The Corporate Governance of Listed Companies:

A Manual for Investors (Reading 41)

Exercise Problems:

1.      Based on best practices in corporate governance procedures, it is most appropriate for a company’s compensation committee to:

A. include a retired executive from the firm.

B. link compensation with long-term objectives.

C. include a representative from the firm’s external auditor.

Ans: B;

B is correct. Under appropriate corporate governance procedures, the compensation committee should link compensation with long-term objectives.

2.      The type of voting in board elections that is most beneficial to shareholders with a small number of shares is best described as:

A. statutory voting.

B. voting by proxy.

C. cumulative voting.

 Ans: C;

Cumulative voting allows shareholders to direct their total voting rights to specific candidates, as opposed to having to allocate their voting rights evenly among all candidates. Thus, applying all of the votes to one candidate provides the opportunity for a higher level of representation on the board than would be allowed under statutory voting.

3.      Which of the following is most likely a sign of a good corporate governance structure?

A. Independent board members comprise a minority proportion on the company’s board.

B. The separation of the chief executive position from the chair position on the company’s board.

C. Independent board members are allowed to meet shareholders only in the presence of the entire board.

Ans: B;

The CEO and board chair should be separated to prevent too much executive power.

4.      An investment fund owns 8 percent of the outstanding voting shares of a public company. There are several larger voting blocks of shares such that the investment fund is not assured of being able to elect representation on the board of directors. Which type of shareholder voting right would be most beneficial in allowing the investment fund to ensure their interests are represented on the board?

A. Proxy

B. Cumulative

C. Confidential

Ans: B;

Cumulative voting enhances the likelihood that minority interests are represented on the board.

5.      Which of the following is least likely a condition present in a “fraud triangle”?

A. Constraining debt covenants.

B. Adding independent members to the Board of Directors.

C. Management’s belief that a decline in performance is due to temporary economic conditions.

Ans: B;

The “fraud triangle” requires incentives (e.g., debt covenants), opportunities, and management’s ability to rationalize (temporary economic conditions). Adding independent members to the Board of Directors should improve corporate governance and hence decrease the opportunity for fraud.

6.      A publicly listed company has a 12-person Board of Directors whose composition is as follows:

·         the Chairman, who is the past president of the company and was named Chairman on his retirement date four years ago, five members of senior management including the current president, and six outside directors.

·         Each member is elected for a two-year term and one-half of the positions stand for election every year. The three members of the Audit Committee are all outside directors and have relevant financial experience.

·      The Remuneration Committee is composed of the Chairman and two outside directors.

Which of the following actions would provide the greatest improvement in the corporate governance of this company?

A. The Chairman of the Board should be an independent director.

B. All members of the Board of Directors should stand for election every year.

C. The company’s Vice-President of Finance should be a member of the audit committee.

Ans: A;

If the chair of the board is a former chief executive of the company, it may hamper efforts to undo the mistakes made by him or her as chief executive. It is not clear if it is better to have all members elected annually (more flexibility to meet changes in the marketplace) or if it is better to have staggered board terms (better continuity of board expertise). All members of the audit committee should be independent members of the board.

7.      Regarding corporate governance, which of the following most likely would be a reason for concern when evaluating an independent board member’s qualifications?

The board member:

A. has served on the board for 14 years.

B. owns 1,000 shares of the corporation’s equity.

C. has formerly served on the boards of several successful companies.

 Ans: A;

Such long-term participation may enhance the individual board member’s knowledge of the company, but it also may cause the board member to develop a cooperative relationship with management that could impair his/her willingness to act in the best interests of shareowners.

8.      Which of the following is least likely to concern an investor evaluating a corporation’s shareowner rights provisions?

A. Shareowners may nominate board members.

B. Shares held by the founding family have supernormal voting rights.

C. To ensure accuracy, company executives tabulate and verify shareowner voting.

Ans: A;

The ability to nominate one or more individuals to the board can prevent erosion of shareowner value. Shareowners may be able to force the board or management to take steps to address shareowner concerns.

9.      Regarding corporate governance, which of the following is most likely a reason for concern when evaluating the compensation committee? The compensation committee:

A. includes members of executive management.

B. purchases shares on the open market to fund stock option commitments.

C. discloses information about compensation paid to executives and board members.

 Ans: A;

The compensation committee should be independent from executive management.

10.  Which of the following is least likely classified as a takeover defense?

A. Greenmail.

B. Cumulative voting.

C. Golden parachutes.

Ans: B;

The ability to use cumulative voting enables shareowners to vote in a manner that enhances the likelihood that their interests are represented on the board. It is a valuable shareowner right.