Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
Chapter 4
Corporate Governance: Foundational Issues
LEARNING OUTCOMES
After studying this chapter, you should be able to:
1. Link the issue of legitimacy to corporate governance.
3. Discuss the principal way in which companies can improve corporate governance.
4. Discuss the role of shareholders and the idea of strengthening shareholder voice. What are
some of the mechanisms that enable this?
6. Discuss the principal ways in which shareholder activists exert pressure on corporate
management to improve governance.
8. Compare and contrast the shareholder-primacy and the director-primacy models of
corporate governance. What are their strengths and weaknesses? Which do you prefer and
why?
TEACHING SUGGESTIONS
INTRODUCTION – In this chapter, the authors explore corporate governance and the ways in
which it has evolved, and propose an alternative model of corporate governance. They first
examine the concept of legitimacy and the part that corporate governance plays in establishing
the legitimacy of business. They then explore how good corporate governance can mitigate the
problems created by the separation of ownership and control and examine some of the specific
challenges facing board members today.
KEY TALKING POINTS – In some sense, discussing corporate governance may seem a bit
premature for business students, especially at the undergraduate level. Most of the students will
not have direct contact with board members of publicly-traded companies and their issues for
quite some time. However, the issues are highly relevant to them in many ways. Some
undergraduates plan to start their own business upon graduation and need to understand the
mechanics and obligations of corporate formation. Further, when starting their own business,
many will operate as owner-managers. They need to understand their various roles in the
corporate form, as well as their legal obligations to other investors should they serve as directors.
Further, as citizens, they should be concerned with the legitimacy of corporations and understand
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
reality, that the power structure is inverse to the theory, may come as quite a surprise. It is at this
juncture that the alternative model of corporate governance may be suggested – the director-
As the authors point out, boards are making an effort to wrest control back from management. In
addition to the steps pointed out in the textbook, there are many efforts to “create” better board
members, through education and research. The National Associate of Corporate Directors works
Sonnenfeld, J. A. Good governance and the misleading myths of bad metrics. Academy of
Management Executive, Feb 2004, Vol. 18 Issue 1, p108.
Sonnenfeld, J. A. What Makes Great Boards Great. Harvard Business Review, Sep 2002, Vol. 80
Issue 9, p106.
Students also may be interested in finding out more about the issue of executive compensation.
Two excellent websites provide a wealth (no pun intended) of information about the topic. The
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
PEDAGOGICAL DEVICES – In this chapter, instructors may utilize a combination of:
Cases:
3-The Body Shop (B) – Reputation is Tarnished
4-The Body Shop (C) – Into the New Millennium
6-The Waiter Rule: What Makes for a Good CEO?
11-Family Business
15-Nike, Inc. and Sweatshops
16-Coke & Pepsi in India
17-Chiquita – An Excruciating Dilemma
20-DTCA – The Pill Pushing Debate
21-Big Pharma’s Marketing Tactics
23-McDonald’s Coffee Spill
24-The Betaseron Decision (A)
25-The Hudson River Cleanup and GE
27-New Belgium Brewing, Defining a Business on Sustainability
28-Safety, What Safety
Ethics in Practice Cases:
Excessive Director Compensation at Facebook?
Monitoring the Monitors
Spotlight on Sustainability:
Shareholder Impact on Sustainability
Power Point slides:
LECTURE OUTLINE
I. LEGITIMACY AND CORPORATE GOVERNANCE
A. The Purpose of Corporate Governance
B. Components of Corporate Governance
1. Roles of Four Major Groups
2. Separation of Ownership from Control
II. PROBLEMS IN CORPORATE GOVERNANCE
A. The Need for Board Independence
B. Issues Surrounding Compensation
2. Excessive CEO Pay
4. Outside Director Compensation
5. Transparency
C. The Governance Impact of the Market for Corporate Control
1. Poison Pills
2. Golden Parachutes
D. Insider Trading
III. IMPROVING CORPORATE GOVERNANCE
A. Legislative Efforts
B. Changes in Boards of Directors
C. Board Diversity
IV. THE ROLE OF SHAREHOLDERS
A. Shareholder Democracy
V. THE ROLE OF THE SEC
VI. SHAREHOLDER ACTIVISM
A. The History of Shareholder Activism
B. Shareholder Resolutions
C. Shareholder Lawsuits
VII. INVESTOR RELATIONS AND SHAREHOLDER ENGAGEMENT
VIII. AN ALTERNATIVE MODEL OF CORPORATE GOVERNANCE
IX. SUMMARY
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
Students should recognize that their answers to these discussion questions should be well
reasoned and supported with evidence. Although some answers will be more correct than others,
students should be aware that simplistic answers to complex questions, problems, or issues such
as these will never be “good” answers.
1. Question: Explain the evolution of corporate governance. What problems developed? What
are the current trends?
Answer: Corporations at their inception were run by owner-managers who retained full
responsibility for all functions of the enterprise. As corporations grew (the availability of
2. Question: What are the major criticisms of boards of directors? Which single criticism do
you find to be the most important? Why?
Answer: The major criticisms of boards of directors center on their effectiveness. Boards
are less effective than they should be because too many members are inside directors, they
3. Question: Explain how governance failures such as Enron and the global financial crisis
could happen. How might they be avoided?
Answer: Governance failures like Enron happen primarily because the power relationship
between the board and top management is inverse. Although the board should have
4. Question: Outline the major suggestions that have been set forth for improving corporate
governance. In your opinion, which suggestions are the most important? Why?
