Identify the corporate governance problems leading up to the corporate scandals of the early 21st century. Which of these problems might McBride fall prey to if Hugh does not accept your proposed solution?
Corporate governance has provided its fair share of publicity over the past decade. Most of which was a result of foul practices on the part of management, while some was due to a genuine interest in investor well being. Many issues of corporate governance have led to many of the scandals that have been publicized in recent years. Below is list of many of these practices and how they subsequently affect business on a global scale. This list is by no means exhaustive but I do believe it provides significant information as to why some of the scandals of recent years have occurred.
Management as owners vs. Management as representatives- This statement may seem one in the same but prior to 1990, management's duties and responsibilities where polar opposite to those of today. In the 1980's management was seen primarily as a "representative" of the entire business entity. As a result, stockholder and investor interests where junior to the needs of the overall business. Managers did not use assets in a manner is which stakeholders benefited. In fact, most management was inclined to underuse capacity. Companies with competitive advantages such as economies of scale or distribution networks simply did not use them to their fullest extent. This benefited the manager who had compensations packages that were based very loosely on metrics that can be easily manipulated. This metrics included revenue, earning per share, and sales growth (1). All management had to do was to simply alter assumptions within the annual report to "create" earnings or manipulate earnings as their compensation was not in the form of stock. For example, one method earnings can be created or manufactured is by manipulating the pension fund assumptions in the annual report. By "expecting" a higher growth rate within the pension fund, a company can contribute less overall fund the pension. These pension savings are then transferred to the bottom line as a profit increase, when in reality; the increase was a result of accounting gimmicks (2). Such was the case in the 1980's as many companies used these gimmicks to manipulate financial information. To be fair, the 1980's and prior decades where marked with economic uncertainties that created a sense of caution among businesses. This cautious attitude can reasonably attribute to the notion of unutilized capacity. However, this underused capacity was still a detriment to shareholders as costs per unit and overhead per unit increases due to this unused capacity. What would eventually ensure was a wave of hostile takeovers and proxy fights in an effort to better align corporate goals with those of its owners. Many investors who found companies with assets that where not utilized to their fullest potential would simply obtain a majority stake in the business and either sale or use those assets to generate profits or cash. Companies began to take notice and began to better align corporate objectives with owner objectives through the issuance of stock options.
Direct Appointments and the Board of Directors- the Board of Directors; seem to most, as an elite group of businessmen and women who offer their expertise to better aid the overall operations of the business franchise. This expertise, which many believe to be rare, will help the business navigate tumultuous economic uncertainty while generating earnings growth for years to come. In exchange for their expertise and service, they are appropriately compensated relative to their peers with similar background and knowledge. On the surface this form of corporate governance seems adequate. However, upon further examination, the Board of Directors is in many respects, nothing more than a face of the company. For one, the board only meets, at most, 10 times a year in many instances. These ten meetings usually don't consist of anything material in regards to the operations of the overall business (3). In fact, it is my opinion, that these meetings detract from shareholder wealth as many board members command high salaries but do not benefit the business. Additionally, the board is usually good friends with the CEO. In fact the CEO can be chairmen of the board! This presents a conflict of interest as the board does not want to "Bite the hand that feeds them." To further illustrate this point, on many instances the board is elected by the shareholders. The shareholders however defer to top executives as they believe they are closer to the actual business operations, thus they have more insight relative to the average shareholder. Knowing this, the executives recommend friends to the board who are all almost unanimously chosen. Once on the board, these individuals do not safe guard the interests of the business but instead, are merely pawns to the executive that recommended them in the first place. As such, this creates issues of corporate governance as an entire layer of oversight is virtually eliminated. Much has been done to mitigate this occurrence such as requiring the board to be independent, meeting with non-management directors and so forth. However, these rules have done little to abate the prevalence of the overall corporate governance issues.
Executive Compensation- Is stock-based compensation really the best method in which to align corporate objectives with those of the owners. It is my personal opinion that it DOES NOT. It is my belief that stock options create a management structure that is too concentrated on near-term performance and the expense of long-term performance. As such, stock options only increase the risk taking behavior of executives who are looking to exercise the option at a higher price. Because of this shortsightedness, corporate governance comes into play as excessive risk taking will be a detriment to the owners of the business. Countrywide Financial, a subprime mortgage lender is evidence of this as the company is still a detriment to Bank of America's operations. As such, stockholders have suffered as result, with the stock plunging 50% last year alone (4). The stock would need a 100% increase simply to break even!
Banking and Corporate Relationships- An issue not thoroughly discussed in regards to the case but I believe is important to the notion of corporate governance is the investment banking and corporation relationship. Here a conflict of interest exists between the interests of both parties involved. On one end, the investment bankers have a corporate client that is usually profitable in terms of overall business. Investment bankers can influence market behavior and sentiment towards a business with their market research and recommendations. As such, they may portray an overly optimistic scenario of a corporate client they have a relationship with. Because of their clout, investment bankers can help push a stock price upwards with a simple recommendation to buy and some mediocre research to back it up. All the company would need to do is make the earnings estimates included in the research. That way, the investment bank maintains is clout in regards to research accuracy and the business stock price continues to move upward. On the other end of the spectrum, the corporation allows the investment banker to collect fees through issuance of debt or equity securities. It is a win-win for both parties involved. However, management, who is now compensated in stock, will go above and beyond to make the earning estimates set by the investment banking. In many instances, as I alluded to earlier, accounting tricks and gimmicks are used to mask legitimate earnings shortfalls. As such corporate governance comes into play as management is very shortsighted in their decisions regarding the overall business operations.
Implications for McBride- Many of the issues above are issues that plague McBride. For one, the CEO is only concerned with his stock as oppose to the owners stock. This is evident with his email statement on Feb 6th, "…at this time I'm not interested in diluting my shares." Throughout the entire email correspondence, there was no mention of shareholders or their interests at all. Additionally, McBride's board appointments are lackluster at best. None of the board members have a genuine interest or expertise regarding the business. Instead, they are used merely to appease the owners, which again is a detriment to the business. There is no oversight on the part of the CEO in regards to the accounting firm. He simply delegated the task and was content with signing off on anything. This shows lack of interest on the part of the CEO in regards to internal controls and oversight of the business operations.
Examine the influence of the governance rating industry on American corporations. What implications does this have in regards to McBride?
Now that corporate governance and is implications on investor wealth have come to the forefront, many agencies have adopted standards in which to measure companies relative to their peers. These ratings corporation now can influence, directly, the stock price and wealth of…