LOS d: Describe the responsibilities of the board of directors, and explain the qualifications and core competencies that an investment analyst should look for in the board of directors. ffice ffice" />
Q1. Kathryn Rutherford recently joined the Board of Directors for Orvis Asset Management Company (Orvis) and will participate in its annual Board of Directors meeting. ffice:smarttags" />Rutherford is an Executive Vice President with Signature Bank, and knows Orvis’ finances well, serving as a commercial lender to Orvis for the last five years. Besides Rutherford, OAMC’s board consists of the following seven members:
- Dane Corser, CFO for Orvis who also serves on the board for Spencer Pharmaceuticals
- Tricia DeLucia, a granddaughter of Orvis’ founder, Michael Orvis
- Wendy Kepling, a former Executive Vice President with Orvis
- Troy Montgomery, the retired CEO of Forner Capital Management, another asset management firm
- Mike Shute, President of Spencer Pharmaceuticals
- Robert Stuart, an attorney with Bricker and Palmer, Orvis’ outside counsel
- Jason Winterfeld, Chairman and CEO of Orvis
Orvis is a publicly traded firm that specializes in managing equity portfolios for both institutional and individual clients. The firm’s investment philosophy is to focus on companies with a history of not changing their dividend payments in order to achieve stable returns. The firm’s marketing approach focuses on tax-exempt pension funds and endowments as well as individuals who depend on dividend payments to meet living expenses. Historically, Orvis has been a successful manager, but recently performance has declined relative to the firm’s benchmark. The primary focus at this board meeting is defining the long-term strategic objectives for the company and making sure the assets of the company, specifically its proprietary investment process, are being used in the best interests of the firm’s shareholders.
Winterfeld states that Item 1 on the Board’s agenda is to discuss the impact of dividends on shareholder value. Kepling begins the discussion by questioning whether Orvis’ investment process should focus on dividends at all. Kepling states, “According to work by Modigliani and Miller, dividends are irrelevant. If an investor holds a non-dividend paying stock, but wants the benefits of a dividend, all they have to do is sell a portion of the stock to get the cash flow they want. Whether the individual receives a cash dividend or sells a portion of their stock, the combination of the investment in the firm and the cash in hand is the same.” Montgomery replies, “I disagree with the theory that dividends are irrelevant. According to work by Gordon and Lintner, dividend payments matter because they are less risky than capital gains. Since investors perceive dividends as being less risky, a firm that starts paying a dividend is likely to see an increase in their P/E ratio.”
Kepling is also aware that Modigliani and Miller have done a great deal of work regarding capital structure theory. She asks Corser if Modigiani and Miller’s theory on capital structure has any implications for the percentage of debt and equity that Orvis has in its capital structure. Corser replies with two statements:
(1) Since Orvis has to pay taxes on its earnings, according to Modigliani and Miller, the optimal capital structure would be 100% debt.
(2) If bankruptcy costs are included in Modigliani and Miller’s capital structure theory, the value of a firm will be maximized when a firm’s cost of debt is minimized.
Which of the following questions about board independence is most accurate?
A) Montgomery qualifies as an independent director, but Stuart does not.
B) Stuart qualifies as an independent director, but Kepling does not.
C) Shute qualifies as an independent director, but DeLucia does not.
Correct answer is A)
Montgomery may have prior ties to the asset management business, but there appears to be no prior relationship with Orvis. Stuart, as an attorney with Orvis’ outside counsel, cannot be classified as independent due to his firm’s relationship with Orvis.
DeLucia, as a family member, and Kepling as a former employee cannot be classified as independent. Also, due to interlocking directorships, Shute cannot be classified as an independent director (Corser serves on the board for Spencer Pharmaceuticals, where Shute is the President and Shute serves on the board for Orvis, where Corser is the CFO).
Q2. Jason Winterfeld is the Chairman of the Board of Directors at Orvis, as well as the firm’s CEO. Which of the following best describes Winterfeld’s position according to corporate governance best practices? Having the CEO also serve as Chairman of the Board is:
A) in the best interest of shareholders because the CEO has the knowledge and experience to provide information to the board about company strategy and operations.
B) not in the best interest of shareholders because only an independent Chairman insures the proper functioning of the Board.
C) not in the best interest of shareholders because the Chairman/CEO could influence the culture of the board room and diminish the role of independent board members.
Correct answer is C)
Corporate governance experts believe that having a CEO also serve in the role of Chairman of the Board can negatively influence boardroom culture and diminish the role of independent board members. It is for this reason that corporate governance best practice supports having the Chairman and CEO as separate positions. Note that while the CEO does have the knowledge and experience to provide information to the board about company strategy and operations, if management is doing their job, it will provide the board with all necessary information, while it is the board’s responsibility to see that they get the information. Having the CEO as a knowledge base is not a valid justification for the dual role.
Q3. Given that Orvis does not meet the global corporate governance best practice that 75 percent of directors are independent, which of the following would be the best recommendation for a more effective system of corporate governance?
A) Reduce the potential for conflicts of interest between principals and agents of the firm.
B) Determine board member responsibilities and how the board will be held accountable.
C) Create long-term strategic objectives for the company that are consistent with shareholders’ best interests.
Correct answer is A)
Since one of the two primary objectives of corporate governance is to eliminate or reduce conflicts of interest in a firm, and Orvis obviously has many potential conflicts of interest on their board, reducing the potential conflicts of interest between principals and agents of the firm is the best answer. In a corporation, principal-agent relationships exist between shareholders and management, and directors and shareholders. A principal agent problem occurs when managers or directors (the agent) act in their own best interests rather than those of the owners of the firm (the shareholders/principals). Both remaining answer choices are all good things, but do not get to the core principals of corporate governance which are reducing or eliminating conflicts of interest, and using company assets productively and in the best interests of shareholders.
