd-Frank Act of 2010) 259 9. Provisions of DOF 260 10. Corporate Disclosures/Governance Provisions of the DOF Act 261 11. Effects of Provisions of the DOF Act on the Insurance and Banking Industry 262 12. DOF Act Efficacy 262 13. Comparison Between the SOX and DOF Acts 262 14. The Jumpstart Our Business Startups Act (JOBS Act) of 2012 263 15. JOBS Provisions 264 16. JOBS Act Efficacy of 2012 265 17. Corporate Governance Reform and Transparency Act of 2016 265 18. Financial CHOICE Act of 2017 266 19. Accountability Act of 2018 267 20. Securities and Exchange Commission 267 21. SEC and Corporate Governance 268 22. SEC Influence on Corporate Governance Beyond US Borders 269 23. SEC Financial Penalties/Enforcement 269 24. SEC Enforcement Actions 271 25. SEC Comment Letters 272 26. Public Company Accounting Oversight Board 272 27. Role of Regulators and Standard Setters 274 28. Committee of European Securities Regulators 276 29. American Institute of Certified Public Accountants 276 30. AICPA Roles in the Post-SOX Era 277 31. AICPA's Center for Audit Quality 278 32. Financial Accounting Standards Board (FASB) 279 33. Government Accounting Standards Board 280 34. International Federation of Accountants (IFAC) 280 35. Role of the State and Federal Attorney General 281 36. Corporate Governance and Courts 281 37. Corporate Governance and Self-Regulatory Organizations 283 38. Best Practices 285 39. Institutional Investors 285 o Council of Institutional Investors 286 o National Association of Corporate Directors 287 o Business Roundtable 287 o Public Pension Funds 287 40. Regulations and Corporate Governance 288 41. Summary 288 42. Key Points 289 43. Discussion Questions 290 44. Review Questions 290 45. Multiple Choice Questions 291 Chapter 7 External Auditing Function 300 1. Learning Objectives 300 2. Introduction 300 3. External Auditing and Corporate Governance 301 4. New Focus for External Auditors 302 5. External Auditor Responsibilities 304 6. Auditor Competencies 305 7. Audit Quality and Audit Failures 306 8. Value of Regulatory Audit Opinion 308 9. Safeguarding the Auditing Profession 311 10. Professional Skepticism 312 o Bias in Judgment 313 11. Public Company Accounting Oversight Board 314 12. PCAOB Auditing Standards 315 13. PCAOB Rules on Auditor Independence, Ethics, and Taxes 315 14. Inspection of Public Accounting Firms 315 15. PCAOB Enforcement Investigations 317 16. Audit Committee Oversight of External Auditors 318 o Appointment, Compensation, and Retention of Auditors 319 o Preapproval of Audit Services and Permissible Non-Audit Services 319 o Review of Independent Auditor Plan for the Integrated Audit 320 o Review and Discussion of Financial Reports 320 o Monitoring the Auditor's Independence 321 17. Lead Auditor Rotation Requirement 322 18. Rotation of Public Accounting Firms 322 19. Audit Firm Selection 324 20. Independent Auditor Communication With the Audit Committee 325 21. Audit Committee and PCAOB Inspection 326 o Working Relationships Among Internal Auditors, External Auditors, and Audit Committees 326 22. Auditor Independence 327 o SEC Rules on Auditor Independence 328 o Professional Judgments (Skepticisms) and Auditor Independence 329 23. Consolidation and Competition in Public Accounting Firms 330 24. Auditor Limited Liability Provisions 331 25. Integrated Audit Approach 332 o Audit Strategy 333 o Auditor Responsibilities in Integrated Audit 334 o Internal Auditor's Role in Integrated Audit 334 o Materiality Assessment Under Integrated Audit Approach 334 26. Double Materiality Assessment 336 o Going Concern 338 27. Audit Risk Model Under the Integrated Audit Approach 338 28. Audit of Defined Benefit Pensions 339 29. Audit of Executive Compensation, Including Stock Options 340 30. Big Data, Data Analytics, and Continuous Auditing 342 31. Key/Critical Audit Matters Reporting 343 32. Sustainability Assurance 344 33. Summary 345 34. Key Points 345 35. Discussion Questions 346 36. Review Questions 347 37. Multiple Choice Questions 347 Chapter 8 The Internal Auditing Function 356 1. Learning Objectives 356 2. Introduction 356 3. The Internal Auditing Function and Corporate Governance 357 4. Internal Auditors as Assurance Providers 361 5. The Internal Auditor and Integrated Sustainability Reporting and Assurance 362 6. Internal Auditors as Consultants 363 7. Trend and Relevance of Internal Auditors 363 8. Regulatory Reform and the Role of Internal Auditors 367 9. Institute of Internal Auditors 367 10. Internal Auditing Education 368 11. Audit Committee Relationship With Internal Auditor 368 12. Internal Auditors' Role in Internal Control 369 13. Authorities and Responsibilities of Internal Auditors 371 o Authority 371 o Responsibility 372 14. Evaluation of the Internal Audit Function 