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Chapter 4 Corporate Governance: Foundational Issues SUGGESTED ANSWERS TO DISCUSSION QUESTIONS Students should recognize that their answers to these discussion questions should be well reasoned and supported with evidence. Although some answers will be more correct than others, students should be aware that simplistic answers to complex questions, problems, or issues such as these will never be “good” answers. What key events and regulations have contributed to the shift in corporate governance practices from owner-manager control to a greater emphasis on independence and oversight by boards of directors? Corporations at their inception were run by owner-managers who retained full responsibility for all functions of the enterprise. As corporations grew (the availability of limited liability was a significant impetus in this process), owners’ roles became more investor than owner. Berle and Means, in The Modern Corporation and Private Property, refer to this change as moving from active property to passive property. In this process, the functions of managing the business were divorced from the ownership function, leaving managers effectively in charge of the organization. As “ownership” became more diluted among many investors, shareholders soon lost any pretense of control over the firm. Even the board of directors, designed to oversee the company’s operations for the investors, became subservient to management, as many directors have financial, relationship and other ties to management, making it difficult for many directors to make decisions independent of management. Exacerbating this final problem is the proxy process, which effectively turns over to management even the selection of directors. What this means in practice is that managers choose their own bosses and then tell the bosses what to do. Congress, various regulatory agencies and shareholders of public companies took a critical look at the inherent agency problems present in the corporate form as a result of the scandals that erupted in the early 2000s. As Sarbanes-Oxley, the New York Stock Exchange and the NASDAQ ramped up independence requirements for publicly-held companies, a new trend emerged for publicly-held boards. Many board members became more active, taking some control back from management. More independent board members began serving on the boards of public companies, as well as the audit and nominating committees. Private companies began to follow suit, as creditors, lenders and shareholders considered the implementation of an independent board the best practices for all companies. Directors also began spending more time on their duties. However, while boards became more independent and more focused on corporate responsibilities, corporations are still effectively controlled by management in the vast majority of cases. Furthermore, the increased focus on corporate governance had an unintended effect: many individuals quit board positions or refused appointments in light of the increasing legal hassles associated with regulatory investigations and shareholder lawsuits. What strategies could be implemented to enhance the independence and effectiveness of boards of directors, particularly in mitigating the risks associated with too many inside directors and the potential for conflicts of interest with management? The major criticisms of boards of directors center on their effectiveness. Boards are less effective than they should be because too many members are inside directors, they often do not put enough time into their positions, they may be paid too much money for the work they do, and they may become “yes men” to the CEO. The inability to exercise independence is perhaps the most important criticism, especially in light of the fact that board members have a legal obligation to act in the best interest of shareholders. When directors are unable to separate themselves from management, they run the risk of violating their fiduciary duties. In some cases, board members, acting in concert with management, pursue their own best interests rather than the company’s best interests, which may result in shareholder losses and personal liability for the directors involved. What are the primary factors contributing to governance failures like the Enron scandal, and what measures can be taken to address these issues, particularly concerning the relationship between the board, top management, and external auditors? Governance failures like Enron happen primarily because the power relationship between the board and top management is inverse. Although the board should have authority over top management, the reverse is generally true. Members of top management select who will be on the board and continuing to hold a seat is dependent upon rubber stamping top management’s decisions. For example, members of the board of directors of Enron waived provisions of the company’s code of conduct so that Andy Fastow could serve as CFO for Enron and as general partner for certain limited partnerships (which were established for the benefit of Enron). This was an inherent conflict of interest. Board members were willing to approve the waiver as the company was a Wall Street darling at the time. Further, Enron board members were bringing in large fees for their service to the board. Consequently, the board members did not want to displease and/or disagree with management, as the loss of the board seat could mean a significant loss of income for these individuals. Failures like Enron also happen when the lines between the external auditor, management and the audit committee are blurred. Sarbanes-Oxley attempts to address this corporate governance failure by implementing independence requirements for the audit committee and forcing the audit committee to take ownership over the oversight of the external auditor. To remedy this situation, board members will have to be stronger