Q4. Which of the following statements best reflects Orvis’ investment philosophy and marketing approach? Orvis’ investment philosophy is:
A) not consistent with a stable dividend policy, and the marketing approach depends on the signaling effect.
B) not consistent with a stable dividend policy, and the marketing approach depends on the clientele effect.
C) consistent with a stable dividend policy, and the marketing approach depends on the clientele effect.
Correct answer is B)
Orvis’ investment philosophy is to focus on companies with a history of not changing their dividend payments, which is NOT consistent with a stable dividend policy. A stable dividend policy aligns the company’s dividend with the firm’s long-term growth rate to achieve stability in the rate of increase for the dividend each year. If the company never changed their dividend payments, the value of the dividend would decline over time as a result of inflation. The marketing approach seems to depend on the clientele effect which refers to the varying preference for dividends among different groups of investors. Tax considerations, institutional investor requirements, and individual investor preferences to spend dividends only and not dip into principal are all rationales for the clientele effect.
Q5. With regard to their statements about dividend theories:
A) Kepling is correct; Montgomery is correct.
B) Kepling is correct; Montgomery is incorrect.
C) Kepling is incorrect; Montgomery is correct.
Correct answer is A)
Kepling is correct. According to Modigliani and Miller’s dividend irrelevance theory, a stock holder can effectively create their own dividend policy by buying or selling a firm’s stock to get the combination of cash flow and ownership they want to receive. Note that Modigliani and Miller’s theory only holds in a perfect world with no taxes or brokerage costs. Montgomery is also correct. According to Gordon and Lintner’s “bird-in-the-hand theory,” a dollar of dividends is less risky than a dollar of capital gains. Since dividends are less risky, a company that pays dividends will cause its cost of equity to decrease. Since the cost of equity declines, the required return for the investor will also decline, which will result in a higher P/E ratio.
Q6. With regard to Corser’s statements about Modigliani and Miller’s theory on capital structure, Kepling should:
A) agree with Statement 1, but disagree with Statement 2.
B) agree with both Statements 1 and 2.
C) disagree with Statement 1, but agree with Statement 2.
Correct answer is A)
Modgliani and Miller’s work on capital structure theory concludes that in a world with no taxes and no bankruptcy costs, capital structure is irrelevant. However, in a subsequent study, they updated their work to include the effect of taxes. Since corporations can deduct interest payments when determining taxable income, the stockholders will benefit from the use of debt. According to their theory, the optimal capital structure in a world with taxes is 100% debt – Statement 1 is correct. However, if bankruptcy costs are factored into their results, debt is useful initially for its tax savings to lower the cost of capital, but only up to the point where it increases risk and the cost of debt and equity starts to rise. In a world with taxes and bankruptcy costs, the optimal capital structure is the one that minimizes the weighted average cost of overall capital - not simply the cost of debt.
Q7. Which of the following statements concerning the audit committee of the board of directors is least accurate? The audit committee:
A) should directly oversee the internal audit staff of the company.
B) should not have any dialogue with management in order to ensure that the committee’s actions are independent of management activities.
C) should consist entirely of independent board members.
Correct answer is B)
The audit committee should have full access to and the cooperation of management in order to perform their duties.
Q8. Ashley Jones is considering joining the board of directors of Dusseau Investment Management (DIM). Before joining the board, Jones wants to make sure she fully understands what her responsibilities would be as a board member. Kenley Walker, administrative assistant to DIM’s CEO prepares a memo to Jones detailing responsibilities of board members.
Responsibility 1: Establish corporate values and governance structures to ensure that business is conducted in an ethical, fair, and professional manner.
Responsibility 2: Determine which proxy issues that have received a majority of shareholder votes should be addressed or ignored.
Responsibility 3: Hire the company’s chief executive officer (CEO), and determine the CEO’s compensation package.
Which of the responsibilities listed by Walker are CORRECT?
A) Responsibility 1 only.
B) Responsibilities 1 and 3 only.
C) Responsibilities 1, 2, and 3.
Correct answer is B)
Directors should always address all proxy issues that have received a majority of shareholder votes. Responsibilities of directors include hiring the firm’s CEO and determining the CEO’s compensation, and establishing corporate values and governance structures to ensure that business is conducted in an ethical, fair, and professional manner.
Q9. Sunil Reddy is an analyst for Worldwide Financial Services. Reddy thinks that Worldwide’s procedures for analyzing companies for inclusion in client portfolios would be more robust if it included a review of the company’s board of directors. Reddy prepares a list of five items concerning the board of directors that analysts should assess:
Item 1: Frequency of separate sessions for independent directors.
Item 2: Use of independent legal counsel as opposed to company in-house counsel.
Item 3: Composition of the nominating committee.
Item 4: Composition of the compensation committee.
Item 5: Whether the board has staggered or annual elections.
Which of the items on Reddy’s list are attributes of a board of directors that are important for an analyst to assess?
A) All five items.
B) Items 1, 3, and 5 only.
C) Items 2, 3, and 4 only.
Correct answer is A)
All five of the items on Reddy’s list are important factors that an analyst should review when assessing a board of directors.
Q10. All of the following are responsibilities of the board of directors for a corporation EXCEPT:
A) ensure new board members are adequately trained to perform board functions.
B) make disclosures regarding company operations, risk, and financial position that are accurate and transparent.
C) ensure that management has supplied the board with sufficient information to be fully informed and make appropriate decisions.
Correct answer is B)
Actually making disclosures about company operations is the responsibility of management. It is the responsibility of the board to make sure management is acting in the best interests of shareholders, which may entail appointing/serving on the audit committee to review those disclosures. Both remaining choices listed are all board responsibilities.
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发表于 2009-3-3 14:48
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