{"id":297,"date":"2014-05-13T17:45:20","date_gmt":"2014-05-13T17:45:20","guid":{"rendered":"http:\/\/opentextbc.ca\/strategicmanagement\/?post_type=chapter&p=297"},"modified":"2019-07-02T23:17:04","modified_gmt":"2019-07-02T23:17:04","slug":"boards-of-directors","status":"publish","type":"chapter","link":"https:\/\/opentextbc.ca\/strategicmanagement\/chapter\/boards-of-directors\/","title":{"raw":"Boards of Directors","rendered":"Boards of Directors"},"content":{"raw":"
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Learning Objectives<\/p>\r\n\r\n<\/header>\r\n

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  1. Understand the key roles played by boards of directors.<\/li>\r\n \t
  2. Know how CEO pay and perks impact the landscape of corporate governance.<\/li>\r\n \t
  3. Explain different terms associated with corporate takeovers.<\/li>\r\n<\/ol>\r\n<\/div>\r\n<\/div>\r\n

    The Many Roles of Boards of Directors<\/h1>\r\n\u201cYou\u2019re fired!\u201d is a commonly used phrase most closely associated with Donald Trump as he dismisses candidates on his reality show,\u00a0Celebrity Apprentice<\/em>. But who would have the power<\/em> to utter these words to today\u2019s CEOs, whose paychecks are on par with many of the top celebrities and athletes in the world? This honor belongs to the [pb_glossary id=\"2778\"]board of directors[\/pb_glossary]<\/strong>\u2014a group of individuals that oversees the activities of an organization or corporation.\r\n\r\nThe ability to appoint, or dis-appoint(!), CEOs is arguably the most important task of the board of directors in [pb_glossary id=\"2779\"]effective corporate governance[\/pb_glossary]<\/strong>\u00a0for the firm. An effective board plays many roles, ranging from the approval of annual budgets and financial objectives, advising on strategic issues, making the firm aware of relevant laws, and representing [pb_glossary id=\"2780\"]stakeholders[\/pb_glossary]<\/strong>\u00a0who have an interest in the long-term performance of the firm (Figure 10.1 \"Board Roles\"<\/a>). Effective boards may help bring prestige and important resources to the organization. For example, Air Canada's board often\u00a0includes the CEOs of other firms as well as former high-ranking politicians and prestigious academics.\r\n\r\nThe key stakeholder of most corporations is generally agreed to be the shareholders of the company\u2019s stock. Most large, publicly traded firms in Canada are made up of thousands of shareholders. While 5 percent ownership in many ventures may seem modest, this amount is considerable in publicly traded companies where such ownership is generally limited to other companies, and ownership in this amount could result in representation on the board of directors.\r\n\r\nThe possibility of conflicts of interest is considerable in public corporations. On the one hand, CEOs favor large salaries and job stability, and these desires are often accompanied by a tendency to make decisions that would benefit the firm (and their salaries) in the short term at the expense of decisions considered over a longer time horizon, when they may no longer be the CEO. In contrast, shareholders prefer decisions that will grow the value of their stock in the long term. This separation of interest creates an [pb_glossary id=\"2781\"]agency problem[\/pb_glossary]<\/strong>\u00a0wherein the interests of the individuals that manage the company (agents such as the CEO) may not align with the interest of the owners (such as stockholders).\r\n\r\nThe composition of the board is critical because the dynamics of the board play an important part in resolving the agency problem. However, who exactly should be on the board is an issue that has been subject to fierce debate. CEOs often favor the use of [pb_glossary id=\"2782\"]board insiders[\/pb_glossary]<\/strong>\u00a0who often have intimate knowledge of the firm\u2019s business affairs. In contrast, many [pb_glossary id=\"2783\"]institutional investors[\/pb_glossary]<\/strong>\u00a0such as mutual funds and pension funds that hold large blocks of stock in the firm often prefer significant representation by [pb_glossary id=\"2784\"]board outsiders[\/pb_glossary]<\/strong>\u00a0that provide a fresh, nonbiased perspective concerning a firm\u2019s actions.\r\n\r\nOne particularly controversial issue in regard to board composition is the potential for [pb_glossary id=\"2785\"]CEO duality[\/pb_glossary],<\/strong>\u00a0a situation in which the CEO is also the chairman of the board of directors. This has also been known to create a bitter divide within a corporation.\r\n\r\nFor example, during the 1990s, the Walt Disney Company was often listed in BusinessWeek<\/em>\u2019s rankings for having one of the worst boards of directors (Lavelle, 2002).\u00a0In 2005, Disney\u2019s board forced the separation of then CEO (and chairman of the board) Michael Eisner\u2019s dual roles. Eisner retained the role of CEO but later stepped down from Disney entirely. Disney\u2019s story reflects a changing reality that boards are acting with considerably more influence than in previous decades when they were viewed largely as rubber stamps that generally folded to the whims of the CEO.<\/a>\r\n\r\n[caption id=\"attachment_2288\" align=\"aligncenter\" width=\"400\"]\"Figure<\/a> Figure 10.1: Board Roles [Image description]<\/a>[\/caption]\r\n