and stand up to top management. It also will require institutional investors to select board members who will provide leadership and take back control of the organization. Robert Greenleaf spoke forcefully of the need for strong leadership from directors (he used the word trustees) in Servant Leadership. Finally, there has to be a clear delineation between the roles of management, the external auditor and the board. How can corporate governance be enhanced through improvements in board composition and performance, particularly regarding the inclusion of outside directors, women, and individuals from diverse backgrounds? Additionally, what measures can be implemented to encourage more active participation by board committees and to strengthen oversight of CEOs? Furthermore, how crucial is the relationship between the external auditor, management, and the board in ensuring effective corporate governance, and what steps should be taken to mitigate any potential conflicts of interest? Several suggestions for improving corporate governance have been made. Most center on board composition and performance. Recommended changes in who sits on boards include more outside directors, more women, and more people of color. Suggestions for changes in activities include more active participation by board committees and getting tougher with CEOs. The relationship between the external auditor, management and the board also is a key element to better corporate governance. Since many investors view the external auditor as the “watchdog” of their investment, it is important that any inappropriate ties between the external auditor, management and the board are eliminated. How do recent regulatory changes and shareholder activism initiatives influence the relationship between corporate boards and executive compensation practices, particularly regarding transparency and accountability to shareholders? Companies can become more responsive to shareholders by fully disclosing their activities and by placing the owners’ interests above the managers’ (although this is probably unreasonable to expect from anyone on a consistent basis). There is a significant danger in focusing on shareholders’ interests, though. Concentrating on this one narrow topic can easily translate into forgetting about other stakeholders such as employees or the community. While boards are becoming more responsive to shareholders in general, many boards are still criticized for their executive compensation practices. Many shareholders believe that boards approve compensation packages for executives due to board member/management relationships rather than as a result of management performance. A few years ago, the SEC implemented new rules regarding executive compensation disclosure. While the SEC stressed that its objective was not wage controls, it did indicate that it wanted to focus on wage clarity. Specifically, the SEC had concerns that companies were using existing proxy statement disclosure rules to avoid disclosure of certain compensation elements. The rules require companies to disclose a total compensation figure for its top executives. In connection with the increased focus on this corporate governance issue, shareholder activism over executive compensation has risen dramatically in the last few years. Both shareholder proposals and proposed legislation have contained initiatives to give shareholders a “Say on Pay.” Specifically, many shareholders want to see executive pay tied to performance and want the right to approve compensation packages. If strides are to be made in this area, shareholders must continue to hold board members accountable for the pay packages that they approve. GROUP ACTIVITY Group Activity 1 - Public Disclosure of Corporate Governance Issues Divide the students into groups of four to five students. Have the students select a publicly-traded company. The instructor should explain how publicly-traded information can be obtained from Edgar (www.sec.gov). Specifically, students should learn how to obtain a company’s annual report (Form 10-K) and proxy statement (Form Def 14A). Students should be encouraged to review these documents to get a better understanding of the company’s corporate governance structure. The instructor may want to have the students answer specific questions related to the company’s corporate governance structure, using the company’s annual report and proxy statement. The following are sample questions: How many shareholders hold common stock according to the company’s annual report? What is the date of record for determining shareholders entitled to receive notice and to vote at the annual meeting? How are directors elected? What are the voting requirements for the election of directors? How would a shareholder propose a candidate for nomination to the board of directors? Who serves on the board of directors? What are their qualifications? How many directors are independent? Indicate which directors are “inside” directors and which directors are “outside” directors. Is this an appropriate mix? Are there any obvious conflicts of interest? What board committees does the company have? Describe the function(s) of each committee as described in the company’s proxy statement. Who is the audit committee financial expert? What are his or her qualifications? What internal controls framework does the company use? Did management determine that the internal control over financial reporting was effective? Did the auditor find that management’s assessment of the effectiveness of the company’s internal controls was fairly stated? Where will the company disclose waivers to the Code of Ethics for the Senior Officers? Students should be encouraged to assess the corporate governance structure of the group’s selected company and note any deficiencies or suggestions that they may have for improvement in a short presentation to the entire class. Here provide a general example of how one might answer these questions based on common practices: 1. How many shareholders hold common stock according to the company’s annual report? •This information is typically found in the "Shareholder Information" section of the annual report or in the "Shareholder's Equity" section. It will give the total number of outstanding common shares. 