One of my Friends is working in the area of Corporate Governance..... I think it is somehow related..

Hi Latifa,

I note that you have a special interest in corporate valuation issues. Could you say a little more about the extent of your interest in corporate valuation. For instance, are you interested in how a corporation is valued in connection with a merger and acquisition? I have in mind whether the value established in terms of what is offered to current shareholders is fair. If that is your area of interest, please let me know. It is not that I have a particular expertise in this area; but, I am very opinionated and am currently having an argument with counsel to a Commission I am on as to whether or not the Board of Directors has an obligation to independently verify that the valuation established by outside appraisers is reasonable. I'd love to win someone over to my way of thinking on this; but won't bore you if that is not the area you are seeking input on.

Gwen

Hey Gwen... The issue you are talking about is called Corporate Governance.

Corporate governance in layman terminology means protecting the stakes and interest of general share holder which may otherwise get compromised by the large stake holders in a company.

In order to protect the interests of minority shareholders, there has to be an independent audit. Also proper disclosure of all the required information is needed. According to the Corporate Governance Laws,a company has to has an external and independent directors in the BOD, who has got no prior associations with the Company and who is neither a shareholder of the COmpany. There are many more things worth discussing but if you can make your query more precise may be i can help...??

Khaki

Thank you, Khaki; I was just trying to understand Latifa's statement about "corporate value issues," hoping her interest was the same as mine. I did see your first post in which you directed Latifa to peoplein the Corporate Governance area. Much of my scholarship is in Corporate Governance area (see my profile on RG) so I wondered if Latifa's interest fell within an ongoing dispute I am having about amending NJ statutes to broaden the "hold harmless" coverage for corporate directors.

However, I am glad you have offered to help because I would like an opinion (from the standpoint of good Corporate Governance and Applied Ethics) as to whether the Board of Directors of a corporation that is targeted for acquisition is justified in simply relying on the opinion of an outside appraiser (someone retained by the Board) as to what would be a fair price per share for the corporation's stock? Or, does the Board have a MORAL OBLIGATION BEYOND the LEGAL OBLIGATION of fiduciaries (in the corporation's state of incorporation) to independently reach a decision as to whether the shareholders are being treated fairly (i.e., receiving enough compensation for their stock).

Khaki, I am not interested in the law; I know the law. I am in disagreement with one of the legal advisors to our Commission (NJ Corporate and Business Law Study Commission) over whether corporate boards should be held harmless from liability for an undervaluation of the stock just because they have followed the legal protocol of hiring an outside assessor to evaluate the stock. So, I am asking for an ethical opinion not a legal one (I have membership in 4 state bars so know more about the law than is healthy for someone who answers to a higher authority than earthly laws).

So, thank you so much for offering to help. And, Audil, I will appreciate any response even if it is just your gut reaction.

Gwen

Thanks Gwen for an enlightening look-up at your profile....

Well there has been so many Corporate Failures/Debacles in the history of Corporates - Enron, DotCom, Satyam.... All can be treated as a failure of Corporate Governance. The main issue leading to such debacles is scandalous window-dressing and inflationary valuation, what however at the heart lies is the failure to check the fraudulent practices at the top management level including BOD. It is quite an interesting topic to analyse such practices at the merger/acquisition levels, There is no fool proof mechanism to check these fraudulent practices. However, with every coming day laws as well as practices are becoming so complex in the corporate governance paradigm that unless and until there is no serious cartelisation and political appointments to the BOD, the chances for such frauds are extremely minimised. It is also as I said in the preceeding comment, enactments don't lead to enforcement always - and as the case is with the Corporate Governance, it is not practiced in its true letter and spirit.

And surely, valuations - be it at the times of mergers/acquisitions are bound to be prone to frauds if proper structure of BOD is not maintained. If your BOD is a heterogenous entity and you are having an external/independent assessor and.or an external auditor to cross check these frauds will take place one in a thousand only...

And to Ethics - again not enforceable is a residuary and optional performance..... So far as practical world is concerned... ethics and business are at logger heads with each other...

