Roles and Responsibilities of Management

1. Roles and Responsibilities of Management Chapter VI

2. Chapter Objectives: • Introduce the managerial function of corporate governance. • Understand the roles, responsibilities, and duties of corporate senior executives, including the CEO and CFO. • Identify the components of executive compensation, and illustrate how each of these components relates to effective corporate governance. • Identify the financial reporting requirements of public companies and SOX provisions that pertain to management certifications of financial reports and internal controls. • Be aware of financial reporting challenges facing public companies, including off balance sheet arrangements, aggregate contractual obligations, and critical accounting policies and practices. • Discuss management’s responsibilities for ICFR. • Provide an overview of the costs and benefits resulting from Section 404 compliance. Video ( Video)

3. Key Terms Chief audit executive (CAE) Chief risk officer (CRO) Corporate development officer (CDO) Enterprise risk management (ERM) Extensible Business Reporting Language (XBRL) Financial Accounting Standards Board (FASB) Institute of Internal Auditors Research Foundation International Accounting Standards Board (IASB) International Financial Reporting Standards (IFRS) Joint Committee on Taxation Other postemployment benefits (OPEB) Tax shelter

4. Management Responsibilities Operating Process. The operating process entails: (1) operating activities of designing products and services, marketing and delivering products, invoicing products, and servicing customers; (2) investing activities of investing in both human and capital resources; and (3) financing activities of funding investments and expenditures through internal growth, issuing stocks, or incurring debt. Financial Reporting Process. Management should report both financial and nonfinancial KPIs that assist investors to predict the company’s future cash flows from operating, investing, and financing activities. Compliance Process. The compliance process involves compliance with all applicable rules, regulations, laws, and standards, including regulatory, legal, tax, environmental, social, and ethical standards and best practices.

5. Management Pre-SOX • Information asymmetry between management and owners Post-SOX • New certification requirements • Assessment of disclosure controls and procedures • Assessment of internal controls and procedures over financial reporting • Plan to comply with accelerated filing deadlines • Prepare for new disclosure requirements • Incorporate audit and non-audit service pre-approval procedures • Enhanced code of ethics for senior officers • Increased time and attention to governance activities

6. Corporate Officers CEO CEO. The CEO faces some challenges, including: fiduciary duties (including duty of loyalty and duty of care) self-serving and self-dealing succession planning Duality (please refer to chapter 4) financial knowledge and understanding The role of the CFO consists of both strategic performance and reporting compliance activities. The Corporate Development Officer’s position is especially important for the companies which are actively involved in the merger and acquisition process. CFO CDO

7. Corporate Officers CRO The Chief Risk Officer is a part of the Enterprise Risk Management (ERM) framework. So, in the post-SOX era, the CRO does not only have to identify and control risk, but also has to identify growth opportunities. A keen focus on internal control in the post-SOX period has necessitated companies to centralize their compliance efforts with internal control requirements. One way to synergize the compliance activities is to establish a new managerial position of the chief internal control officer (CICO) or to strengthen the existing position of CCO. CICO

8. Bank of America with new split ends

9. Executive Compensation Components of Executive Compensation: Salary Annual incentive compensation (bonus) Long-term incentive compensation Stock options award (These should be recognized as expenses in the income statements, according to the provisions of SFAS No. 123[R]) Employment contracts, severance, and change-of-control payments Retirement arrangements Stock ownership Executive Compensation Disclosure - On July 26, 2006, the SEC approved comprehensive changes in the disclosure requirements, and to comply with these requirements, companies should provide greater disclosure in their proxy statements, annual reports, and registration statements regarding total compensation of their directors, principal executive officer, principal financial officer, and three highest-paid officers.

10. Policymakers (Congress Regulators (SEC) Users Integrated Financial and Internal Control Reporting (IFICR) External Auditors StandardSetters (PCAOB, FASB, AICPA) Internal Auditors Management Financial Reporting Process

11. Public companies with more than $10 million of assets whose shares are held by more than 500 investors are required to file auditor’s annual reports (Form 10-K or 10-KSB) and quarterly reviewed reports (Form 10-Q or 10-QSB) with the SEC. The annual report of public companies normally contains the following financial information: 1. Audited financial statements, including their notes 2. MD&A of financial condition and results of operations 3. Management certifications of financial statements and internal controls 4. Management’s assessment of the effectiveness of ICFR 5. ACR 6. Independent auditor’s report on financial statements 7. Independent auditor’s report on the effectiveness of ICFR 8. Five-year summary of selected financial data 9. Summary of selected quarterly financial data for the past two years 10. Quarterly market data for the past two years, including high and low stock prices for common stock, dividends paid, and price earnings ratio. Section 302 Financial Reporting Requirements

12. Corporate Annual Reports • Summarize operating activities for the past year and plans for the future. • Many variations in the order and form, but all include: • Financial statements and notes • Management discussion and analysis • Independent auditors’ report

13. Management Discussion and Analysis (MDA) • Provides critical information in interpreting the financial statements and assessing the future of the company. • Includes an analysis about past performance and financial condition. • Discusses management’s opinion about future performance. • Discusses significant risk exposure.

14. Horizontal Analysis The percentage analysis of increases and decreases in related items in comparative financial statements.

15. Vertical Analysis A percentage analysis used to show the relationship of each component to the total within a single statement.

