Test ID: 7440565
Reading 25/26 Corporate Performance & Governance
Question #1 of 63
Question ID: 462758ᅚ A) ᅞ B) ᅞ C)
Question #2 of 63
Question ID: 472522ᅞ A)
ᅞ B)
ᅚ C)
Questions #3-8 of 63
Entering into a merger that would provide benefits for management, but ultimately would destroy shareholder value is an example of:
strategic policy risk. asset risk.
liability risk.
Explanation
Strategic policy risk is the risk that managers may enter into transactions or incur other business risks that would not be in the best long-term interests of shareholders, but would result in large payoffs for managers or directors.
All of the following are examples of the principal-agent relationship (PAR) problem EXCEPT:
an employee calls in sick to use up their sick time since they cannot carry it over to the next year.
a senior executive routinely leaves the office early claiming to work from home yet there is no accountability.
two members of a board of directors are having an illicit relationship.
Explanation
The PAR problem is generally viewed as being between shareholders (principals) and company executives (agents) but any employee of the firm could be viewed as an agent and therefore contribute to the principal-agent problem if they act in their own best interests to the detriment of the firm. Examples of the PAR problem are:
CEOs enjoying on-the-job consumption in the form of excessive corner offices or lavish travel that is passed off as a necessary business expense.
CEOs manipulating the board of directors for excessive compensation packages which are not linked to company performance.
Executives seeking status by expanding the business (empire building) through acquisitions that do not benefit the existing shareholders. Company size has been strongly linked to executive compensation.
Question #3 of 63
Question ID: 462746ᅞ A) ᅚ B) ᅞ C)
Dane Corser, CFO for Orvis who also serves on the board for Spencer Pharmaceuticals Tricia DeLucia, a granddaughter of Orvis' founder, Michael Orvis
Wendy Kepling, a former Executive Vice President with Orvis
Troy Montgomery, the retired CEO of Forner Capital Management, another asset management firm Mike Shute, President of Spencer Pharmaceuticals
Robert Stuart, an attorney with Bricker and Palmer, Orvis' outside counsel Jason Winterfeld, Chairman and CEO of Orvis
Orvis is a publicly traded firm that specializes in managing equity portfolios for both institutional and individual clients. The firm's investment philosophy is to focus on companies with a history of not changing their dividend payments in order to achieve stable returns. The firm's marketing approach focuses on tax-exempt pension funds and endowments as well as individuals who depend on dividend payments to meet living expenses. Historically, Orvis has been a successful manager, but recently performance has declined relative to the firm's benchmark. The primary focus at this board meeting is defining the long-term strategic objectives for the company and making sure the assets of the company, specifically its proprietary investment process, are being used in the best interests of the firm's shareholders.
Winterfeld states that Item 1 on the Board's agenda is to discuss the impact of dividends on shareholder value. Kepling begins the discussion by questioning whether Orvis' investment process should focus on dividends at all. Kepling states, "According to work by Modigliani and Miller, dividends are irrelevant. If an investor holds a non-dividend paying stock, but wants the benefits of a dividend, all they have to do is sell a portion of the stock to get the cash flow they want. Whether the individual receives a cash dividend or sells a portion of their stock, the combination of the investment in the firm and the cash in hand is the same." Montgomery replies, "I disagree with the theory that dividends are irrelevant. According to work by Gordon and Lintner, dividend payments matter because they are less risky than capital gains. Since investors perceive dividends as being less risky, a firm that starts paying a dividend is likely to see an increase in their P/E ratio."
Kepling is also aware that Modigliani and Miller have done a great deal of work regarding capital structure theory. She asks Corser if Modigiani and Miller's theory on capital structure has any implications for the percentage of debt and equity that Orvis has in its capital structure. Corser replies with two statements:
(1) Since Orvis has to pay taxes on its earnings, according to Modigliani and Miller, the optimal capital structure would be 100% debt.
(2) If bankruptcy costs are included in Modigliani and Miller's capital structure theory, the value of a firm will be maximized when a firm's cost of debt is minimized.
Which of the following questions about board independence is most accurate? Stuart qualifies as an independent director, but Kepling does not. Montgomery qualifies as an independent director, but Stuart does not. Shute qualifies as an independent director, but DeLucia does not.
Explanation
Question #4 of 63
Question ID: 462747interlocking directorships, Shute cannot be classified as an independent director (Corser serves on the board for Spencer Pharmaceuticals, where Shute is the President and Shute serves on the board for Orvis, where Corser is the CFO). (Study Session 8, LOS 25.d)
Question #9 of 63
QuestionID:462737ᅚ A) ᅞ B) ᅞ C)
Question #10 of 63
QuestionID:462740corporations candeduct interest payments whendetermining taxable income, the stockholders will benefit from the use of debt.According to their theory, the optimal capital structure ina world with taxes is 100% debt - Statement 1is correct.
However, if bankruptcy costs are factoredinto theirresults, debt is useful initially forits tax savings to lower the cost ofcapital, but only up to the point where it increases riskand the cost ofdebt and equity starts torise.Ina world with taxes and
bankruptcy costs, the optimal capital structure is the one that minimizes the weightedaverage cost ofoverall capital -not simply the cost ofdebt. (Study Session6, LOS 20.a)
Sunil Reddy is ananalyst for Worldwide Financial Services.Reddy thinks that Worldwide's procedures foranalyzing companies forinclusioninclient portfolios would be more robust ifit includedareview of the company's boardofdirectors. Reddy prepares a list offive items concerning the boardofdirectors that analysts shouldassess:
Item1: Frequency of separate sessions forindependent directors.
Item2: Use ofindependent legal counsel as opposed tocompany in-house
counsel.
Item3: Compositionof the nominatingcommittee. Item4: Compositionof the compensationcommittee.
Item5: Whether the board has staggeredorannual elections.
Which of the items onReddy's list are attributes ofa boardofdirectors that are important forananalyst toassess?
All five items.
Items 2, 3, and4only. Items 1, 3, and5only.
Explanation
All five of the items onReddy's list are important factors that ananalyst shouldreview whenassessinga boardofdirectors.
Ashley Jones is considering joining the boardofdirectors ofDusseauInvestment Management (DIM).Before joining the board, Jones wants tomake sure she fully understands what herresponsibilities would be as a boardmember. Kenley Walker,
administrative assistant toDIM's CEO prepares amemo to Jones detailingresponsibilities of boardmembers.
Responsibility 1: Establish corporate values andgovernance structures to ensure that business is conductedinan
ethical, fair, andprofessional manner.
Responsibility 2: Determine which proxy issues that have receivedamajority of shareholdervotes should be addressed orignored.
Responsibility 3: Hire the company's chief executive officer (CEO), anddetermine the CEO's compensationpackage.
