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Kimi Hatcher is a consultant for Druson Corporate Consultants. Hatcher recently evaluated the management team at Burnett Television Productions and wrote a report of her observations.
Observation 1:Over 65% of senior management compensation is in the form of executive stock options. Management tends to aggressively take on risky projects that will generate large profits if the projects succeed.
Observation 2:Management frequently uses retained profits to purchase potential competitors as well as business unrelated to television production in an effort to diversify their revenue base.
Observation 3:Management makes a practice of setting aside provisions for loss contingencies.

A Burnett shareholder that is reading the report is particularly concerned about ways that management may act for their own best interests rather than those of shareholders. Which of observations in Hatcher’s report should alarm the shareholder?
A)
All of the observations.
B)
Observation 1 only.
C)
Observations 1 and 2 only.



While managers are hired to make decisions to maximize shareholder wealth, they may make decisions to maximize their own wealth. Examples of ways that management may act for their own interests include expanding the size of the firm, which can increase the manager’s job security and power, and managers compensated largely by stock option taking large risks that will generate huge payoffs for the managers if successful, but cost the managers nothing if they do not. Note that setting aside provisions for loss contingencies is considered a conservative accounting practice.

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Corporate governance systems are primarily concerned with potential principal-agent problems between:

A) managers and directors.  

B) managers and creditors.

C) directors and shareholders.  





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Corporate governance systems attempt to minimize or eliminate any potential agent problems that may arise between two groups: (1) directors and shareholders and (2) managers and shareholders

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A principal-agent problem may exist between:
A)
shareholders and directors.
B)
managers and directors.
C)
regulators and directors.



An agency relationship exists when an individual (the agent) acts on behalf of another individual (the principal). Such a relationship creates the potential for a principal-agent problem where the agent may act for his own well being rather than that of a principal. The key test of whether a principal-agent problem may exist is if one party is responsible for acting in the best interest of the other. Of the answer choices given, directors are responsible for acting in the best interests of shareholders.

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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.



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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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)
Items 1, 3, and 5 only.
B)
All five items.
C)
Items 2, 3, and 4 only.



All five of the items on Reddy’s list are important factors that an analyst should review when assessing a board of directors.

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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.



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.

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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.



The audit committee should have full access to and the cooperation of management in order to perform their duties.

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Which of the following is most consistent with corporate governance best practice?
A)
Any related-party transactions must be approved in advance by the board of directors.
B)
Elections are staggered with at least 3 directors up for reelection to the board each year.
C)
Half of the board members are independent.



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.

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Which of the following is least consistent with corporate governance best practice?
A)
Board members conduct a self-assessment on an annual basis.
B)
The CEO and Chairman of the board are separate positions held by separate individuals.
C)
Directors have access to in-house legal counsel whenever necessary to assess the company’s compliance with regulatory requirements.



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

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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:
Statement 1:The audit committee consists of four independent members, one of which has a background in accounting and auditing.

Statement 2:The audit committee has an annual meeting with auditors and management to assess any issues which may arise in the audit process.

Statement 3:TCC’s internal auditors report directly to the audit committee.


Which of Williams’s statements about TCC’s committee structure are consistent with corporate governance best practice?
A)
Statement 3 only.
B)
Statements 2 and 3 only.
C)
Statements 1, 2, and 3.



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.

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