Introduction to Business Governance and Ethics

Master in Management: Introduction To Business Law

Professor Drew Shagrin

Our 8-session agenda
1. Housekeeping, and introduction to setting up the business (January 6th)
2. More on setting up the business (January 6th)
3. Business governance and ethics (January 7th)
4. Introduction to worker relations (January 10th)
5. More on worker relations (January 14th)
6. Distributing what you sell (January 17th)
7. Protecting your ideas and data (January 21st)
8. Dispute resolution (January 27th)
Homework for next time

Next session we’ll shift gears to worker relations. Bring an

internship or employment contract that you’ve signed.
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
Questions that seem easy to answer but might in fact be
difficult for you
Part 1

1.What is corporate governance?

2. What is good governance?
3. What is bad governance?
4. List as many governance functions as you can.
5. For each function that you listed in #4, explain what good
governance would be for that function, and what bad
governance would be for that function.
Part 2

6. What is the role of a board of directors?

7. What are their main functions?
8. What is management?
9. What is a senior management executive committee?
10. What are the differences between corporate governance
and management?
11. How is a senior management executive committee different
from a governing board?
Part 3

12. What does it mean that a board is a collegial body?

13. What is the role of an individual director on a board of
directors?
14. What are the differences between executive and non-
executive board members?
15. What does the term “independent” mean in connection with
a member of a board of directors? What does the term mean
in connection with the board chairperson?
Part 4

16. How common is it for the CEO to be on the board?

17. How are board members chosen? What's the formal
process? What's the informal behind-the scenes process?
18. Why is executive compensation such a big issue? What's
the typical process? What are the trends?
19. Whose interests should an individual director advance?
20. How does a board member prepare for a meeting?
Part 5

21. What are important characteristics for any person who

serves on a corporate board of directors?
22. What are important skills or capabilities for any person who
serves on a corporate board of directors?
23. What are important additional skills or capabilities that
should be possessed by at least one member of each
corporate board of directors?
24. What does ESG mean?
Through whom does a company act?

A company is a bit like a puppet: real people are needed

to make it speak, take decisions, and act.
Through whom specifically?

Board of directors
CEO
Other senior management
Middle and lower-level management
Non-management employees
Agents
But there are other interested parties!

We’ll talk a little later about all the stakeholders

Separation of powers for state governance

Some states have a government divided into branches, each

having separate, independent powers and responsibilities

Consider a state government with a separate legislature,

executive, and judiciary

Contrast that with a state government where the executive

and legislative branches overlap
Separation of powers provides checks and balances

Generally speaking, the more the powers are separated and

not concentrated, the more checks and balances there are to
serve as guardrails
Separation of powers for corporate governance

Company governance similarly involves different actors,

each having separate, independent powers and
responsibilities

However, corporate governance checks and balances are

quite different from state governance checks and balances
What is corporate governance?

The definition varies from source to source, even though the

definitions overlap substantially

”The structure of rights and responsibilities of the different

stakeholders and its consequences for the process by which
companies are controlled and operated.”
Another scholarly definition

“Essentially, corporate governance is about the way power is

exercised over corporate entities. It covers the activities of
the board and its relationships with the shareholders or
members, and with those managing the enterprise, as well
as with the external auditors, regulators, and other legitimate
stakeholders.”
Still another scholarly definition

This one first identifies the problem that corporate governance

solves, then describes the solution as corporate governance:

“Executives make investment, financing, and operating

decisions that better themselves at the expense of other
parties related to the firm. To lessen agency costs, some type
of control or monitoring system is put in place in the
organization. That system of checks and balances is called
corporate governance.”
Now for a popular definition (from Wikipedia)

“Corporate governance is the collection of mechanisms, processes

and relations by which corporations are controlled and operated.
Governance structures and principles identify the distribution of rights
and responsibilities among different participants in the corporation
(such as the board of directors, managers, shareholders, creditors,
auditors, regulators, and other stakeholders) and include the rules
and procedures for making decisions in corporate affairs. Corporate
governance is necessary because of the possibility of conflicts of
interests between stakeholders, primarily between shareholders and
upper management or among shareholders.”
And another popular definition (from Investopedia)

“Corporate governance is the system of rules, practices, and

processes by which a firm is directed and controlled. Corporate
governance essentially involves balancing the interests of a
company's many stakeholders, such as shareholders, senior
management executives, customers, suppliers, financiers, the
government, and the community. Since corporate governance also
provides the framework for attaining a company's objectives, it
encompasses practically every sphere of management, from action
plans and internal controls to performance measurement and
corporate disclosure.”
What do these definitions have in common?

These different definitions collectively invoke systems, structures,

mechanisms, people, relationships, practices, procedures, and rules,
all in service of establishing and limiting power in an entity recognized
to have legal personhood (that is, with the capacity to own property,
enter into contracts, sue, and be sued).
So what is corporate governance? Here’s a synthesis of the many
definitions.

A system of rules, practices, and procedures by which managers and

boards are held accountable to those who have a stake in the
enterprise, which may be limited to shareholders, or may include
other stakeholders.
What is good corporate governance?

It’s easier to define in the negative: it’s not bad governance.

What is bad corporate governance?

• Weak systems
• Weak organizational culture
• Failure of leadership
• Failure of internal controls and oversight
• Failure to model ethical conduct
• Elevation of law over ethics
 A Few Thoughts About Ethics And Law

Laws generally fall short of providing a guide for good business

practice.

Managers who equate compliance with law with ethical behavior are
endorsing a model of ethical mediocrity.

