Published by FT Press (March 10, 2021) © 2021
David Larcker | Brian Tayan
The Definitive Guide to High-Performance Corporate Governance
Fully updated for the latest research, trends, and regulations, Corporate Governance Matters, Third Edition, offers comprehensive and objective information for everyone seeking to improve corporate governance—from directors to institutional investors to policymakers and researchers.
To help you design highly effective governance, David Larcker and Brian Tayan thoroughly examine current options, reviewing what is and isn't known about their impact on organizational performance. Throughout, they take a strictly empirical and non-ideological approach that reflects rigorous statistical and research analysis and real-life examples. They address issues ranging from board structure, processes, operations, and functional responsibilities to institutional investors, outside stakeholders, and alternative forms of governance.
New discussions of:
Extensively revised coverage of:
The authors' balanced approach provides useful tools for making better, more informed decisions on governance.
Fully updated for the latest research, trends, and regulations, Corporate Governance Matters, Third Edition, offers comprehensive and objective information for everyone seeking to improve corporate governance—from directors to institutional investors to policymakers and researchers.
To help you design highly effective governance, David Larcker and Brian Tayan thoroughly examine current options, reviewing what is and isn't known about their impact on organizational performance. Throughout, they take a strictly empirical and non-ideological approach that reflects rigorous statistical and research analysis and real-life examples. They address issues ranging from board structure, processes, operations, and functional responsibilities to institutional investors, outside stakeholders, and alternative forms of governance.
New discussions of:
- Environmental, Social, and Governance (ESG) activity and ratings
- Stakeholder interests
- CEO activism
- CEO misbehavior
- Cybersecurity risks
Extensively revised coverage of:
- Executive compensation
- Leadership and succession planning
- Director recruitment, evaluation, turnover, and more
The authors' balanced approach provides useful tools for making better, more informed decisions on governance.
Preface xviii
Chapter 1 Introduction to Corporate Governance 1
Self-Interested Executives 4
Defining Corporate Governance 8
Corporate Governance Standards 9
Best Practice or Best Practices? Does “One Size Fit All”? 12
Relationship between Corporate Governance and Firm Performance 13
Endnotes 15
Chapter 2 International Corporate Governance 19
Capital Market Efficiency 19
Legal Tradition 22
Accounting Standards 23
Enforcement of Regulations 25
Societal and Cultural Values 26
Individual National Governance Structures 28
United States 29
United Kingdom 31
Germany 35
Japan 37
South Korea 40
China 41
India 43
Brazil 44
Russia 46
Endnotes 47
Interlude 53
Chapter 3 Board of Directors: Duties and Liability 55
Board Responsibilities 55
Board Independence 56
The Operations of the Board 57
Board Committees 60
Duration of Director Terms 64
Director Elections 64
Removal of Directors 66
Legal Obligations of Directors 66
Fiduciary Duty 67
Environmental, Social, and Governance (ESG) 70
Disclosure Obligations under Securities Laws 71
Legal Enforcement of State Corporate Law (Fiduciary Duties) 72
Legal Enforcement of Federal Securities Laws 73
Director Indemnification and D&O Insurance 73
Endnotes 75
Chapter 4 Board of Directors: Selection, Compensation, and Removal 79
Market for Directors 79
Criteria for Director Recruitment 80
Active CEOs 81
International Experience 82
Special Expertise 82
Diverse Directors 84
Professional Directors 85
Disclosure Requirements for Director Qualifications 86
Director Recruitment Process 87
Director Compensation 90
Ownership Guidelines 95
Board Evaluation 96
Removal of Directors 98
