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FFIRS.indd ii6/2/11 12:34:44 PM

Corporate GovernanceFFIRS.indd i6/2/11 12:34:44 PM

FFIRS.indd ii6/2/11 12:34:44 PM

Corporate GovernanceFifth EditionRobert A. G. Monks and Nell MinowFFIRS.indd iii6/2/11 12:34:44 PM

This edition fi rst published in 2011Copyright 2011 John Wiley & SonsRegistered offi ceJohn Wiley & Sons Ltd, The Atrium, Southern Gate, Chichester, West Sussex, PO19 8SQ, United KingdomFor details of our global editorial offices, for customer services and for information about how to apply for permissionto reuse the copyright material in this book please see our website at www.wiley.comThe right of the author to be identified as the author of this work has been asserted in accordance with the Copyright,Designs and Patents Act 1988.All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, inany form or by any means, electronic, mechanical, photocopying, recording or otherwise, except as permitted by theUK Copyright, Designs and Patents Act 1988, without the prior permission of the publisher.Wiley also publishes its books in a variety of electronic formats and by print-on-demand. Some content that appears instandard print versions of this book may not be available in other formats. For more information about Wiley products,visit us at www.wiley.com.Designations used by companies to distinguish their products are often claimed as trademarks. All brand names andproduct names used in this book are trade names, service marks, trademarks or registered trademarks of their respectiveowners. The publisher is not associated with any product or vendor mentioned in this book. This publication is designed toprovide accurate and authoritative information in regard to the subject matter covered. It is sold on the understanding thatthe publisher is not engaged in rendering professional services. If professional advice or other expert assistance is required,the services of a competent professional should be sought.Library of Congress Cataloging-in-Publication DataMonks, Robert A. G., 1933–Corporate governance / Robert A.G. Monks and Nell Minow. — 5th ed.p. cm.Includes bibliographical references and index.ISBN 978-0-470-97259-5 (pbk.)1. Corporate governance—United States. I. Minow, Nell, 1952– II. Title.HD2745.M66 2011658.4–dc222011013532ISBN: 978-0-470-97259-5(pbk) ISBN: 978-0-470-97273-1(ebk)ISBN: 978-0-470-97274-8(ebk) ISBN: 978-1-119-97773-5(ebk)A catalogue record for this book is available from the British Library.Typeset in Bembo Regular 10/11pt by Thomson Digital, New Delhi, IndiaPrinted and bound in Great Britain by TJ International, Padstow, CornwallFFIRS.indd iv6/2/11 12:34:44 PM

BRIEF CONTENTSIntroduction1. What is a Corporation?2. Shareholders: Ownership3. Directors: Monitoring4. Management: Performance5. International Corporate Governance6. Afterword: Final Thoughts and Future DirectionsFTOC01.indd v131012513474154756/2/11 1:36:59 PM

FTOC01.indd vi6/2/11 1:36:59 PM

CONTENTSCases in PointPrefaceAcknowledgmentsIntroduction – How to Use this Book1. What is a Corporation?Defi ning the Corporate Structure, Purpose, and PowersEvolution of the Corporate StructureThe Purpose of a CorporationSatisfying the human need for ambition, creativity, and meaningSocial structureEfficiency and efficacyUbiquity and flexibilityIdentityMetaphor 1: The Corporation as a “Person”Metaphor 2: The Corporation as a Complex Adaptive SystemAre Corporate Decisions “Moral”?Are Corporations Accountable?Three Key External Mechanisms for Directing Corporate Behavior:Law, the Market, and Performance MeasurementGovernment: legislation, regulation, enforcementWhat Does “Within the Limits of the Law” Mean?When and how do you punish a corporation?Probation of corporationsThe problem of serial offendersSecurities analyst settlementWhat is the role of shareholders in making this system work?The market: too big to failThe corporation and electionsCitizens unitedThe corporation and the lawA Market Test: Measuring PerformanceLong term versus short termCorporate decision making: whose interests does this“person”/adaptive creature serve?FTOC02.indd 3233364041454750556/8/11 11:48:49 AM