Thanks

Khaki

Hi Khaki,

Yes, of course you are right that business and ethics often conflict. However, with respect to the Corporate Board, it has a fiduciary relationship with the shareholders/owners. So, my feeling is that the Board is more culpable in terms of being hit with a derivative- or class-action lawsuit (brought by shareholders defrauded by an undervaluation of their shares in connection with an M&A) than are the other executives of the corporation who generally have the "Business Judgment" rule to protect them. The Board is the governing authority so the buck stops with them.

So, Khaki, knowing that M&A's are, as you say, "prone to frauds," don't you feel that persons selected for the Board because of their special knowledge and expertise (and who moreover have complete access to all of the corporate books and records) should have some kind of "Due Diligence" obligation to do more than just hide behind meeting the minimum legal requirements by obtaining a pro forma valuation of the corporation's stock from an outside appraiser? Or, do you agree with the viewpoint expressed by the Commission's counsel; i.e., that Board members should be able to rely on the reports of appraisers in the same manner that they rely on legal opinions rendered by outside legal counsel to the Board?

It is possible that relying on legal advice and relying on valuation advice are no different; but, I have difficulty accepting this view. Board members have been selected to sit on the Board because of their extensive corporate experience and special insight so certainly they should have the ability to discern an undervaluation of the stock of a corporation when they are sitting on the Board!

You should know, Khaki, at bottom this is an issue of whether the corporation will have to pay the legal expenses incurred by sued Board members as well as any damages awarded to plaintiffs that prevail in the class action or derivative lawsuit.

Of course, if Corporate Boards are subjected to the kind of liability and duty of care that I am advocating, it will be difficult to get anyone to serve on a board. So what? Keep in mind I am not seeking pragmatic advice (I teach in a Business School so am surrounded by pragmatists). What I want is a moral judgment from you as someone familiar with the Corporate Governance area. And, don't worry, Khaki, I won't get angry if you don't agree with me that this is a moral issue rather than a legal or business issue. I know my opinion is a minority one.

Gwen

Thanks,

Gwen

Thank you, Charles, for elucidating so many points (most of which I had never thought about, being so intent on getting my point across). This is why I dragged you into the discussion; I knew that I needed a dispassionate voice with a quick wit and a thoughtful analytical approach to 'slow down my train'. So, to respond to you: First, Why did I even think of derivative and class-action lawsuits as a looming threat? Maybe it is because as a disgruntled shareholder of Lucent I am still bitter that the shareholders were not given sufficient time to consider the Alcatel offer before it was a done-deal and learning French had become a prerequisite for keeping track of the merged company's activities across the Ocean. (Yes, Charles, I am part of the class action lawsuit filed against Lucent -- joining the class was the only respectable thing for a lawyer to do.)

Second, I can appreciate your reference to the Model Business Corporation Act (MBCA)since our Commission utilizes the MBCA and the laws of progressive states like Delaware and New York as guidelines in recommending changes to the NJ Legislature with respect to corporate governance and business law issues. However, Charles, stubbornly coming back to my argument with the Commission's legal counsel, I don't feel the duties of a fiduciary are solely legal in nature. Indeed, I think the unwritten law of moral conscience should bear the most weight. So, I am willing to impute a certain amount of insider knowledge to the Board that exceeds what can realistically be accessed by an outside appraiser; so, I ask, why should the Board be allowed to escape liability for negligence by hiding behind the "expert" opinion of an outsider? I ask you Charles to assess whether that seem fair and just; keep in mind that ethics in democratic societies such as ours entails both justice and fairness. In short, the duty of a fiduciary is stewardship!

For more on the Commission on which I sit as one of three Commissioners, see short the NJ LAW JOURNAL article I posted on RG (I think it's called "The Littlest Commission").

Again, Charles, thanks for putting considerable talents to work on this!

Gwen

Gwen:

There are several journals that deal with corporate governance--Jim Post at Boston University has addressed this topic and you will find articles dealing with the topic in the journal Business&Society, in the SOcial Issues in Management division of the National Academy of Management and in the annual meetings of the INternational Association for Business and Society.

Gwen, try these:

Hussein Dewji and Scott Miller (2013) Assessing the Components of Effective Corporate Governance. Strategic Management Review: January 2013, Vol. 7, No. 1, pp. 47-63.

