300
C H A P T E R 2 0
Directors, Officers, and Controlling Shareholders
TRUE-FALSE QUESTIONS
1. The Securities and Exchange Commission recognizes the affirmative responsibility of officers and
directors under federal securities laws to ensure the accuracy and completeness of public company
filings with the SEC.
2. To comply with their duty of loyalty, directors and managers must subordinate their own interests to
those of the corporation.
3. In evaluating a buyout proposal, the directors should consider material nonprice provisions of the
proposed agreement.
4. The Dodd-Frank Wall Street Reform and Consumer Protection Act outlaws corporate executives
from holding stock in companies for which they work.
5. The duty of care includes the duty to make informed decisions.
6. Termination fees are sometimes characterized as liquidated damages.
7. A person must own a majority of shares in a corporation in order to be considered a controlling
shareholder.
CHAPTER 20 DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS 301
8. In certain cases, the duty of good faith may be subsumed within the duty of loyalty.
9. Under no circumstances do controlling shareholders owe fiduciary duties to other shareholders.
10. A poison pill is a defensive measure that would make any takeover not approved by the directors
prohibitively expensive.
11. In order to take advantage of the business judgment rule, directors must have made an informed
decision and have no conflict of the interest with the corporation.
12. A shareholder derivative action is a suit brought by a shareholder on behalf of the corporation.
13. A controlling shareholder has a duty not to transfer the power of management to a purchaser that he
knows or has reason to believe will use that power to the detriment of the corporation.
14. Companies listed on the New York Stock Exchange must have compensation committees composed
entirely of independent directors.
15. The Delaware Corporation Code allows the certificate of incorporation to include a provision
limiting or eliminating the personal liability of directors to the corporation or to its shareholders for
monetary damages for breach of the duty of loyalty.
302 MANAGERS AND THE LEGAL ENVIRONMENT
16. Breakup fees are liquidated damages for a terminated proxy fight.
17. Once a sale or breakup of the corporation is inevitable, directors have a fiduciary duty to prevent a
freeze out of the majority shareholders.
18. Controlling shareholders, but not officers or directors, of a corporation may use the corporation’s
confidential information for personal gain.
19. The business judgment rule is applicable only if the directors make an informed decision.
20. In the context of takeovers, board members cannot reject an offer without taking sufficient time to
analyze its merit.
MULTIPLE-CHOICE QUESTIONS
1. What is required by the Sarbanes-Oxley Act of 2002 in regard to the certification of the accuracy of
public companies’ SEC filings and the adequacy of internal controls?
A. The chief executive officer, the chief financial officer, and all inside directors must certify the
accuracy of public companies’ SEC filings and the adequacy of internal controls.
B. The chief executive officer, the chief financial officer, and any controlling shareholder must
certify the accuracy of public companies’ SEC filings and the adequacy of internal controls.
C. The chief executive officer and the chief financial officer must certify the accuracy of public
companies’ SEC filings and the adequacy of internal controls.
D. The chief executive officer, the chief financial officer, and all outside directors must certify the
accuracy of public companies’ SEC filings and the adequacy of internal controls.
CHAPTER 20 DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS 303
2. What was the result in Smith v. Van Gorkom, the case in the text in which it was alleged that
directors were grossly negligent in failing to inform themselves adequately before making a decision
about a merger?
A. That the board failed to obtain adequate information on merger terms and would not be
protected by the business judgment rule.
B That the board was protected by the business judgment rule because there was no conflict of
interest.
C. That the board was not protected by the business judgment rule but was protected by the merger
business rule.
D. That the board was protected by the business judgment rule because fraud could not be
established.
3. Which of the following is true regarding statements of officers?
A. An outside director, but not an inside director, may in good faith rely upon any statement of an
officer.
B. An inside director, but not an outside director, may in good faith rely upon any statement of an
officer.
