Dan's Answers

Corporate Governance Outline

By Dan Branum

Created in Fall of 2007 for Professor Cunningham‘s Corporate Governance Course

For more outlines go to www.DanBranum.com



This ―outline‖ consists of questions provided to the class by professor Cunningham to

prepare for the final, and my best attempt at answering the questions. I used various sources to

answer these questions. Many of the answers are those of my classmates who helped compile

this. This document is very disorganized but should prove useful to anyone taking the class.



Dan’s Answers



1. What questions should every corporate director ask every CEO?



Ask each of these 10 Questions, each of which opens door to follow-up questions. The purpose of these is

to help directors discover areas that might need improving.

#1 Do you have the right CEO? This is the most important thing to be comfortable w/as director. If

answer is yes, then you ask how are you helping him get better. If no, ask what you are going to do about it.

Also you must be comfortable with the succession process. Know internal candidates, if none know a plan to

get outside candidates.

#2 How well is CEO‘s compensation linked to actual performance? CEO‘s comp is a critical link

between board‘s philosophy for company & actions of CEO. Ask whether comp plan will encourage correct

behavior? The total compensation number will be listed in media. Know what effect stock price has & if he

retires early.

#3 What is the precise recipe for how company makes money? No 2 companies, even in same market

make money in exactly the same way. Directors must all know & be on same page. Then, you can incorporate

relevant activities into CEO evaluation & compensation.

#4 Is management looking at external trends & diagnosing opportunities and threats? Survival of corp

depends on adjusting to all sorts of external changes. Management must assess external trends & have plan.

Ask whether rival firms are getting in or out of business.

#5 What are sources of organic growth? All public companies must grow. Acquisitions play role, but

organic growth is best for long term stockholder value. Ask if CEO‘s growth plan is realistic and if CEO‘s

compensation is properly linked to organic growth. You only want ―good growth.‖

#6 Do you develop leadership gene pool well? Critical success factor is quality of internal leaders. You

must be comfortable with filters which leaders are selected, promoted & developed. Long term good.

#7 Do you have right approach to diagnosing financial health? Best directors look at cash flow, not net

income or earnings. You must understand how in/out flow creates value and be comfortable that company can

survive obstacles.

#8 Are you examining measures that capture the root causes of performance? For most businesses

accounting figures, revenue recognition, costs, inventories, etc are a historical aggregate of estimates. You

must ID physical drivers of performance today and understand them thoroughly to make constant use.

#9 Does management share bad news with the board? Timely? If so, is the plan to address it credible?

#10 How productive are executive sessions? They are a critical vehicle to air feelings and test hypothesis

to a group. They can make CEO more productive or can add or weaken his power when necessary.



2. What mistakes do general counsel’s feel boards are most likely to make?



#1 Not asking questions: boards are smart, but from different backgrounds and people are afraid to ask a

dumb question. The most effective boards ask questions. If too scared call CEO after meeting.

#2 Failing to understand the company and the risks it faces: boards will never understand company like

management does, but you must give new boards members a solid intro to corp and follow up with programs

to keep boards up to date. Best if directors can visit facilities and meet managers who run corp day-to-day.

#3 Failing to lead on ethics compliance: Directors haven‘t been leading the way in ethics like they

should. Sarbanes-Oxley Act of 2002 changed a lot, but companies have been slow to work towards always

doing the right thing not matter what. Setting in place the right safeguards is like taking yucky medicine. It

tastes bad, but it‘s much better than getting the flu. Once of prevention, etc…

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#4 Not insisting on a crisis-management plan: Companies can save or ruin their rep depending on how

they react to crisis. Bad example is Firestone that denied claims about tires from 1990s until 2000s. On other

hand is Johnson & Johnson‘s handling of Tylenol murders in 1982. Most fail, because they don‘t have clear

protocols for dealing with compliance failures and related probs. It‘s hard to get senior management to take

out time to do risk assessment, but its essential.

#5 Speaking out in a crisis before the facts are in: you can‘t speak out until you get the facts in.

Frequently boards comment on confidence of managers far before they know all facts. It can ruin a company‘s

credibility to have to retract statement when facts come in. It can be so tempting to stand up for something

soon, but you must wait.

#6 Relying on wrong outside council: Many boards have relationships with trusted council and will call

the same ones in during crisis. Not smart because may have previous involvement or prejudice about what‘s

going on, or attachment to management, etc. You need truly independent council. Frequently attorney costs

keep companies from hiring what they really need until it is too late.

#7 Misunderstanding attorney client privilege: it‘s great, but communication is only privileged, when the

person is seeking the advice of lawyer and asking lawyer to give an opinion on a set of facts. Frequently

executives assume any doc that goes under a lawyer‘s nose is privileged.

#8 Underestimating Regulators: hard to believe it, but directors do this. Regulators typically warn at

first, and when they are need given enough attention they come down with nasty penalties. When a board has

been asleep at the wheel they need to look ahead and set stuff straight rather than look over shoulder and worry

about personal liability. They have a fiduciary duty!

#9 Giving too much leeway to rainmakers: SEC says freq probs come when boards give too much leeway

to a high performing salesman. Easy to let a bad performer go for ethical probs, but tough when he has a big

book of business.

#10 Getting caught up in the dilemma of false options: there‘s an ongoing false belief that in lawsuits,

boards think that you have to either settle all of them or none of them. But, that‘s ridiculous because each case

may have different facts, and may be best to take varied approach.



3. What are common problems between Martha Stewart, Samual Waksal, Dennis Kozlowski,

John Rigas, Ken Lay & Richard Scrushy?



 Like Scott Halliday (Ernst & Young partner) told us in class: we will always be confronted with

situations where we will want to act greedily… we should just follow the law… everyone should

make a dollar but do it ethically. These are all CEO‘s who made money by breaking the law and

undermining investor confidence.

 Common prob: many execs treat companies like they‘re personal property; feel entitled to huge

compensation, borrowed huge sums and improperly use property as own. Disconnected w/reality.

The money they‘ve earned isn‘t enough. Fail to appreciate that even they must follow rules.

 Waksal: ImClone founder & former ceo: heard that his meds were going to be rejected by FDA &

told family before news broke & all sold shares. Undermined investor confidence in company.

 Stewart: lied about reasons she sold shares of ImClone: She got only 45k from the trade!

 John Rigas: top exec (along with son) of cable co Adelphia Communications. Classic greed: execs

made up numbers for investors & lenders; regularly withdrew money from company w/o reimbursing;

paid 40k annual salary to personal masseuse; used co‘s plane to fly Christmas tree to a family member

in NYC costing 6k. Family had crazy lavish spending habits.

 Kozlowski: former top exec of Tyco Intl: blatantly looted Tyco of more than 150 million. Among

highest paid execs in US & found guilty on 22 of 23 charges. Lavish spending: company funds on a

30 million apt, a yacht, 2 million Sardinia bday party for his wife.

 Lay: Once enron chairman.. one of the biggest business success stories of 1990s; its collapse marked a

dramatic end to the stock market boom & created wave of corporate & regulatory reforms, including

2002 Sarbanes-Oxley Act. Lay quietly sold $70million back to company w/out reporting it.

 Scrushy: HealthSouth Corp boss; accused of masterminding a 2.7 billion accounting fraud at the

Birmingham Al medical concern… acquitted.



4. Describe power relationship between board, management & shareholders. What can be

done to align these groups?









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 Corp balance of power is delicate: relies on the 3 anchors of management, shareholder & board. If a

part is weak it challenges strength of whole. Now SEC & Congress have been trying to implement

reform in all these relationships, particularly board/management.

 Management/Shareholder

o Shareholders provide capital, & in return management responsible for running company well

& delivering timely & accurate financial reports. SEC/NYSE have targeted this relationship

with Congress so reporting standards & regs that promot transparacy are strong.

 Management/Board

o Board monitors performance & counsels; hires/fires/sets pay of CEO. In return CEO is

responsible for managing co & keeping board informed.

o Board‘s allegiance is generally to management, when it should be to shareholders. This skews

governance triangle, collapsing one side; sets stage for cordial consensus driven environment.

CEO power is formidable when this happens.

 Shareholders/Board

o Link receives less attention & most effort goes to linking their financial interests. This works

w/CEO who‘s personal wealth is mostly tied to co, but the board has a smaller % of wealth

and less to loose in co; they may just be serving to learn, serve, etc. Instead focus should be

on increasing transparency & accountability, which is at heart of good governance & is

missing.

o Directors don‘t know what shareholders want & while shareholders technically elect bd, they

can‘t slate nominees & don‘t know voting record & gen don‘t know what bd is doing.

o This creates a weak side of triangle and allows bd & management to become united & sets

stage for consensus-driven environment for which bds are criticized.