ᅚ A) ᅞ B) ᅞ C)
Question #11 of 63
QuestionID:462734ᅞ A) ᅚ B) ᅞ C)
Question #12 of 63
QuestionID:462725ᅞ A) ᅞ B) ᅚ C)
Question #13 of 63
QuestionID:462719Responsibilities 1 and 3 only.
Responsibilities 1, 2, and3. Responsibility 1only.
Explanation
Directors shouldalways address all proxy issues that have receivedamajority of shareholdervotes.Responsibilities of directors include hiring the firm's CEO anddetermining the CEO's compensation, and establishingcorporate values and governance structures to ensure that business is conductedinan ethical, fair, andprofessional manner.
Aprincipal-agent problemmay exist between:
managers and directors. shareholders anddirectors. regulators anddirectors.
Explanation
Anagency relationship exists whenanindividual (the agent)acts on behalfofanotherindividual (the principal). Such a relationshipcreates the potential foraprincipal-agent problem where the agent may act for his own well beingrather than that
ofaprincipal.The key test of whetheraprincipal-agent problemmay exist is ifone party is responsible foractingin the best
interest of the other. Of the answerchoices given, directors are responsible foractingin the best interests of shareholders.
Which formof business is mostlikelyto have conflictsofinterest betweenmanagersandowners? Sole-proprietorship.
Partnership. Corporation.
Explanation
Corporationsare typically owned by shareholders whoplay norole inday-to-day managementdecisions.Instead, managers are hiredtocontrol anddeploy the assetsofthe company, andsupposedly dosointhe shareholders' bestinterest.This separation betweenownershipandmanagementcreatesthe potential forconflictsofinterest. Note thatinthe case of partnershipsandsole proprietorships, the ownersandmanagersare one inthe same.
ᅞ A) ᅞ B) ᅚ C)
Question #14 of 63
QuestionID:472529ᅞ A) ᅚ B)
ᅞ C)
Question #15 of 63
QuestionID:472519ᅞ A) ᅚ B) ᅞ C)
Question #16 of 63
QuestionID:462716ᅞ A)
Employees. Creditors. Auditors.
Explanation
Corporate governance policiesattemptto eliminate the opportunity formanagementtoplace theirowninterestaheadofother stakeholders, such asshareholders, creditors, directors, employees, andcustomers.
The FriedmanDoctrine can be criticizedfromthe standpointthat:
it does not sufficiently address the long term need of business to be profitable. acompany canfollow all applicable lawsandstill be guilty ofunethical business practices.
itdoesnotdirectly addressadherence tosociety'srules.
Explanation
Milton Friedmanaddressedthe social responsibility of business by statingthat businessshouldmaximize profitability
consistent with law andthe "rulesofthe game." The criticismisthatthismightstill allow unethical behavior. Nike wasprovided asan example offollowingthe law butstill initially engaginginunethical behavior.
An external stakeholder would be an example of which ofthe following? An independent member of the board of directors of the firm. Acustomer who wantsto buy the firm'sproductata lowerprice. Astockholder whoissupplyingriskcapital.
Explanation
Customers would be consideredan external stakeholderalong with suppliers, creditors, unions, andgovernments.Internal stakeholders would be stockholders, employees, managers, andmembersofthe boardofdirectors.
Which ofthe following bestdescribesthe importance ofacorporate governance system? Astrongcorporate governance system:
ᅚ B)
ᅞ C)
Question #17 of 63
QuestionID:462722ᅞ A)
ᅚ B)
ᅞ C)
Question #1
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of 63
QuestionID:462718ᅞ A) ᅚ B) ᅞ C)
Question #1
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QuestionID:472520is essential forcompaniestooperate efficiently, while the lackofan effective corporate governance systemcanthreatenthe very existence ofafirm. maximizesshareholdervalue.
Explanation
Astrongcorporate governance systemis essential forcompaniesandfinancial marketstooperate efficiently, while the lackof strongcorporate governance systemrepresentsamajoroperational riskthatcanthreatenthe very existence ofafirm.A strongcorporate governance systemcannotinitselfmaximize shareholdervalue, butstudies have shownthatthe lackof effective systemcertainly reducesshareholdervalue.
The mainobjectivesofacorporate governance systemare bestdescribedasto:
define the rights of shareholders, and to facilitate fair and equal treatment in dealings between management and other stakeholders.
eliminate orreduce conflictsofinterest, andtouse the company'sassetsinamanner consistent with the stakeholders' bestinterests.
facilitate opencommunication betweenmanagementandstakeholders, andtomost effectively utilize corporate assets.
Explanation
Acorporate governance systemgenerally focusesonthe eliminationorreductionofconflictsofinterest, particularly between managementandshareholders, as well asthe prudentutilizationofcorporate assetsforthe benefitofinvestorsandother stakeholders.
Mostcorporate governance systemsfocusonthe eliminationorreductionofany potential conflictsthatmay arise between managementand:
directors. shareholders. employees.
Explanation
There ispotential formany conflictsofinteresttoarise inacorporation, butmostcorporate governance systemsfocuson those betweenmanagementandshareholders.
ᅚ A)
ᅞ B) ᅞ C)
Question #20 of 63
QuestionID:462756ᅞ A) ᅚ B) ᅞ C)
Question #21 of 63
QuestionID:472525agent uses the information advantage for their own best interests to the detriment of the interests of the principal.
boardofdirectorstake advantage oftheirpositionatthe expense ofthe shareholders. ownersofthe firmgainatthe expense ofthe employees.
Explanation
The principal-agentrelationship (PAR)arises whenone groupdelegatesdecisionmakingorcontrol toanothergroup.The PARcancreate problems because the groupreceivingthe power (the agent)generally hasanasymmetricinformation advantage overthe groupmakingthe delegation (the principal).The PARproblem beginsifthe agentusesthe information advantage fortheirown bestintereststothe detrimentofthe interestsofthe principal.Itiscompoundedasthe asymmetric
informationmakesitdifficultforthe principal toknow enough todetectthe problemand evaluate the agent'sactions. Modern corporationsare builtonshareholders (principals) whodelegate authority torunthe businessto executive officersofthe company (agents).The boardofdirectorsare charged with overseeingthe executivesofthe firm.Itispossible forthe boardof directorstoalignthemselvestooclosely with the executivesofthe firmthuscontributingtothe PARproblem.
DanBerger, ananalystforRomulusCapital ManagementInc. (RCMI), istalking with acolleague, Amy Woods, aboutthe benefitsofincludingcorporate governance assessmentsinthe firm'svaluationmodels.Bergermakesthe following statements:
Statement1: Although the resultsare inconclusive in emergingmarkets, companiesindevelopedcountriesthat have strongcorporate governance systems have providedshareholders with higherreturnsthancompanies with weakgovernance system.