C. Any director may in good faith rely upon any statement of an officer.
D. Not every statement of an officer can be relied upon in good faith.
4. Which of the following is considered an inside director of a corporation?
A. A director who is also an officer of the corporation.
B. A director who is also an officer of any corporation.
C. A director who is both an officer of any corporation and who stands to personally profit by an
action being considered by the board.
D. A director who is qualified as an expert in regard to any product of the company.
5. Which of the following is true in regard to the business judgment rule if one or more individual
directors have a personal interest in a transaction being considered by the board?
A. The decision may be entitled to the protection of the business judgment rule if the transaction is
approved by a majority of the inside directors.
B. The decision may be entitled to the protection of the business judgment rule if the transaction is
approved by a majority of the disinterested directors.
C. The decision is not entitled to the protection of the business judgment rule resulting in a higher
level of proof regarding the reasonableness of the transaction being required from the board of
directors.
304 MANAGERS AND THE LEGAL ENVIRONMENT
D. The decision is not entitled to the protection of the business judgment rule leading to a legally
established conclusion of illegality on the part of the board of directors.
6. Some jurisdictions permit the shareholders to amend the articles of incorporation to relieve directors
of any financial liability for violations of the duty of
A. care.
B. loyalty.
C. avoiding self dealing.
D. voting.
7. Which of the following was the result on appeal in the case in the text Omnicare, Inc. v. NCS
Healthcare, Inc., involving whether directors of an insolvent publicly traded company violated their
fiduciary duty when they entered into an agreement for the sale of the company to a particular
interested buyer regardless of other offers?
A. That the directors violated their fiduciary duty and lacked the authority to agree to an absolute
lock-up guaranteeing the sale and agreeing to forego consideration of future offers.
B. That the directors violated their fiduciary duty because the agreement was kept secret from
majority shareholders but that, otherwise, the agreement foregoing consideration of future offers
would have been valid.
C. That the directors violated their fiduciary duty because the agreement was kept secret from
minority shareholders but that, otherwise, the agreement foregoing consideration of future offers
would have been valid.
D. That the directors satisfied all fiduciary duties because there was no evidence of bad faith or self
dealing.
8. Which of the following was the result on appeal in the case in the text Air Products & Chemicals,
Inc. v. Airgas, Inc., involving whether the defendant’s board of directors breached its fiduciary
duties to stockholders by refusing to redeem a poison pill in place and allow a hostile takeover to
proceed?
A. That the board satisfied its fiduciary duties because as a matter of law directors may use poison
pills to block hostile takeovers that would result in a change of management.
B. That the board satisfied its fiduciary duties because the members acted reasonably in response to
the belief, based on reasonable grounds, that the hostile takeover offer was inadequate and posed a
legitimate threat if accepted.
C. That the board failed to act reasonably because the members acted in their own self interest, not
in the best interests of the shareholders, and that the board failed to properly seek expert opinion
regarding the hostile take over offer in relation to the value of the company.
D. That the board failed to act reasonably because as a matter of law it could not leave the poison
pill in place in the face of a hostile takeover bid.
CHAPTER 20 DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS 305
9. A shareholder derivative suit is a lawsuit by
A. shareholders on behalf of the corporation.
B. the shareholders directly.
C. the controlling shareholders on behalf of the majority shareholder.
D. the corporation.
10. Which of the following was the result in the case in the text from the Delaware Court of Chancery
involving a dead-hand pill under Delaware law?
A. That the directors appropriately used the dead-hand pill which guaranteed that majority
shareholders in place before a hostile bidding attempt were entitled to vote to block any later
proposed vote on a merger.
B. That the directors appropriately used the dead-hand pill because directors are entitled to use any
means necessary in order to block a hostile takeover.
C. That the pill violated the state general corporation law for a number of reasons including that it
violated the directors’ duty of loyalty.
D. That the pill, which could only be redeemed by directors in office after a hostile bidder gained
control or by their designated successors, violated the state general corporation law because it
prejudiced directors in place prior to the takeover.
11. Which of the following was the result in the case in the text involving a no-hand pill under
Delaware law?
