Archive for April, 2011

• Financial Reporting and External Audit (Powerpoint Presentation)

• Accurate financial reporting is critical for the efficiency of capital markets and the proper valuation of securities.
• It allows the board and investors to make an informed evaluation of strategy, business model, and risk.
• It also allows the board to structure compensation packages appropriately and award performance-based compensation knowing that predetermined targets were met.
• It is the role of the audit committee to help to ensure the accuracy of reports:1.Sets parameters for quality, transparency, and controls. 2.Hires external auditor to test for misstatement.

For more read see the entire presentation in the above link.

The Resignation of David Sokol: Mountain or Molehill for Berkshire Hathaway? (PDF)
by Authors: Professor David F. Larcker and Brian Tayan, MBA ’03

Additional related information:
-Berkshire Hathaway Audit Committee Report (Link)
-Questions and Answers From 2011 Annual Shareholders Meeting (Link)

Given its size, Berkshire Hathaway has had a relatively clean record on governance-related matters. This track record speaks to the quality of its governance system and the ability of its “trust-based” model to work.

For these reasons, it came as a shock to many when Warren Buffett announced the sudden resignation of David Sokol in March 2011.  Sokol, CEO of Berkshire Hathaway’s energy subsidiary, was widely considered the front-runner on a short list of potential successors to one day succeed Buffett.  More bizarre were the circumstances surrounding the announcement.  Just days before recommending to Buffett that Berkshire Hathaway purchase specialty chemical company Lubrizol in a $9.7 billion deal, Sokol accumulated common stock in Lubrizol worth $10 million.

The matter raised significant issues for the Berkshire board of directors:

1. Did Sokol violate the company’s insider trading policy?
2. Did Sokol’s actions reveal shortcomings in the company’s governance system that need to be addressed?
3. What will be the long-term impact of these events on company’s reputation?

More broadly, the matter raises questions that are general to all organizations.  How extensive must events be before a company decides that governance changes are required?

Read the attached Closer Look and let us know what you think!

Topics, Issues and Controversies in Corporate Governance:The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. To see the full series of  Stanford Closer Looks go here.

Do ISS Voting Recommendations Create Value? (PDF)
Authors: Professor David F. Larcker and Brian Tayan, MBA ’03

Many institutional investors rely on a proxy advisory firm to assist them in voting the company proxy and fulfilling their fiduciary responsibility to vote in the interest of beneficial shareholders.  The largest and most influential proxy advisory firm is Institutional Shareholder Services (ISS).  The recommendations of ISS are not inconsequential.  Academic and professional research suggests that a recommendation by ISS can change the outcome of a vote by 15 to 20 percent, depending on the matter of the proposal.

At the same time, there is little evidence that proxy advisory recommendations are correct or that they improve corporate outcomes.  In fact recent research suggests that they might actually decrease shareholder value.

We examine these issues as they relate to ISS guidelines for exchange offers and option repricings:

Do proxy advisors have appropriate incentive to verify that their recommendations are correct?

• Should board members require evidence that ISS guidelines are value increasing before they adjust their policies to gain a favorable recommendation?
• Proxy advisory firms enjoy significant barriers to entry and little competition.  Is this desirable for shareholders?

Read the attached Closer Look, and let us know!

Related Research Paper on SSRN: The Role of Proxy Advisory Firms in Stock Option Exchanges
Authors: David F. Larcker , Allan L. McCall and Gaizka Ormazabal , Stanford Graduate School of Business

The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important.

Corporate Governance Matters:
A Closer Look at Organizational Choices and Their Consequences By David Larcker, Brian Tayan

Available from FT Press-Pearson Prentice Hall

Read Chapter 1 of the book

• Executive Equity Ownership (PowerPoint)      

  In theory:          

• Executives who hold equity in the companies they manage have greater incentive to build economic value. 
• Equity ownership should discourage self-interested behavior.
• Actions that impair firm value would inflict corresponding damage to the executive’s personal wealth.
• As such, equity ownership is expected to mitigate agency problems.