Statement2: A weakcorporate governance systemcancause acompany togo bankrupt.
InregardtoBerger'sstatements, Woodsshould:
agree withbothStatements.
disagree with Statement1, butagree with Statement2. agree with Statement1, butdisagree with Statement2.
Explanation
Woodsshoulddisagree with Statement1.Companies with strongcorporate governance systems have beenshownto have higherprofitability andgenerate higherreturnsthancompanies with weakercorporate governance systemsin both developed and emergingmarkets. Statement2iscorrect-in extreme cases, the lackofan effective corporate governance systemcould leadtoacompany's bankruptcy such asthe case of Enronin2001.
ᅞ A)
ᅚ B) ᅞ C)
Question #22 of 63
QuestionID:462757ᅞ A)
ᅚ B) ᅞ C)
Question #23 of 63
QuestionID:462741an executive of a companywho has never violated any ethical standards at work yet has questionable personal ethics.
managementsettingchallenginggoalsinordertomotivate employees. a businessculture thatfocusesprimarily onrewardingshort-termperformance.
Explanation
Settingchallenging (butnotunrealistic)goalsdoesnotnecessarily leadtounethical behavior butaflawed businessculture where topmanagementsetsunrealisticgoalscan leadto lapsesin ethical behavior. Managementmustcommunicate that ethical behavioris expected.Aculture focusedonly onshort-termprofits withoutaskingrelevant questionsseekingto establish ethical dimensionof businessdecisionmakingisone ofthe rootcausesofunethical behaviorin businesses. Employees (agents) whose personal ethicsare flawedare more likely toviolate business ethics.
Which ofthe followingis NOTariskarisingfrom havinganineffective corporate governance system? Management may enter into off-balance sheet obligations that reduce the value of a company.
Anotherwise profitable company may not have cash on handtopay its bondholders. Managementmay use company assetsforpersonal orinappropriate purposes.
Explanation
Aprofitable company havinginadequate cash topay its bondholdersisan example of liquidity riskand would be aresultof poorfinancial managementratherthanpoorcorporate governance.The primary risksofanineffective corporate governance systeminclude financial disclosure risk, assetrisk, liability risk, andstrategicpolicy risk.
Mike Ransom wasrecently electedtothe boardofdirectorsforTedeschiChemical Corporation (TCC).Ransomknowsthatas a boardmember, he isresponsible forservingonat leastone boardcommittee.Inan efforttounderstandthe board
committee structure, he asks Kelly Williams, who hasservedonthe boardfor7 years, todescribe the structure andpractices ofvariouscommitteesto him. Williamsmakesthe followingstatements:
Statement1: The auditcommittee consistsoffourindependentmembers, one of which hasa backgroundinaccounting andauditing.
Statement2: The auditcommittee hasanannual meeting with auditorsandmanagementtoassessany issues which may arise inthe auditprocess.
Statement3: TCC'sinternal auditorsreportdirectly tothe auditcommittee.
ᅚ A) ᅞ B) ᅞ C)
Question #24 of 63
QuestionID:462735ᅚ A) ᅞ B) ᅞ C)
Question #25 of 63
QuestionID:472527ᅚ A) ᅞ B)
ᅞ C)
Question #26 of 63
QuestionID:462754Statement 3 only. Statements1, 2, and3. Statements2and3only.
Explanation
Statement3isa bestpractice -the internal auditstaffofthe firmshouldreportdirectly tothe auditcommittee.The other statementsare notconsistent with bestpractices. Onthe auditcommittee, twoormore membersshould have relevant financial experience.The auditcommittee should have at leastanannual meeting with auditors, butmanagementshouldNOT be present.
Which ofthe followingscenariosisNOT an example ofaprincipal-agentproblem?
A senior manager also serves as a director on the board of another company. Topmanagementisawarded large amountsof executive stockoptions.
A boardmemberalsoservesasaconsultanttothe company.
Explanation
Aseniormanagermay serve onthe boardofanothercompany so longasthere are noothercircumstancesthatmay compromise objectivity. For example, problemsarise ifthe boardsoftwocompaniesare "interlinked" by way ofmanagersof Company Aservingonthe boardofCompany B, andmanagersofCompany Bservingonthe boardofCompany A.
Which ofthe followingstatementsleastaccuratelydescribesaflaw of Utilitarianism which advocatesproducinginamanner thatresultsinthe most benefittothe largestnumberofindividuals?
This doctrine is not sufficient to be considered a complete philosophy. Producingforthe greatest benefittothe largestnumberofpeople candiscriminate againstasmallersubgroupofindividuals.
Itisdifficulttoaccurately measure costsand benefitstosociety across large numbers ofindividuals.
Explanation
ᅚ A) ᅞ B) ᅞ C)
Question #27 of 63
QuestionID:472518ᅞ A) ᅚ B) ᅞ C)
Question #2
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QuestionID:462723ᅞ A)
ᅞ B)
John Zehetmeier, ananalystfor FolkerCapital Managementis helping hiscolleague, ChrisAugustine, understand elementsof acompany'sstatementofgovernance policiesthat would be helpful inanalyzingacompany. Zehetmeiermakesthe following statements:
Statement1: Acorporate code of ethicsthatconveysthe values, responsibilities, and ethical conductofanorganization should be includedinastatementofgovernance policies.
Statement2: Astatementofdirectoroversightresponsibilities would be the bestplace tofindinformationabout nominationandcompensationawardpolices.
Augustine should:
agree withboth of Zehetmaier's statements. disagree with both of Zehetmeier'sstatements. agree with Statement1, butdisagree with Statement2.
Explanation
Augustine shouldagree with both statements.Acorporate code of ethicsshouldarticulate the values, responsibilities, and ethical conductofanorganizationandshould be includedinastatementofgovernance policies.Also, astatementofdirector's oversight, monitoring, andreview responsibilitiesshouldinclude informationregardinginternal controls, riskmanagement, accountingdisclosure, compliance, nominations, andcompensationawards.
Acompany decidesto expanditsoperationsto enternew markets. Which stakeholder'sinterestis mostlikelyto be adversely served by thisdecision?
Union Creditors Stockholders
Explanation
Expansionintonew marketsis likely toincrease the riskofthe businessand hence wouldadversely affectthe creditorsofthe firm. Ex-ante increase ofrisk wouldnotnegatively affectthe stockholdersor employee unions. Ex-post, actual realizationof negative outcomes wouldadversely affectall stakeholders- butthatisnotthe question here.
Corporate governance isdefinedas:
ᅚ C)
Question #2
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QuestionID:462732ᅞ A)
ᅚ B) ᅞ C)
Question #30 of 63
QuestionID:462730ᅞ A) ᅞ B) ᅚ C)
Question #31 of 63
QuestionID:462728the systemofprinciples, policies, procedures, andclearly definedresponsibilitiesand accountabilitiesused by stakeholderstoovercome conflictsofinterestinherentinthe corporate form.