A. That as a matter of law the pill was valid as a response to a takeover bid regardless of whether
independent proof existed that the directors acted reasonably.
B. That the pill was valid because the directors established, based upon reliable expert testimony,
that the hostile takeover bid presented a dangerous threat to the continuation of the company.
C. That the pill, which had to be redeemed within one month of a takeover bid or else be allowed to
remain in place, was invalid because it impermissibly circumscribed the board’s statutory power to
manage the business affairs of the company and the directors’ ability to fulfill their fiduciary duties.
D. That the pill, which could not be redeemed for six months following a takeover, was invalid
because it impermissibly circumscribed the board’s statutory power to manage the business affairs of
the company and the directors’ ability to fulfill their fiduciary duties.
12. Which of the following are among the provisions of the Dodd-Frank Wall Street Reform and
Consumer Protection Act in relation to shareholder control of pay for top executives?
306 MANAGERS AND THE LEGAL ENVIRONMENT
A. The act provides that shareholders of all privately held as well as publicly traded companies are
entitled to vote and set executive compensation on a yearly basis.
B. The act provides that shareholders of public companies have an advisory vote on company
payment practices for top executives and that public companies must hold a shareholder advisory
vote on golden parachutes for executives.
C. The act provides that shareholders of all privately held as well as publicly traded companies are
entitled to vote and set executive compensation on a yearly basis and also that the shareholders must
specifically approve any golden parachute provisions for executives.
D. Based on the belief that ill informed shareholder input negatively affected nationwide corporate
performance the act provides that shareholders need not be involved in setting executive
compensation.
13. A[n] _______ gives the person to whom it is granted the right to buy a certain number of shares at a
fixed price for a fixed number of years during a period known as the ______ period which is not
usually for more than _______.
A. call right, exercise, twelve months
B. option, redemption, twelve months
C. option, redemption, ten years
D. option, exercise, ten years
14. The ________ requires that officers and directors not take personal advantage of a desirable business
investment that rightfully belongs to the corporation.
A. right of first refusal
B. corporate opportunity doctrine
C. line of business test
D. expectancy test
15. Which of the following is true regarding state rules of corporate governance?
A. Under the U.S. Constitution, a state may only apply its corporate governance rules to
corporations incorporated in the state.
B. California imposes state pro-shareholder rules on quasi-foreign corporations.
C. There are no state rules of corporate governance because the Securities and Exchange
Commission has preempted the field.
D. By federal law, if a state wishes to impose corporate governance requirements on corporations
incorporated in the state, then the same rules must be imposed on corporations operating in the
state but incorporated in another state.
16. In the context of executive compensation, ______ stock usually means stock subject to vesting
restrictions.
A. regulated
B. restricted
C. illegally issued
D. kickback
17. Which of the following is true regarding any duties of controlling shareholders in relation to control
of a corporation?
A. Controlling shareholders owe no duties other than to maximize their own wealth.
B. Controlling shareholders generally have a duty to control the corporation in a fair, just, and
equitable manner, known as the standard of entire fairness.
C. Controlling shareholders may act to maximize their own wealth only so long as they do not
intentionally harm and exhibit bad faith toward minority shareholders, a standard known as minority
shareholder respect and fair dealing.
D. Controlling shareholders must appoint minority shareholders to vote a certain percentage of their
shares in instances in which the minority shareholders demand that right.
18. Which of the following is true regarding hostile takeovers in the European Union?
A. All member states must observe the neutrality rule and the breakthrough rule.
B. Member states may opt out of the neutrality rule and the breakthrough rule.
C. Member states may opt out of the neutrality rule, but all member states must observe the
breakthrough rule.
D. Member states may opt out of the breakthrough rule, but all member states must observe the
neutrality rule.
19. Which of the following is not a prime consideration in determining whether a fiduciary has taken an
opportunity that belongs to a corporation?