Endnotes 102
Chapter 5 Board of Directors: Structure and Consequences 109
Board Structure 110
Chairman of the Board 113
Lead Independent Director 116
Outside Directors 119
Board Independence 122
Independent Committees 125
Bankers on the Board 126
Financial Experts on Board 127
Politically Connected Boards 127
Employee Representation 129
Boards with “Busy” Directors 131
Interlocked (or Connected) Boards 134
Committee Overlap 135
Board Size 136
Board Diversity 136
Female Directors 138
Summary 139
Endnotes 141
Interlude 150
Chapter 6 Strategy, Performance Measurement, and Risk Management 151
Organizational Strategy 151
Strategy Implementation Process 154
Business Model Development and Testing 156
Example 1: Fast-Food Chain and Employee Turnover 156
Example 2: Financial Services Firm and Investment Advisor Retention 158
Key Performance Measures 159
How Well Are Boards Doing with Performance Measures and Business Models? 162
Risk and Risk Management 164
Risk and Risk Tolerance 165
Risk to the Business Model 166
Risk Management 169
Oversight of Risk Management 172
Assessing Board Performance on Risk Management 174
Cybersecurity 175
Endnotes 177
Chapter 7 CEO Selection, Turnover, and Succession Planning 181
Labor Market for Chief Executive Officers 181
Labor Pool of CEO Talent 184
CEO Turnover 186
Newly Appointed CEOs 191
Models of CEO Succession 193
External Candidate 193
President and/or Chief Operating Officer 195
Horse Race 196
Inside–Outside Model 197
The Succession Process 197
How Well Are Boards Doing with Succession Planning? 201
Executive Search Firms 203
Endnotes 205
Chapter 8 Executive Compensation and Incentives 211
The Controversy over Executive Compensation 212
Competing Theories of CEO Pay 213
Components of Compensation 214
Determining Compensation 218
Compensation Consultants 221
Compensation Levels 221
Ratio of CEO Pay to Other Top Executive Pay 226
Ratio of CEO Pay to Average Employee Pay 229
Compensation Mix 230
Short-Term Incentives 233
Long-Term Incentives 235
Benefits and Perquisites 237
Compensation Disclosure 238
Say-on-Pay 239
Competing Theories of CEO Pay 242
Endnotes 243
Chapter 9 Executive Equity Ownership 251
Equity Ownership and Firm Performance 251
Equity Ownership and Risk 254
Equity Ownership and Agency Costs 259
Accounting Manipulation 260
Manipulation of Equity Grants 261
Other Examples of Value Extraction through Timing 263
Equity Sales and Insider Trading 264
Rule 10b5-1 267
Hedging 269
Pledging 273
Repricing and Exchange Offers 274
Endnotes 277
Chapter 10 Financial Reporting and External Audit 285
The Audit Committee 285
Accounting Quality, Transparency, and Controls 286
Financial Reporting Quality 288
Non-GAAP Reporting 290
Financial Restatements 291
Models to Detect Accounting Manipulations 297
The External Audit 299
Audit Quality 302
Structure of Audit Industry 302
Impact of Sarbanes–Oxley 305
External Auditor as CFO 307
Auditor Rotation 308
Endnotes 310
Chapter 11 The Market for Corporate Control 319
The Market for Corporate Control 320
Stock Market Assessment of Acquiring and Target Firms 324
Who Gets Acquired? 324
Who Gets the Value in a Takeover? 327
Antitakeover Protections 330
Antitakeover Actions 331
Poison Pills 333
Staggered Board 335
State of Incorporation 337
Dual-Class Shares 339
Warding Off Unwanted Acquirers 341
Endnotes 344
Chapter 12 Shareholders and Shareholder Activism 351
The Role of Shareholders 351
Blockholders and Institutional Investors 354
Institutional Investors and Proxy Voting 357
Activist Investors 359
Pension Funds 361
ESG and Socially Responsible Investing 363
Individual Activist Investors 364
Activist Hedge Funds 366
The Rise of Index Investing 370
Shareholder Democracy and Corporate Engagement 371
Majority Voting in Uncontested Director Elections 371
Proxy Access 372
Proxy Voting 372
Corporate Engagement 374
Proxy Advisory Firms 375
Endnotes 381
Chapter 13 Stakeholders and Stakeholder Activism 391
Pressure to Incorporate Stakeholder Interests 392