Explanation
McEnally and Kimdefine corporate governance as "the systemofprinciples, polices, procedures, andclearly defined responsibilitiesandaccountabilitiesused by stakeholderstoovercome conflictsofinterestinthe corporate form."
The principal-agentproblemcan best be describedas:
the agent may act for the wellbeing of the principal rather than that of the stakeholders.
the agentmay actfor hisown well beingratherthanthatofthe principal. the agentmay actforthe well beingofmanagementratherthanthatofthe stakeholders.
Explanation
Inaprincipal-agentrelationship, one party (the agent)actson behalfofanotherparty (the principal).Aprincipal-agent problemarises whenthe agentplaces hisowninterestsaheadofthe principal.
The purpose ofthe boardofdirectorsistoactasanintermediary betweenshareholdersandmanagementtoassure that managementisactinginshareholders' bestinterest. Which ofthe followingis NOTafactorthatmay cause directorstoalign more closely with managersthanshareholders?
Directors receive excessive compensation.
Directorsare employed by financial institutionsthat lendmoney tothe firm. Directorsare responsible forCEO successionplanning.
Explanation
Successionplanningforthe CEO isone ofthe dutiesofthe boardofdirectors, andshouldnotcause directorstoalign with managementovershareholders. Factorsthatcouldcause directorstoalignmore closely with managementinclude:
Lackofindependence (i.e.family relationships, prior employment, or existing businessrelationships). Interlinked boards.
Directorsare overcompensated.
ᅚ A)
ᅞ B)
ᅞ C)
Question #32 of 63
QuestionID:462755ᅚ A) ᅞ B) ᅞ C)
Question #33 of 63
QuestionID:462715ᅞ A)
ᅞ B)
ᅚ C)
The potentiallegalliability for the owner of a sole proprietorship is limited to the market value of the business.
Inasole proprietorship, there isno legal distinction betweenthe businessandits owners.
Akey benefitofthe corporate formof businessisthe ease intransferringownership.
Explanation
Inasole proprietorship, there isno legal distinction betweenthe businessanditsowner.Inthe eventof lossesor bankruptcy, creditorscouldtheoretically goafterthe owner'spersonal assets, resultinginunlimited liability.
Which ofthe followingleastaccuratelydescribesone ofthe nontraditional "ESG" businessfactorsthatmay be critical toa company's long-termsustainability?
security risk exposures governance risk exposures environmental risk exposures
Explanation
Environmental, social, andgovernance ("ESG")risk exposuresare the nontraditional businessfactorsthatare now recognized ascritical toacompany's long-termsustainability.
Which ofthe followingstatementsregarding effective corporate governance systemsisleastaccurate? A corporate governance system must be continuously monitored because of
changes in management and the board of directors.
The primary responsibilitiesofacorporate boardofdirectorsare toinstitute corporate valuesand establish long-termstrategicobjectivesthatare inthe bestinterestsof shareholders.
Acomprehensive listofcorporate governance bestpracticescan be applied effectively toany corporation worldwide tostrengthenthe company'scorporate governance structure.
Explanation
Question #34 of 63
QuestionID:462738ᅞ A) ᅞ B) ᅚ C)
Question #35 of 63
QuestionID:462726ᅞ A)
ᅞ B)
ᅚ C)
Question #36 of 63
QuestionID:462743ᅚ A)
Which ofthe followingstatementsconcerningthe auditcommittee ofthe boardofdirectorsisleastaccurate? The audit committee:
should consist entirely of independent board members. shoulddirectly oversee the internal auditstaffofthe company.
shouldnot have any dialogue with managementinorderto ensure thatthe committee'sactionsare independentofmanagementactivities.
Explanation
The auditcommittee should have full accesstoandthe cooperationofmanagementinordertoperformtheirduties.
Michael Tormey andAmy Arnettare the foundingpartnersof McMillanCorporate Services. Foundingthe business was relatively straightforwardandoverthe last20 years, the expertise provided by Tormey andArnett have beenkey tomaking McMillanasuccess. Every Friday afternoon, Tormey andArnettmeettodiscussthe statusofthe business, and have decided todevote this week'smeetingtostrategicalternatives.Tormey believesthat while the partnershipstructure hasserved McMillan well duringits history, itmay be time toreformthe businessintoacorporate structure.Arnett, however, isnotso sure. Which ofthe followingarguments would be most effective toconvince Arnettthatacorporate structure would be beneficial for McMillan? The corporate structure would:
create a legal separation between the owners and the business, allow for fewer conflicts of interest, and reduce the liability that they as owners would incur. allow for easiertransitionofownership, reduce legal requirementsassociated with runningthe business, andcreate a legal separation betweenthe ownersandthe business.
provide more opportunitiesforraisingcapital, allow for easiertransitionofownership, andreduce the liability thatthey asowners wouldincur.
Explanation
Apartnershipallowstwoormore people tostarta business with few legal requirements.Disadvantagesofthe partnership structure include a limitedability toraise capital, unlimited liability forowners, andnon-transferability ofownership.A
corporationisadistinct legal entity that hasrightssimilartoaperson.Comparedtoapartnership, acorporation hasanearly unlimitedability toraise capital, ownershipis easily transferable, andthe legal separation betweenthe businessanditsowners limitsthe liability ofthe businessowners.Disadvantagestothe corporate forminclude increase legal andregulatory
requirementsandincreasedconflictsofinterestasaresultofthe separation betweenownersandmanagersofthe business.
Which ofthe followingisleastconsistent with corporate governance bestpractice?
ᅞ B)
ᅞ C)
Question #37 of 63
QuestionID:462753ᅞ A) ᅚ B) ᅞ C)
Question #3
8
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QuestionID:472526ᅚ A) ᅞ B) ᅞ C)
The CEO andChairmanofthe boardare separate positions held by separate individuals.
Boardmembersconductaself-assessmentonanannual basis.
Explanation
Directorsshould have accesstoindependent, notin-house legal counsel forany questionsrelatedtothe company's
compliance with regulatory requirements.Both remainingstatementsare all consideredcorporate governance bestpractices.
Jon Fisherisa junioranalystfor FolkerCapital Management. JimRussell, DirectorofResearch hasasked Fishertoprepare a listofitemsthatmay be includedinacompany'sstatementofgovernance practicesthat would helpassesscompany
governance policiesconcerningthe operationofthe boardofdirectors. Fisher's listincludesthe followingitems: Item1: Boardandcommittee self-assessmentreports.
Item2: Statementofthe responsibilitiesdirectors have toreview andoversee management.
Item3: Reportsoffindingsindirectors' oversightandreview ofmanagement.