 When shareholders fail to engage either in setting direction or holding board members accountable for

behavior, this link is missing & director‘s allegiance shifts from proper base (shareholders) to nearby

boardroom where fellow directors & managers fill void. Here, CEO‘s power can be formidable.

Directors feel obligated to CEO who recruited them. Plus CEOs are generally very persuasive people

 Hard to change things even if independent directors are brought in b/c each director is joining a group

with already established norms.

 Directors‘ degree of independence is the most visible driver of director behavior, but other less visible

forces are harder to change and present: nomination and recruitment process, board culture and

relationship with CEO, level of accountability to shareholders

 Ways to align:

o Make directors accountable to shareholders by recording key votes on resolutions in proxy

statements; have groups like Institutional Shareholders Services create scorecards

o Separate positions of chairman & CEO: corps that fuse 2 positions collapse governance

triangle, undermining system of checks & balances that are essential to responsible corp gov.

o Reinvigorate shareholders: In nomination & election process, shareholders could signal their

support for candidates the board puts forth & vote accordingly. (Ex: Posting principles &

votes on web). Also if they vote against something they should be able to tell board why.

Urge shareholders to seek each other out & work in concert on issues w/common ground

o Give Boards Funding: For huge decisions insight from an external perspective could help.

(experts). SOX requires that audit committees have their own funds for paying auditors and

advisors. Giving budgets to full boards would extend this practice

o Encourage boards to monitor their own performance

 Other Side

o Naysayers will sing usual chorus that greater transparency & shareholder involvement will

make it more difficult for corps to attract good directors. But this isn‘t fair. Change takes

time yes.

o Some say revealing individual votes wont do any good b/c most votes are unanimous, but its

not good to go into voting process knowing it will be unanimous b/c then where‘s the debate?

o Also some think revealing votes will open up bd for further liability, but on other side

individual votes can leave record to get rid of some liability for voting against bad decision.

o Prob needs to be fixed, but even best efforts will be shot down in current environment.



5. What are the key responsibilities of members to the boards they serve?



 Provide checks and balances on management

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 Provide oversight of the company

 Properly representing shareholders

 Determining the culture of the co and how that affects profitability

 Being informed of the decisions they must make

 Hire qualified CEO

 Review CEO‘s performance/approve CEO‘s compensation

 Review/approve corporate strategy

 Review/approve acquisitions

 Approve hiring and compensation of CEO‘s direct reports.

 Nominate (select) new directors

 Review financial reports

 Promote the ―Best Interest‖ of the firm

 Act without conflict of interest

 Act in good faith to further the best interests of co and stockholders



6. How does the “business judgment rule” protect directors?



 A case law-derived concept in Corporations law whereby a court will refuse to review the actions of a

corporation's board of directors in managing the corporation unless there is some allegation of conduct

that (1) violates (a) the directors' duty of care, (b) duty of loyalty, or (c) duty of good faith; or (2) that

the decisions of the directors lacks a rational basis. Courts often analyze the rational basis requirement

as part of the director's duty of good faith. (It remains unclear whether the duty of good faith is a

separate duty. The Delaware Supreme Court's decision in Disney did not clarify the issue.)

 W/out this rule no one would be willing to serve.

 Basically this rule means that directors can make bad decisions as long as they were honest mistakes,

in their authority & decision complies with fiduciary responsibilities. Two exceptions:

o First, in special committees:

 When you sell corp: you must get highest price you can; special committee of

directors & make decision; independent parties will be liable for guaranteed opinion

 Transaction w/dominant shareholders

o Second when directors are ―consciously indifferent‖ like in Disney example they almost

were.

 Creates a strong presumption in favor of the Board of Directors of a corporation, freeing its members

from possible liability for decisions that result in harm to the corporation.

 In short, it exists so Board wont suffer legal action b/c bad decision.



7. What are the implications for the Disney case for corporate directors?



 In Disney, Board approved K w/out reviewing draft, no cost analysis of terminating agreement w/diff

scenarios, no outside consultant was used, no comparable peer compensation considered, no review of

stock option agreement, compensation committee meting lasted less than an hour!

 Del Sup Crt: crt wont ―substitute its own notions of what is or is not sound business judgment"

(Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984)) if "the directors of a corp acted on an informed

basis, in good faith & in the honest belief that the action taken was in the best interests of the

company."

 Delaware law forbids either a corp or its provider of Directors‘ & Officers‘ insurance from covering

any damages where Directorctor or Officer was found to have failed to have ―acted in good faith.‖

 In Disney Crt said Board ―did not breach their fiduciary duties or commit waste‖ by hiring & firing

Ovitz. Ovitz tenure at Disney was a ―spectacular failure‖ w/ ―breathtaking amounts of severance pay

the consequences.‖

 Unreasonable to ―apportion liability based on the ultimate outcome of decision taken in good faith by

faithful directors or officers...would necessarily (result in) decisions that minimize risk, not maximize

value. That is why under our corporate law, corporate decision-makers are held strictly to their

fiduciary duties, but within the boundaries of those duties are free to act as their judgment and abilities

dictate, free of post hoc penalties from a reviewing court using perfect hindsight.‖

 Crt also said that ―redress for failures that arise from faithful management must come from the

markets, through the action of shareholders and the free flow of capital, and not from this court.‖



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 Fiduciary Duties vs. ideal corporate practices: Crt said that although notions of ideal corp practices

have changed since Enron & WorldCom collapses, ―a fiduciary‘s duties do not change over time.‖

Although crt strongly encouraged employment of ―best corp practices,‖ wont be held liable for not

complying w/aspirational ideal of best practices.



8. What are directors doing to become better fiduciaries for firm’s shareholders? What does

this mean for management?



 Getting into the trenches

o In past bd members stayed away from nuts & bolts & were rubberstamp for CEO. Now bds

realize that asking tough questions about company is tough if management is filtering the

info. Directors are mingling w/employees and opening communication w/investors to hear

complaints. They‘re hiring their own advisors to check managers decisions & even taking

over some CEO responsibilities.

o Some changes were required by Sarbanes-Oxley, but corporations seem to be embracing new

level of responsibility. Experts applaud but say bds shouldn‘t overstep their bounds.

o In past CEO‘s handpicked bd w/possible conflicts of interest. Now SOX requires

independent nominating committees for directors & The Big Board requires listed companies

to hold reg meetings w/out management: executive sessions.

 Self Evaluations

o See #17



[this answer deals mostly with the ―duties‖ of corp bd & not how they are ―improving‖… ad more or change it

 This is the slide to help you stay out of jail.

 Directors of a solvent Del Corp owe fiduciary duties exclusively to the stockholders of the corporation

o Duty of Care: directors must act on an informed basis and in a deliberative manner

o Duty of Loyalty: directors must act without any conflict of interest derived from a material

personal financial interest in the matter under consideration

o Duty of Good Faith: directors must also act in a manner that they honestly believe to be in

the best interests of the corporation and its stockholders, without regard to personal or private

motives, even if non-financial in nature

o Duty of Disclosure: directors are expected to make full and fair disclosure to the stockholders

and the board of directors of pertinent information within the Board‘s control (also sometimes

referred to as the ―duty of candor‖)

o Duty of Obedience: Requires a director to avoid committing acts beyond the scope of the

powers of the corporation as defined by its charter or the laws of the state of incorporation.

 Directors of an insolvent Del Corp continue to have task of attempting to max economic value of corp.

Insolvency doesn‘t change primary object of directors‘ duties, which is the corp itself.

o Have an obligation to max value for the primary benefit of all creditors, not stockholders.

o Duty to stockholders is not terminated, but is generally subordinated to duty of creditors.

 Directors who breach their fiduciary duties can be held personally liable to the corp & stockholders

 Directors must be willing to challenge management if nec.

 Most people get into trouble/the duty of loyalty. You always have to say that the corp comes first.

You can‘t try to sell co something that‘s beneficial to you and not above board. Also if you find out

about something coming up you can‘t sell stock b/c that‘s for you, not co. This doesn‘t just apply to

finances; can‘t do something against co that‘s beneficial to you in any way.

 Obedience to charter is typically not a prob, especially if charter is so general as SW Airlines‘.