Legal and Economic Implications 397
Director and CEO Views on Stakeholders 401
ESG Metrics and Disclosure 402
External Assessment of ESG 407
Endnotes 417
Chapter 14 Corporate Governance and ESG Ratings 425
Third-Party Ratings 425
Credit Ratings 426
Commercial Corporate Governance Ratings 428
ISS: Corporate Governance Quotient 428
ISS: Governance Risk Indicators 430
ISS: QualityScore 430
MSCI ESG Governance Metrics 431
Testing the Predictability of Corporate Governance Ratings 432
Governance Rating Systems by Academic Researchers 433
The Viability of Governance Ratings 438
ESG Ratings 439
MSCI ESG 440
Sustainalytics 441
Vigeo Eiris 442
HIP (Human Impact + Profit) 442
ISS E&S Disclosure QualityScore 442
TruValue Labs 443
Evaluation of ESG Ratings 443
Endnotes 444
Chapter 15 Alternative Models of Governance 449
Family-Controlled Corporations 449
Venture-Backed Companies 452
Private Equity-Owned Companies 458
Nonprofit Organizations 462
Endnotes 466
Chapter 16 Summary and Conclusions 473
Testing Remains Insufficient 474
The Current Focus Is Misdirected 475
Important Variables Are Clearly Missing 476
Context Is Important 477
Rights of Shareholders and Stakeholders 478
Endnotes 478
Index 481
Chapter 1 Introduction to Corporate Governance 1
Self-Interested Executives 4
Defining Corporate Governance 8
Corporate Governance Standards 9
Best Practice or Best Practices? Does “One Size Fit All”? 12
Relationship between Corporate Governance and Firm Performance 13
Endnotes 15
Chapter 2 International Corporate Governance 19
Capital Market Efficiency 19
Legal Tradition 22
Accounting Standards 23
Enforcement of Regulations 25
Societal and Cultural Values 26
Individual National Governance Structures 28
United States 29
United Kingdom 31
Germany 35
Japan 37
South Korea 40
China 41
India 43
Brazil 44
Russia 46
Endnotes 47
Interlude 53
Chapter 3 Board of Directors: Duties and Liability 55
Board Responsibilities 55
Board Independence 56
The Operations of the Board 57
Board Committees 60
Duration of Director Terms 64
Director Elections 64
Removal of Directors 66
Legal Obligations of Directors 66
Fiduciary Duty 67
Environmental, Social, and Governance (ESG) 70
Disclosure Obligations under Securities Laws 71
Legal Enforcement of State Corporate Law (Fiduciary Duties) 72
Legal Enforcement of Federal Securities Laws 73
Director Indemnification and D&O Insurance 73
Endnotes 75
Chapter 4 Board of Directors: Selection, Compensation, and Removal 79
Market for Directors 79
Criteria for Director Recruitment 80
Active CEOs 81
International Experience 82
Special Expertise 82
Diverse Directors 84
Professional Directors 85
Disclosure Requirements for Director Qualifications 86
Director Recruitment Process 87
Director Compensation 90
Ownership Guidelines 95
Board Evaluation 96
Removal of Directors 98
Endnotes 102
Chapter 5 Board of Directors: Structure and Consequences 109
Board Structure 110
Chairman of the Board 113
Lead Independent Director 116
Outside Directors 119
Board Independence 122
Independent Committees 125
Bankers on the Board 126
Financial Experts on Board 127
Politically Connected Boards 127
Employee Representation 129
Boards with “Busy” Directors 131
Interlocked (or Connected) Boards 134
Committee Overlap 135
Board Size 136
Board Diversity 136
Female Directors 138
Summary 139
Endnotes 141
Interlude 150
Chapter 6 Strategy, Performance Measurement, and Risk Management 151
Organizational Strategy 151
Strategy Implementation Process 154
Business Model Development and Testing 156
Example 1: Fast-Food Chain and Employee Turnover 156
Example 2: Financial Services Firm and Investment Advisor Retention 158
Key Performance Measures 159
How Well Are Boards Doing with Performance Measures and Business Models? 162
Risk and Risk Management 164
Risk and Risk Tolerance 165
Risk to the Business Model 166
Risk Management 169
Oversight of Risk Management 172
Assessing Board Performance on Risk Management 174
Cybersecurity 175
Endnotes 177
Chapter 7 CEO Selection, Turnover, and Succession Planning 181