Item4: Statementdetailing how directorsare trained before they jointhe board.
Which itemsshouldanalystsinclude inordertounderstandacompany'scorporate governance practicesasthey relate tothe boardofdirectors?
Items 1 and 3 only.
All 4itemsshould be included. Item1only.
Explanation
All ofthe itemsonthe listare elementsofacompany'sstatementofcorporate governance policiesthatshould be assessed by investorsandanalysts.
Amanagermakesadifficultdecisionnotknowingall the ramificationsofthatdecisionotherthanfinancial and economic benefits will accrue tosociety andthe firm.The managerreasonsthatthe decision has benefitsforsome ofthe poorest countries.Thisisan example of:
the veil of ignorance and the differencing theory. rightsand justice theories.
acombinationofthe Friedmandoctrine andutilitarianism.
Question #3
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QuestionID:462720ᅚ A)
ᅞ B)
ᅞ C)
Question #40 of 63
QuestionID:472524Rights theoryarguesthatall individuals have fundamental rightsandprivileges. Evenifanactionsuch assweatshop laboris legal, itmay violate fundamental rightsand be unethical.
Justice theoryfocusesona justdistributionof economicoutput. Undera "veil ofignorance" managers lackingall the necessary informationare charged with making ethical decisionsrequiringdifficulttradeoffs.Thistheory is basedonthe premise thatas longasthere are gainstoall partiesinvolvedthisisa legitimate way ofmaking ethical decisions. Justice theory recognizesunequal divisionsof wealth andincome may be acceptable underthe differencingprincipal, which holdsthe unequal divisionmust benefitthe leastadvantagedmembersofsociety.
MiltonFriedman addressedthe social responsibility of business which touchesonthe issue of business ethics by statingthat
as longasthe business hasfollowedall applicable lawsthenit hasmetitsobligationtothe employee.
Utilitarianism arguesthat businessesmust weigh the consequencestosociety of each oftheiractionsandseektoproduce the highestgoodforthe largestnumberofpeople.
Kantian ethics arguesthatpeople are differentfromotherfactorsofproduction, they are more than justan economicinput
anddeserve dignity andrespect.
Mitchell Cash isacorporate governance consultantfor Yostand Karl Consulting.Inapresentationtoaprospective new client, Cash statesthatan effective corporate governance system will:
Provide forfairand equitable treatmentinall dealings betweenmanagers, directors, andshareholders.
Have complete transparency andaccuracy inall disclosuresregardingoperations, performance, risk, andfinancial systems.
Which ofthe followingisacore attribute of effective corporate governance systemsthatCash leftoutof hispresentation?
Clearly defined manager and director governance responsibilities to stakeholders.
Chiefofficersofacorporationare legally authorizedto enterintocontractson behalf
ofthe business.
Legal andregulatory requirementsare complied with fully andinatimely fashion.
Explanation
All effective corporate governance systemsshare the followingattributes: Define the rightsofshareholdersandotherimportantstakeholders.
Clearly identify manageranddirectorgovernance responsibilitiestostakeholders.
Provide clearandmeasurable accountability formanagersanddirectorsinassumingtheirresponsibilities. Provide forfairand equitable treatmentinall dealings betweenmanagers, directors, andshareholders.
Have complete transparency andaccuracy indisclosuresregardingoperations, performance, risk, andfinancial position.
ᅞ A)
ᅞ B)
ᅚ C)
Questions #41-46 of 63
Question #41 of 63
QuestionID:462761ᅞ A)
ᅞ B)
ᅚ C)
Lapses in ethicalbehavior bybusinesses maybe due to failure to ask relevant questions.
Aperson with strongsense ofpersonal ethicsis likely to behave ethically ina business setting.
Business ethicsiscompletely separate frompersonal ethics.
Explanation
Business ethicsisnotdivorcedfrompersonal ethicsand hence persons with strongsense ofpersonal ethicsare unlikely to behave unethically in businesssettings. Notaskingrelevant questionremovesany considerationof ethical dimensionin businessdecisionmaking.
Samantha Zillner, CFAis evaluatingcorporate governance issuesatPeabody SystemsInc.Recently, Peabody has been
undermarketscrutiny asthe firm hasannouncedrestatementsoffinancial statementsforthe pastthree years.Additionally, the ChairmanandCEO hasresignedamidallegationsofimproperself-dealingsandthe company isunderreview by the SEC. Zillnernotesthat:
i. Corporate governance systems will vary accordingtothe legal environment, culture andindustry in which the firm operates; however, there are core attributesthatall effective corporate governance systemsshare.
ii. The BoardofDirectorsofacorporationisanimportantdeterminantofthe effectivenessofcorporate governance systemsactingasacheckand balance betweenmanagementandshareholders.Itisanecessary taskforthe analyst toassessthe effectivenessofthe Board.
iii. One ofthe key objectivesofgoodcorporate governance istotry andavoidthe potential conflictsofinterestthatcan
occuramongstthe variousstakeholdersofthe business.
iv. There are three major businessforms, Sole Traders, PartnershipsandCorporations. Each ofthese three business structuresisthoughttosuffertosome degree frompotential conflictsofinterestamongststakeholders.
v. The strength and effectivenessofacorporate governance system hasadirectimpactonthe value ofa business.A
numberofstudies have beenundertakentoassessthe impact.
vi. The existence ofa weakorineffective corporate governance systemincreasesthe risktothe investor.Thisincreased risk will reduce the value ofthe company andin extreme casesdeficientcorporate governance cancause acompany togo bankrupt.
Which ofthe followingisleastlikelyto be acore attribute ofan effective corporate governance system? Effective corporate governance systems:
define and communicate to stakeholders the oversight responsibilities of managers and directors.
provide forfairand equitable treatmentinall dealings betweenmanagers, directors
andshareholders.
Question #42 of 63
QuestionID:462762ᅞ A) ᅚ B)
ᅞ C)
Question #43 of 63
QuestionID:462763ᅞ A) ᅚ B)
ᅞ C)
Question #44 of 63
QuestionID:462764ᅞ A)
ᅞ B) Explanation
This wouldnot be acore attribute ofthe corporate governance system-thisisrathersomethingforthe seniormanagementof
the businesstodecide upon, with helpandinputfromthe board. (Study Session 9, LOS 28.a)
Which ofthe followingstatements would be evidence ofacorporationthat hadnotadoptedglobal bestpractice with regardsto the BoardofDirectors?
Has not adopted staggered elections for appointment to the Board of Directors. ABoardthat hasanumberofindependentmembers whoserve onseveral other
Boards, inorderto bringavariety of business experience tothe Corporation. The compositionofthe Boardismade upof75% ofmembers whoare independent.