9. How do well run boards make decisions?



 They make decisions after far reaching analysis of question itself;

 Extensive discussion formally & informally, w/management & independently w/ each other; by

incorporating a common law-like approach where they heed lessons learned from previous

applications;

 Good boards challenge numbers & assumptions & require mgt to justify & explain positions;

 They speak outside boardroom;

 They monitor implementation of decisions; they seek tangible evidence; they address strategic

decisions in a step by step process; they press for explanations of financial pros and cons; they ask the

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ceo how the decisions mesh with the strategic plan; they research and review and speak with other

knowledgeable persons.



10. What are the key factors that should be analyzed in determining if a director is independent?



 Does director have a material relationship w/co?

 Does he have close friendships w/other directors or executives?

 Has he participated in business ventures w/other directors or executives?

 Is he capable of making independent decisions?

 Can he serve the best interests of shareholders & be entrusted to govern corp as a director?



11. How “engaged” should a board be with the firm?



It depends on the circumstances, but at start of board building program, this Q must be answer. 5 possible

bd models, which are on continuum; the pt of classifying a bd isn‘t to put it in a box; these are archetypes. In

real world, board slide back & forth on a continuum depending on current events.

Passive Board: This ―traditional model‖ functions at CEO‘s Discretion; limits activities & participation;

limits accountability, ratifies mgt‘s preferences.

Certifying Board: Emphasizes credibility to shareholders; Bd certifies to shareholders that CEO is doing

w/bd expects & mgt will take corrective action when needed; emphasizes need for independent directors &

meets w/out CEO; stays informed about current performance & designates external bd members to

evaluate CEO. Establishes an orderly succession process; is willing to change mgt to be credible to

shareholders.

Engaged Board: Bd serves as CEO‘s partner; provides insight, advice & support on key decisions; bd

recognizes its responsibility in overseeing CEO & co performance; Bd conducts 2way discussions about

key decisions; seeks out sufficient industry & financial expertise; actively defines its role & CEO‘s

boundaries.

Intervening Board: Common in crisis; Bd Becomes intensely involved in decision making around key

issues; convenes frequently w/intense meetings often on short notice.

Operating Board: Deepest level of ongoing bd involvement; bd makes key decisions that management

then implements. Model is common in early-stage start-ups whose top executives may have specialized

expertise but lack broad management expertise.



12. What steps can be taken to improve the performance of corporate boards?



―Everyone knows what most boards have been: gentleman's-club-era relics characterized by ceremony

and conformity. And everyone knows what boards should be: seats of challenge and inquiry that add value

without meddling and make CEOs more effective but not all-powerful.‖

 High-performance bd must be focused on unambiguous goal & don‘t simply evolve, they must be

built.

 Have the right mindset.

o Must keep going back to same questions about purpose, resources & effectiveness

o Annual Self-Assessments: realized that bds must constantly improve;

 Choose the right role / Determine level of bd involvement (See #11)

o Set out bd‘s responsibilities (as compared to those which are exclusively management‘s)

o Have directors fill out form about what they think are their responsibilities & have

management do the same and then fill gaps and decide who is really in control of overlapping

areas.

 Choose Right Directors

o Capable, qualified individuals who exhibit the characteristics described in #16

 The Right Info

o 2 ways to keep bd in dark: First is providing to little info, and the second is providing too

much.

o Let bd control agenda so that CEO wont overload it and stifle debate

o Give Bd nec info but don‘t weigh down w/useless info & numbers

o It‘s management‘s job to ensure bds get right info, & best bds design process to deliver

formal info that combines both leading and lagging performance indicators. But bds should



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also feel free to gather their own info. Some corps encourage directors to visit facilities

unaccompanied by senior execs.

 Promote the right board cultures

o ―Engaged cultures are characterized by candor and a willingness to challenge, and they reflect

the social and work dynamics of a high-performance team.‖ (Building Better Boards)

o As board members start to act as a team, they can move closer to creating an engaged culture.



13. Why are more CEO’s saying “no thanks” to board seats?



 Since Enron & WorldCom, directorships have become increasingly risky & time-consuming.

o 10 Former directors at these had to use personal finances to settle shareholder lawsuits.

o Hours increased, liability increased & compensation has stayed the same.

 Further, growing number of companies limit number of outside boards on which CEOs may serve.

 In 1997 CEOs of S&P 500 served on average of 2 outside bds, but today number is .9 outside bds

 Also there are increased potential for conflicts of interest

 Also, today everything can be communicated in a nano second and CEOS stay home b/c of the

pressures of doing their job every second of every day.



14. How should a lead director interact with management & the board?

About 50% of corps now have a lead director.

Duties of Lead Director:

 Preside over executive sessions of independent directors

 Conduit for info to chairman

 Annual evaluation of CEO

 Lead in times of crisis when CEO is part of prob

Lead director‘s role has not generally been expressly defined. However, the NYSE has at least given a

vague standard which many corps are looking to. Lead director should act as intermediary between CEO, the

chairman & board. He should have authority to call meetings of independent directors & to set agendas for

meetings. All aspects come together in responsibility for executive sessions where he must first listen to other

directors and then convey accurately to CEO. The role requires soft skills, diplomacy & judgment, plus the

courage to raise tough issues.

Everyone agrees that lead director is not the CEO nor the straw boss of other directors.

Of course, all directors have equal access to CEO, but 7 bd members calling CEO to report on exec session

would drive him nuts, so the bd should gen decide to let collective judgment be transmitted to CEO through

lead director. Bd must trust lead director to accurately communicate their views & CEO must trust that he is

being honest & not trying to manipulate situation to get ahead, etc. Trust has to be built by lead director.

Best way to be a bad director is to be reluctant to let CEO know that there is dissent in the board room. Lead

director‘s biggest asset is an ability to encourage everyone to talk and synthesize differing views to be reported

to CEO.

There is also always a risk that the CEO & leader director will get too close and becomes allies against

the board. Of course friendships do develop and sometimes bd picks lead director b/c of friendship, but being

friends can make it difficult to give it to the CEO straight and to fire him when nec.



15. What process should a firm use to recruit its board of directors?



The nominating and governance committee should have the main responsibility of finding good

candidates for directorship.

Nominations should not be based on friendships that exist with current board members of members of

the executive team of the company.

Rather, individuals should be evaluated on the basis of their credentials. Ask whether they are a good

candidate regardless of the friendship and whether the friendship could cause a problem when it comes to

director independence.



16. What qualifies an individual to serve on a corporate Board of Directors?



 Level of independence

 Financial expertise

 Industry Expertise

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 Business credibility

 Confidence

 Teamwork

 Sound Business Judgment

 Friends

 Willingness to Challenge Management

 Availability

 Process

 Age requirements

o No law for age requirement, but many have one, typically at 72.

 Not typical to have a rotation system set up, but in public sector more likely & typical term is 6 yrs.





17. Should a corporate board try & evaluate its own performance? If you feel it should, how should

it proceed?



 Yes Self Evaluations!

 ―As corporate scandals make investors more vocal about accountability, boards are slowly but surely

moving into the sensitive territory of evaluating individual directors' performance. Advocates hope the

feedback will help directors improve their dealings with colleagues and get them to address issues that

were previously taboo, from poor work habits to difficult personalities.‖

 NY Stock Exchange & some other countries already req this. Wouldn‘t have been accepted 5 yrs ago,

but many corps greatly appreciate chance for more candid criticism. When required, there‘s no

standard for how it must be done, & strategies run the gammet. For some it‘s just a rubber stamp, for

others a long process w/third party evaluator.

 ISS has begun rewarding bds that do such evaluations in rankings on corp gov.

 Resistance: Many corp bd members resist b/c they say they aren‘t doing for money & don‘t want to

have to prove every yr that they belong on the bd. But even Tiger Woods takes Golf Lessons. Others

fear that it will lead to confrontation and disturbance of collegiality of bd.

 Objectivity & one-on-one interviews are key to getting the meat out and every good evaluation leads

to taking actions & steps to improve. Third parties are great but sometimes hard to quickly get a

handle of where company needs most attention. Some third parties just have cookie-cutter plans that

don‘t help as much, but doing it yourself can lead to personality conflicts, etc. Also bd tends to keep

in house for privacy issues, but you can guard against by having rule from get go that stuff gets

shredded, but beware not to shred docs if under going litigation presently. Keep summary of

evaluation regardless.

 Bds can evaluate individual directors either w/self evaluations or peer reviews, but both should aim to

improve job by reviewing quantitative and qualitative performance.

 2 ways to do it:

o Send questionnaires asking about directors‘ participation in meetings, their grasp of financial

& other issues & willingness to challenge CEO; request constructive criticism and/or

recommendations for what entire bd might be able to do better.

o Have outside consultant or attorney confidentially interview each director & tell group

summary

 Individual evaluations shouldn‘t be announced to entire bd. Only gen comments go to full bd.