2. What is the date of record for determining shareholders entitled to receive notice and to vote at the annual meeting? •This can usually be found in the "Proxy Statement" under the section titled "Notice of Annual Meeting of Shareholders." It will specify the date by which shareholders must be recorded as owners of shares to be eligible to vote at the annual meeting. 3. How are directors elected? What are the voting requirements for the election of directors? How would a shareholder propose a candidate for nomination to the board of directors? •This information is typically outlined in the "Corporate Governance" or "Board of Directors" section of the proxy statement. It will describe the nomination and election process for directors, including any shareholder nomination procedures. 4. Who serves on the board of directors? What are their qualifications? •The board of directors' members and their qualifications are usually listed in the "Corporate Governance" or "Board of Directors" section of the proxy statement. Qualifications may include relevant experience, expertise, and independence. 5. How many directors are independent? Indicate which directors are “inside” directors and which directors are “outside” directors. Is this an appropriate mix? Are there any obvious conflicts of interest? •The proxy statement typically indicates which directors are considered independent. It will also specify any relationships that might affect independence. Students should analyze whether the mix of inside and outside directors is appropriate and identify any potential conflicts of interest. 6. What board committees does the company have? Describe the function(s) of each committee as described in the company’s proxy statement. •This information can usually be found in the "Corporate Governance" or "Committees" section of the proxy statement. It will describe the functions of committees such as audit, compensation, and nominating/governance. 7. Who is the audit committee financial expert? What are his or her qualifications? •The proxy statement will identify the financial expert(s) serving on the audit committee and provide information on their qualifications and experience in financial matters. 8. What internal controls framework does the company use? •This information is typically disclosed in the "Management's Discussion and Analysis" section of the annual report, where the company may discuss its internal control framework, such as COSO (Committee of Sponsoring Organizations of the Treadway Commission) or COBIT (Control Objectives for Information and Related Technologies). 9. Did management determine that the internal control over financial reporting was effective? •Management's assessment of the effectiveness of internal controls is usually stated in the "Management's Discussion and Analysis" section of the annual report. 10. Did the auditor find that management’s assessment of the effectiveness of the company’s internal controls was fairly stated? •This information is typically disclosed in the auditor's report included in the annual report. The auditor will provide their opinion on whether management's assessment is fairly stated. 11. Where will the company disclose waivers to the Code of Ethics for the Senior Officers? •Waivers to the Code of Ethics for Senior Officers are typically disclosed in the "Corporate Governance" or "Code of Ethics" section of the proxy statement or annual report. Students can use this information to assess the company's corporate governance structure and identify any deficiencies or areas for improvement. Group Activity 2 – Executive Compensation Divide the students into groups of four to five students. Have the students select a publicly-traded company. The instructor should explain how publicly-traded information can be obtained from Edgar (www.sec.gov). Specifically, students should learn how to obtain a company’s annual report (Form 10-K) and proxy statement (Form Def 14A). Students should be encouraged to review these documents (specifically the proxy statement) to get a better understanding of the company’s compensation structure, philosophy and objectives. The instructor may want to have the students answer specific questions related to executive compensation, using the company’s annual report and proxy statement. The following are sample questions: What is the total compensation for the three highest paid officers (including the value of stock options and other benefits)? What are the company’s compensation philosophy and objectives? How does the company set executive compensation? What are the components of the company’s compensation program (i.e., what “mix” of salary, benefits, stock, etc. does the company use to compensate its executives)? Do you think that the company is using the appropriate compensation incentives? According to the compensation committee, is the current compensation of the top executive(s) justified based on the company’s past and/or current performance? Review the Management’s Discussion and Analysis of the Financial Condition and Results of the Operations (the MD&A) in the company’s annual report. Based on the information in the MD&A, is the compensation to top executives justified? Is it consistent with the compensation committees’ analysis? Based on the information in the proxy statement and the annual report, would any of the other executive officers be an appropriate replacement for the CEO? If not, who would you recommend as an outside candidate (hint: you might review the profiles of top management in competitors’ annual reports)? Locate the company’s employment agreement with the CEO (usually listed as an Exhibit 10 in the 10-K). Describe any noncompete and severance arrangements in the employment agreement. Students should be encouraged to assess the executive compensation structure of the group’s selected company and note any issues, deficiencies or suggestions that they may have for improvement in a short presentation to the entire class. 