372 15. Internal Audit Outsourcing 373 16. Institute of Internal Auditors 373 17. Determinants of an Effective Internal Audit 375 18. Best Practices 375 o Internal Audit Framework 378 19. Internal Auditing Education 379 20. Summary 379 21. Key Points 380 22. Discussion Questions 380 23. Review Questions 381 24. Multiple Choice Questions 381 Chapter 9 Legal and Advisory Function 388 1. Learning Objectives 388 2. Introduction 388 3. Legal and Financial Advisory Function 389 4. Legal Counsel 390 5. Responsibilities of Legal Counsel 392 6. SEC Rules 393 7. Attorney-Client Privilege 394 8. Financial and Investment Advisors 395 9. Securities Analysts 397 10. Role of Securities Analysts 398 11. Ethical Guidelines for Securities Analysts 399 o Standard I: Information Flow 400 o Standard II: Analyst Conduct 400 o Standard III: Corporate Communications and Access 400 o Standard IV: Issuer-Paid Research Reports 400 12. Objectivity of Post-SOX Securities Analysts 401 13. Investment Banks 402 14. Summary 402 15. Key Points 403 16. Discussion Questions 403 17. Review Questions 404 18. Multiple Choice Questions 404 Chapter 10 Monitoring Function 410 1. Learning Objectives 410 2. Introduction 410 3. Monitoring Function 410 4. Shareholders 412 5. Shareholder Monitoring 412 o Property Rights 414 o Financial System 415 o Intercorporate Networks 416 6. Shareholder Power 417 o Power to Elect Directors 417 o Power to Amend Bylaws 418 o Power to Approve Charter Amendments and Mergers 418 o Power to Submit Proposals 418 o Proxy Voting and Shareholder Activism 418 o Litigation 419 7. Strengthening Shareholder Rights 419 o Access to Information 420 o Potential Conflicts of Interest Between Shareholders and Management 421 8. Shareholder Democracy 422 9. Proxy Advisors 423 10. One-Share, One-Vote Principle 425 11. Say-on-Pay and Pay Ratio Disclosure 426 12. Institutional Investors 427 13. Institutional Investor Monitoring 429 14. Governance of Institutional Investors 432 15. Mutual Funds 433 16. Hedge Funds 434 17. Pension Funds 435 18. Investor Activists 435 19. Employee Monitoring 438 20. Summary 440 21. Key Points 441 22. Discussion Questions 442 23. Review Questions 442 24. Multiple Choice Questions 442 Chapter 11 Corporate Governance of Private Companies and Not-for-Profit Organizations 450 1. Learning Objectives 450 2. Introduction 450 3. Corporate Governance of Private Companies 450 4. Effect of SOX on Private Companies 452 5. Corporate Governance and the Initial Public Offering 453 6. Corporate Governance of Emerging Growth Companies 455 7. Best Practices of Corporate Governance Relevant to Private Companies 456 8. Not-for-Profit Organizations 457 9. Types of NPOs 458 10. State and Local Governments 458 11. Healthcare Organizations 458 12. Educational Institutions 458 13. Charitable Organizations 459 o Other Not-for-Profit Organizations 459 14. Purpose of Not-for-Profit Organizations 459 15. Governance of Not-for-Profit Organizations 460 16. Corporate Governance Reforms Relevant to NPOs 463 17. Governance Mechanisms 465 18. Board Committees 466 19. Duties of the Board of Directors/Trustees 466 20. Responsibilities of the Board of Directors/Trustees 467 21. Attributes of Board Members 468 22. Audit Committees of NPOs 468 23. Best Practices 469 24. Internal Control in Not-for-Profit Organizations 471 25. College and University Governance 472 26. Corporate Governance Relevant to Minority Shareholders 473 27. Banks' Corporate Governance 474 28. Family-Owned Governance 476 29. Convergence in Corporate Governance 477 30. Corporate Governance of Multinational Corporations 480 31. Summary 482 32. Key Points 483 33. Discussion Questions 484 34. Review Questions 484 35. Multiple Choice Questions 485 Chapter 12 Contemporary Issues in Corporate Governance 492 1. Learning Objectives 492 2. Introduction 492 3. Corporate Governance Performance Evaluation 493 4. Information Technology (IT) 495 5. Cyber Company Model 497 6. Shareholders 498 7. Electronic Commerce 499 8. Information Technology Governance 500 9. IT Board Oversight 500 10. IT Executive 501 11. Electronic Financial Reporting 501 12. Information Infrastructure 502 13. Internal Controls 502 14. Information Security 503 15. Big Data and Data Analytics 504 16. Blockchain Platform 505 17. Corporate Governance and Artificial Intelligence 506 18. Corporate Governance Education 507 19. Corporate Governance Research 509 20. Corporate Governance Reporting 511 21. Corporate Governance Key Performance Indicators 514 22. Corporate Governance Ratings 515 23. Corporate Governance Assurance 517 24. Corporate Governance and Business Sustainability 519 25. Summary 523 26. Key Points 524 27. Discussion Questions 525 28. Review Questions 525 29. Multiple Choice Questions 526 Index 534