 Another approach is group evaluation: rather than evaluation of individuals, group-level appraisal can

assess ability of bd as whole or diff committees.

 Ask following: What are bd‘s strengths & weaknesses? Does Committee meet often enough to fulfill

duties? Does committee receive & process info efficiently? Etc.



18. Explain the differences between a strategic & a financial investment from both the perspectives

of the venture firm & the recipient of the funds.



 Strategic investments: made primarily to increase sales & profits of corp‘s own businesses. A

company making strategic investments seeks to ID & exploit synergies between itself & a new

ventures. (Ex: Lucent venture partners make investments in start-ups that have infrastructure or

serves for voice or data networks. Many have formal alliances w/lucent to help it sell Lucent



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equipment. While Lucent would certainly like to make $ on these start up investments, it is willing to

accept low returns if its own business‘s performance is improved as result.

o Venture co w/strong links to the investing company‘s current operational capabilities

(resources & processes) can make use of their distribution channels, technology, or brand. It

might adopt the investing co‘s business practices to build, sell, or service its products (driving

investing).

o Also, if Vco & investing firm offer complientary products, this could stimulate demand for

each other‘s offerings w/out them using each other‘s operations (enabling investing)

 Financial investments: when co is mainly looking for attractive $ returns. Here corp seeks to do as

well as or better than private VC investors, due to what it sees as superior knowledge of markets &

technologies, its strong balance sheet & its ability to be a patient investor. Ex: Dell Computer‘s in

house VC operation has made numerous Internet investments that it has expected to earn attractive

returns. While the co hopes the investments will help its own business to grow, the main rationale for

the investments has been the possibility of high financial returns.



19. Is it true that investors in first round financing normally get "crushed?" If so, why do people

and venture funds invest in first round financing?

Certainly not in the pre-bubble, but maybe more so now since risks are higher that co wont succeed.

Early-stage enterprises simply aren‘t likely to pay the dividends that they once did. Most VCs have

abandoned seed-stage investing. Smaller funds (such as angel investors) are finding that they have no

competition from larger VCs so they can pack & choose & get in early.



20. What is meant by an "angel" investor?



A director of a small private co should market himself as ―angel investor.‖ This is an affluent person who

provides capital for a business start up usually in exchange for debt or ownership equity. A small but

increasing number of angel investors are organizing themselves into angel networks or angle groups to share

research & pool their investment capital. Angel investors typically invest their own funds, unlike venture

capitalists who manage the pooled money of others in a professionally managed fund.





21. What role does a board of directors play in most venture-backed firms? How does role of board

of venture-backed firm vary from a mature publicly-traded co?



Because the VC‘s have seats on bd, they can be helpful in tasks like hiring, setting strategy, forming

partnerships & raising money; but they can be difficult. Bad directors often meddle in operations & make

bad/self-interested financial decisions. Some VCs have hidden agendas: they back another horse in same race

or have secret plans to replace management soon after deal is consummated.

Bd in a venture backed firm is designed to ID a market & try & make sure the product or technology

is developed to appeal to that market. The bd is a mentor to the management. In a large co, where products

are already available, you have management structure, capital structure, M&A, Alignment issues, competitor

issues, and less bout developing the product & tech.





22. What is meant by "venture debt?" What are the advantages and disadvantages of venture debt,

to the entrepreneur, and the venture capitalist?



This is anew form of funding start-ups. Instead of a traditional VC procedure where VC buys a stake in

co, venture debt firms loan substantial sums to start-ups. Lenders who fund start-ups charge double-digit

interest rates on par w/interest payments on high-risk corp junk bonds. Lenders also typically get potential

future stakes in companies via warrants that can be converted into equity. Warrants convert to equity if start-

up eventually goes public. (Contrast to venture capitalists who invest in such companies by paying cash for

immediate stake in hopes of payout later when co sells.)

Disadvantages to entrepreneur: risky for early stage start-ups. Loans need to be repaid over time,

which can burden them if it ahs trouble generating revenue. Very dangerous if start-up has no revenue b/c

startup has no cash flow to pay down debt, the co may end up paying off loan‘s high interest rates w/cash that

VC has invested in firm to begin with.



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Disadvantages to other VC: As creditors, lenders also have first right to payback before other

investors

Advantage for entrepreneur/co: now it takes longer to go public, like 6 yrs & many cos need more

money to stay private longer. This also brings more opportunity for venture lenders. While taking money

form VC often requires giving away a big chunk of firm, venture debt doesn‘t dilute founder‘s stakes as much.

Loans are good for helping start-ups keep going for a few more months.



23. What does Mr. Aragona mean by “there are no new business models?”



The bubble taught us that there are no new business models: one huge characteristic of a good VC deal is

a viable business model. Click-through ratio, etc. No number or stat really matters unless it means bringing in

more cash.

He means that technology changes and economics laws do not. It is much harder to innovate business

models than it is technology, and many companies are figuring this out and beginning to acquire tech outfits

even before they have a business model. (Ex: google's purchase of youtube) Since technology is easier to

innovate it is better for a venture capitalist to search for tech companies that can innovate and use existing

business models than to try to invest in a new business model that will not likely succeed

SWA CEO said he didn‘t like the term.



24. What makes a good venture capital deal from the perspective of the venture capitalists?



 Management (a co‘s unfair advantage)

o Experienced team w/deep relevant experience

o History of execution; only best will be funded & the bar is very high; new MBA‘s wont make

cut

o Vision to deliver world class proprietary technology

 Markets

o Prospects for dominance in large growing market; large growing market req to overcome risk

 Viable Business Model

o Bubble taught us that there are no new business models.

 Capital Efficiency

o Valuations will be 20-50% of peak consistent w/NASDAQ / Decline commensurate w/risk of

private equity

o Capital Efficiency is simplest way to mitigate dilution issues and retain high multiple

returns… it must be adhered to at the investor level and part of the culture of the portfolio

companies

 Unyielding belief that Customer validation is the key milestone/leading indicator of success.

 VC is only for huge market taking over ideas, not for niche markets. Don‘t beat a dead horse. If

market doesn‘t buy, get out and take best and brightest to next co that might make the big win.

 It is a good time to invest, but it‘s a marathon, not a sprint.



25. Why should you care about success of Venture Capital Industry?

 If VC investing stops, so does the economy.

 2005 Gloal Insight Study Revealed:

o Overall VC funded co‘s were directly responsible for more than 10mil jobs & $2.1

trillion in sales in 2005, which is 9.4% of US private sector employment and 16.6% of

GDP. VC investement itself represents .2%, but venture-backed companies accounted

for nearly 17% of GDP.

o Since the stock market correction, VC backed companies outperformed nonventured

companies in job creation. Between 2000 & 2005 Venture-backed companies‘

employment grew by 6.5% vs. only 1.3% increase in overall private sector jobs during

same period.

o You have often noted the productivity returns on R&D investing. Our study showed the

share of US R&D performed by firms with fewer than 500 employees rose from 5.9% in

1984 to over 20% in 2003. When adjusted for size, venture-backed companies spent 2x

as much on R&D as non-ventured companies.

o Venture backed co‘s represent 40% of all IPOs during study - average 37% since 1997



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o This study shows high correlation between VC investing, R&D, productivity, and

economic development/ job creation.

 You should care b/c it has brought about so many great companies, economic growth, gives

people the change to take great risks that like 1 out of 10 lead to great things happening.

Suffering through risks is what American success is all about.

 10% of US companies are backed by VCs. US has dominated for some time in capital markets

but Sarbanz Oxly is causing everyone to go overseas.



26. Should “carried interest” be taxed as ordinary income?

 Carried interest is the percent (norm 20%) of fund‘s profits that fund managers are compensated.

It has been counted for taxing purposes as capital gains, but some are trying to make it income.

Aragona thinks that it must remain capital gains or else he will get out of biz b/c its much less

beneficial too him. Also he sees it as capital not as income and he thinks big pay outs for VC &

CEOs are great b/c they are huge driving force behind so much of the economy.

 Other arg: Tax preference for cap gains undermines capitalism – a system in which capitalists,

not the state, are supposed to make the investment decisions. If a proposed investment loses

money before tax but actually turns a profit after tax b/c of the preferentially low capital gains

rate… it is rational to take it! The govt is able to induce people to make bad investments, which is

a good way to run an economy into the ground.



27. What are implications for class action lawsuits for board members?

When suit is filed there is ―Shock & Pall…" even if cases are dismissed there is still issue of dealing

w/worried employees & shareholders who don‘t understand that lawsuits are often frivolously filed.