Explanation
Bestpractice recommendsthatBoard Membersshouldnotserve onmore thantwoorthree boards. Staggered boardsare not
recommendedasthey limitthe ability ofshareholderstoalterthe compositionofthe board quickly. (Study Session 9, LOS 28.d,e)
Lookingatthe relationship betweenDirectorsand Shareholders, which ofthe following wouldleastlikely be regardedasa
significantpotential conflictofinterestforthose Directors with non-operational responsibilities?
Interlinked Boards.
Growingthe size ofthe businesstoreceive increased job security, powerand compensation.
Directorsreceiving high levelsofcompensation.
Explanation
This wouldnormally be aconflictofinterestthat would be associated with amanagerofthe businessnotaBoard Member with non-executive responsibilities.
(Study Session 9, LOS 28.c)
Which ofthe followingstatementsinrespectofthese three typesof businessisleastlikelyto be correct?
Partnerships solve their internal conflicts of interest with the existence of partnership agreements that clearly spell out the roles and responsibilities of partners.
ᅚ C)
Question #45 of 63
QuestionID:462765ᅚ A)
ᅞ B)
ᅞ C)
Question #46 of 63
QuestionID:462766ᅚ A)
ᅞ B)
ᅞ C)
Question #47 of 63
QuestionID:472521Since stockholdersinacorporation have limited liability andcanonly lose the amount
investedandnomore, corporationsface little ornoconflictofinterest.
Explanation
Corporate shareholders have limited liability butthisdoesnotpreclude the existence ofaconflictofinterest betweenthe shareholdersandthe managementand/ordirectors.
(Study Session 9, LOS 28.b)
Which ofthe followingstatementisleastlikelyto be correct with respecttothe findingsofstudies evaluatingthe impactof corporate governance onfirmvalue?
Portfolios of companies with strong shareholder rights protections were found to outperform companies withweaker protections by 25% per annum.
The bestgovernedcompaniesgenerate anROE that exceedspoorly governedfirms by 23.8%.
US andInternational Companies with strongcorporate governance have beenshown
to have highermeasuresofprofitability andgenerate higherreturnstoshareholders.
Explanation
Aslightly excessive claim-the study only foundthe excessto be 8.5%.The otherstatementsare all correct. (Study Session 9, LOS 28. h)
Which ofthe followingisleastlikelythe descriptionofone ofthe risksofpoorcorporate governance?
The directors of the firm invest in assets that are inherently risky and therefore cause volatility in the earnings stream of the business. This is asset risk. Informationthatinvestorsuse tomake investmentdecisionsaboutthe company is
incomplete, misleadingormaterially misstated.Thisisfinancial disclosure risk. Managementmay enterintotransactionsthatmay not be inthe bestinterestof
shareholders but will provide benefitstomanagers.Thisisstrategicpolicy risk.
Explanation
Assetriskarises whenmanagersanddirectorsuse company assetsinappropriately. Examples wouldinclude paying excess
compensationandperks. (Study Session 9, LOS 28.h)
ᅞ A) ᅞ B) ᅚ C)
Question #4
8
of 63
QuestionID:472523ᅚ A) ᅞ B) ᅞ C)
Question #4
9
of 63
QuestionID:462731ᅞ A) ᅞ B) ᅚ C)
Question #50 of 63
QuestionID:462717Alter the behavior of executives through goal setting. Fire employees whomisbehave.
Increase the asymmetry ofinformation betweenthe ownersofthe firmandthe employees.
Explanation
Decreasingthe asymmetry ofinformation betweenthe ownersofthe firm (principals)and executives (agents) would helpto
control the principal-agentrelationship (PAR)problem.The PARproblemarisesfromthe agents (executives/ employees) havingmore informationaboutthe company thanthe principals (owners/shareholders)andmisusingthatinformationtothe advantage ofthe agentsatthe expense ofthe firmorprincipals.The othertwoanswerchoicesare methodsforreducingthe PARproblem by affectingthe behaviorofagents by settinggoalsandprinciplesof behaviorandremovingagents who misbehave andviolate ethics.
Which ofthe followingchoicesis NOTarootcause ofunethical behavior?
Maximizing profits.
Flawedorganizational culture. Pressure tomeetunrealisticgoals.
Explanation
The rootcausesofunethical behaviorincludes: Flawedpersonal ethics, failure tosee an ethical dimensionin business decisions, flawedorganizational culture, pressure fromtopmanagementtomeetunrealisticgoals, andunethical leadership.
Corporate governance systemsare primarily concerned with potential principal-agentproblems between: managers and creditors.
managersanddirectors. directorsandshareholders.
Explanation
Corporate governance systemsattempttominimize or eliminate any potential agentproblemsthatmay arise betweentwo
groups: (1)directorsandshareholdersand (2)managersandshareholders.
Chen Michibaisan Executive Vice President with the SakaiCorporation. Michibaisconcernedthat Sakaidoesnot have an effective corporate governance systeminplace anddraftsamemotothe company'sseniormanagementteamdetailinga
ᅞ A) ᅚ B) ᅞ C)
Question #51 of 63
QuestionID:462724ᅞ A) ᅞ B) ᅚ C)
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e
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1:
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Michibais:
correct with respect to bothObjectives. incorrect with respectto both Objectives.
correct with respectto Objective 1, butincorrect with respectto Objective 2.
Explanation
Although Michiba liststwoadmirable goalsandactionsthatshould be performed by afirm's boardofdirectors, neitheritemis one ofthe twokey objectivesofacorporate governance system.The twokey objectivesofacorporate governance system: (1) Eliminate orreduce conflictsofinterest (particularly those betweenmanagersandshareholders), and (2) Ensure thatthe assetsofacompany are used efficiently andproductively andinthe bestinterestsofitsinvestorsandotherstakeholders.
Inapresentationtoagroupofstudentsinan Executive MBAclass, Professor StevenDawestellsthe classthatcorporate governance systems will tendtodiffer basedonthe legal environment, culture anindustry in which afirmoperates, however, all corporate governance systemsshare certaincommonattributes.Dawescontinuesontomake twostatements:
Statement1: All corporate governance systems will define the rightsofshareholdersandotherimportantstakeholders.
Statement2: All corporate governance systemsshould be implemented by individuals with nopotential conflictsof
interest with company managementorshareholders.
Which ofDawes' statementsare consistent with the core attributesofan effective corporate governance system?
BothStatement 1 and Statement 2 are consistent. Statement1isinconsistent, but Statement2isconsistent. Statement1isconsistent, Statement2isinconsistent.
Explanation
All effective corporate governance systemsshare the followingattributes: Define the rightsofshareholdersandotherimportantstakeholders.
Clearly identify manageranddirectorgovernance responsibilitiestostakeholders.