17. Solvency and Profitability • Solvency – the ability to meet debt obligations as they become due. • Profitability – the ability to earn income. Solvency and Profitability are interrelated!

18. Solvency and Profitability • Solvency – the ability to meet debt obligations as they become due. • Profitability – the ability to earn income. Solvency and Profitability are interrelated!

19. Solvency Analysis • Normally assessed by examining balance sheet relationships, using the following major analyses: • Current position analysis • Accounts receivable analysis • Inventory analysis • Ratio of fixed assets to long-term liabilities • Ratio of liabilities to stockholders’ equity • Number of times interest charges are earned

20. Current Position Analysis • Using measures to assess a business’s ability to pay its current liabilities. • Working capital – current assets less current liabilities. • Current ratio – current assets divided by current liabilities. • Quick ratio – total “quick” assets divided by current liabilities.

22. Accounts Receivable Analysis • Measures efficiency of collection. • Reflects liquidity. Accounts receivable turnover = Net Sales Avg. A/R Days’ Sales in Receivables = Avg. A/R Net Sales/365

23. A/R Turnover The company increased its accounts receivable turnover by 38% measured in terms of the number of times receivables are collected within the year.

24. Days’ Sales in Receivables The company improved its collections of accounts receivable by 10.9 days in 2009 measured in days receivables have been outstanding.

25. Inventory Analysis • Measures inventory efficiency. • Avoid tying up funds in inventory. • Avoid obsolescence. • Reflects liquidity. Inventory turnover = COGS Avg. Inventory Days’ Sales in Inventory = Avg. Inventory COGS/365

26. Inventory Turnover The company turned its inventory 1 time more in 2009, measured in terms of the number of times inventory turns over within the year.

27. Days’ Sales in Inventory The company reduced the time it held inventory by nearly 28% in 2009 measured in days the inventory was held in warehouses.

28. Ratio of Fixed Assets to Long-Term Liabilities • Indicates the margin of safety for noteholders or bondholders. • Indicates the ability to borrow additional funds on a long-term basis. Fixed Assets (net) Long-term Liabilities

29. Ratio of Fixed Assets to Long-Term Liabilities The company increased its margin of safety in financing fixed assets mainly by lowering long-term debt.

30. Ratio of Liabilities to Stockholders’ Equity • Indicates the margin of safety for creditors. • Indicates the ability to withstand adverse business conditions. Total Liabilities Total Stockholders’ Equity

31. Ratio of Liabilities to Stockholders’ Equity The ratio shows an increasing margin of safety for creditors.

32. Number of Times Interest Charges Earned • Indicates the general financial strength of the business. • Indicates the ability to withstand adverse business conditions. Income before Taxes + Interest Expense Interest Expense

33. Number of Times Interest Charges Earned The company covers its interest costs by 4 times. Does this seem adequate?

34. Profitability Analysis • Normally assessed by examining the income statement and balance sheet resources, using the following major analyses: • Ratio of net sales to assets • Rate earned on total assets • Rate earned on stockholders’ equity • Rate earned on common stockholders’ equity • Earnings per share on common stock • Price-earnings ratio • Dividends per share • Dividend yield

35. Ratio of Net Sales to Assets • Shows how effectively a firm utilizes its assets. Net Sales Avg. Total Assets (excluding LT Investments)

36. Ratio of Net Sales to Assets The ratio improved in 2009 primarily due to an increase in sales.

37. Rate Earned on Total Assets • Measures the profitability of total assets without considering how the assets are financed. Interest Expense + Net Income Avg. Total Assets

38. Rate Earned on Total Assets This ratio improved in 2009. It would also be a good idea to compare this rate with industry averages.

39. Rate Earned on Stockholders’ Equity • Emphasizes the rate of income earned on the amount invested by the stockholders. • Leverage is the rate on stockholders’ equity over the rate on total assets. Net Income Avg. Stockholders’ Equity

40. Rate Earned on Stockholders’ Equity

41. Leverage The company’s leverage of 3.1% for 2009 compares favorably with the 2.7% leverage for 2008.

42. Rate Earned on Common Stockholders’ Equity • Focuses on the rate of profits earned on the amounts invested by the common stockholders. • Different from the rate earned on stockholders’ equity if the company has preferred stock. Net Income – Preferred Dividends Avg. Common Stockholders’ Equity

43. Rate Earned on Common Stockholders’ Equity

44. Earnings Per Share on Common Stock • The income earned for each share of common stock. Net Income – Preferred Dividends Common Shares Outstanding

45. Earnings Per Share on Common Stock A share of common stock earned more in 2009 than it did in 2008. What is the importance of trends in EPS?

46. Price-Earnings Ratio • Indicator of the firm’s future earnings prospects. Market Price Per Share of Common Stock Annual Earnings Per Share

47. Price-Earnings Ratio The stock price has increased as a multiple of its earnings on common stock. This is a good thing!

48. Dividends per Shareand Dividend Yield • Dividend yield shows the rate of return to common stockholders in terms of cash dividends. Dividends per Share = Common Dividends Common Shares Dividend Yield = Common Dividend/Share Market Price/Share

49. Dividends per Shareand Dividend Yield

50. Dividends Per Shareand Dividend Yield The dividend yield decreased because the stock price rose more than the dividend.