best practices corporate governance

1. Corporate Governance
Best Practices:
Implications for Commercial Underwriters
Dr. Gail S. Russ
Dr. Meredith Downes
Associate Professors of Management
Illinois State University

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3. Corporate Governance
• Core concern: How do we make sure that
top managers are doing what they’re
supposed to be doing?
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4. The Agency Perspective
• Separation of ownership & control
 Principals & agents
 Misalignment of interests
• What’s good for the managers may not be what is
good for the owners
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5. The Agency Perspective
• The Agency Problem:
 The misalignment of agents & principals’
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).
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6. The Agency Perspective
• The Agency Problem:
 The misalignment of agents & principals’
interests leads to agents (managers) pursuing
strategies that are not in the best interests of the
principals (stockholders).
 Focus is on protecting shareholder rights
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7. The Stakeholder Perspective
• The board has broader responsibilities
 Focus is on protecting key stakeholder rights
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• Shareholders
• Employees
• Vendors
• Customers
• Society as a whole

8. Best Practices
• The board of directors
• Executive compensation
• Anti-takeover measures
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9. The Board of Directors
• Role is to monitor & evaluate top
management
• But, is the board a complete solution?
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10. Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board
 Role duality gives CEO too much power
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11. Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board
 Role duality gives CEO too much power
• Appointment of lead outside director
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12. Best Practices:
Board of Directors
• Separate CEO & Chairman of the Board
 Role duality gives CEO too much power
• Appointment of lead outside director
• Former CEO does not continue to sit on the
board
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13. Best Practices:
Board of Directors
• Active board members
 Not a rubber-stamp board
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14. Best Practices:
Board of Directors
• Active board members
 Not a rubber-stamp board
• Evidence that the directors are in contact
with employees, vendors, & customers
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Best Practices:
Board of Directors
• Active board members
 Not a rubber-stamp board
• Evidence that the directors are in contact with
employees, vendors, & customers
• Board composition
 Size
 Age
 Diversity
 Expertise

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Best Practices:
Board of Directors
• Board composition
 Insiders versus outsiders

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Best Practices:
Board of Directors
• Board composition
 Insiders versus outsiders
 “Having a board monitor itself is like having
the fox watch the henhouse.”

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Best Practices:
Board of Directors
• Board composition
 Insiders versus outsiders
 “Having a board monitor itself is like having
the fox watch the henhouse.”
 The majority should be independent

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Best Practices:
Board of Directors
• Board composition
 Insiders versus outsiders
 “Having a board monitor itself is like having
the fox watch the henhouse.”
 The majority should be independent
 Should have formal resolution requiring this
AND a written definition of independence

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Best Practices:
Board of Directors
• Board composition
 What is meant by “independent”?
• No material relationship with the company, either
directly or as a partner, shareholder or officer of a
firm that has a relationship with the company

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Best Practices:
Board of Directors
• Board composition
 What is meant by “independent”?
• Five year “cooling off” period before can be
considered independent:
– Former employees of the firm
– If formerly part of an interlocking directorate in which an
executive of the firm sat on the compensation committee
of the firm employing the director
– Same applies to directors with immediate family members
in the above categories

22. Best Practices:
Board of Directors
• Board members (insiders & outsiders)
 Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position
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23. Best Practices:
Board of Directors
• Board members (insiders & outsiders)
 Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position
 CEOs should not serve on each other’s boards
(interlocking directorates)
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24. Best Practices:
Board of Directors
• Board members (insiders & outsiders)
 Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position
 CEOs should not serve on each other’s boards
(interlocking directorates)
 Directors & their firms barred from doing
consulting, legal, or other work for the firm
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25. Best Practices:
Board of Directors
• Board members (insiders & outsiders)
 Limits on number of other board memberships
• Average director spends 176 hours a year for each
board position
 CEOs should not serve on each other’s boards
(interlocking directorates)
 Directors & their firms barred from doing
consulting, legal, or other work for the firm
 Significant stock ownership of firm by directors
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Best Practices:
Board of Directors
• Board committees
 Key committees at least chaired by outsiders
• Audit, compensation, corporate governance
(nominating) committees

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Best Practices:
Board of Directors
• Board committees
 Key committees at least chaired by outsiders
• Audit, compensation, corporate governance
(nominating) committees
 Preferred: Key committees composed entirely
of independent directors

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Best Practices:
Board of Directors
• Board committees
 Compensation committee
• Conduct formal evaluation of all company officers
(including CEO) and set compensation

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Best Practices:
Board of Directors
• Board committees
 Corporate governance (nominating) committee
• Create charter for board

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Best Practices:
Board of Directors
• Board committees
 Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant

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Best Practices:
Board of Directors
• Board committees
 Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members

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Best Practices:
Board of Directors
• Board committees
 Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members
• Board term limits

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Best Practices:
Board of Directors
• Board committees
 Corporate governance (nominating) committee
• Create charter for board
• Conduct formal governance review using an
external consultant
• Nominate board members
• Board term limits
• Elections
– One class of directors
– Each director stands for re-election each year

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Best Practices:
Board of Directors
• Board committees
 Audit committee
• Select independent auditor
– Not also employed for consulting work

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Best Practices:
Board of Directors
• Board committees
 Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so

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Best Practices:
Board of Directors
• Board committees
 Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so
• Rotate auditors – at least rotate the lead auditor, if
not the entire firm, every 5 years

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Best Practices:
Board of Directors
• Board committees
 Audit committee
• Select independent auditor
– Not also employed for consulting work
– Do not seek SEC exemption to do so
• Rotate auditors – at least rotate the lead auditor, if
not the entire firm, every 5 years
• CEO & CFO should not be former employees of the
auditing firm

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Best Practices:
Board of Directors
• Board meetings
 Frequency of overall board & committee
meetings

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Best Practices:
Board of Directors
• Board meetings
 Frequency of overall board & committee
meetings
 Attendance

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Best Practices:
Board of Directors
• Board meetings
 Frequency of overall board & committee
meetings
 Attendance
 “Executive” sessions
• Lead outside director with term limit

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Best Practices:
Board of Directors
• Board meetings
 Frequency of overall board & committee
meetings
 Attendance
 “Executive” sessions
• Lead outside director with term limits
 Risk assessment function
• Reports identifying risks & methods of addressing

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Best Practices:
Board of Directors
• Board meetings
 Frequency of overall board & committee
meetings
 Attendance
 “Executive” sessions
• Lead outside director with term limits
 Risk assessment function
• Reports identifying risks & methods of addressing
 Access to internal information

43. Best Practices:
Executive Compensation
• CEO has substantial stock ownership
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44. Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance
 not size of the company
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45. Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance
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46. Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance
• No modification of performance goals
 No re-pricing or swapping stock options
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47. Best Practices:
Executive Compensation
• CEO has substantial stock ownership
• Salary, bonuses, & stock options reward
superior performance
 not size of the company
• AND penalize poor performance
• No modification of performance goals
 No re-pricing or swapping stock options
• Expense stock options
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48. Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover
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 Golden parachutes

49. Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover
 Golden parachutes
 Poison pill provisions
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50. Best Practices:
Anti-takeover measures
• Lack of provisions designed to thwart a
hostile takeover
 Golden parachutes
 Poison pill provisions
 Greenmail
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