Lawsuits are being filed at alarmingly growing rates where shareholders allege they bought stocks and

suffered losses due to violations of one or more DED/state securities laws. Average settlement of all

shareholder suits is a bit more than 10 million. Directors aren‘t routinely named parties.

Directors beware: Restating financial results all but guarantee a lawsuit will follow. Directors should look

for red flags & must have independent members on audit committee. Must make sure mgt‘s pay is not tied too

closely to short term perf. Carry adequate D&O insurance. Move as quickly as possible to assess liability and

seek to have the case dismissed or settled. Speedy response controls discovery. Decide whether to bow or

make counteroffer. Typical settlement, plaintiffs receive five to twenty percent of what they were seeking.

Loss mitigation insurance whereby company hands over liability to the insurer.

Directors can minimize risk by knowing what sorts of events trigger law suits. Restating financials means

that law suit is likely. When stock drops suddenly or bd says that someone did something questionable, etc.



28. Why is “intent” so important in white-collar crimes?



a. The biggest hurdle for prosecutors in corporate corruption cases is that they must prove not

only that the accused did something bad, but also that they meant to do something bad.

b. A lot harder in these crimes b/c the accused are rarely caught on tape saying they intend to

commit fraud. Prosecutors have to use circumstantial evidence to show that the def knew that

what they were doing was unlawful or unauthorized.

c. Another defense, see Tyco, is acting out in the open. If it‘s all on the books, there‘s a good

indication that they didn‘t realize they were breaking the law.

a. This leads to paradox. If you have evidence then it was in the open and you prob

can‘t prove intent, but without any evidence you have no case to begin with.

d. On other hand prosecutors typically use deceit as evidence of intent, like w/Stewart

e. Another defense is that they were relying on advice or approval from lawyers, bd or auditors



29. What are implications of settlement in lawsuits against WorldCom directors, announced Jan05?



a. Directors are asking themselves whether it is still safe to sit on Board of a public US corp in

aftermath of Enron, Sarbanes-Oxley, & WorldCom directors‘ 18 mil personal settlements

b. However, Worldcom was an extreme case … also, payments by directors were part of a

negotiated settlement (not judicial precedent)

c. Worry b/c Cutler, Director of SEC‘s division of enforcement warned in sept 2004 that over

the next year they will focus closely in investigating whether outside directors have lived up

to their roles as guardians of the shareholders they serve

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d. If you serve on a board be active and attentive and put in time and effort (including reading

all materials carefully)

e. Have best in class governance practices

f. Be careful in review of any transactions involving management participation

g. Take the independence reqmts set forth under Stock Exchange Rules and SOX seriously, and

avoid any appearance of impropriety. Act solely in interests of co and its shareholders

h. Do your diligence carefully before accepting a seat and associate yourself only with

institutions and mgt teams of high integrity

i. Take all regulatory/compliance/acct deficiencies seriously and demand rapid corrective

actions on part of mgt

j. Make sure there is adequate D&O insurance including, where practicable, separate side a

insurance covering the directors separate and apart from the corp. This is particularly impt in

the context of a bankruptcy.



30. What are the major responsibilities of Gen counsel of a major world-wide corporation?





In class Charles Matthews, Gen Council for Exxon: The design of gen council‘s office depends on

company. Exxon has 400+ in 40 countries. The organization of department will have broad effects. A

common trend in the companies that have gotten into legal probs is a disconnect between organization and the

lawyers.

Attorney/Client Privilege & separateness of dept: Sometimes attorneys in business think they are

businessmen & lawyers but this can mess w/the idea of attorney client privileged. Legal dept needs to make

clear that there is client privilege. The law dept is a function to itself. The org goes up to top of legal dept. It

is separate from company. A lawyer in filed deals w/clients but boss is in legal dept. Head of legal dept

reports directly to CEO & Board but separately. Lawyers shouldn‘t bill hours to tiny sub-groups of org b/c

that would discourage people form talking to lawyer due to costs billed to their dept.

Lawyers have to reli on specialists.

Assigned responsibilities: every lawyer should know who he is to work with.

Must have full access from legal to rest of org. instant access in system to management is very important.

Legal must be accessible to answer little and big questions. Also must be at edge of future to help predict

trends for how to prep for future. Gen council helps w/public affairs person b/c any time someone is talking,

there are legal issues.

Compliance: they are not the companies‘ police officers, but its important that everyone has the right info.

For ex: anti-trust issues are huge w/Exxon & so are labor issues. Exxon gets sued 7 times per day.

¾ of company is outside US, but ¾ of legal work is in US.

Gen council ends up even having to know criminal law b/c so many laws, like environmental laws have

criminal law aspects to them.

Staff firm across the world… have own lawyers on hand at every location. Communicate with mgt and

directors. Have direct access to mgt. Coordinate all litigation efforts. Hire the best outside counsel when

appropriate, communicate goals and limits to them. Be aware of all lawsuits instituted against corporation at all

times. Know the status of all actions. Ensure separation between internal law firm and operations. Ensure

compliance with policies, existence of policies and regulations

Thirty percent of Matthews‘ time is spent counseling mgt; 20 percent is evaluating risks; 15 percent is on

administration of the law dept; 10 percent with the board, and 25 is doing actual legal work. Also, he must

work with outside auditors, and ensure sox compliance.





31. What can be done to change the litigation culture in US?

Excessive litigation is especially evident in area of shareholder lawsuits & derivative actions. These types

of actions have proliferated mainly b/c low costs & high payoffs they represent for plaintiff lawyers. Some

possible mechanisms to encourage a change in this trend include:

 Provide plaintiff attorney‘s incentives to curtail claims.

 Stricter enforcement of Rule 11 of the Fed Rules of Civ Pro which prohibits frivolous pleadings.

 Increasing fines for violations to Rule 11.

 Increase the costs of filing lawsuits.

 To encourage companies & boards that are really ―innocent‖ to fight frivolous lawsuits until end

and not settle, because ptf lawyers usually file suits even if they have a weak case b/c they guess

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(most of the time correctly), that dft will settle. If trend changes, ptf attys will be less likely to file

weak suits.

 Increase the use of mediation



32. When does an alliance that is legal cross line to become a collusion that is illegal?



a. If the govt can get actual evidence (email or witness testimony) that firms have entered an

agreement to limit competition, the government can argue a ―per se‖ violation of the Sherman

Antitrust Act, meaning that no proof of harm to shareholders is necessary. Some agreements

are so obviously harmful to the free market system that they are automatically condemned.

b. If a firm agrees not to compete on every auction: ―I‘ll bid on this case, you bid on the next

one‖ this is per se illegal

c. Antitrust cases rarely work out like the above… Without this evidence governments have to

show actual economic harm – a process that involves economic analysis of prices, and the

players‘ powers in that market. Making these cases can be hard.

d. Companies are allowed to band together for business purposes (moves they ostensibly make

to stay competitive… but issues arise when the agreements are seen as stifling competition.

Fed antitrust law typically involves a delicate dance of identifying when free-market

arrangements hamper the mkt itself.

e. Private equity firms don‘t have ultimate control over the value of the co‘s they target. The

seller doesn‘t have to sell. The board can always say they aren‘t going to sell. The large deals

that have attracted club bids (like recent bidding for cos like Harrah‘s Entertainment or

Freescale Semiconductor probably wouldn‘t have occurred w/o private equity firms teaming

up, b/c so much capital was required. In the absence of these team bids, the share prices of

target companies might have been lower (so teaming up helped to raise share prices not lower

them).

f. This question is often asked by lawyers following private-equity industry in wake of news

that JD is pursuing an inquiry into how private equity firms conduct their bidding for control

of public companies. Antitrust cases are hard to make. Wallstreet is especially hard

i. Unlike some industries dominated by 1 or 2 players, Wall Street is a highly

competitive arena. Private equity represents only one pool of capital competing for

company shares. There is so much money out there that there is almost unlimited

potential competition.

ii. Mid 1990s: Merril Lynch and Goldman Sachs allegedly conspired to fix trading costs

on Nasdaq stock market shares. (JD reached a settlement with the securities firms

prohibiting them from colluding in the future, but the firms weren‘t forced to pay

fines and didn‘t admit or deny wrongdoing.





33. How should a white collar criminal try & adjust to prison?

Gisan (first of Enron execs to go to prison), formed relationships with prison gang leaders, negotiated with

federal officials over the conditions of his incarceration.