“It is not an adequate ethical standard to aspire to get through the

day without being indicted.” (Richard Breedon, former SEC Chair)
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
MAIN ACTORS
Shareholders

Management

The board
SHAREHOLDERS
We’ve already talked about them: owners of shares (not the
corporation itself), with specific economic, decision-making, and
ancillary rights
 THE TERM “MANAGEMENT”
The previous slide used the term “management” to mean an
actor of corporate governance, an actor to be contrasted with
shareholders and the board.

The term “management” can also refer to a function within the

ecosystem of corporations, a function to be contrasted with the
governance function that’s the focus of this course.

The multiple meanings of the term “management” can (and

often does) lead to confusion!
SHAREHOLDERS
 SHAREHOLDERS AS OWNERS
This is a premise of the famous Milton Friedman article The Social
Responsibility Of Business Is to Increase Its Profits.

This is the cornerstone of the shareholder primacy model.

As frequently repeated as this premise may be, and as intuitively appealing

as it may sometimes be, is it defensible?
OWNERSHIP
To own something is to have the right to possess it, to use
it, to prevent others from possessing or using it, to
destroy it, to improve it, and to transfer it.
 SO WHO OWNS THE
CORPORATION?
Shareholders? It’s the conventional answer, but what they really own are
shares, and shares aren’t the same thing as the corporation itself.

Maybe some or all of the other stakeholders? Not a very satisfying

answer.

Maybe nobody? Possibly the best answer.

Let’s look at what the shares owned by shareholders specifically provide in

the way of rights.
 SHAREHOLDERS OWN SHARES

Shares are not the same thing as the corporation itself.

SHAREHOLDER ECONOMIC RIGHTS

1. Receive a proportionate share of distributed profits (dividends), if any

profits are realized and distributed

2. Receive a proportionate share of distributed liquidation proceeds, if

the corporate assets are liquidated and the corporation is dissolved

3. Receive the buyer’s payment in exchange for any shares that the
shareholder sells
SHAREHOLDER DECISION-MAKING
RIGHTS
1. Elect some or all of a decision-making board

2. Approve or reject “ordinary” shareholder ballot measures (ranging

from the identity of the corporation’s auditor and the fees paid to the
auditor to the CEO’s compensation)

3. Approve or reject “extraordinary” shareholder ballot measures

(ranging from a change in corporate purpose and/or charter
documents to major merger or acquisition transactions, with some
ballot measures being binding and others merely exhortatory)
 SHAREHOLDER VOTING
Under shareholder democracy, the rule isn’t “1 voter, 1 vote.” It’s “1 share, 1
vote.” One shareholder can have much more voting power than another
shareholder.

Where multiple classes of shares exist under the corporation’s charter

documents, there can also be a separation of economic rights and voting
rights such that a shareholder with only a minority of economic rights can still
control a majority of voting rights. For instance, Meta founder Mark
Zuckerberg reportedly owns about 13% of the shares in Meta, giving him
about 13% of the economic rights, but some of his shares give him 10 votes
per share, for a total voting control of abut 60% of the votes.
SHAREHOLDER VOTING
ADVISORS
Also called “proxy advisors,” shareholder voting advisors
are an important part of the corporate governance
ecosystem.
OTHER SHAREHOLDER RIGHTS

Inspect corporate records (with the specific right varying

from place to place and from situation to situation)

File lawsuits against the corporation’s officers or board of

directors for wrongful acts in a “derivative” lawsuit made
in the name of the corporation—more on that later

Transfer the shares

THE TERM “MANAGEMENT”
The term “management” can mean an actor of corporate governance, to be
contrasted with shareholders and the board.

The term “management” can also refer to a function within the ecosystem of
corporations, a function to be contrasted with the governance function that’s
the focus of this course.

The multiple meanings of the term “management” can (and often does) lead
to confusion!
MANAGEMENT
Here, we’re talking about “management” as an actor, not as a
function

High-executive-level employees

Not just the CEO, but also the CEO’s lieutenants (the “management
committee” or the “executive committee”)

In corporate governance, “management” as an actor is narrower

than in labor and employment law
THE BOARD
Sometimes the boards, plural

When it’s singular, when there’s just one unitary board (as is the
case in many countries), it’s typically called a board of directors

Where there are two boards (as is usually the case in Germany but
is also sometimes the case in several other countries), one board is
typically called the supervisory board and is elected, and the other
board is typically called the management board and is appointed by
the supervisory board

To keep things simple, in this course we’ll mostly assume just 1

board, a board of directors
BOUNDARIES
The general public tends to misunderstand the differences between
what management does and what the board does.
MODELS
Different models of corporate governance exist, because corporate
governance reflects the economic, historical, cultural, ethical and
legal characteristics of a country and system

It’s also shaped by the ownership structures and patterns of that

economy and by the financing options available.

Hidden within these models are implicit answers to the question,

What’s the purpose of a corporation?
 SHAREHOLDER PRIMACY MODEL
Rooted in Dodge v Ford, a 1919 Michigan Supreme Court decision

The primary purpose of a corporation is to benefit its shareholders

Returns to shareholders are to be prioritized over other social objectives (for instance
benefitting employees or customers)

Expanded through the 1970 Friedman doctrine

Under the shareholder primacy model, corporations exist principally to serve shareholders

And the purpose of a corporation under the shareholder primacy model? To enrich the
shareholders (a purpose that tends to encourage short-term decision-making).
STAKEHOLDER MODEL
An alternative to shareholder primacy

The stakeholder model explicitly takes into account the interests of

company stakeholders other than shareholders, including some or
all of the following: customers, lenders, suppliers, employees, local
communities and the environment
STAKEHOLDER MODEL: OECD
The OECD Principles of Corporate Governance stipulate that any
assessment of corporate governance should include the place of
the company in society as a whole, recognizing the interests of
various stakeholders in financial stability, wealth creation, job
creation and sustainability
STAKEHOLDER MODEL: EXTREME

An extreme form of the stakeholder model holds that companies

exist solely to meet society’s needs
FOR WHOM DOES THE
CORPORATION EXIST?
WHAT’S THE PURPOSE OF A
CORPORATION?