Labor Market for Chief Executive Officers 181
Labor Pool of CEO Talent 184
CEO Turnover 186
Newly Appointed CEOs 191
Models of CEO Succession 193
External Candidate 193
President and/or Chief Operating Officer 195
Horse Race 196
Inside–Outside Model 197
The Succession Process 197
How Well Are Boards Doing with Succession Planning? 201
Executive Search Firms 203
Endnotes 205
Chapter 8 Executive Compensation and Incentives 211
The Controversy over Executive Compensation 212
Competing Theories of CEO Pay 213
Components of Compensation 214
Determining Compensation 218
Compensation Consultants 221
Compensation Levels 221
Ratio of CEO Pay to Other Top Executive Pay 226
Ratio of CEO Pay to Average Employee Pay 229
Compensation Mix 230
Short-Term Incentives 233
Long-Term Incentives 235
Benefits and Perquisites 237
Compensation Disclosure 238
Say-on-Pay 239
Competing Theories of CEO Pay 242
Endnotes 243
Chapter 9 Executive Equity Ownership 251
Equity Ownership and Firm Performance 251
Equity Ownership and Risk 254
Equity Ownership and Agency Costs 259
Accounting Manipulation 260
Manipulation of Equity Grants 261
Other Examples of Value Extraction through Timing 263
Equity Sales and Insider Trading 264
Rule 10b5-1 267
Hedging 269
Pledging 273
Repricing and Exchange Offers 274
Endnotes 277
Chapter 10 Financial Reporting and External Audit 285
The Audit Committee 285
Accounting Quality, Transparency, and Controls 286
Financial Reporting Quality 288
Non-GAAP Reporting 290
Financial Restatements 291
Models to Detect Accounting Manipulations 297
The External Audit 299
Audit Quality 302
Structure of Audit Industry 302
Impact of Sarbanes–Oxley 305
External Auditor as CFO 307
Auditor Rotation 308
Endnotes 310
Chapter 11 The Market for Corporate Control 319
The Market for Corporate Control 320
Stock Market Assessment of Acquiring and Target Firms 324
Who Gets Acquired? 324
Who Gets the Value in a Takeover? 327
Antitakeover Protections 330
Antitakeover Actions 331
Poison Pills 333
Staggered Board 335
State of Incorporation 337
Dual-Class Shares 339
Warding Off Unwanted Acquirers 341
Endnotes 344
Chapter 12 Shareholders and Shareholder Activism 351
The Role of Shareholders 351
Blockholders and Institutional Investors 354
Institutional Investors and Proxy Voting 357
Activist Investors 359
Pension Funds 361
ESG and Socially Responsible Investing 363
Individual Activist Investors 364
Activist Hedge Funds 366
The Rise of Index Investing 370
Shareholder Democracy and Corporate Engagement 371
Majority Voting in Uncontested Director Elections 371
Proxy Access 372
Proxy Voting 372
Corporate Engagement 374
Proxy Advisory Firms 375
Endnotes 381
Chapter 13 Stakeholders and Stakeholder Activism 391
Pressure to Incorporate Stakeholder Interests 392
Legal and Economic Implications 397
Director and CEO Views on Stakeholders 401
ESG Metrics and Disclosure 402
External Assessment of ESG 407
Endnotes 417
Chapter 14 Corporate Governance and ESG Ratings 425
Third-Party Ratings 425
Credit Ratings 426
Commercial Corporate Governance Ratings 428
ISS: Corporate Governance Quotient 428
ISS: Governance Risk Indicators 430
ISS: QualityScore 430
MSCI ESG Governance Metrics 431
Testing the Predictability of Corporate Governance Ratings 432
Governance Rating Systems by Academic Researchers 433
The Viability of Governance Ratings 438
ESG Ratings 439
MSCI ESG 440
Sustainalytics 441
Vigeo Eiris 442
HIP (Human Impact + Profit) 442
ISS E&S Disclosure QualityScore 442
TruValue Labs 443
Evaluation of ESG Ratings 443
Endnotes 444
Chapter 15 Alternative Models of Governance 449
Family-Controlled Corporations 449
Venture-Backed Companies 452
Private Equity-Owned Companies 458
Nonprofit Organizations 462
Endnotes 466
Chapter 16 Summary and Conclusions 473
Testing Remains Insufficient 474
The Current Focus Is Misdirected 475
Important Variables Are Clearly Missing 476
Context Is Important 477
Rights of Shareholders and Stakeholders 478
Endnotes 478
Index 481