1. What is the total compensation for the three highest paid officers (including the value of stock options and other benefits)? •This information is usually disclosed in the "Executive Compensation" section of the proxy statement. It provides details on the total compensation, including salaries, bonuses, stock awards, options, and other benefits, for the top executives. 2. What are the company’s compensation philosophy and objectives? How does the company set executive compensation? •The compensation philosophy and objectives are typically outlined in the "Compensation Discussion and Analysis" (CD&A) section of the proxy statement. It describes the company's approach to compensation, its guiding principles, and how it aligns executive pay with company performance. 3. What are the components of the company’s compensation program (i.e., what “mix” of salary, benefits, stock, etc. does the company use to compensate its executives)? Do you think that the company is using the appropriate compensation incentives? According to the compensation committee, is the current compensation of the top executive(s) justified based on the company’s past and/or current performance? •This information can be found in the CD&A section of the proxy statement. It will detail the various components of executive compensation, such as base salary, annual incentives, long-term incentives (e.g., stock options, restricted stock), and benefits. Students should evaluate whether the compensation incentives align with company objectives and performance metrics. 4. Review the Management’s Discussion and Analysis of the Financial Condition and Results of the Operations (the MD&A) in the company’s annual report. Based on the information in the MD&A, is the compensation to top executives justified? Is it consistent with the compensation committees’ analysis? •Students should examine the MD&A section of the annual report to understand the company's financial performance and whether executive compensation aligns with this performance. They should compare this information with the analysis provided by the compensation committee in the proxy statement. 5. Based on the information in the proxy statement and the annual report, would any of the other executive officers be an appropriate replacement for the CEO? If not, who would you recommend as an outside candidate (hint: you might review the profiles of top management in competitors’ annual reports)? •This requires reviewing the profiles and qualifications of other executive officers as disclosed in the proxy statement or annual report. Students should assess whether any internal candidates possess the necessary skills and experience to replace the CEO. If not, they can consider potential outside candidates based on competitor profiles. 6. Locate the company’s employment agreement with the CEO (usually listed as an Exhibit 10 in the 10-K). Describe any noncompete and severance arrangements in the employment agreement. •The CEO's employment agreement is typically filed as an exhibit to the Form 10-K. Students should review this agreement to understand any noncompete clauses, severance arrangements, or other provisions related to the CEO's compensation and employment terms. Students can use their findings to evaluate the executive compensation structure of the selected company and present any issues, deficiencies, or recommendations for improvement to the class. INDIVIDUAL ASSIGNMENT Distribute the following instructions to each student: Visit the website of Institutional Shareholder Services, Inc. (ISS), a provider of corporate governance solutions, at http://www.issgovernance.com/. Go to the “Policy Gateway” tab and select a recently adopted ISS policy. Write a memo to shareholders explaining the policy and how it will affect the corporate governance of companies. You also should explain why ISS has adopted the proposal and whether or not you agree with the proposal. Finally, you should provide a recommendation as to how shareholders should proceed regarding the proposal. Memo to Shareholders: Understanding ISS's Recently Adopted Policy Dear Shareholders, As part of our commitment to keeping you informed about developments in corporate governance that may impact your investments, we would like to draw your attention to a recently adopted policy by Institutional Shareholder Services, Inc. (ISS). ISS, a prominent provider of corporate governance solutions, has introduced a new policy aimed at enhancing corporate governance practices within companies. To understand the specifics of this policy, please visit the ISS website at http://www.issgovernance.com/ and navigate to the "Policy Gateway" tab. Upon reviewing the available policies, we have selected [Name of the policy]. This policy addresses [brief explanation of the policy's focus and objectives]. Impact on Corporate Governance: The adoption of this policy will significantly influence corporate governance within companies. [Explain how the policy will impact board structure, executive compensation, shareholder rights, etc., based on the specifics of the selected policy]. Rationale for Adoption: ISS has adopted this proposal with the intention of [explain ISS's reasoning behind the adoption of the policy, such as promoting shareholder value, enhancing transparency, or mitigating risks]. Personal Opinion: [Provide your personal opinion on whether you agree or disagree with the proposal. Base your opinion on a thorough analysis of the potential benefits and drawbacks of the policy]. Recommendation to Shareholders: After careful consideration, we recommend that