What do YOU think?

THREE APPLICATIONS OF
SHAREHOLDER PRIMACY AND
THE STAKEHOLDER MODEL
US

Japan

Europe
THE US: SHAREHOLDER PRIMACY
The system is largely designed to allow shareholders, especially
institutional investors, to play an active role in monitoring and controlling
management through a unitary board—this is sometimes called a
“monitoring model” of corporate governance

A major goal of US corporate governance is to strengthen scrutiny of

management (because of information asymmetry) and promote
shareholder activism

Share value of the company is used as the primary, if not sole, measure of
company performance

The relationship between company performance and executive

compensation has encouraged aggressive management
THE US: RECENT REFORMS
Reforms of the system in the past 20 years have improved financial
reporting and board independence

In the wake of a number of corporate failures, the Sarbanes-Oxley

Act (SOX) was passed to restore public confidence in the system

SOX has established higher standards for financial disclosure, board

structure, and audit committee independence, but has proven
inadequate at addressing many persisting organizational, cultural,
and ethical challenges
JAPAN: STAKEHOLDER MODEL
Stakeholder model featuring a unique banking system, cross-
shareholdings (including keiretsu), typically lifetime employment,
and powerful HR departments and unions

Limited board independence, little board monitoring of the actions

of top management —this is sometimes called a “management
model” of corporate governance

An example of how a strong national culture can define corporate

governance even in the face of global pressures to the contrary
 JAPAN: RECENT REFORMS
Policy reforms have introduced a more western-style corporate governance
system, moving a bit toward a monitoring model

Boards are now required to have a committee system, including an audit

committee, with independent auditors (before 2001, most large companies
used former employees as auditors)

Boards of large companies must now establish an internal control system to

ensure compliance with applicable law and company policies

A financial reporting system known as J-SOX (or “SOX Light”) has been
adopted

Listed companies are now required to have at least two independent

directors
THE EU: STAKEHOLDER MODEL
Stakeholder model with variation from country to country, including
voluntary measures in some and mandatory measures in others

Sometimes unitary board, sometimes 2 boards

Board selection: power to vote for at least some board members is

sometimes given to stakeholders other than shareholders (eg, employees),
creating a special kind of board diversity

Ownership patterns tend to be concentrated and complex, with cross-

holdings being common

Longer-term orientation
OPEN QUESTIONS
Is globalization leading to convergence in corporate governance practices?

What types of reforms lead to better corporate performance, and more

ethical behavior, in the short and long term?

Should nations preserve their own CG standards, perhaps because local

differences can be a source of competitiveness and an effective way to
compete globally?

Can developing countries simply adopt the corporate governance practices

of more developed nations? Or must corporate governance standards be
developed country by country, taking into account varying cultural and
ethical norms?
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
BOARD MISSIONS VS
MANAGEMENT MISSIONS
We referred a few minutes ago to boundaries between the board and
management

Remember, management is both a function (contrasted with governance), and

an actor (contrasted with the board and shareholders). The word is polysemic,
ambiguous.

The board is responsible for governing the company

Senior executives, ie management, are responsible for managing the company

AMBIGUITY: THE TERM GOVERNANCE
We just saw that the board is responsible for governing the company. That
makes “governance” the board’s responsibility.

But “governance” is also the larger framework within which the board does
what it does:

The different definitions of “corporate governance” collectively invoke

systems, structures, mechanisms, people, relationships, practices,
procedures, and rules, all in service of establishing and limiting power in an
entity recognized to have legal personhood (that is, with the capacity to own
property, enter into contracts, sue, and be sued).

So governance the word sometimes describes only what the board does, and
sometimes it describes something much bigger.
WHO DOES WHAT
A common metaphor is that the board steers the boat while
management rows the boat

Board governance: policy/strategy development, and oversight

Management by senior executives: policy/strategy implementation

“(E)xecutive management is responsible for running the enterprise,

but the governing body ensures that it is running in the right
direction being run well.”
BOARD MISSIONS, MORE DEEPLY
Strategy
Risk management
Finance
ESG (Environment, Social, Governance)
Leadership supervision
Regulatory
STRATEGY
The board adopts/approves company strategy: defining the larger
business continuity goals and value creation goals, along with the
resources needed to achieve those goals.

Management of course helps develop company strategy.

Management also adopts/approves ancillary strategies: a product

strategy, a sales strategy, a marketing strategy, a financing strategy,
a recruiting strategy, etc. But these are all in support of the larger
company strategy.
RISK MANAGEMENT
Economic risk Financial risk

Security (including cybersecurity) risk Compliance risk

Fraud risk Reputational risk

Operational risk Competition risk

Political risk Geopolitical risk

FINANCE
The board is the steward of the financial soundness of the
corporation

The board oversees the corporate accounts (the profit-and-loss

operating statement, and the assets-and-liabilities balance sheet
statement)

An auditor usually validates the corporate accounts, but auditing

lapses have been known to exist! We’ll come back to this.
ESG: BOARD TASKS
Define key ESG orientation and ensure that ESG considerations are included
in all key strategic decisions

Review, challenge and approve the action plan set up by management

Follow up the roll-out of the ESG action plan within the company

Include ESG and other non-financial parameters in setting management’s

annual objectives and assessing their annual performance

Review non-financial communication and related reports (including KPI’s)

Pay attention to the company’s rating by ESG rating agencies and SRI funds
LEADERSHIP SUPERVISION
Recruiting the CEO: choosing the right person

Compensating the CEO: not too high, not too low, often
benchmarked against « peers »

Terminating the CEO (and recruiting a replacement): when the

board is no longer confident in the CEO

Assuring a smooth emergency succession through succession

planning
REGULATORY
Understanding the big picture of regulatory compliance (which is
quite complex!)