Provide clearandmeasurable accountability formanagersanddirectorsinassumingtheirresponsibilities. Provide forfairand equitable treatmentinall dealings betweenmanagers, directors, andshareholders.
Question #52 of 63
QuestionID:462759ᅞ A)
ᅚ B) ᅞ C)
Question #53 of 63
QuestionID:462733ᅞ A) ᅞ B) ᅚ C)
Dawes' firststatementisconsistent with these attributes; however, hissecondstatementisnot.
Studiessupportthe conclusionthatcompanies with effective corporate governance systems have beenshownto have higher
measuresofprofitability andgenerate higherreturnsthancompanies with weakcorporate governance systems. Which ofthe followingisthe mostcritical activity thatananalystcan engage intoassessthe strength ofacorporate governance systemat
afirm?
Determine whether a corporate code of ethics and statement of governance policies is easily accessible for investors and stakeholders.
Evaluate the quality and quantity offinancial informationprovidedtoinvestors. Note whetherfinancial transactions betweenacompany anditsseniormanagement
are approved by the boardofdirectors.
Explanation
Overthe lastfew years, mostofthe majorcorporate scandals (i.e. Enron, Worldcom) have involvedattemptsto hide orfalsify financial informationprovidedtoinvestors. Since investorsrely oninformationprovided by managementtomake investment decisions, havingmisinformationcanresultinthe mispricingofsecurities, misallocationofcapital, andultimately a lackof
confidence thatcanreduce the efficiency and effectivenessoffinancial markets.Asaresult, one ofthe mostcritical rolesan analystcanplay inthe corporate governance processisto evaluate the quantity (more is better)and quality offinancial data
thatcompaniesprovide.
Kimi HatcherisaconsultantforDrusonCorporate Consultants. Hatcherrecently evaluatedthe managementteamatBurnett TelevisionProductionsand wrote areportof herobservations.
Observation1: Over65% ofseniormanagementcompensationisinthe formof executive stockoptions. Managementtends toaggressively take onrisky projectsthat will generate large profitsifthe projectssucceed.
Observation2: Managementfrequently usesretainedprofitstopurchase potential competitorsas well as business unrelatedtotelevisionproductioninan efforttodiversify theirrevenue base.
Observation3: Managementmakesapractice ofsettingaside provisionsfor losscontingencies.
ABurnettshareholderthatisreadingthe reportisparticularly concernedabout waysthatmanagementmay actfortheirown bestinterestsratherthanthose ofshareholders. Which ofobservationsin Hatcher'sreportshouldalarmthe shareholder?
Observation 1 only. All ofthe observations. Observations1and2only.
Explanation
Question #54 of 63
QuestionID:462736ᅞ A) ᅚ B) ᅞ C)
Question #55 of 63
QuestionID:462729generate huge payoffsforthe managersifsuccessful, butcostthe managersnothingifthey donot. Note thatsettingaside provisionsfor losscontingenciesisconsideredaconservative accountingpractice.
Jill Tangemanand Lawrence Winkelmanare shareholdersfor Hilliard ElectricComponents, Inc. (HECI).Tangemanand Winkelmanare concernedaboutpotential conflictsofinterestthatmay affectthemasshareholdersof HECIanddecide to drafta lettertovarious HECIdecisionmakerstoaskthem whatthey are doingto eliminate orreduce potential conflictsof
interest.
The basicpremise ofTangemanand Winkelman's letteristhatcorporate governance systemsshouldfocusontwopotential areas where decisionmakersmay notactinshareholders bestinterests:conflicts betweenmanagersandshareholders, and
conflicts betweendirectorsandshareholders.
Winkelmanstatesinthe letterthan he isconcernedabout executive compensation. "Havingtoomuch executive wealth concentratedin employee stockoptionscan leadtomanagersavoidingpotentially risky projectsthat wouldactually maximize wealth forshareholders." Tangemanadds herowncomment: "The primary responsibility ofthe boardofdirectorsistoassure thatshareholders' interestsare balanced with those ofmanagement whennegotiatingonissuessuch ascompensation." Whenthe letteriscomplete, both signitasshareholdersinthe company andmail out12copies.
The assertionmade by Tangemanand Winkelmanaboutthe focusofcorporate governance systemsis:
invalid, and only Tangeman makes a correct statement in the letter.
valid, andneither WinkelmanorTangemanmake acorrectstatementinthe letter. valid, andonly Winkelmanmakesacorrectstatementinthe letter.
Explanation
The assertionmade by Tangemanand Winkelmanisvalid-one ofthe twomainobjectivesofcorporate governance isto eliminate orreduce conflictsofinterest.The twoprimary areasforpotential conflictsofinterestinacorporationare conflicts betweenshareholdersandmanagementandconflicts betweendirectorsandshareholders.
Winkelman'sstatementisincorrect. Executive compensationinthe formof large amountsofstockoptionscancause
managerstotake ontoomuch riskasthe asymmetricpayoffofthose optionsmeansthatmanagerscanreap huge rewardsif the riskspay off, but will notshare inthe lossesifthe risky projectsfail. Note thatmanagerstakingtoo little riskisalsoa concern, buttakingtoo little riskisasymptomofmanagers holdingtoomuch stock-notstockoptions.Ifthe manager hasthe bulkoftheir wealth tiedtocompany stock, the managermay wanttoavoidrisky projectstoprotectthe value ofthe stock even
though the risky projectsmay doa better job ofmaximizingvalue forthe firm'sshareholders.
Tangeman'sstatementisincorrectintworespects.The mostimportantrolesforthe boardofdirectorsistoinstitute long-term strategicobjectivesforthe company andinstitute corporate valuesthat will insure that businessisconductedinan ethical and fairmanner.Also-the boardshouldnot "balance shareholderandmanagementneeds" whennegotiating with managementin areassuch ascompensation.The boardneedstodetermine managementcompensation with shareholders' bestinterestas theirsole consideration.
ᅚ A) ᅞ B) ᅞ C)
Question #56 of 63
QuestionID:462744ᅚ A)
ᅞ B)
ᅞ C)
Question #57 of 63
QuestionID:462739ᅞ A) ᅞ B)
ᅚ C)
businessformsisleastaccurate?
Corporations are easily formed with fewlegal requirements. Acorporation has easieraccesstocapital markets.
Itisunnecessary foranownerofacorporationto have knowledge or expertise inthe industry in which a businessoperates.
Explanation
Advantagestothe corporate formof businessinclude the ease ofraisingcapital, the ease ofthe transferability ofstock ownership, andthe lackof expertise needed by ownersofacorporationsince managerscontrol the business' assets.A disadvantage ofcorporationsisthe factthatsince corporations have many non-managerowners, they are subjecttoagreat deal of legal requirementsandregulations.
Which ofthe followingis mostconsistent with corporate governance bestpractice?