viiiCONTENTSAnother (failed) market test: NGOsMeasuring value enhancementGAAPMarket valueEarnings per shareEVA : economic value addedHuman capital: “It’s not what you own but what you know”The “value chain”Knowledge capitalThe value of cashCorporate “externalities”Equilibrium: The Cadbury ParadigmESG: Environment, Social Governance – A New Way to Analyze InvestmentRisk and ValueQuantifying Nontraditional Assets and LiabilitiesFuture DirectionsSummary and Discussion QuestionsNotes2. Shareholders: OwnershipDefi nitionsEarly Concepts of OwnershipEarly Concepts of the CorporationA Dual Heritage: Individual and Corporate “Rights”The Reinvention of the Corporation: Eastern Europe in the 1990sThe Evolution of the American CorporationThe Essential Elements of the Corporate StructureThe Mechanics of Shareholder RightsThe Separation of Ownership and Control, Part 1: Berle and MeansFractionated OwnershipThe Separation of Ownership and Control, Part 2: The Takeover EraWaking the Sleeping GiantA Framework for Shareholder Monitoring and ResponseOwnership and ResponsibilityNo innocent shareholderTo Sell or Not to Sell: The Prisoner’s DilemmaWho the Institutional Investors AreBank trustsMutual fundsInsurance companiesUniversities and foundationsExecutive pay from the consumer side – a leading indicator of riskPension plansThe Biggest Pool of Money in the WorldPension plans as investorsPension plans as ownersFTOC02.indd 91491501541541641666/8/11 11:48:49 AM

CONTENTSPublic Pension FundsDivestment initiativesEconomically targeted investmentsAFSCMEFederal Employees’ Retirement SystemTIAA–CREFPrivate Pension FundsThe Sleeping Giant Awakens: Shareholder Proxy Proposals on Governance IssuesFocus on the BoardHedge FundsSynthesis: HermesInvesting in ActivismNew Models and New ParadigmsThe “Ideal Owner”Pension Funds as “Ideal Owners”Is the “Ideal Owner” Enough?Summary and Discussion QuestionsNotes3. Directors: MonitoringA Brief History of Anglo-American BoardsWho Are They?SizeTermInside/outside mixQualificationsWho Leads the Board? Splitting the Chairman and CEO and theRise of the Lead g with ShareholdersSpecial Obligations of Audit ley ChangesBoard Duties: The Legal FrameworkThe Board’s AgendaThe Evolution of Board Responsibilities: The Takeover EraThe Fiduciary Standard and the Delaware FactorHow did boards respond?Greenmail“Poison pills”Other anti-takeover devicesThe Director’s Role in CrisisLimits and Obstacles to Board Oversight of ManagersFTOC02.indd 2662662672812832842872872882902912956/8/11 11:48:49 AM

xCONTENTSInformation FlowPractical Limits: Time and MoneyThe Years of Corporate Scandals – Boards Begin to Ask for MoreDirector Information ChecklistWho Runs the Board?Catch 22: The Ex-CEO as DirectorDirector ResignationCEO SuccessionDirector NominationLimits and Obstacles to Effective Board Oversight by ShareholdersCarrots: Director Compensation and IncentivesSticks, Part 1: Can Investors Ensure or Improve Board Independence by ReplacingDirectors who Perform Badly or Suing Directors who Fail to Act as Fiduciaries?Can Directors be Held Accountable through the Election Process?Staggered boardsConfidential votingSticks, Part 2: Suing for Failure to Protect the Interests of Shareholders – Are theDuties of Care and Loyalty Enforceable?Future DirectionsMajority voting and proxy accessImproving director compensationIncreasing the authority of independent directors“A market for independent directors”“Designated director”Board evaluationExecutive session meetingsSuccession planning and strategic planningMaking directors genuinely “independent”Involvement by the federal governmentInvolvement by shareholdersSummary and Discussion QuestionsNotes4. Management: PerformanceIntroductionWhat Do We Want from the CEO?The Biggest ChallengeRisk ManagementExecutive CompensationThe pay CzarPost-meltdown payThe Council of Institutional InvestorsStock OptionsRestricted StockYes, We Have Good ExamplesShareholder Concerns: Several Ways to Pay DayFTOC02.indd 3593633633703703713743793803806/8/11 11:48:49 AM

CONTENTSFTOC02.indd xiThe “guaranteed bonus” – the ultimate oxymoronDeliberate obfuscationThe Christmas treeCompensation plans that are all upside and no downsideLoansAccelerated vesting of optionsManipulation of earnings to support bonusesManipulation of peer groupsHuge disparity between CEO and other top executivesImputed years of serviceExcessive departure packagesBackdating, bullet-dodging, and spring-loading optionsPhony cutsGolden hellosTransaction bonusesGross-ups and other perquisitesRetirement benefitsObstacles to restitution when CEOs are overpaidFuture Directions for Executive CompensationCEO Employment ContractsCauseChange of controlHalf now, half laterCEO Succession PlanningSarbanes–OxleyCreation of the Public Company Accounting Oversight BoardSection 404Other changesDodd–FrankEmployees: Compensation and OwnershipEmployee Stock Ownership PlansMondragón and Symmetry: Integration of Employees, Owners, and DirectorsConclusionSummary and Discussion 43953994034094104115. International Corporate GovernanceThe Institutional Investor as Proxy for the Public InterestNorway in the driver’s seatThe International Corporate Governance NetworkICGN: Statement of Principles on Institutional Shareholder ResponsibilitiesThe Global Corporate Governance 435437438441xi6/8/11 11:48:49 AM

xiiCONTENTSGermanyChinaJapanGovernanceMetrics International (GMI)World Bank and G7 ResponseAzerbaijanSlovakiaJordanThailandPolandThe Global Carbon Project (GCP)A Common Framework for Sustainability ReportingTowards a Common LanguageVisionSummary And Discussion QuestionsNotesFTOC02.indd 36. Afterword: Final Thoughts and Future DirectionsBeyond the Nation StateGovernment as Shareholder: The Institutional Investor as Proxy forthe Public InterestNotes475477484486Index4896/8/11 11:48:49 AM