A. Whether the opportunity is in the corporation’s line of business.
B. The amount of money the fiduciary stands to make.
C. Whether the fiduciary developed the idea using corporation resources.
D. Whether the involvement by the fiduciary will hinder the corporation’s purposes.
20. Which of the following was the result on appeal in In re Abbott Laboratories Derivative
Shareholders Litigation, the case in the text alleging corporate directors’ breach of the duty of good
faith through their failure to follow up on repeated notices of regulatory noncompliance?
A. That the directors were not liable and did not breach any duty of good faith because they were
unaware of the issues, and accepted corporate governance procedures did not require the disclosure
of the noncompliance notices to them.
B. That the directors could not be held liable because the corporation’s certificate of incorporation
exempted directors from liability for breach of the duty of care.
C. That the business judgment rule applied and that the plaintiffs’ allegations could not withstand
the protection of that rule.
D. That the plaintiffs sufficiently pleaded allegations that, if true, constituted a breach of the duty of
good faith leading to the directors’ actions falling outside the protection of the business judgment
rule.
21. Which of the following is true regarding breakup fees?
A. They are sometimes characterized as liquidated damages.
B. The Securities and Exchange Commission prohibits the payment of breakup fees.
C. Breakup fees are typically 20 to 25 percent of the value of the deal.
D. They are sometimes characterized as liquidated damages, and breakup fees are typically 20 to 25
percent of the value of the deal.
22. What is a no-shop agreement?
A. An agreement whereby shareholders agree to not replace directors for a certain period of time.
B. An agreement whereby directors agree to not replace officers for a certain period of time.
C. An agreement whereby a target company agrees with a potential purchaser not to actively solicit
other bidders but retains the right to negotiate with parties who submit unsolicited bids to the
target.
D. An agreement whereby shareholders agree to not replace directors or officers for a certain period
of time.
23. Traditionally, a transaction benefiting a director’s self interest is ________ unless the director could
show it was fair and reasonable to the corporation.
A. void
B. voidable
C. illegal
D. all of the responses are correct
24. In a _______, someone wishing to replace the board with his or her own candidates attempts to
acquire a sufficient number of shareholder votes to do so through limited written powers of attorney
entitling the holder to vote the shares owned by the person giving the power of attorney.
A. hostile takeover
B. proxy contest
C. poison pill
D. greenmail takeover
25. A shareholder who owns sufficient shares to outvote the other shareholders, or to otherwise set
corporate policy, and thus to control the corporation is known as a _______ shareholder.
A. controlling
B. absolute
C. manipulative
D. chargeable
26. A contractual provision insisted upon by a bidder limiting the ability of board members to negotiate
with other bidders is referred to as a[n] _______ clause.
A. obedience
B. loyalty
C. negotiation
D. no-talk
27. __________ is a purchase of a dissident shareholder’s stock by the issuer at a premium over market,
often in exchange for a standstill agreement, whereby the shareholder agrees not to commence a
tender offer or proxy contest or to buy additional shares of the issuer for a period of time.
A. Greenmail
B. A freeze out
C. Choice agreement
D. Equitable agreement
28. A ________ occurs when minority shareholders are forced to convert their shares into cash, for
example, when a subsidiary merges with its parent.
A. hostile takeover
B. sale of assets
C. freeze out
310 MANAGERS AND THE LEGAL ENVIRONMENT
D. tender offer
29. The duty of ________ requires officers to exercise reasonable supervision over the business affairs
of the corporation.
A. care
B. loyalty
C. obedience
D. ethics
30. A ________ is an agreement in a proposed takeover that allows the board of directors to negotiate
with other bidders or to terminate a merger agreement.
A. termination clause
B. fiduciary out
C. revolving door
D. no talk provision
31. Brice is on the board of ABC Corporation. XYZ Corporation has made a move to acquire ABC.
Tina, the president of ABC advises the board that the offer made by XYZ is a good one that should
be accepted. She did not disclose, however, that XYZ had offered her a generous bonus if she could
convince the board members of ABC to take XYZ’s offer. Brice tells the other board members that
they should simply rely on Tina because she is probably right, and under the business judgment rule
they are protected even if she is wrong. Which of the following is true regarding Brice’s advice?