Ensuring that there’s appropriate expertise and head count to

achieve compliance

Auditing compliance to get real-world feedback

What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
SHAREHOLDER DUTIES
Do shareholders owe a duty?

Of course a shareholder can have a duty to the corporation. Generally applicable

duties under tort law still apply. And a contract can create a specific contract duty.

And a shareholder can have a duty to fellow shareholders. Generally applicable

duties under tort law still apply. And a contract can create a specific contract duty.

But in most countries there’s no special shareholder duty, to the corporation or to

other shareholders, or to other stakeholders, simply by virtue of a shareholder’s
status as a shareholder. (Contrast this with rules for partners in a partnership!)
DIRECTOR DUTIES
Shareholders may not have specific duties by virtue of being
shareholders, but that’s not true for directors.

In carrying out their broad missions, directors owe specific duties, to

the corporation itself and possibly also to specific stakeholders.

The two main duties are a duty of loyalty and a duty of care.

This is an American lens. Under the laws of other countries, the

framework can be different, even as the issues tend to be quite
similar.
DUTY OF LOYALTY
No self-dealing transactions

No appropriation of corporate opportunities or advantages

No other conflicts of interest

Generally place the corporation’s interests ahead of one’s own

interests
DUTY OF CARE
The duty of care requires reasonable diligence and prudence.

The specific duty of care will vary from place to place, of course.
DUTY OF GOOD FAITH
We saw a few slides earlier that there are only two main director duties, the
duty of loyalty and the duty of care. What about the duty of good faith?

Acting in good faith is a subset of the duty of loyalty—acting in bad faith is

considered a breach of the duty of loyalty.
 FIDUCIARY DUTY
The term “fiduciary” means different things in different contexts.

The term is often used in the context of a trust relationship, where the owner of
assets entrusts those assets to another person. The person to whom the assets are
entrusted can in some cases be called a “fiduciary,” responsible to the assets’ owners.

The term “fiduciary” more generally can mean a person who owes an extraordinary
duty by virtue of a position of trust or responsibility. This is the case of a corporate
director, entrusted with the responsibility of making decisions for the corporation.

The director’s fiduciary duty is owed to the corporation, and encompasses the two
duties we just saw: a duty of loyalty, and a duty of care.

Is there a SEPARATE fiduciary duty in corporate governance? Not

really—it’s just the duty of loyalty + the duty of care.
 Board of directors and preventing fraud

Company directors have the role of preventing and detecting any material
financial fraud in the company. An effective internal system of controls
should be implemented to reduce any undetected fraud from happening in
the financial statements.
 The role of the board of directors in Enron’s collapse
• Much that was wrong with Enron was known to the board, from high-risk
accounting practices and inappropriate conflicts of interest to extensive
undisclosed off-the-books activity and excessive executive compensation.
• A US Senate committee hearing later identified more than a dozen red flags
that should have caused the Enron board to ask hard questions, examine
Enron policies, and consider changing course. Those red flags were not heeded.
In too many instances, by going along with questionable practices and relying
on management and auditor representations, the Enron board failed to provide
the prudent oversight and checks and balances that its fiduciary obligations
required and that a company like Enron needed. By failing to provide sufficient
oversight and restraint to stop management excess, the Enron board
contributed to the company’s collapse, and bears a share of the responsibility
for it.
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
 OZY SCANDAL

Ozy, a media scale-up, was running out of cash. It approached Goldman Sachs for a
loan for $40 million.

The Ozy CEO and COO tried to convince Goldman Sachs that Google/You Tube
viewed Ozy as being more successful than Ozy really was. They tried really hard: the
COO impersonated a Google/You Tube employee in a conference call to give
Goldman Sachs the incorrect impression that Google/You Tube viewed Ozy as being
more successful than it really was!
OZY BOARD MEMBERS
Marc Lasry: billionaire, financier, owner of a major sports team

Laurene Powell Jobs: billionaire, broad and deep business

experience

Louise Rogers: broad and deep business experience

OZY BOARD LESSONS
A board composed of sophisticated people isn’t enough

Procedures, methods, and culture count A LOT

Board oversight, with critical thinking and question, can really make
a difference
THERANOS SCANDAL

Elizabeth Holmes dropped out of Stanford to found the company

Promise: sophisticated blood tests using only the blood extracted

from a pin prick

Rise: spectacular given the promise

Fall: spectacular when fraud was revealed

THERANOS AND BOARD
COMPOSITION

They must have been out of their league, right?

 THERANOS BOARD MEMBERS
Riley Bechtel, former CEO of a major company

George Shultz, former Secretary of Labor and Secretary of State

David Boies, a very prominent lawyer

William Foege, doctor and former director of the Centers for Disease Control

Richard Kovacevich, former CEO and chair of a major bank

Jim Mattis, retired general and later Secretary of Defense

Fabrizio Bonanni, former executive vice president of a major pharma company

THERANOS BOARD LESSONS
A board composed of sophisticated people isn’t enough

Procedures, methods, and culture count A LOT

Board oversight, with critical thinking and question, can really make
a difference
YES, A BOARD REQUIRES
SOPHISTICATED DIRECTORS
Procedures, methods, and culture don’t help without a foundation
of accumulated knowledge and experience

Experience is a key to judgment!

But sophistication isn’t enough . . .

THESE WERE PRIVATE FIRMS

Loose processes

Little oversight
WHY WAS OZY’S CHAIR EVEN ON THE
BOARD?