Assessing the Components of Effective Corporate Governance

Abstract

This paper examines the various internal and external components of corporate governance, offers recommendations based on existing research and suggests areas for future research. The internal factors of corporate governance that are reviewed in this paper include the composition of the board of directors, the structure of managerial compensation, the concentration of share ownership, and the level of firm debt. These factors are typically under a firm's control and can be adjusted to match an organization's firm-specific needs for governance. The external factors we consider include the market for corporate control, the managerial labor market, and the legal implications. Normally out of a firm's direct control, these factors provide an additional form of governance for shareholders. Together, internal and external factors work to resolve agency conflict between management and shareholders; however, they need to be carefully evaluated when implementing an optimal and unique governance structure for each particular firm. This paper contributes to the existing literature by examining the issue of corporate governance from the perspective of multiple business disciplines and discussing the implications of the results for practitioners.

Corporate Governance and Value Creation: Evidence from Private Equity

Viral V. Acharya, et al

Using deal-level data from transactions initiated by large private equity houses, we find that the abnormal performance of deals is positive on average, after controlling for leverage and sector returns. Higher abnormal performance is related to improvement in sales and operating margin during the private phase, relative to that for quoted peers. General partners who are ex-consultants or ex–industry managers are associated with outperforming deals focused on internal value-creation programs, and ex-bankers or ex-accountants with outperforming deals involving significant mergers and acquisitions. The findings suggest the presence, on average, of positive but heterogeneous skills at the deal-partner level in large private equity transactions.

Measurement Malaise in Strategic Management Studies

The Case of Corporate Governance Research

Dan R. Dalton

Herman Aguinis

We adopt a construct validity lens to provide a critical reexamination of established corporate governance research. In particular, we focus on the body of work relying on the theoretical bases of agency theory and involving boards of directors’ independence, CEO duality, equity holdings, and their relationships to corporate financial performance. We offer a five-step protocol involving the following components: (1) establishing the base rate for the phenomenon in question, (2) evaluating the extent to which the dependent variables are germane, (3) evaluating the extent to which the independent variables are germane, (4) determining whether explanatory power is improved as a consequence of improved measurement, and (5) concluding whether previously established estimates should be revised. We implemented the proposed protocol and used alternative measures that reduce threats to construct validity. Results yielded substantially higher estimates of relationships in corporate governance research. Future research can adopt the proposed protocol to understand whether a similar improvement in explanatory power could be achieved in other research domains.

Castañer, X. and Kavadis, N. (2013), Does good governance prevent bad strategy? A study of corporate governance, financial diversification, and value creation by French corporations, 2000–2006. Strat. Mgmt. J., 34: 863–876. doi: 10.1002/smj.2040

Building on and extending prior research, we propose a comprehensive framework which posits that free cash flow moderates the impact of corporate governance on financial diversification. We argue that because it increases CEO perceived risk, alignment devices increase rather than decrease financial diversification. In a sample of 59 publicly traded French corporations during 2000–2006, we show that financial diversification negatively impacts shareholder return and firm value. We obtain support for several of our hypotheses: at high levels of free cash flow, CEO variable compensation increases financial diversification, whereas chairman/CEO non-duality reduces it. In contrast, independent directors increase financial diversification at low values of free cash flow (although weakly). We also find that ownership concentration only reduces financial diversification when free cash flow is low.

Charles:

I hope you know that my suggestion of articles for Gwen should not be seen as an endorsement of their position or argument but merely as a reference to be read and considered.

The problem with diversification and other strategies (mergers, acquisitions) is that unlike stock portfolios, managers have to actually "manage" the resultant enterprise--and results seem to suggest the new entity is no where near as successful or profitable as predicted.

Indeed, in many cases if value to the shareholder is the driving factor, many organizations should be dismembered and sold as the value of the assets in the actual selling of them often exceeds the "book" value.

The Zen Master Thich Nhat Hanh has argued that there are only two emotions in the world--fear and love and that we have to recognize what is driving us in decisions that we make.

I note your use of aretaic values--do you see no role then for deontological ethics or consequentialism?

One of the challenges when attempting to really consider the relationship between CSR and the law or regulations is to recognize that the law/regulation is the floor of responsible behavior and not the upper limit. Actions can be taken that are unethical but legal or ethical but not necessarily legal. The operational challenge is to convince organizations that the law/regulation is the floor of behavior and not the ceiling.