CASES IN POINTCHAPTER 1Shlensky v. Wrigley (1968)Corporate Crime and PunishmentA UK Attempt to Redefi ne Corporate ManslaughterWhat Happens When You Let Corporations Choose their Own Regulators?Just What You Would ExpectChryslerThe Voluntary Restraint Agreement in the Auto IndustryCorporate Political Donations in the UK and the US“Delaware Puts Out”The Years of Accounting DangerouslyProtection, Pennsylvania StyleThe “Good,” the “Bad,” and the RealGreen Tree FinancialFASB’s Treatment of Stock OptionsThe Battle of the Theme ParksDaimler-Benz and the New York Stock ExchangeJohnson & JohnsonSocially Responsible InvestingPrice Fixing152126333638444548525564667077808488CHAPTER 2Mis-Trust: The Mysterious Case of the Hearst WillHow Much is a Fiduciary Worth – And Can He Charge More than That?Of Vouchers and Values – Robert A.G. Monks Visits Vaclav HavelStandard Oil and the Arrival of Big BusinessPartnership versus CorporationAnnual Shareholder MeetingsThe Confl icted OwnerWhen is the Employee Stock Plan Obligated to Step in or Sell?FBETW.indd xiii1031031101121161181211216/8/11 4:36:39 PM

xivCASES IN POINTWho Owns Hershey?F&C Advises Its Clients to Vote Against Excessive Compensation – At F&CJunior Invests in Boothbay HarborOne Share, One VoteRefcoHermesR.P. Scherer and CiticorpT. Rowe Price and TexacoDirector ResignationsInterlocking DirectorsThe Alumni Protest Fees Paid to Managers of the Harvard EndowmentThe Rose Foundation Takes on MaxxamReader’s DigestEating the Seed Corn: NY’s Pension Fund Borrows from ItselfMaine State Retirement SystemCalPERS and EnronPublic Fund ActivismCalPERS Invests in ActivismInstitutional Investors Address Climate ChangeShareholder Influence on Standardizing and Integrating CorporateEthics and SustainabilityMyners Shifts the Burden of Proof on ActivismThe Institutional Shareholders CommitteeAFSCME’s Economically Targeted Investment PolicyCan a Fiduciary Invest in Volkswagen?Socially Responsible InvestingCampbell Soup Company and General Motors“Universal Widget”Honeywell and Furr’sSwib and CellstarRevolt of the Yahoos: United Companies Financial and Luby’sDeutsche Asset Management Changes Its VoteFrom DuPont to Relationship InvestingA&P, Paramount, and 15217223230231CHAPTER 3Warren Buffet on BoardsThe Worldwide Frustration of Audit CommitteesThe Corporate Library’s Interlock ToolThe Walt Disney Company and the Magical Kingdomof Executive CompensationThe Disney DecisionFBETW.indd xiv2542552592682706/8/11 4:36:39 PM

CASES IN POINTIllicit Backdating: Trends in Illegal Executive CompensationUpper Deck v. Topps: Getting a Fair ChanceThe Duty of Loyalty – A Race to the Bottom?Further Exploration of the Requirement of Good FaithTrans UnionUnocal and RevlonCompaq ComputersRJR Nabisco, Lone Star Industries, Tambrands, and EnronA Director QuitsA Director Demands More from the BoardTwo Directors Depart at EmapDirector Pay at Coca-ColaSearsSalomon APTER 4Merck Creates a Product No One Can Pay ForTony Hayward and BP’s Deepwater Horizon Oil LeakAT&T and NCRBeyond the Balance SheetMore About H-P and HurdExxon, AT&T, and General Electric and Creative Destruction –Internal and ExternalWarnacoICGN on CompensationThe Chairman SpeaksBordenUnited Airlines and Employee OwnershipThe “Temping” of the WorkplaceMondragon and “Cooperative Enterpreneurship”or “Cooperation Instead of 406CHAPTER 5Offshore OutsourcingRussia’s Hostile TakeoverEmbraerCapital Flight, Tax Avoidance, and Tax CompetitionFBETW.indd xv4174184194286/8/11 4:36:39 PM

