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Corporate Governance Post Enron

Corporate Governance Post Enron. By Martin Lipton. What went wrong Wall Street. Poor performance in 70’s and 80’s US firms lost competitive edge Shareholder activism grew Led to Managing earnings short-term For option maximization Made any level of compensation acceptable.

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Corporate Governance Post Enron

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  1. Corporate GovernancePost Enron By Martin Lipton

  2. What went wrong Wall Street • Poor performance in 70’s and 80’s • US firms lost competitive edge • Shareholder activism grew • Led to • Managing earnings short-term • For option maximization • Made any level of compensation acceptable

  3. What went wrong Wall Street • Analysts glorified and overvalued steady earnings • Led firms to strain rules to meet expectations • Many managers thought of nothing else • Pre-occupied with short-term results

  4. What went wrong Wall Street • Special purpose entities marketed to create revenue of remove debt from balance sheet • Analysts accepted pro forma earnings • Hot IPOs became a currency for courting favor • Media extolled the “new era” • SEC and Congress ignored problems

  5. What went wrong Corporate Governance • Boards of directors independent in name only • CEO dominated boards • Ethics codes waived by directors • Board meetings short and unfocused • Audit committees did not understand accounting and failed to insist on adequate explanations

  6. What went wrong Corporate Governance • Whistleblowers silenced • Non-management directors had no leader or a forum • Companies made unsecured loans to officers • Large stock profits realized by managers shortly before stock price declines

  7. What went wrong Corporate Governance • Executive compensation increased exponentially • Decisions on compensation often accepted based solely on recommendations by compensation consultants

  8. What went wrongAccountants • Accountants failed to demand true transparency • Auditors routinely went to work for client after leaving CPA firm • Auditor also did internal audit • Could use rules-based GAAP rules to present a misleading picture

  9. What went wrongAccountants • Auditor’s basic relationship with management not board • Auditors were paid more and better for consulting rather than auditing • Might “low ball” audit fee to get engagement

  10. What went wrongGatekeepers • CEO’s and CFO’s used creative accounting • Blamed subordinates and accountants for failure • Board of directors blamed management and accountants • Accountants blamed management

  11. What went wrongGatekeepers • Lawyers approved questionable transactions and did not force recognition or disclosure violations • Investment bankers assisted accountants and management by developing more sophisticated financing vehicles • Sometimes “suggested” alternatives

  12. Where do we go from here • Shift power to board • Make majority of board independent • Limit board interlocks • Exclude CEO from some board meetings • Shareholders approve use of stock in compensation • Enhance shareholder powers • May encourage more proxy fights • Result may be that CEO tenure will be shorter with more tension with board in poor performers

  13. Where do we go from here • Board meetings will be longer and more meaningful • Hard questions expected • Dissent viewed as an obligation • Board make customary strategic reviews • Only independent directors on key board committees

  14. Where do we go from here • Directors serve on fewer boards • Boards will be smaller • Ten or fewer • Board do meaningful self evaluation and peer reviews • Board seek help from independent advisors

  15. Where do we go from here • Board less tolerant of poor performance • Director compensation will be higher • National rather than local boards consisting of “comparable” execs • Executive compensation receive more scrutiny

  16. Where do we go from here • Accounting and disclosure more transparent • New rules limit ability of pro forma earnings being misleading • Audit committee much more aware of auditor’s qualifications and history of problems

  17. Where do we go from here • Audit committee will insist auditor take more responsibility on disclosure • Gatekeepers will be gatekeepers • Directors exposure to liability will not increase • SEC and NYSE will insist on limit to exposure to director acting in good faith

  18. Where do we go from here • Corporate governance, and accounting, in US and EC will converge

  19. Recommendations from Higgs Report in UK • Majority of board should be independent • Still should be strong executive representation • Roles of Chairman and chief executive should be separated • Responsibilities of each determined by Board

  20. Recommendations from Higgs Report in UK • Rules set down for what is an independent director • Annual report should disclose which directors are independent • Independent directors should meet at least once a year alone • A senior independent director should be identified as being available to shareholders

  21. Recommendations from Higgs Report in UK • Chairman and CEO should establish training programs for future directors • An annual evaluation of board, committees and individual directors • Terms should be limited to two three year stints with limited exceptions • A full-time exec should serve on the board on no more than one other company

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