Many private company boardmembers view their board role in a

very limited way: protecting their investment

They may correspondingly give short shrift to best practices (and

requirements) followed in publicly traded companies
WHEN YOU’RE ON A START-UP
BOARD
Should you aspire to the same practices as in a public firm?

If not, then what is the role of the start-up board?

What CAN the board do?

What SHOULD the board do?

What practices and structures should apply, subject to what

standards?
HOW BIG IS THE BOARD?
 BOARD SIZE PRINCIPLES
The maximum and minimum allowed are based on rules in the
company law of the territory where the company was organized. The
range can be quite broad, giving companies discretion to choose what
the company believes to be the right number of directors.

That discretion gets exercised in the company’s governing documents,

most frequently the bylaws. In some case cases the bylaws specify a
fixed number of directors within the range authorized by company
law. In other cases, the bylaws, give the board of directors discretion
to decide for itself from time to time how many directors there ought
to be on the board.
 BOARD SIZE PRINCIPLES 2

It’s rare for a company to reduce the size of its board. Boards tend to
grow, not to get smaller. This tendency toward growth creates a risk
of having too many board members, and having too many board
members is bad for two reasons.

First, the larger the board, the higher the chance of the board
splintering into sub-groups that are difficult for the board chair to
lead to a consensus on difficult issues.

In addition, the more directors on the board, the less time each
director has to contribute to a board meeting discussion, asking
questions and making observations. Stated otherwise, a board that’s
too large can lead to inefficiency, hindering the ability of the board to
make optimal decisions.
 BOARD SIZE IN FRANCE
The French Commercial Code permits a range, with a minimum of 3
and a maximum of 18 members on a board of directors.

The same range applies to the supervisory board in companies with a

two-tiered board.

As an exception, a post-merger board can have up to 24 members for

the first three years after the merger.

In practice, the average number of directors typically depends on the

size of the company. Small- and medium-sized businesses usually
have fewer directors, averaging about 6 directors on the board.
Larger businesses often operate with larger boards. The average
board size in the CAC Forty is 14 directors.
 BOARD SIZE IN US/UK
US and UK company law are more permissive. Delaware company law
requires the board to have at least one member. And UK company
law has hardly any rules at all as to board size, saying just that the
number needs to provide for the board to be effective.

Advisory firms and governmental commissions sometimes make

recommendations as to optimal board size. In the US, the proxy advisory
firm Institutional Shareholder Services recommends that boards have no
fewer than 6 members and no more than 15, and goes on to narrow that
to an ideal board size of between 9 and 12 members.

In the UK, the commission known as the Walker Review stated several
years ago that the ideal board size for banks and financial institutions in
particular was between 10 and 12 members.
 SOME REAL COMPANY BOARDS
Microsoft
General Motors

L’Oreal
AirLiquide
Microsoft
General Motors
L’Oreal
Air Liquide
IS THE CEO ON THE BOARD?
Frequently. There are benefits to having the CEO on the board, and
there are rarely drawbacks.

There’s greater controversy over whether to combine the roles of

CEO and board chair.
ELECTION TO THE BOARD:
OPEN SEAT
Occasions for an election: death, resignation, or removal of a sitting
director.

But these are also occasions for the appointment, by the remaining
board, of a new board member to serve until the next election.

Additional occasion for an election: the expiration of the term of a

sitting director (typically expiring, conveniently, at the annual
shareholders meeting at which there’s an election)
ELECTION TO THE BOARD:
WHO VOTES?
Shareholders

What about employees? Consider Germany, where workers elect

up to half the members of supervisory boards

What about other stakeholders?

ELECTION TO THE BOARD:
WHO’S NOMINATED?
Common approach: the board nominates a slate, and shareholders
can propose competing candidates

Competing candidates never win

Except that in 2021, at the Exxon shareholder meeting, competing

candidates did win!
REMOVAL FROM THE BOARD
Generally, a director serves on the board for a term of years.

Even if shareholders are unhappy with a director, they have no ability to

remove a director during the term.

Even if other directors are unhappy with a director, they generally have
no ability to remove the director.

EXCEPTION: if a director fails to comply with specified conditions,

then the board can remove that director. Examples: if a director fails to
attend a specified number of board meetings, or if a director behaves
improperly or illegally.-
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
 The board chair presides over the board

• The chairperson sets the agenda, schedules meetings, coordinates

actions of committees, and generally oversees the board.

• Yet board decisions are made by majority rule, and the chairperson has
just one vote, the same as all other directors.

• To make informed decisions, the board relies on information provided by

management.
IS THE CEO ALSO THE BOARD CHAIR?
A combined chair/CEO can provide single-minded leadership and
expertise and knowledge from being more involved in both activities,
management and governance.

On the other hand, combining the two roles in one increases risk, because
decision-making responsibility isn’t spread across different people who
might assess situations differently.

More and more corporate governance codes around the world prefer, and
in some cases require, separating the two roles. At the same time,
combining the chair and CEO in a single person continues to dominate
some countries.
 CEO AS CHAIR IN FRANCE
Whether to combine the chair and CEO, or have two separate individuals, is up
to each corporation’s board.

The Afep-Medef code is deliberately neutral on the subject, noting that the
most important factor to consider is transparency: the choice of structure and
the motivations for choosing that structure should be made clear to the
shareholders.

The AMF agrees, adding that where the roles are split across 2 people, the
duties assigned to each of these people should be made clear, especially as
concerns CEO compensation.

The Middlenext Code is silent on the subject, but refers to sources that call for
splitting the roles across 2 people.
CEO AS CHAIR IN FRANCE 2

Where the board chair isn’t also the CEO, there’s no corporate
governance code requirement for the chair to be independent, but
there ARE some restrictions on having served as a company
executive in the past 5 years.