Survival rules that he noticed: Don‘t disrespect, don‘t get on anyone‘s bad side, be friendly, especially

toward powerful people, share books and things; Join the underground economy (prison obs) Accepting of

your own wrongdoing is a major step. Cooperate with investigators. Take problems to the gang of your own

race. Gang leaders nixed inmates‘ efforts to retaliate against him for testifying.



34. What can firms do to avoid public relations problems?

Have PR transparency so not deceive public. Ex: there was a blog set up praising Wal-Mart & later people

found out it was run by the sister of an executive in Wal-Mart‘s outside PR company Edelman; this gave fuel

to fire from Wal-Mart‘s critics and resulted in public relations problems.



In crisis management, be quick thinking and have strong leadership & avoid slow decision making

process. Firm should work to be perceived as a societal problem solver.



Firms need to understand the changes occurring in PR and how they can affect a company‘s image and a

company‘s ability to get its message out, i.e., bloggers, blurring of lines b/t news and entertainment w/ Jay

Leno, John Stewart, etc., and power of special interest groups.

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Firms should also work actively on PR, i.e., Wal-Mart never worried much about image and then ran into

image problems.



35. How has Wal-Mart tried to improve its image? Do you feel it will be successful?



Problems Wal-Mart had: Wal-Mart is the country‘s largest public company & also world‘s biggest corporate

target. It had largely ignored criticism throughout its history. Problems Wal-Mart had included image problems

w/ discrimination, sub standard wages, health care, buying products from overseas. Walmart was also fined in

many cases for withholding or destroying evidence.



Wal-Mart really used to just focus on pleasing customers with low prices, products, etc but in recent yrs

increased competition and activism and media/books against them has forced them to go on offensive. They

must improve image in order to keep growing b/c when they go into new towns, if PR is low they have to fight

legislation which costs a lot to do.



Things it did to improve: Then it changed and started letting CEO take on critics and engage opposition. CEO

Scott recruited new corporate counsel and hired outside firm to review the way Walmart handles cases. Scott

reached out to critics and Walmart agreed to improve monitoring of labor conditions. Conducted a reputation

survey & began responding more to ciritcs & began running TV ads highlighting opportunities at walmart and

walmart‘s civic involvement. Bought newspaper ads defending itself. Scott has met w/ many special interest

groups (Black Caucus, environmental groups.



Was it successful: While many of Wal-Mart‘s tactics helped improve its image, it still has a long way to go. In

order to continue building good-will, Wal-Mart needs to continue its aggressive public relations campaign.





36. What role should PR play the firm’s communications strategy?

Image is crucial to growth & expansion of a firm, i.e., Wal-Mart‘s image problems caused a decrease in

sales and caused it to scale back expansion efforts. Firm must make PR and promoting a positive image a

priority. Firms should use crisis as an opportunity to show how the company is moving forward-public is

forgiving so firm should use this to its advantage. Make sure good works done by company get the appropriate

amount of coverage, i.e., Wal-Mart‘s efforts after Hurricane Katrina. However, companies need to balance the

role of promoting public good with ensuring prosperity and free markets.



37. What does the CEO need to understand about public relations?

Example of problem CEO might face: AT&T CEO Armstrong: criticized by media for moving too fast &

acting too boldly showing that business today is as much about managing perceptions & external relations as it

is managing employees, finance, and assets.

Don‘t Over sell your story: Need to balance risks in boosting company‘s image w/ creating false

expectations about the company. Avoid on the record interviews until you know what plan is or create buzz

that can‘t live up to. Avoid overselling stories that don‘t actually materialize: i.e. AT&T announcing

agreement w/Time Warner to use its cable lines and deal never went through. Damage control is harder when

you have hyped up change & expectations that don‘t materialize;

Understand the media‘s mindset: CEOs are accustomed to personalizing business stories & media loves

colorful personalities. Media focuses on who is winning and who is losing and it can change quickly & so view

events as competitive struggles. Be selective w/ granting interviews so story won‘t be misconstrued--require

chunks of interview to be run verbatim & use competition between publications to get it done.

Don‘t miss the symbolism in the facts: CEO needs to look beyond rational arguments and address

shareholders‘ emotional concerns so make sure to share in the sacrifices of employees and shareholders. Need

to understand people‘s emotional attachment to certain things. i.e. AT&T employees outrage of proposal to get

rid of statue Golden Boy to cut down on maintenance costs;

Pay more than lip service to your stakeholders: PR is about building long term relations between

institutions & stakeholders. Create value in all stakeholders: employees, customers, investors



38. What are the implications of risk-based auditing procedures?

W/recent wave of corporate fraud, people have been asking how the auditors missed it?

―Risk-Based Auditing‖ is at least partially to blame.



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What is Risk-Based Auditing? This is the approach widely used through the accounting profession (at

least as of 2004 when article written). Risk-based auditing is where auditors assess how risky they think that a

company is & then they audit more closely companies w/higher risk levels and less closely companies with

lower risk levels.

Old vs. New System: Under traditional ―bottom up‖ audit, auditors gain assurance by examining all the

component parts of financial statements, ensuring that transactions recorded are complete & accurate. The

new ―top down‖ approach focuses ―less on the details of individual transactions‖ and instead auditors use their

knowledge of a company‘s business & organization to ID risks that could affect the financial statements & to

target audit effort in those areas. Proponents point out that the approach is much more cost effective.



Implications of Approach: Even though auditors tend to plow through reviews of even ―high-risk

companies,‖ auditors will barely give a cursory review of ―low risk‖ items such as ―cash on the balance sheet

or accounts that fluctuate little from yr to yr.‖ Instead auditors will rely heavily on what management tells

them and the auditors‘ assessments of a company‘s ―internal controls.‖ Ex: for inventory, the lower the

perceived risk, the less frequently jr-level accountants might be dispatched on surprise visits to clients‘

warehouses



Potential Problems: In theory the approach should work fine if auditors are good at identifying areas

where misstatements are most likely to occur. However, there‘s no evidence that auditors are good at

assessing risk & if an auditor assess the risk as low and it isn‘t, then the auditor will miss all kinds of stuff.

Of course auditors could never check all of a company‘s numbers, it would be impossible & the tools

available haven‘t really changed in past 160 yrs.

Tools: look for inconsistencies, ask people questions, including independently contacting a client‘s

customers to make sure they aren‘t making side deals; they examine all sorts of business records. Common

trick to watch for is that co isn‘t making a lot of small errors that ad up to a big fraud. Auditors shouldn‘t

become too predictable or companies learn how to sneak around their methods. One good thing to do is to

sample test some very small transactions to see if they are trying to sneak something through on small

amounts.

The problem with Risk-Based Auditing is that a co reaches a certain point of ―trustworthiness‖ and the

auditors really stop double-checking them to a large part.

Reason why it started/wont stop: By the 1970s a new factor came into play, price competition between

auditing companies. This lead to competition to keep hours down, etc. Increasingly audits became a

commodity product. Flat-fee pricing became common. The big accounting firms spent much of 1980s and

1990s building more-lucrative consulting operations. Many audit clients soon were paying their independent

accounting firms far more money for consulting than auditing. The ―audit‖ became a mere foot in the door for

consultants. Proponents just argue that the approach is cost-efficient & forces auditors to pay more attention to

areas that are more risky.

Even before recent rash of accounting scandals, the shift away from extensive line-by-line number

crunching was drawing criticism.

From 1987 to 1997 80% of accounting-fraud cases involved top executives. Risk-based approach focused

on info systems & employees who fed them, but auditors really needed to expand their scrutiny to include top

executives who w/a few keystrokes could override their companies‘ systems.

WorldCom: they met & brainstormed where high risk areas might be… then they asked management

whether they made any ―top side‖ adjustments, and when assured that they hadn‘t, the auditors conducted no

testing. They only tested major swings, but if they had dug into specific journal entries they would have seen

lots of huge entries of suspiciously round numbers that had no supporting documentation.



39. What advice do convicted executives have for other executives who are not in jail?

I would hope that the advice from convicted executives for those currently in executive‘s positions would

be that no matter how hard you try to hide something, it will be caught. From Enron to WorldCom, and

Healthsouth, all of these companies could fool outside auditors for some time; however, eventually this will

catch up to you. Even if documents are falsified to make one quarter or to have investors perceive a favorable

year end, this practice will lead to eventually having financials with invoices that cannot be accounted for

(example, Healthsouth.) Moreover, with Sarbanes-Oxley top executives have to sign off on the financials and

are held personally accountable. This should, in theory, provide enough incentive for top management to not

commit fraud, but also monitor potential fraud in the organization.