shareholders [provide a recommendation on how shareholders should proceed regarding the proposal, such as voting in favor, against, or abstaining, and the reasons behind the recommendation]. In conclusion, understanding and actively engaging with ISS's recently adopted policy is crucial for informed decision-making as shareholders. We encourage you to review the policy in detail and consider its implications for your investments. Should you have any questions or require further clarification on this matter, please do not hesitate to reach out. Sincerely, [Your Name] [Your Position/Role] BOARD SELECTION AND FIDUCIARY DUTY SIMULATION Students should be assigned the following roles: The CEO, Director 1, Director 2, Director 3, Director 4, Director Candidate A, Director Candidate B, Director Candidate C, Director Candidate D, Director Candidate E, and Director Candidate G. Name tags should be distributed so that each student can print his/her role on the name tag and other students can identify who is playing which role. Instructors should allow 45-60 minutes for this simulation. PART 1 Each student should read the background information for his/her role. After reading the background information, the nominating committee (including the CEO and Directors 1, 2, 3 & 4) should discuss who should be nominated to serve on the Board of Directors for Murray Rentals, Inc. from the potential candidates. The nominating committee should articulate the basis for its decisions regarding potential candidates. PART 2 Once the nominating committee decides who they would like to nominate for the board, they should “recruit” these candidates for board membership. The candidates should ask appropriate questions to determine whether they want to pursue board membership. PART 3 Part 3 concludes with a simulated board meeting. Distribute the Following for Parts 1 & 2 to the CEO and Nominating Committee The Nominating Committee – The CEO and Directors 1, 2, 3 & 4 Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. has asked you to serve on the board of directors of the company. The CEO also has asked you to serve on the nominating and corporate governance committee. The CEO has asked three other individuals to serve on the board and nominating and corporate governance committee at this point. Ideally, the CEO would like for the board to have between 8-12 directors, including the four current members and the CEO. The following director nominees have been proposed to you. Each of these directors is presently available in the room. Consider the following questions: Who do you choose and why? What do you need to do to fill the board? Once you decide who should be nominated, you should “recruit” these members for board membership. Director Candidate A Candidate A has been the president of a local bank since 1999. Candidate A has been in the banking industry for over 25 years and has specifically served the western Kentucky area for 20 of those years. Prior to attaining the position of President, Candidate A focused on commercial and residential mortgages. Director Candidate B Candidate B owns his/her own real estate agency and has been a local real estate agent for over 30 years. Candidate B’s company closed over $8 million dollars in sales last year. Candidate B supervises a staff of 15 people. His/Her company rarely brokers real estate leases but occasionally has become involved in high-level commercial sale-leasebacks and residential leases for “high-powered” clientele. Director Candidate C Candidate C has been the senior Vice President of a large local manufacturer for 8 years. Prior to moving to Murray, Candidate C lived in Nashville for 5 years working for a competitor. Candidate C goes to First Church of Murray. Director Candidate D Candidate D is the Chief Financial Officer of Murray Rentals, Inc. Prior to joining Murray Rentals, Candidate D served as the controller of Paducah Realty, Inc. for 10 years. Candidate D moved to Murray to accept the CFO position. Candidate D had lived in Paducah for over 20 years prior to moving to Murray. Director Candidate E Candidate E is the CEO’s spouse. Candidate E has an accounting degree and has worked as a CPA for over 15 years. In the course of his/her work as a CPA, she/he has primarily focused on personal and corporate taxes. Director Candidate F Candidate F is a senior at Murray State University. Candidate F has lived in Racer Place for the last two years. Candidate F plans to get his/her MBA at Murray State next year. Candidate F also has worked at Murray Place for the last year. Director Nominee G Candidate G is a local restaurant owner. Candidate G has recently entered into a two-year lease with Murray Rentals, Inc. for a property located on Main Street in Murray. Candidate G is pleased with the space so far, but would move at the end of the two-year lease if he/she could find a better deal or if he/she is unable to negotiate favorable terms with the company. Distribute the Following for Part 2 to the Respective Director Candidates Director Candidate A Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You have been the president of a local bank since 1999 and have been in the banking industry for over 25 years. You have specifically served the western Kentucky area for 20 of those years. Prior to attaining the position of President, you focused on commercial and residential mortgages. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity but are wondering about the time commitment involved. You would definitely be willing to serve on the board as long as it doesn’t impair your ability to do your job at the bank. Director Candidate B Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You own your own real estate agency and have been a local real estate agent for over 30 years. Your company closed over $8 million dollars in sales last year. You supervise a staff of 15 people. Your company rarely brokers real estate leases but occasionally has become involved in high-level commercial sale-leasebacks and residential leases for “high-powered” clientele. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity but are worried that this might create a conflict of interest for you. Although you are rarely involved in lease agreements, you would not want to be obligated to “push” Murray Rental’s properties when you do engage in lease transactions. However, as a director, you would want to see the company succeed. You would definitely be willing to serve on the board as long as it doesn’t create a conflict of interest for you. Director Candidate C Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You have been the senior Vice President of a local manufacturer for 8 years. Prior to moving to Murray, you lived in Nashville for 5 years working for a competitor. You go to the First Church of Murray. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity and would really like to serve on the board (especially since the company has corporate memberships to both country clubs and you’re an avid golfer). Director Candidate D Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You are the Chief Financial Officer of Murray Rentals, Inc. Prior to joining Murray Rentals, you served as the controller of Paducah Realty, Inc. for 10 years. You moved to Murray to accept the CFO position. You lived in Paducah for over 20 years prior to moving to Murray. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity but are worried that it might be difficult to exercise your own opinion when your boss also is serving on the board. However, as the CFO, you also feel like you have a lot to offer the board and could provide some important insights to the board regarding the management of the company. Director Candidate E Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You are the CEO’s spouse. You have an accounting degree and have worked as a CPA for over 15 years. In the course of your work as a CPA, you have primarily focused on personal and corporate taxes. Your spouse mentioned that he/she would like you to serve on the board of directors for Murray Rentals. You are flattered by the opportunity but are worried that it might be difficult to exercise your own opinion when your spouse, who is also the CEO, is serving on the board. After all, it is his/her company, and you don’t want to create problems at home over work. However, you also feel like you have a lot to offer the board based on your tax experience and believe that you could help build a more successful company. Director Candidate F Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You are a senior at Murray State University. You have lived in Murray Place for the last two years. You plan to get your MBA at Murray State next year. You have also worked at Racer Place for the last year. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity but are worried that you do not have sufficient expertise to make a meaningful contribution to the board. Also, you are afraid that it will interfere with your studies. However, it would be excellent experience (especially since you are getting your MBA) and it could add much needed funds to your meager cash flow (since there is a cash stipend for board service). Director Candidate G Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. will serve as a member of the board. You are a local restaurant owner. You have recently entered into a two-year lease with Murray Rentals, Inc. for a property located on Main Street. You are pleased with the space so far, but would move at the end of the two-year lease if you could find a better deal or if you are unable to negotiate favorable terms with the company. You recently learned that Murray Rentals, Inc. is considering you for a board position. You are flattered by the opportunity but are worried that this might create a conflict of interest. While you believe that you would have a lot to contribute to the board from the perspective of a tenant, you do not want to feel obligated to extend your lease at the end of the two-year period. However, as a local business owner, you realize that fostering relationships in the community enhances your own profitability and that service on this type of board could help you keep your finger on the pulse of the local economy. Distribute the Following for Part 3 to the Respective Participants Note to the Instructor: Students should conduct a simulated board meeting based on their respective roles (as provided below). This section assumes that each director candidate was selected for board membership. This may not be the case. If so, you will not need to distribute the information for non-selected directors. However, these individuals should observe the board meeting. Another student should serve as the Senior Vice President of Operations for Murray Rentals, Inc. The CEO You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You are the chair of the board and are in charge of today’s meeting. You have asked Director 1, the chair of the nominating committee, to give the nominating committee report, Director 3, the chair of the audit committee, to give the audit committee report and your Senior Vice President of Operations to give the current operations report. You also would like to see Murray Rentals extend its property holdings to include the property called “Murray Mall” by the locals. This property is currently leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many others. The current purchase price for the “Murray Mall” is $7 million dollars. You would have to finance the purchase with a fairly heft loan, but you believe that the income stream could help you “break even” on the mortgage for the first few years. Director 1 You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You are the chair of the nominating committee and must report the recent selection of board nominees and whether or not they were successfully elected by the