The AMF, however, recommends that where the chair is an

independent member, the chair’s situation should be examined
every year.
 CEO AS CHAIR IN FRANCE 3

Commonly, separation of the positions is somewhat correlated to

the size of the business: smaller corporations often consider it
impractical to separate the chair and CEO positions, while the
larger the corporation is, the more likely it is that the positions will
be split.

Despite past common practice separating the positions, a combined

chair/CEO has recently been the trend for CAC 40 companies (a
“return to the PDG”). Combined roles are seen as more flexible and
better able to respond to crisis, so after the 2008 financial crash,
the percentage of CAC 40 companies with one combined leadership
role jumped from 34% to 64% over three years (2008-2011). As of
2018, that figure had dropped back down to 55%.
CEO AS CHAIR IN US
The board determines its own leadership structure in accordance
with the corporation’s charter and by-laws.

Company law leaves it up the corporation to decide whether the

two positions should be combined or separated, and if they ARE
separated, company law also leaves it up to the corporation to
decide whether the chair should be executive or non-executive, or
dependent or independent.
 CEO AS CHAIR IN US 2

There’s an overlay on top of company law : securities law.

SEC rules require public disclosure of which structure the public

company board has chosen, and why that specific structure was used.

In addition, where the positions are combined, the public company

needs to disclose whether the board has a lead independent director,
the reasoning for including or not including a lead independent
director, and the role that any identified lead independent director
plays in the board leadership. On a board whose chair is also CEO,
independent directors ensure that the chair/CEO is properly
scrutinized, just as independent auditing provides proper scrutiny.
 CEO AS CHAIR: SPLITTING IT
When a company runs into trouble, it’s common to question the
leadership structure. When Boeing’s 737 Max jet experienced tragic
crashes, the board first resisted calls to strip chair and CEO Dennis
Muilenburg of the chair role. However, the board ended up asserting its
independence, holding a number of meetings without Mr. Muilenberg.
Ultimately, the roles were separated, and he was removed as chair while
remaining as CEO. (He was later removed as CEO too.)

A similar sequence of events occurred at Danone in 2021. Activist

investors pushed for chair/CEO Emmanuel Faber to not fill both roles. The
context was alleged financial underperfomance from an alleged
overprioritization of non-financial performance. The board first resisted;
then it separate the two roles, keeping Emmanuel Faber as CEO but not
board chair (the replacement chair stressed his duty to serve as a “truly
independent chair”); then the board fired Faber as CEO, too.
INDEPENDENT DIRECTORS: IDEAL
Directors with no affiliation or other relationship with the company,
other being a director, that could affect or be perceived to affect the
director’s ability to exercise objective judgment.

In contrast, dependent directors have some affiliation or relationship that

prevents them from acting objectively; or even if it doesn’t literally
prevent them from acting objectively, the affiliation or relationship
creates a perception of not being able to act objectively .

Independent directors are thought to strengthen corporate governance,

lessening the chance that their own goals will conflict with the
corporation’s goals or unduly influence their judgment.
 INDEPENDENT DIRECTORS:
REALITY
What kind of affiliation or relationship is enough to do undermine independence?

In most places it’s enough to not be an employee or ex-employee of the company, or

otherwise be beholden to the CEO or board chair.

A strict definition of independence would preclude a financial interest in the company. In

such a strict definition, owning company shares, or receiving a salary as an employee, or
receiving fees as a service-providing consultant, or having a close family member in one of
these situations, or possibly even owning shares in a different company that financially
benefits from a relationship with the first company, would be enough to label the director
dependent, insufficiently independent to act objectively. This strict definition is rarely
adopted by law.
INDEPENDENT DIRECTORS: USA
To be independent, a directors cannot hold a management position at
the company, or at its parents or subsidiaries

Former executives are not considered independent for three years after
their departure

There are other standards, too, depending on the source of the rule
(stock exchange listing requirements, SEC regulations, proxy advisory
principles, and the laws of the state of incorporation)

There’s no uniform US rule either defining independence or setting a

minimum number of independent directors
LEAD INDEPENDENT DIRECTOR

A counterweight to a board chair who’s also CEO

Required in some countries when the board chair is also CEO

What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
The role of lawyers in governance
Corporate lawyers are experts in company and business law. They understand the
minute differences between legal entities and how to best utilise them for
different purposes. They also assist companies in various transactions and
business operations. Among other things, corporate lawyers offer guidance in:
• choosing the business structure
• licensing and complying with regulations
• drafting and understanding contracts and legal documents
• protecting intellectual property
• resolving disputes
• debt and bankruptcy
• insurance and finance
-dissolving the business
The role of auditors in governance

The outside independent auditor is engaged to render an opinion on whether a

company’s financial statements are presented fairly, in all material respects, in
accordance with financial reporting framework. The audit provides users such as
lenders and investors with an enhanced degree of confidence in the financial
statements.
To form an opinion, the auditor gathers appropriate and sufficient evidence and
observes, tests, compares and confirms until gaining reasonable assurance. The
auditor then forms an opinion as to whether the financial statements are free of
material misstatement, whether due to fraud or error.
At the completion of the audit, the auditor may also offer objective advice for
improving financial reporting and internal controls to maximize a company’s
performance and efficiency.
The failure of auditors behind the Enron scandal

In the Enron scandal a few decades ago, the company misstated its financial
reality, misleading investors into thinking more highly of the company than the
true financial reality would justify.

The company’s auditors, Arthur Andersen, went along with the misstatements of
financial reality, and also improperly destroyed records.

Arthur Andersen’s consultancy work for Enron, in addition to its auditing of

Enron for the investing public, compromised its judgment in the audit process.
The consulting arm split off just before Arthur Andersen filed for bankruptcy
protection, later dissolving. (The new consulting firm is now known as
Accenture.)
Why did Arthur Andersen risk so much?