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40. What can be done to reverse the pattern of the use of aggressive and often deceptive accounting

practices to improve short-term earnings?



In the late eighties to nineties, more than 80% of an accounting agency‘s fraud cases involved top

executives. Therefore while the risk-based approach was focusing on information systems and the employees

who fed them, auditors really needed to expand their scrutiny to include top executives. For instances, in the

WorldCom case, the internal controls and software that auditors used showed that WorldCom was a

―maximum risk.‖ However, the auditors relied too heavily on answers supplied by management. Accounting

firms should focus more on where the information is coming from in order to mitigate aggressive and

deceptive accounting procedures by not only questioning the internal controls of the firm, but also the source

of where the information in coming from.

Employ more forensic accountants

Focus on more executive action and deception rather than just that occurring in accounting departments.

Ensure that entries have matching documentation

Aggressively question executives and accountants

Return to the old model of line by line accounting.

Learn from lessons of the past

Do not disclose high risk metrics to clients



41. What are the implications of Sarbanes-Oxley for corporate America?



 What SOX requires of corps:

o Bd meets more often w/out execs.

o Ethics training is more intense

o Greater accountability in bdroom (more bds resolve probs before they explode)

o Better internal control instituted. Extensive control reviews.

o Sox created the Public Accounting Oversight Board to oversee audit of public companies

o Expanded SEC‘s role: Rules and regulations that may be appropriate to the public

interest.

o Now the principal executive officer and CFO must certify that annual or quarterly reports

filed are true based on officer‘s knowledge

o Insider trading is totally illegal

o Enhanced financial disclosures are required

o There cannot be loans to officers and directors

o New Codes of Ethics

o Financial Experts required

o Analyst conflict of interest rules

o Federal Sentencing of violators

 SOX has been critical step towards reassuring investors & restoring confidence in company‘s

financial statements

 Demanded more rigorous internal controls, forced top execs to certify the accuracy of financial

results and created a watchdog for auditing firms.



Negative Implications: $26 billion spent last yr alone for companies to comply. It deters companies from

going public due to required costs & is causing companies to want to go or stay overseas. Now sr. mgt is

responsible and can be held accountable for financial statements of firm.

Positives: However sr. execs are admitting that SOX has brought it in more accountability to the efforts

that companies are already suppose to be making & has increased collaboration among directors of the firm &

audit committee as they now meet to talk about issues more freely.

Even critics of SOX defend it has demanded more rigorous internal controls, forced top execs to certify

the accuracy of financial results & created watchdog for auditing firms thereby leading to more accountability

in boardroom. Also expanded role of board audit committees & required companies to take "whistleblower"

complaints more seriously.

Mr. Aragona‘s Opinion (Austin Venture Capital) – SOX has lead to $300-400 billion of market value

taken out of system. SOX will go down as one of the worst pieces of legislation ever! They said it would cost

92k for company to comply for first year and then go down, but average that company‘s pay is aprox $2.5

million! It has caused everyone now to not want to be CEO. Now if someone in business messes up CEO of

public co can go to jail even if he was trying he best. He went on to bitch about how they are wanting co‘s to

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have to do evaluations for all stock options, and how the accountants use the wrong equations, and overprice

stocks, etc. he was very bitter about SOX.



42. How should the independent auditor interact with the audit committee, the Board, and

management?

Independent auditors should work more closely with audit committees and the Board and not just listen to

management‘s opinion of the financial position of the firm. Risk-based auditing procedures causes many

outside auditors to just take management for their word and only concentrate on the high risk areas of potential

problems from firms. Due to the difficulty in raising fees, major accounting firms began to do audits for large

firms almost just to get the firm‘s consulting work, which made the accounting firms more money. Flat fee

pricing became the norm for auditing services as audits became a commodity product. Unlike the watchdog

mentality of accounting firms when they were first started, instead auditors began to rely more heavily on what

management tells them and the auditors' assessments of a company's "internal controls."



 Independent Auditor & Audit Committee: IA should communicate w/Audit Committee about:

o All critical accountings policies & practices

o All alternative treatments of financial info that have been discussed w/management

o Any communication w/management involving unadjusted differences

 Independent Auditor & Board: Will periodically report to the board to tell of the board‘s

examinations and recommendations.

 Independent Auditor & Management



43. Is CEO's compensation being driven primarily by basic economic forces? Explain.

Economists who have recently studied the issue contend that basic economic forces still play a big role in

determining pay at the very top of the corporate ladder. It just happens to be working to the advantage of

an increasingly narrow slice of business leaders. Today executives earn much more than in the past; in the

1960s and '70s, chief executives running the nation's biggest companies earned 80 percent more, on

average, than the third-highest-paid executives but today the gap in the executive suite between No. 1 and

No. 3 had swollen to 260 percent.

This is primarily due to economic forces of supply and demand. The pay of chief executives is being

driven by superstar dynamics similar to those that determine the inordinate rewards for pop stars and

athletes.

As American companies, American hedge funds -- and even American lawsuits -- have grown in size, it

has become ever more valuable to get the ''best'' chief executive or fund manager or litigator. This has

fueled a fierce competition for talent at the top, which has pushed economic rewards farther up the ladder

of success, concentrating the richest pay levels even more.

a. Many experts argue that CEOs have a particular ability to drive their own pay upward, in part

by manipulating directors they work closely with and encouraging the use of consulting firms

that have a built-in incentive to increase pay packages for those who hire them. In this sense

the CEO‘s pay is not being determined by supply and demand

b. However, economists who have recently studied the issue contend that basic economic forces

still play a big role in determining pay at the very top of the corporate ladder. It just happens

to be working to the advantage of an increasingly narrow slice of business leaders.

c. The pay of CEOs is being driven by superstar dynamics similar to those that determine the

inordinate rewards for pop stars and athletes. (underlined more than a decade ago by

economists in the book The Winner Take All Society).

d. As American companies, American hedge funds, and even American lawsuits have grown in

size, it has become ever more valuable to get the ―best‖ chief exec or fund manager or

litigator. This fueled a fierce competition for talent at the top, which has pushed economic

rewards farther up the ladder of success, concentrating the richest pay levels even more.



44. What can corporate boards do to help make compensation plans more acceptable to

shareholders?

New proxy disclosure rules approved by the Securities and Exchange Commission last July are shedding a

harsh light on the breadth of corporate chiefs' oversized packages. But, new rules also give investors a better

handle on perquisites, pensions, deferred compensation and stock-option grants -- awards that previously were

buried in the fine print of public filings.



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Board members typically blame their inability to control runaway rewards on competitive pressures --

especially when the boards are recruiting new management.



However, ten steps help shareholders with executive pay packages. These ten ways to make compensation

plans more acceptable to shareholders are: Make sure the board's pay consultants don't also work for

management, during outside CEO hunts, set limits on the projected compensation, hire a savvy negotiator and

find a back-up candidate, Skip severance for anyone with a sizable stock stake and deferred-compensation

account, Retreat from "pay for failure" by making it easier to fire for cause, Take a skeptical view of "peer

group" comparisons, Kill unjustifiable perquisites, Link all long-term incentives to performance goals, Divulge

precise measures that shape payouts for performance-based awards, and set hurdles high, Conduct regular

checkups about pay practices, and Give investors a voice about executive-pay packages.

a. (1) Make sure the board‘s pay consultants don‘t also work for management; (2) During

outside CEO hunts, set limits on the projected compensation, hire a savvy negotiator, and find

a back-up candidate (3) Skip severance for anyone with a sizable stock stake and deferred-

compensation account (4) Retreat from ―pay for failure‖ by making it easier to fire for cause

(5) Take a skeptical view of ―peer group‖ comparisons (6) Kill unjustifiable perquisites (7)

Link all long-term incentives to performance goals (8) Divulge precise measures that shape

payouts for performance-based awards, and set hurdles high (9) Conduct regular checkups

about pay practices; (10) Give investors a voice about executive pay packages, a right that

exists in four countries



45. Should shareholders be given the right to vote on executive compensation?

Ahead of this year's annual meetings, activist investors have submitted shareholder proposals at roughly

60 companies seeking an advisory vote on executive pay, according to Institutional Shareholder Services. The

vote would be nonbinding, but activists hope that public censure, or the threat of it, would prompt directors to

curb outsized awards and better link pay with performance. The proposals come as new Securities and

Exchange Commission rules requiring greater disclosure promise to cast a brighter spotlight on compensation.