Any related-party transactions must be approved in advance by the board of directors.
Electionsare staggered with at least3directorsupforreelectiontothe board each year.
Halfofthe boardmembersare independent.
Explanation
Any insiderorrelated-party transactions, such asmakingapersonal loantoacompany CEO should be approvedinadvance by the boardofdirectors. Note thatforpurposesofthe exam, global bestpractice callsfor75% of boardmembersto be independent, boardmembersdonotserve onmore than2-3 boardstotal, andthatall directorsare electedannually.
All ofthe followingare responsibilitiesofthe boardofdirectorsforacorporation EXCEPT: ensure newboard members are adequately trained to perform board functions. ensure thatmanagement hassuppliedthe board with sufficientinformationto be fully informedandmake appropriate decisions.
make disclosuresregardingcompany operations, risk, andfinancial positionthatare accurate andtransparent.
Explanation
Actually makingdisclosuresaboutcompany operationsisthe responsibility ofmanagement.Itisthe responsibility ofthe board tomake sure managementisactinginthe bestinterestsofshareholders, which may entail appointing/servingonthe audit
Question #5
8
of 63
QuestionID:472517ᅚ A) ᅞ B) ᅞ C)
Question #5
9
of 63
QuestionID:462727ᅞ A) ᅚ B) ᅞ C)
Question #60 of 63
QuestionID:472528ᅚ A) ᅞ B) ᅞ C)
Which ofthe followingchoicesis least likely to be aninternal stakeholder?
Suppliers. Stockholders. Employees.
Explanation
Employees, managers, stock holdersand boardmembersare key internal stakeholders. Suppliersare external stakeholders.
Mitchell Cash of Yostand Karl Consultingiscomparingandcontrastingsole proprietorships, partnerships, andcorporationsfor anew clientthatis lookingtostarta business.Cash makesthe followingstatementstothe client:
Statement1: Sole proprietorships have potentially unlimited liability, butthe liability foracorporate owneris limitedtothe amountoftheirinvestment.
Statement2: Sole proprietorshipsandpartnerships have fewercorporate governance risksthancorporations.
Statement3: Inmostcases, there isno legal distinction betweenthe ownerandthe business withinasole-proprietor
structure.
RegardingCash'sstatements:
Statements 2 and 3 are incorrect,but Statement 1 is correct. all three statementsare correct.
Statements1and3are correct, but Statement2isincorrect.
Explanation
Cash iscorrect with respecttoall three statements.
Which ofthe followingtheoriesrelatedto ethical decisionmakingandthe social responsibility of businessconcludesthat people are more than justan economicinputandthusdeserve more weightandrespect?
Kantian Ethics. The FriedmanDoctrine. Utilitarianism.
Explanation
Question #61 of 63
QuestionID:462752ᅚ A) ᅞ B)
ᅞ C)
Question #62 of 63
QuestionID:462742deserve more dignity andrespect.The FriedmanDoctrine isalmost justthe opposite;itstatesthatthe only social responsibility of businessesistoincrease profits withinthe confinesofadheringtoapplicable laws. Utilitarianismargues businessesmust weigh the consequencestosociety of each oftheiractionsandseektoproduce the highestgoodforthe largestnumberof people.
Which ofthe following would be the mosteffectivemeansforamanufacturingfirmtocommunicate itscorporate governance
policiestoshareholders?
Provide access to internal management performance assessment reports.
Adoptastatementofgovernance policiesthatisprovided by the North American Associationof Manufacturers.
Include astatementonthe company website thatthe company iscommittedtoglobal
corporate governance bestpractices.
Explanation
Managementperformance assessmentsas well asreportsofdirector'soversightandreview ofmanagementare animportant
elementofastatementofgovernance policiesthatinvestorsandanalystsshouldassess. Note thatastatementofgovernance
practicesshould be company specific (nota boilerplate statement)andthatitshould be detailed-simply tellinginvestorsthat the company iscommittedto bestpracticesisinsufficient.
McCool andCompany isaconsultingfirmthatprovidesresearch reportsoncorporate governance at large corporationsand
whethercorporate governance systemsare consistent with global bestpractices. McCool recently completedan evaluationof ARCIndustriesand listedthe followingobservations:
2ofthe 10directorsforARCIndustriesare former employeesand4ofthe 10 have large personal stock holdingsinthe
company.
The Chief Executive OfficerforARC hasregularmeetings with the Chairmanofthe Board.
Each boardmemberisupforreelectiontothe boardonanannual basis.
The nominatingcommittee consistsof3independentdirectorsandthe CEO ofARCIndustries. The compensationcommittee consistsof5independentdirectors.
ARC hasarequirementthatall boardmembersservingonthe auditcommittee must be independentandmust have a
backgroundinfinance oraccounting.
McCool andCompany gives each company they evaluate ascore basedon how many ofthe followingfouritemsare
consistent with global bestpractice:
It
e
m
1:
Board
Ind
e
p
e
nd
e
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.
It
e
m
2:
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e
m
3:
M
ak
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up
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e
nominating
committ
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.
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m
4:
M
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up
of
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committ
ee
.
ᅞ A) ᅚ B) ᅞ C)
Question #63 of 63
QuestionID:462721ᅞ A)
ᅚ B) ᅞ C)
50%.
75%. 25%.
Explanation
Basedonthe observations, ARCIndustriesisinaccordance with global corporate governance bestpractices with respectto3 ofthe 4items, resultinginascore of75%.
With respecttoBoardindependence, global bestpractice statesthat75% ofthe directorsshould be independent. McCool
observesthat2ofthe 10directorsare former employees, butassumingnootherconflicts, this wouldstill resultin 80% ofthe board beingindependent. Note thatpersonal stock holdingsamong boardmembersshould be encouragedasitputsthe boardmembersinthe same positionasinvestorsandcan helpalign boardmemberandinvestorinterests.
Global corporate governance bestpractice supportsannual electionsof each boardmemberratherthanstaggered elections
-basedonthe observations, ARCisconsistent with thispractice.
The nominatingcommittee should be made up entirely ofindependentdirectors. Havingthe company CEO onthiscommittee
meansthatARCisnotconsistent with corporate governance bestpractice with respecttothisitem.
The auditcommittee should be made up entirely ofindependentdirectorsandat leasttwomembersofthe committee should
have relevantaccountingorauditing experience.Itappearsfromthe observationsthatARCreceivedapositive score fortheir requirementsforservingonthe auditcommittee.
All ofthe followingare attributesofan effective corporate governance system EXCEPT:
provide for fair and equitable treatment in all dealings between managers,
directors, and shareholders.
executive compensationisnot excessive incomparison with otherindustry firms.
have complete transparency andaccuracy indisclosuresregardingoperations,
performance, risk, andfinancial position.
Explanation
