Corporate Governance

Best Practices: Implications for Commercial Underwriters

Adel Abouhana

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Corporate Governance Core concern: How do we make sure

that top managers are doing what they’re

supposed to be doing?

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The Agency Perspective Separation of ownership & control

◦ Principals & agents

◦ Misalignment of interests

What’s good for the managers may not be what is

good for the owners

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The Stakeholder Perspective

The board has broader responsibilities

◦ Focus is on protecting key stakeholder rights

Shareholders

Employees

Vendors

Customers

Society as a whole

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Best Practices

The board of directors

Executive compensation

Anti-takeover measures

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The Board of Directors

Role is to monitor & evaluate top

management

But, is the board a complete solution?

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Best Practices:

Board of Directors Separate CEO & Chairman of the Board

◦ Role duality gives CEO too much power

Appointment of lead outside director

Former CEO does not continue to sit on

the board

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Best Practices:

Board of Directors Active board members

◦ Not a rubber-stamp board

Evidence that the directors are in contact with

employees, vendors, & customers

Board composition

◦ Size

◦ Age

◦ Diversity

◦ Expertise

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Best Practices:

Board of Directors Board composition

◦ Insiders versus outsiders

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Best Practices:

Board of Directors Board composition

◦ Insiders versus outsiders

◦ “Having a board monitor itself is like having

the fox watch the henhouse.”

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Best Practices:

Board of Directors Board composition

◦ Insiders versus outsiders

◦ “Having a board monitor itself is like having

the fox watch the henhouse.”

◦ The majority should be independent

◦ Should have formal resolution requiring this

AND a written definition of independence

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Best Practices:

Board of Directors Board composition

◦ What is meant by “independent”?

No material relationship with the company, either

directly or as a partner, shareholder or officer of a

firm that has a relationship with the company

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Best Practices:

Board of Directors Board composition

◦ What is meant by “independent”?

Five year “cooling off” period before can be

considered independent:

Former employees of the firm

If formerly part of an interlocking directorate in which an

executive of the firm sat on the compensation committee of

the firm employing the director

Same applies to directors with immediate family members in

the above categories

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Best Practices:

Board of Directors Board members (insiders & outsiders)

◦ Limits on number of other board memberships

Average director spends 176 hours a year for each board position

◦ CEOs should not serve on each other’s boards (interlocking directorates)

◦ Directors & their firms barred from doing consulting, legal, or other work for the firm

◦ Significant stock ownership of firm by directors

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Best Practices:

Board of Directors Board committees

◦ Key committees at least chaired by outsiders

Audit, compensation, corporate governance

(nominating) committees

◦ Preferred: Key committees composed entirely

of independent directors

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Best Practices:

Board of Directors Board committees

◦ Compensation committee

Conduct formal evaluation of all company officers

(including CEO) and set compensation

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Best Practices:

Board of Directors Board committees

◦ Corporate governance (nominating) committee

Create charter for board

Conduct formal governance review using an external consultant

Nominate board members

Board term limits

Elections One class of directors

Each director stands for re-election each year

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Best Practices:

Board of Directors Board committees

◦ Audit committee

Select independent auditor

Not also employed for consulting work

Do not seek SEC exemption to do so

Rotate auditors – at least rotate the lead auditor, if

not the entire firm, every 5 years

CEO & CFO should not be former employees of

the auditing firm

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Best Practices:

Board of Directors Board meetings

◦ Frequency of overall board & committee meetings

◦ Attendance

◦ “Executive” sessions

Lead outside director with term limits

◦ Risk assessment function

Reports identifying risks & methods of addressing

◦ Access to internal information

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Best Practices:

Executive Compensation CEO has substantial stock ownership

Salary, bonuses, & stock options reward superior performance

◦ not size of the company

AND penalize poor performance

No modification of performance goals

◦ No re-pricing or swapping stock options

Expense stock options

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Best Practices:

Anti-takeover measures Lack of provisions designed to thwart a

hostile takeover

◦ Golden parachutes

◦ Poison pill provisions

◦ Greenmail

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