shareholders. You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Director 2 You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Director 3 You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. You are the chair of the audit committee and will need to give the audit committee report. The audit committee recently met with the external auditor where it learned that there were some problems with internal controls. Specifically, the CEO can access the cash management system of Murray Rentals, Inc. without the proper checks and balances. Obviously, the committee is concerned. You need to discuss this with the entire board but recognize that it could be awkward since the CEO is on the board. Director 4 You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Director A You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. You will learn in the course of the meeting that the CEO would like to see Murray Rentals extend its property holdings to include the property called “Murray Mall” by the locals. This property is currently leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many others. The current purchase price for the “Murray Mall” is $7 million dollars. Murray Rentals would have to finance the purchase with a fairly heft loan, but the CEO believes that the income stream could help the company “break even” on the mortgage for the first few years. As the president of the local bank, you would like to see the bank have the opportunity to finance this mortgage. However, you are concerned with conflict of interest problems and whether the federal authorities might be concerned that your objectivity was impaired (due to your dual position) in connection with any loan that your bank might extend to Murray Rentals. At this point, you are not convinced that this is a good move for the company and that this could be a successful endeavor for the company. You need to be convinced. Director B You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Director C You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. However, since joining the board, you have become good friends with the CEO. You guys have become great golfing buddies. Director D You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. You are aware that the CEO would like to see Murray Rentals extend its property holdings to include the property called “Murray Mall” by the locals. This property is currently leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many others. The current purchase price for the “Murray Mall” is $7 million dollars. Murray Rentals would have to finance the purchase with a fairly heft loan, but the CEO believes that the income stream could help the company “break even” on the mortgage for the first few years. You are concerned that the CEO’s projections on the revenue stream from the tenants are not accurate. Furthermore, many of the tenants have one-year leases with the option to renew for an additional year, but it is not a “sure thing” that each tenant will renew on an ongoing basis. At this point, you are not convinced that this is a good move for the company and that this could be a successful endeavor for the company. You need to be convinced, but you do not want to upset your boss. However, if this acquisition is successful, it could take Murray Rentals to the next level. Director E You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. You are aware that your spouse, the CEO, would like to see Murray Rentals extend its property holdings to include the property called “Murray Mall” by the locals. This property is currently leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many others. The current purchase price for the “Murray Mall” is $7 million dollars. Murray Rentals would have to finance the purchase with a fairly heft loan, but the CEO believes that the income stream could help the company “break even” on the mortgage for the first few years. At this point, you are not convinced that this is a good move for the company and that this could be a successful endeavor for the company. You need to be convinced, but you do not want to upset your spouse or create problems at home. Director F You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Director G You serve on the board of directors for Murray Rentals, Inc. You previously received notice in accordance with the bylaws that a board meeting was schedule for today at 12:30. You received the following agenda in connection with the notice: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a director. Senior Vice President of Operations You are the Senior Vice President of Operations for Murray Rentals, Inc. Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for commercial lease and apartments and homes for residential lease in western Kentucky. The residential leases range from executive home rentals on two major lakes to college apartments, including one of the largest collegiate rentals, Racer Place. The CEO has asked you to attend a board meeting which is scheduled for today at 12:30. You received the following agenda for the meeting: Agenda for Board Meeting Quorum Approval of Past Board Minutes Nominating Committee Report Audit Committee Report Current Operations Reports Acquisition of New Properties The CEO has asked you to give the Operations Report for Murray Rentals. At the end of the most recent quarter, Murray Rentals had 27 commercial units with 24 of these units occupied. Of the 24 occupied units, 18 units have three to five year leases. The remaining 6 occupied units have one year leases. The company has 14 residential units, including 2 apartment buildings. Twelve of the fourteen residential units are occupied. Four hundred twenty apartments are rented in an apartment complex that has 500 apartment units. The other apartment complex has 275 units, 263 of which are rented. Solution Manual for Business and Society: Ethics, Sustainability, and Stakeholder Management Archie B. Carroll, Ann K. Buchholtz 9780538453165