Answer: Several suggestions for improving corporate governance have been made. Most
center on board composition and performance. Recommended changes in who sits on
5. Question: Discuss the pros and cons of the shareholder-primacy and director-primacy
models of corporate governance. Which do you prefer and why?
Answer: Companies can become more responsive to shareholders by fully disclosing their
activities and by placing the owners’ interests above the managers’ (although this is
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
GROUP ACTIVITY
Group Activity 1 – Public Disclosure of Corporate Governance Issues
Divide the students into groups of four to five students. Have the students select a publicly-
traded company. The instructor should explain how publicly-traded information can be obtained
How many shareholders hold common stock according to the company’s annual report?
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
What is the date of record for determining shareholders entitled to receive notice and to vote at
the annual meeting?
How are directors elected? What are the voting requirements for the election of directors? How
would a shareholder propose a candidate for nomination to the board of directors?
Who serves on the board of directors? What are their qualifications?
How many directors are independent? Indicate which directors are “inside” directors and which
directors are “outside” directors. Is this an appropriate mix? Are there any obvious conflicts of
interest?
What board committees does the company have? Describe the function(s) of each committee as
described in the company’s proxy statement.
Who is the audit committee financial expert? What are his or her qualifications?
What internal controls framework does the company use?
Did management determine that the internal control over financial reporting was effective?
Did the auditor find that management’s assessment of the effectiveness of the company’s internal
controls was fairly stated?
Where will the company disclose waivers to the Code of Ethics for the Senior Officers?
Group Activity 2 – Executive Compensation
Divide the students into groups of four to five students. Have the students select a publicly-
traded company. The instructor should explain how publicly-traded information can be obtained
from Edgar (www.sec.gov). Specifically, students should learn how to obtain a company’s
annual report (Form 10-K) and proxy statement (Form Def 14A). Students should be
encouraged to review these documents (specifically the proxy statement) to get a better
understanding of the company’s compensation structure, philosophy and objectives. The
instructor may want to have the students answer specific questions related to executive
compensation, using the company’s annual report and proxy statement. The following are
sample questions:
What is the total compensation for the three highest paid officers (including the value of stock
options and other benefits)?
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
What are the company’s compensation philosophy and objectives? How does the company set
executive compensation?
What are the components of the company’s compensation program (i.e., what “mix” of salary,
benefits, stock, etc. does the company use to compensate its executives)? Do you think that the
company is using the appropriate compensation incentives? According to the compensation
committee, is the current compensation of the top executive(s) justified based on the company’s past
and/or current performance?
Review the Management’s Discussion and Analysis of the Financial Condition and Results of the
Operations (the MD&A) in the company’s annual report. Based on the information in the MD&A, is
the compensation to top executives justified? Is it consistent with the compensation committees’
analysis?
Based on the information in the proxy statement and the annual report, would any of the other
executive officers be an appropriate replacement for the CEO? If not, who would you recommend as
an outside candidate (hint: you might review the profiles of top management in competitors’ annual
reports)?
INDIVIDUAL ASSIGNMENT
Distribute the following instructions to each student:
Visit the website of Institutional Shareholder Services, Inc. (ISS), a provider of corporate
governance solutions, at http://www.issgovernance.com/. Go to the “Policy Gateway” tab and
select a recently adopted ISS policy. Write a memo to shareholders explaining the policy and
how it will affect the corporate governance of companies. You also should explain why ISS has
adopted the proposal and whether or not you agree with the proposal. Finally, you should
provide a recommendation as to how shareholders should proceed regarding the proposal.
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
BOARD SELECTION AND FIDUCIARY DUTY SIMULATION
Students should be assigned the following roles: The CEO, Director 1, Director 2, Director 3,
Director 4, Director Candidate A, Director Candidate B, Director Candidate C, Director
Candidate D, Director Candidate E, and Director Candidate G. Name tags should be distributed
so that each student can print his/her role on the name tag and other students can identify who is
playing which role.
Instructors should allow 45-60 minutes for this simulation.
PART 1
Each student should read the background information for his/her role. After reading the
background information, the nominating committee (including the CEO and Directors 1, 2, 3 &
PART 2
Once the nominating committee decides who they would like to nominate for the board, they
should “recruit” these candidates for board membership. The candidates should ask appropriate
questions to determine whether they want to pursue board membership.
PART 3
Part 3 concludes with a simulated board meeting.
Distribute the Following for Parts 1 & 2 to the CEO and Nominating Committee
The Nominating Committee – The CEO and Directors 1, 2, 3 & 4
Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. has
Ch 4, Instructor’s Manual, Business & Society, Carroll 10e
Director Candidate A
Candidate A has been the president of a local bank since 1999. Candidate A has been in the
Director Candidate B
Candidate B owns his/her own real estate agency and has been a local real estate agent for over
30 years. Candidate B’s company closed over $8 million dollars in sales last year. Candidate B
Director Candidate C
Candidate C has been the senior Vice President of a large local manufacturer for 8 years. Prior
to moving to Murray, Candidate C lived in Nashville for 5 years working for a competitor.
Candidate C goes to First Church of Murray.
Director Candidate D
Candidate D is the Chief Financial Officer of Murray Rentals, Inc. Prior to joining Murray
Director Candidate E
Candidate E is the CEO’s spouse. Candidate E has an accounting degree and has worked as a
Director Candidate F
Candidate F is a senior at Murray State University. Candidate F has lived in Racer Place for the
Director Nominee G