A. Brice is correct.
B. Brice is correct only if the directors of Success had been soliciting offers, and Tina was charged
with reviewing them.
C. Brice is incorrect unless it can be established that Tina has prior experience in mergers and
acquisitions.
D. Brice is incorrect because no statement made by an officer is entitled to blind reliance.
Fact Pattern 20-1 (Questions 32-34 apply)
Tonya is the president of Big Corporation. Big Corporation is looking for land on which to build a
new facility. Tonya locates suitable land, but purchases it for herself with plans to sell it at a profit
at a later date. Rick, the majority shareholder of Big Corporation hears about Tonya’s purchase and
complains to her about it. She tells Rick that she viewed and purchased the land on her own time
CHAPTER 20 DIRECTORS, OFFICERS, AND CONTROLLING SHAREHOLDERS 311
and that she did not breach any duties owed to the corporation. Rick tells her that she should
reconsider and that he plans to discuss the matter with the rest of the board.
32. Refer to fact pattern 20-1. Which of the following is a widely used test for determining whether an
opportunity belongs to a corporation?
A. The line–of-business test
B. The time-spent test
C. The corporate-interest test
D. The officer-corporate equilibrium test
33. Refer to fact pattern 20-1. Which of the following is a right of the corporation if it is determined that
an officer wrongfully takes an opportunity belonging to the corporation?
A. An absolute trust
B. A constructive trust
C. A 10% penalty based upon the value of the lost opportunity which is imposed by federal law
D. As imposed by most states, a 10% penalty based upon the value of the lost opportunity
34. Refer to fact pattern 20-1. Did Tonya violate any duties owed to the corporation?
A. Yes, by buying the land for herself without disclosure to the corporation, she violated the
corporate opportunity doctrine.
B. Yes, by buying the land for herself without disclosure to the corporation, she violated the duty of
responsible decision making.
C. Only if the land involved was worth over $50,000 did she violate any duties because any smaller
amount would be considered de minimus.
D. No.
35. Yolanda, a ballroom dance instructor, was recently asked to be a director of ABC Company which is
publicly traded. She is very honored and excited. Her friend, Joe, asked her if she had any
experience in accounting, business, or SEC requirements. Yolanda told him no, but that the
president of ABC had assured her that the only responsibility of a director was acting as a figurehead
because the officers took care of all detailed corporate business. Yolanda says that she is accepting
the position because it will get her exposure in the community and perhaps increase her dance
clientele. Is Yolanda correct regarding her responsibilities, and why or why not?
A. Yes, Yolanda is correct that the primary job of a director is to serve as a figurehead.
B. Yolanda is correct that the primary job of an outside bank director is to serve as a figurehead, but
that is not true of inside directors.
C. Yolanda is not entirely correct, but she has no affirmative responsibility to ensure the accuracy of
any reports because that is entirely the responsibility of officers of the corporation.
312 MANAGERS AND THE LEGAL ENVIRONMENT
D. Yolanda is incorrect, and the SEC emphasizes the responsibility of directors to ensure the
accuracy and completeness of public company filings with the SEC.
ESSAY QUESTIONS
1. What is a poison pill? What factors favor keeping a poison pill in place?
2. Define and explain the purpose of the business judgment rule. Under what circumstances would the
rule apply? When would the protection not apply? Discuss fully.
3. What are the seven key factors that directors should consider in deciding whether to sell a company?
4. What is meant by the business judgment rule?
5. What was the conclusion of the court in Unocal Corp. v. Mesa Petroleum Co. regarding the
application of the business judgment rule to actions of directors in response to a takeover attempt?
6. Maurice is a fairly new director at ABC Corp. Peg, another director, tells him that she believes that
the company is in Revlon mode and that the directors should act accordingly. What is Peg
referencing?
7. What is greenmail? What is a standstill agreement? When, if ever, is the process of greenmail
protected by the business judgment rule?