Professor Ronald Dye of Northwestern’s Kellogg Business School:

"Andersen's problems arose as a result of its attempt to respond to the revenue

shortfall resulting from its consulting arm splitting from its auditing parent.
Andersen's senior management seems to have revised its partners' compensation
and performance evaluation to encourage them to behave more like salesmen
and less like auditors, resulting in sloppy audits.“
The failure of auditors behind the Wirecard scandal
In the Wirecard scandal a few years ago, the company misstated its financial
reality, misleading investors into thinking more highly of the company than the
true financial reality would justify.

The company’s auditors—Ernst & Young—negligently failed to detect the

misstatements of financial reality for several years. For instance, EY failed to
request crucial account information from Singapore’s OCC Bank to confirm that
it held €1bn in cash on behalf of Wirecard. This is routine audit procedure could
have uncovered the fraud much earlier--basic auditor checks should have been
enough to uncover the scandal.

EY then prompted revelation of the scandal, refusing to certify Wirecard’s

accounts. EY institutionally claimed responsibility for uncovering the fraud, but
EY certified the accounts for more than a decade as Wirecard’s accounting
practices were increasingly questioned by journalists and investors.
EY nearly split up following the Wirecard scandal

See for instance this FT article from January 2023 describing the expected split:
https://www.ft.com/content/78ed7b1e-1c3e-442d-a702-1ea590ec02e6

And this FT article from April 2023 describing the abandonment of the split:
https://www.ft.com/content/e38afa0c-0ab3-452a-820c-9db88e24785d
.
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
Who needs to publish financial reports?

• Under EU and national rules, listed companies (publicly traded

companies, those whose securities are traded on a regulated market)
must prepare their consolidated financial statements in accordance with
a single set of international standards called IFRS (international
financial reporting standards).

• Lesser (even non-existent) financial reporting requirements apply to

non-listed companies and small businesses.
The annual financial report
• The corporate governance framework should ensure that timely and
accurate disclosure is made on all material matters regarding the
corporation, including the financial situation, performance, ownership, and
governance of the company.
• Disclosure also helps improve public understanding of the structure and
activities of enterprises, corporate policies and performance with respect
to environmental and ethical standards, and companies’ relationships with
the communities in which they operate.
• The annual report is a once-a-year publication released by companies
several months after the end of their fiscal year. It includes almost
everything an investor needs to know about the business.
Contents of the annual financial report
Disclosure should include, but not be limited to, material information on:
1. The financial and operating results of the company.
2. Company objectives and non-financial information.
3. Major share ownership, including beneficial owners, and voting rights.
4. Remuneration of members of the board and key executives.
5. Board members, including their qualifications, the selection process, other company
directorships and whether they are regarded as independent by the board.
6. Related party transactions.
7. Foreseeable risk factors.
8. Issues regarding employees and other stakeholders.
9. Governance structures and policies, including the content of any corporate governance code
or policy and the process by which it is implemented
10. Anything that might affect the share price.
Financial reporting must also be performed quarterly
Standards and auditing for financial reporting

• Information should be prepared and disclosed in accordance with high

quality standards of accounting and financial reporting.
• An annual audit should be conducted by an independent, competent and
qualified, auditor in accordance with high-quality auditing standards in order
to provide an external and objective assurance to the board and
shareholders that the financial statements fairly represent the financial
position and performance of the company in all material respects.
• External auditors should be accountable to the shareholders and owe a
duty to the company to exercise due professional care in the conduct of the
audit.
• Channels for disseminating information should provide for equal, timely and
cost-efficient access to relevant information by users: the information must
be released in a manner that benefits all investors equally.
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
Going public

• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
Who needs to report on non-financial performance?

The answer is complex. What follows is an excerpt from an article

that I wrote.
In France, a limited non-financial reporting requirement was first adopted in 2001, apparently Europe’s first such
requirement. A few years later, in 2008, Denmark followed suit, imposing a non-financial reporting requirement on a
limited range of companies. In 2017, France exapnded non-financial reporting significantly to require listed
companies to report on climate-related risks and measures.
In light of the experience in France, Denmark, Germany, and other member states, as well as to provide minimum
requirements throughout the EU, in 2018 the EU imposed its first non-financial reporting requirement on about 6000
exceptional companies. The requirement expanded in 2019 to financial market participants and advisors. As this
article goes to press in 2022, the range of covered EU companies is expected to expand to both all publicly traded EU
companies, and also publicly traded foreign companies with an EU subsidiary that generates at least 150 million euros
in EU-based revenue.
A 2021 proposed directive, known as the corporate sustainability reporting directive (CSRD), would expand the
reporting requirement. A press release on June 21 2022 announced that the European Council and European
Parliament had reached a provisional political agreement on CSRD. It’s reasonable to expect the final directive to be
adopted shortly.
PAUSE IN THE ARTICLE:

CSRD officially entered into force in January 2023.

Member states have 18 months, until mid-2024, to transpose the new
standards into national law.
Also in 2024, the first CSRD reports are due from all organizations that were
already within the pre-existing scope of the Non-Financial Reporting Directive
(nearly 12,000 organizations)
In 2025, CSRD requirements extend to all “large” organizations—firms with a net
turnover of €40 million or more, at least €20 million in assets, and 250+ employees
Beyond that, CSRD requirements will extend to all listed companies, including
listed small and medium-sized enterprises (SMEs) but with the exception of micro-
enterprises
In the USA, in early 2022, the Securities and Exchange Commission published two proposed amendments to various rules
and forms that, if adopted, would impose extensive non-financial reporting requirements on covered companies. In
particular, in March 2022, the SEC published a proposed rule on climate-related disclosures that would require all listed
companies to provide, in their registration statements and annual reports, information about climate-related risks that are
reasonably likely to have a material impact on the company’s business, results of operations, or financial condition, as well as
information about greenhouse gas emissions. This proposed rule would also affect financial reporting, requiring climate-
related financial metrics in a registrant’s audited financial statements. Consistent with US administrative law, the SEC
invited comment on the proposed rule. The comment period, after an initial extension, has now ended, and the SEC is
expected to review the comments and possibly amend the proposed rule before adoption.

