Reference no: EM13252059

The law generally gives board of directors the latitude to consider the long view in determining the best interests of the corporation, as well as ethics, legality, and the interests of all stakeholders in the fulfilling of their duties. The adapted case study focuses on a board's responsibility to shareholders. After having read the case study, address the questions found at the end of the case study in paragraph format. Structure your responses around the six characteristics that comprise the responsibilities of a board of directors, outlined in the pre-requisite reading.

Case study

There is a vast research literature that chronicles the impact when a company suffers a major governance failure (which might be due to an ethical or accounting violation or to insufficient risk management and oversight). First, stock prices fall around the initial announcement period, with the magnitude of the decline commensurate with the severity of the failure.

Second, stock price underperformance tends to persist well past the announcement period, suggesting that the damage to the company is of potential long-term consequence. Third, the companies (and their officers and directors) often face lawsuits from shareholders and regulators, who seek to be compensated for their losses.

And finally, there is elevated turnover in both the executive suite and the boardroom, as companies signal to the market that they are serious about reform.

The impact on the long-term careers of the former executives and directors of these companies, however, is less clear. Recent experience suggests that many CEOs and directors of failed companies are able to retain outside directorships-and even obtain new ones-following their forced departures. For example, after resigning from Citigroup in 2007, former chairman and CEO Charles Prince was elected to the board of Xerox. Stanley O'Neill, former chairman and CEO of Merrill Lynch, was not only named a director of Alcoa but was also appointed to that company's audit committee. Nonexecutive directors at Lehman Brothers, Wachovia,

Washington Mutual, Bear Stearns, and AIG all gained new directorships after their companies failed (see Exhibit 1).

Clearly, circumstance plays a role in determining whether leaders of failed companies are fit to serve as directors of other organizations. For example, the opinions might be based on the degree to which these individuals were associated with wrongdoing. They might also depend on the individual's capacity to learn from error. In these cases, companies might benefit from the knowledge and experience gained firsthand by individuals who have been involved with a crisis or failure.

On the other hand, there are reasons why the executives and directors of failed companies might not be fit to hold future directorships. First, governance failures are not the same as managerial failures. Executives are hired with the express purpose of taking strategic risk to increase shareholder value, some of which might not work out as hoped. Corporate monitors, by contrast, are hired with the express purpose of detecting malfeasance. While "failure" is an expected part of a managerial job, it is not an expected part of a monitoring job.

Second, governance failure might reveal underlying character flaws in the leaders themselves. If executives and directors were not sufficiently engaged in their duties (or, worse, if they exhibited low levels of integrity), these shortcomings might manifest themselves again in other settings. Third, companies that retain such individuals in the future might be subject to heightened scrutiny. Rightly or wrongly, these individuals have incurred reputational damage simply through their association with a failed firm. Companies that subsequently employ them are likely to face pushback from shareholders and stakeholders.

There is some evidence that the executives of failed companies are treated more strictly than the directors of those same companies. According to a recent survey of executives and directors, only 37 percent believe that the former CEO of a company that experienced substantial accounting and ethical problems can be a good board member at another company. By contrast, 67 percent of respondents believe that directors of such a company can be a good board member elsewhere. When asked to elaborate, respondents tend to suggest that the CEO is held to a higher standard of accountability, given his or her position of leadership. By contrast, directors are presumed to have less involvement in potential violations and are also seen as able to learn from mistakes of this nature. However, these opinions are not universal (see Exhibit 2).

WHY THIS MATTERS

1. In recent years, there have been many large- and small-scale corporate failures, driven in part by ethical, accounting, or risk management improprieties. However, the executives and directors of these companies have in many cases gained employment as directors of other firms. Should this be a concern for shareholders of these firms?

2. Executives and directors often suffer reputational damage from their association with a failed company. What is the standard by which their "culpability" should be judged? When are these individuals fit to hold future directorships, and when are they "too tainted" by their
experience?

3. How plausible is the argument that an officer or director involved in an accounting or ethical problem "should have learned valuable lessons from the experience" that makes them a valuable board member for other companies?

Attachment:- cfin.zip