Reading 34- LOS c ～ Q1－4

1.McCool and Company is a consulting firm that provides research reports on corporate governance at large corporations and whether corporate governance systems are consistent with global best practices. McCool recently completed an evaluation of ARC Industries and listed the following observations:

§ 2 of the 10 directors for ARC Industries are former employees and 4 of the 10 have large personal stock holdings in the company.

§ The Chief Executive Officer for ARC has regular meetings with the Chairman of the Board.

§ Each board member is up for reelection to the board on an annual basis.

§ The nominating committee consists of 3 independent directors and the CEO of ARC Industries.

§ The compensation committee consists of 5 independent directors.

§ ARC has a requirement that all board members serving on the audit committee must be independent and must have a background in finance or accounting.

McCool and Company gives each company they evaluate a score based on how many of the following four items are consistent with global best practice:

Item 1: Board Independence.
Item 2: How the board is elected.
Item 3: Makeup of the nominating committee.
Item 4: Makeup of the audit committee.

Based on the observations of ARC Industries, what was ARC’s most likely score on the McCool report?

A)   50 percent.

B)   100 percent.

C)   25 percent.

D)   75 percent.

The correct answer was D)

Based on the observations, ARC Industries is in accordance with global corporate governance best practices with respect to 3 of the 4 items, resulting in a score of 75%.

With respect to Board independence, global best practice states that 75% of the directors should be independent. McCool observes that 2 of the 10 directors are former employees, but assuming no other conflicts, this would still result in 80 percent of the board being independent. Note that personal stock holdings among board members should be encouraged as it puts the board members in the same position as investors and can help align board member and investor interests.

Global corporate governance best practice supports annual elections of each board member rather than staggered elections – based on the observations, ARC is consistent with this practice.

The nominating committee should be made up entirely of independent directors. Having the company CEO on this committee means that ARC is not consistent with corporate governance best practice with respect to this item.

The audit committee should be made up entirely of independent directors and at least two members of the committee should have relevant accounting or auditing experience. It appears from the observations that ARC received a positive score for their requirements for serving on the audit committee.

2.Which of the following is most consistent with corporate governance best practice?

A)   Half of the board members are independent.

B)   Board members are limited to serving on a maximum of four other boards.

C)   Any related-party transactions must be approved in advance by the board of directors.

D)   Elections are staggered with at least 3 directors up for reelection to the board each year.

The correct answer was C)

Any insider or related-party transactions, such as making a personal loan to a company CEO should be approved in advance by the board of directors. Note that for purposes of the exam, global best practice calls for 75% of board members to be independent, board members do not serve on more than 2-3 boards total, and that all directors are elected annually.

3.Which of the following is least consistent with corporate governance best practice?

A)   The CEO and Chairman of the board are separate positions held by separate individuals.

B)   Board members conduct a self-assessment on an annual basis.

C)   Directors have access to in-house legal counsel whenever necessary to assess the company’s compliance with regulatory requirements.

D)   All members of the board compensation committee are independent.

The correct answer was C)

Directors should have access to independent, not in-house legal counsel for any questions related to the company’s compliance with regulatory requirements. The other statements are all considered corporate governance best practices.

4.Mike Ransom was recently elected to the board of directors for Tedeschi Chemical Corporation (TCC). Ransom knows that as a board member, he is responsible for serving on at least one board committee. In an effort to understand the board committee structure, he asks Kelly Williams, who has served on the board for 7 years, to describe the structure and practices of various committees to him. Williams makes the following statements:

Which of Williams’s statements about TCC’s committee structure are consistent with corporate governance best practice?

A)   Statement 3 only.

B)   Statements 1, 2, and 3.

C)   Statements 1 and 4 only.

D)   Statements 2 and 3 only.

The correct answer was A)

Statement 3 is a best practice – the internal audit staff of the firm should report directly to the audit committee. The other statements are not consistent with best practices. On the audit committee, two or more members should have relevant financial experience. The audit committee should have at least an annual meeting with auditors, but management should NOT be present. The nominating committee should consist ONLY of independent directors.