    Managing CEO Compensation<\/h1>\r\nOne of the most visible roles of boards of directors is setting CEO pay. The valuation of the human capital associated with the rare talent possessed by some CEOs can be illustrated in a story of an encounter one tourist had with the legendary artist Pablo Picasso. As the story goes, Picasso was once spotted by a woman sketching. Overwhelmed with excitement at the serendipitous meeting, the tourist offered Picasso fair market value if he would render a quick sketch of her image. After completing his commission, she was shocked when he asked for 5,000 francs, responding, \u201cBut it only took you a few minutes.\u201d Undeterred, Picasso retorted, \u201cNo, it took me all my life\" (Kay, 1999).\r\n\r\n[caption id=\"attachment_1693\" align=\"aligncenter\" width=\"400\"]\"the<\/a> Figure 10.2: Zwei Kartenspieler by Paul C\u00e9zanne, one of the most expensive paintings in the world.[\/caption]\r\n\r\nThis story illustrates the complexity associated with managing CEO compensation. On the one hand, large corporations must pay competitive wages for the scarce talent that is needed to manage billion-dollar corporations. In addition, like celebrities and sport stars, CEO pay is much more than a function of a day\u2019s work for a day\u2019s pay. CEO compensation is a function of the competitive wages that other corporations would offer for a potential CEO\u2019s services.\r\n\r\nOn the other hand, boards will face considerable scrutiny from investors if CEO pay is out of line with industry norms. From 1980 to 2000, the gap between CEO pay and worker pay grew from 42 to 1 to 475 to 1 (Blumenthal, 2000).\u00a0Although efforts to close this gap have been made, as recently as 2008 reports indicate the ratio continues to be as high as 344 to 1, much higher than other countries, where an 80 to 1 ratio is common, or in Japan where the gap is just 16 to 1 (Feltman, 2009).\u00a0Meanwhile, shareholders need to be aware that research studies have found that CEO pay is positively correlated with the size of firms\u2014the bigger the firm, the higher the CEO\u2019s compensation (Tosi et al., 2000).\u00a0Consequently, when a CEO tries to grow a company, such as by acquiring a rival firm, shareholders should question whether such growth is in the company\u2019s best interest or whether it is simply an effort by the CEO to get a pay raise.<\/a>\r\n\r\n[caption id=\"attachment_1976\" align=\"aligncenter\" width=\"400\"]\"Figure<\/a> Figure 10.3: CEO Perks [Image description]<\/a>[\/caption]In most publicly traded firms, CEO compensation generally includes guaranteed salary, cash bonus, and stock options. But perks provide another valuable source of CEO compensation (Figure 10.3 \"CEO Perks\"<\/a>). In addition to the controversy surrounding CEO pay, such perks associated with holding the position of CEO have also come under considerable scrutiny. The term perks<\/em>, derived from perquisite<\/em>, refers to special privileges, or rights, as a function of one\u2019s position. Executives often receive additional or supplemental benefits and perquisites, which may include a special retirement plan, a deferred compensation plan, extra insurance coverage, extra vacation, a company car, a chauffeur,\u00a0use of the company plane, club memberships, financial and legal counseling, and so on. Many executive compensation packages even include the kitchen sink\u2014literally. A quick review of public filings reveals numerous executives with company-provided or subsidized housing\r\n\r\nCEO perks have ranged in magnitude from the sweet benefit of ice cream for life given to former Ben & Jerry\u2019s CEO Robert Holland, to much more extreme benefits that raise the ire\u00a0of investors while outraging employees. One such perk was provided to John Thain, who, as former head of NYSE Euronext, received more than $1 million to renovate his office. While such perks may provide powerful incentives to stay with a company, they may result in considerable negative press and serve only to motivate vigilant investors wary of the value of such investments to shop elsewhere.\r\n