A few months later, in May, the SEC published another proposed rule that would require non-financial reporting from
registered investment advisers, certain advisers that are exempt from registration, registered investment companies, and
business development companies.

It’s reasonable to expect that final rules will be adopted soon, imposing extensive non-financial reporting requirements in
the US, too.
End of article excerpt

Also in the US, there’s new California legislation, adopted in October 2023, with two
components, applicable to firms doing business in California:

-SB 253 requires large businesses (with revenues > $1B) that operate in California to
publicly disclose and verify their Scope 1, 2, and 3 greenhouse gas emissions data.
Scope 1 and 2 rules go into effect in 2026. Scope 3 rules start in 2027.

-SB 261 requires large businesses (with revenues > $500M) that operate in California
to publicly disclose their exposure to physical and transition climate risks, and the
measures they’re using to address them. First reports are required before January
2026.
Contents of the non-financial performance report
Disclosure should include, but not be limited to, material information on:
1. environmental protection
2. social responsibility and treatment of employees
3. respect for human rights
4. anti-corruption and bribery
5. diversity on company boards (in terms of age, gender, educational and professional
background)
.
Standards and auditing for non-financial reporting

• Companies subject to the CSRD have to report according to European

Sustainability Reporting Standards (ESRS). The standards are developed
in a draft form by the EFRAG, previously known as the European Financial
Reporting Advisory Group, an independent body bringing together various
different stakeholders.
• The first set of ESRS was published in the Official Journal on 22 December
2023 under the form of a delegated regulation.
What we’ll do today:
• 23 questions about corporate governance
• Actors and models
• Board missions
• Board duties
• Board composition
Going public

• Board leadership
• The role of external advisors in governance
• Reporting requirements for financial performance
• Reporting requirements for non-financial performance
• Going public
What “going public” involves: disclosures
From the previous slides we see that publicly traded companies are subject to
significant disclosure obligations on both financial and non-financial
performance

When a company “goes public” it files a registration statement with the

securities regulators in the country on whose stock exchange the shares will
be publicly traded. That registration statement is a very complete description
of the company and the shares proposed to be traded on the stock exchange.
Registering the securities is a one-time task that occurs before the shares are
listed for trading. In some cases, new accounting practices are needed to
conform to the financial reporting requirements.

After the listing, the company whose shares are now publicly traded needs to
make the quarterly and annual reports of both financial and non-financial
performance that we learned about in the previous slides.
What “going public” involves: shareholder approval

Under the securities laws of most countries and/or the rules of most stock
exchanges, only a corporation can list its shares for trading on a stock
exchange. And in a country with multiple forms of corporation, only specific
types of corporation can list shares. (Example: in France, an SAS is a
corporation but can’t list its shares on a stock exchange.)
If the company seeking to go public needs to change its form to a
corporation, or to the specific type of corporation that can list its shares on a
stock exchange, then the change needs to be approved by shareholders.
In addition, shareholders need to approve the issuance of new shares. If
they haven’t already approved the issuance of the new listed shares to be
issued, then the new issuance needs to be approved by shareholders.
What “going public” involves: marketing the new shares
The shares to be issued will bring capital to the company only if a purchaser is
willing to buy the shares from the company, in a so-called primary market
transaction. (When a shareholder sells on the stock exchange to a substitute
shareholder in a so-called secondary market transaction, the proceeds go to the
selling shareholder, not to the company.)
So the company needs to market the new shares to prospective shareholder-
investors! This is accomplished in several ways:
-A marketing document, typically called a prospectus and typically similar (or even
identical) to the securities registration statement, needs to be prepared and
published.
-A sales pitch needs to be developed, to sell the shares to prospective investors.
-An investment bank verifies the accuracy of the offer materials and promises, in a
so-called underwriting agreement, to buy all the newly issued shares at a specified
price for resale on the stock exchange. The investment bank hopes to resell the
shares at a higher price on the stock exchange, making money on the arbitrage.
Even if that doesn’t happen, the investment bank still earns fees for its role. The
investment bank role is typical but can be dispensed with.
What “going public” involves: complying with other rules
of securities law and the specific stock exchange

Example of an issue: sometimes a founder wishes to have extraordinary voting

power as a shareholder through a special preferential class of shares. (This is
what Mark Zuckerberg did with Facebook / Meta, and today he has only around
15% of the economic rights of shareholders but he has more than 50% of the
voting rights of shareholders.)

Does the law authorize these preferential shares?

Does the specific stock exchange authorize these preferential shares?

What “going public” involves: consultations
In some countries, management needs to have consultations with employee
representatives.

In all countries, large investors may seek to consult with the company issuing
shares as part of their investment due diligence.
What “going public” involves: occasional failure
If there isn’t sufficient demand for the shares at the proposed price, then the
issuance may be suspended.

A wise company seeking to issue shares for public trading will anticipate this
possible failure, and will have a contingency plan, such as issuing shares to a
private investor at a lower price in order to raise the expected equity capital,
along with a press relations strategy.
Case study time!

Carlos Ghosn case, on Blackboard.

Homework for next time

Next session we’ll shift gears to worker relations. Bring an

internship or employment contract that you’ve signed.