FBETW.indd xvi6/8/11 4:36:39 PM

PREFACEJohn D. Rockefeller famously sold out of the stock market just before the 1929 crash because of ashoeshine boy. At least according to legend, he knew that when shoeshine boys were giving outstock tips, it was time to sell.In The Big Short: Inside the Doomsday Machine, by Michael Lewis, there are a couple of shoeshineboy moments. In this case, it was not wealthy industrialists or anyone at the heart of the fi nancialworld who figured out that there would be a collapse triggered by billion-dollar bets on the subprimemortgages and their derivative securities.Lewis writes about four outsiders who saw what was coming and bet it would fail while the entire economy was betting the other way. Steve Eisman had a “light bulb” moment when he foundout that his former baby nurse had six investment properties. Michael Burry asked if he could buya security betting a group of the subprime mortgages would fail. He wanted to bet against a groupmade up entirely of no-doc loans (those where the applicants for the mortgages did not have tosubmit any documentation to demonstrate their ability to repay). He wanted it to be a group ratedA by one of the ratings agencies, the same rating given to groups of mortgages where the applicantshad to demonstrate that they could repay. And he got it.Why were they the only ones who saw that as a problem? And how did that problem get createdin the fi rst place?What went wrong?In late 2007, the United States economy suffered its worst economic catastrophe since the GreatDepression of the 1930s. The American taxpayers found themselves guarantors of the entire fi nancial services industry when almost overnight assets that had been valued at hundreds of billionsof dollars turned out to be worth some undetermined amount but much, much less. The entireeconomy seemed to collapse like a house of cards.This was not supposed to happen. Just five years before, the most sweeping reform legislationin decades was passed to deal with the then-record-setting scandals of the time. From late 2001through 2002 spectacular corporate failures at Enron, Global Crossing, Adelphia, WorldCom,and more resulted in the loss of hundreds of billions of dollars and hundreds of thousands of jobs.Front-page news stories were illustrated with photographs of men in suits doing perp walks. CEOswent to prison.The passage of the Sarbanes–Oxley legislation in 2002 helped to restore confidence in the markets. Perhaps it restored too much confidence because people like Federal Reserve Chairman AlanGreenspan kept insisting that the mushrooming category of derivative securities did not need to beregulated, because he said the efficiency of the market was all that was needed.FPREF.indd xvii6/8/11 4:28:19 PM

xviiiPREFACEHe does not think that any more. “Those of us who have looked to the self-interest of lendinginstitutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief,” hetold the House Committee on Oversight and Government Reform in 2008.So, what happened? The failures that led to this collapse were widespread and the fault extendsto every element of the system: corporations, regulators, accountants, ratings agencies, securitiesanalysts, politicians, shareholders, journalists, and more. A lot of blame has been assigned, mostlyfrom those trying to deflect it from themselves. The alleged culprits have included “monetarypolicy,” the government-sponsored entities (Fannie Mae and Freddie Mac), and lax oversight byregulators. Those all played a role, but unquestionably, the primary culprit was a failure of corporate governance.The proof of that statement will be one of the key themes of this book. The first element of thatproof is a sentence that occurs near the end of The Big Short. “What’s strange and complicated about[the subprime mortgage market], however, is that pretty much all the important people on both sides ofthe gamble left the table rich.”1That tells you everything you need to know – except for how that anomalous situation cameabout, which is what the rest of this book will cover. The point to keep in mind here is that it isnot the market that malfunctioned. On the contrary, the market did exactly what it was supposedto do. It responded to risks and incentives in a rational manner. It was the risks and incentives thatwere distorted. That is what made it possible – in fact, what made it inevitable – that the peopleon both sides of the table got rich.However, if both sides made money, someone had to lose it. The problem is that it was not thebuyer or seller or counter-party or insurer who was on the other side of the transaction, it was therest of us. What happened was a massive shift of costs as Wall Street externalized the risk on to justabout everyone else. For example, a hedge fund called Magnetar helped create arcane mortgagebased instruments, made them even riskier, and then bet against them, putting their customers onthe other side.We have seen a fairly consistent cycle of boom and scandal in the fi nancial markets since thesavings and loan failures of the 1980s, and the one common theme is the ability of one segment ofthe economy to externalize its risks. In every case, the system was gamed so that the upside gainwas diverted in one direction and the downside losses were diverted in another. The market cannotoperate efficiently under those circumstances.Corporate governance is about how public companies are structured and directed. Every strategy, every innovation in product, operations, and mark

FFIRS.indd ii 6/2/11 12:34:44 PM. Corporate Governance FFIRS.indd i 6/2/11 12:34:44 PM. FFIRS.indd ii 6/2/11 12:34:44 PM. Corporate Governance Fifth Edition Robert A. G. Monks and Nell Minow FFIRS.indd iii 6/2/11 12:34:44 PM. This edition fi rst published in 2011

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