    The Market for Corporate Governance<\/h1>\r\nAn old investment clich\u00e9 encourages individuals to buy low and sell high. When a publicly traded firm loses value, often due to lack of vigilance on the part of the CEO and\/or board, a company may become a target of a takeover wherein another firm or set of individuals purchases the company. Generally, the top management team is replaced, and those who\u00a0survive the cut are charged with revitalizing the firm and maximizing its assets.<\/a>\r\n\r\n[caption id=\"attachment_1696\" align=\"aligncenter\" width=\"400\"]\"Figure<\/a> Figure 10.4: Takeover Terms [Image description]<\/a>[\/caption]In some cases, the takeover is in the form of a [pb_glossary id=\"2787\"]leveraged buyout (LBO)[\/pb_glossary]<\/strong>\u00a0in which a publicly traded company is purchased and then taken off the stock market. One of the most famous LBOs was of RJR Nabisco, which inspired the book (and later film) Barbarians at the Gate<\/em>. LBOs historically are associated with reduction in workforces to streamline processes and decrease costs. The managers who instigate buyouts generally bring a more entrepreneurial mind-set to the firm with the hopes of creating a turnaround from the same fate that made the company an attractive takeover target (recent poor performance) (Wright, Hoskisson, & Busenitz, 2001).\r\n\r\nMany takeover attempts temporarily increase shareholder value. However, the data shows that such takeovers and\u00a0mergers have a relatively \u00a0poor longer-term return on investment. Because most takeovers are associated with the dismissal of previous management, the terminology associated with change of ownership has a decidedly negative slant against the acquiring firm\u2019s management team. For example, individuals or firms that hope to conduct a takeover are often referred to as [pb_glossary id=\"2788\"]corporate raiders[\/pb_glossary]<\/strong>. An unsolicited takeover attempt is often dubbed a [pb_glossary id=\"2789\"]hostile takeover[\/pb_glossary],<\/strong>\u00a0with [pb_glossary id=\"2790\"]shark repellent[\/pb_glossary]<\/strong>\u00a0as the potential defenses against such attempts. Although the poor management of a targeted firm is often the reason such businesses are potential takeover targets, when another firm that may be more favorable to existing management enters the picture as an alternative buyer, a [pb_glossary id=\"2791\"]white knight[\/pb_glossary]<\/strong>\u00a0is said to have entered the picture (Figure 10.4 \"Takeover Terms\"<\/a>).\r\n\r\nThe negative tone of takeover terminology also extends to the potential target firm. There is an inherent conflict of interest as CEOs, senior executives and board members are likely to lose their positions after a successful takeover occurs. \u00a0A number of antitakeover tactics have been used by boards to deter a corporate raid. For example, many firms are said to pay [pb_glossary id=\"2792\"]greenmail[\/pb_glossary]<\/strong>\u00a0by repurchasing large blocks of stock at a premium to avoid a potential takeover. Firms may threaten to take a [pb_glossary id=\"2793\"]poison pill[\/pb_glossary]\u00a0<\/strong>where additional stock is sold to existing shareholders, increasing the shares needed for a viable takeover. Even if the takeover is successful and the previous CEO is dismissed, a [pb_glossary id=\"2794\"]golden parachute[\/pb_glossary]\u00a0<\/strong>that includes a lucrative financial settlement is likely to provide a soft landing for the ousted executive.\r\n
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    Key Takeaways<\/p>\r\n\r\n<\/header>\r\n

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