However, if we look to the system set up by the British in 2003, they have had shareholders vote in a non-

binding vote on the pay of their executives and although the embarrassment factor is meant to curb large pay

packages, it has not worked for the most part. It is problematic also in the sense that how do you give

shareholders the right to vote on pieces of a pay package, such as an executive's deferred compensation, which

is necessary to pay by law. Although this seems like it is giving power back into the hands of the shareholders,

I think a vote by the shareholders on executive pay packages is largely ineffective, and may not create the

correct motivation from managers to do what is in the best interest of the company.

a. Yes, in the UK, the non-binding advisory shareholder vote shifted executive compensation

toward bonuses and away from big salary increases… but investors still feel like pay is not

fully alighned with performance in the way that they‘d like. However, the vote appears to

have helped curb severance packages

b. Wells Fargo, on the other hand, argues that an advisory pay vote would provide no

clear/meaningful guidance b/c directors wouldn‘t know which portion of compensation

investors objected to. Shareholders already have plenty of ways to tell directors what they

think. Wells fargo also contends that the US and UK corporate systems have significant

differences in regulatory and corporate governance policies and practices.

c. Say on pay proponents hope investor censure – or the threat of it – will encourage directors to

trim excessive awards and better link pay with performance. An advisory vote ―tamps down

the potential for CEO greed,‖ Shareholders will have to replace compensation committees

that don‘t heed these votes



46. What can be done to tie pay more closely to performance, and cut back on excessive benefits and

perks?



Compensation experts offer eight steps that can be used to tie pay more closely to performance and cut back on

excessive benefits: hire independent advisors, pick the right peer group, stet and stick to targets, review and

negotiate contracts, avoid contracts, scrutinize pensions, let shareholders vote, and get money managers to

vote.



hire independent advisors: it is still common for an outside consultant working on actuary or benefits work

to do give an opinion on the compensation of executives. This puts the consultant in a conflict of interest.

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New SEC rules will require companies to disclose the name of this advisor. However, to help the situation,

companies should choose an outside advisor for this work and not one that is currently hired for other

advisory work.



pick the right peer group: often the pay of executives is compared to other executives in the industry to get

a sense of what is the fair price for compensation. However, companies should be careful on what it

considers a peer company - First, use a handful of peers that are in the same industry as a starting point.

They will likely have similar profit margins, growth patterns and competitive pressures. Comparisons

against other big companies, admired companies, or fast-growing companies often do not make sense,

experts say.



set and stick to targets: Boards need to be clear about their expectations for management and then be

willing to adjust them accordingly. Targets should be revisited based on changes in the business

environment each year.



review and negotiate contracts: Boards are packed with some of the country's best and brightest deal

makers. But when it comes to compensation, several compensation advisers say, they are often reluctant to

negotiate.



avoid contracts: Boards often say they want to pay for performance, but then put contracts together where

they payout large sums if the executives fail. Boards have begun to have clawback provisions to their

executives' contracts, a clause that allows them to recoup compensation in the case of an earnings

restatement or a termination for cause.



scrutinize pensions: Executives often put away compensations in the form of deferred compensation

programs and supplemental retirement plans. Compensation consultants are seeing larger and larger sums

for compensation in this form.



let shareholders vote: Britain became the first country to require a shareholder advisory vote on executive

pay in 2002, the idea has been gaining traction in the United States, especially among institutional

investors. Although the vote is nonbinding it provides a forum for investors and the embarrassment

potential for the executives has been effective.



get money managers to vote: The biggest influence on executive compensation can be the managers of

funds that are typically among the largest shareholders of a company.





47. How are boards reacting to the pressure to reduce executive perks?

As Boards fear greater disclosures, they are now trimming the pay and perks given to CEOs. Boards are

trimming or dropping everything from perquisites to severance pay, deferred compensation and supplemental

pension plans. However, benefits seem to be the first target. These benefits often include free financial

planning, home-security systems and chauffeur-driven cars. The perks frequently cost a company relatively

little, but draw considerable criticism as symbols of irrational largess. Under the new disclosure rules, proxy

statements must list executive perks valued at $10,000 or more apiece. The more-valuable goodies -- such as

severance pay, deferred compensation and supplemental pensions -- are disappearing more slowly, even

though the new proxy rules highlight their stupendous size. Among these big-ticket items, huge severance

deals have come under the sharpest attacks.



48. What criteria should a board examine when its selects a new CEO?

a. Evaluate the business strategy – you have to know where the business is going before you

know what you need in a leader. Be sure you are training your managers to execute your

business strategy.

b. How well he relates to the company culture. One thing that makes Herb Kelleher so

successful is how connected he is to the organization.

c. Team leader – someone who listens more than talks. Bob Bullock said, ―it is amazing what

can be accomplished for the good of Texas if nobody worries about who gets the credit.

d. Ambition and courage—be willing to bet the company.

e. Good communicator and personnel skills.

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f. Execution vs. vision

g. Beware of greed and arrogance.



49. What makes Warren Buffett such a successful CEO?

a. He lets managers of Berkshire Hathaway‘s subsidiary companies run their own business.

Doesn‘t push for extremely detailed info on his acquired companies.

b. Munger and Buffet subcontract all heavy lifting in their business to managers of subsidiaries.

They keep managers of subsidiaries happy and let them make all key decisions. Steps in if a

company is having problems.

c. Very simple, no computers or calculators or anything. Does not use analysts. He can move

more quickly in investing b/c there is no investment committee. He just thinks and is not

influenced by others or outside sources. Replies to mistakes: ―We all make mistakes it‘s

okay‖ and doesn‘t fire managers.

d. Even when he retires he says Berkshire will continue to be run in a decentralized fashion with

enormous discretion in the subsidiary units and a hatred of bureaucracy.



50. What is the most important responsibility of the CEO?



a. Setting culture from top down. Think of the differences between Herb Kelleher and Carly

Fiorina. Herb Kelleher personified the culture of Southwest – friendly, open, flexible,

innovative. Carly Fiorina clashed with HP‘s culture.

b. Communication is also very important. Being able to effectively communicate with the

board, management, shareholders, analysts and the media are crucial.



51. How should the Board of Directors manage the succession process?

a. The directors should know the business strategy: where the company is going before you

know what you‘re likely to need in a leader

b. Management training: They must make sure that the co is developing execs in all areas of the

business who will be able to execute that strategy.

c. Succession plan itself: The CEO should id and develop potential successors for the board to

consider



52. Why is it so hard to fire a CEO?

a. CEO‘s can win millions if they challenge a board that fired him ―for cause.‖

b. These CEO‘s have very well crafted employment contracts and sophisticated lawyers … at

this point to fire a CEO for cause the CEO virtually has to ―burn the building down or have

major, major embezzlement‖

c. Nearly ¾ of CEOs of cos in S&P 500 have employment ks or severance plans. The accords

typically let boards remove a chief for cause in cases of deliberate neglect of duties, gross

misconduct, a felony conviction or company-related fraud. CEO‘s insist on these protections

in case of disagreements with directors, but the terms are often vague, leaving much to the

interpretation of arbitrators, judges, and juries. Decisions such as MassMutuals may dissuade

more boards from firing a CEO for cause.

d. Further these spats can last for years and become expensive.



53. Why are CEO's referred to as "global politicians?"

a. No longer can a CEO take care of his job, take care of his numbers, and let the rest take care

of itself. Post Enrold world CEOs have been forced to respond to a widening array of

shareholder advocates, hedge funds, private equity deal makers, legislators, regulators,

attorneys general, nongovernmental orgs, and countless others who want a say in how public

cos manage their affairs. Today‘s CEO, in effect, has to play the role of a politician,

answering to varied constituents.

b. See Robert Nardelli of Home Depot: he doubled sales and earnings, but did not play the role

of politician: and he was fired. Contrast with Mr. Immelt of GE: tied his pay closely to

performance, adopted a number of popular initiatives such as ―eco-imagination‖ program

which includes an effort to reduce GE‘s emissions of greenhouse gases.

c. See WalMart CEO Lee Scott: When his co was under attack by well organized political

campaign, he responded by reaching out to his opponents, polling opinion leaders and hiring

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political consultants. Embraced environmentally friendly policies, improved employee health-

care coverage and began advocating policies like an increase in the minimum wage.

d. Taking this political route is necessary in post-Enron world but is not alone sufficient.

Citigroup CEO Prince has tried to appease his critics by making ethics a hallmark of his time

at the top but that hasn‘t helped the bank‘s lagging performance or silenced its critics.



54. What is meant by "integrative thinking?" How does it vary from "conventional thinking?"

a. The best leaders are Integrative thinkers have the predisposition and the capacity to hold

in their heads two opposing ideas at once. And then, without panicking or simply settling for

one alternative or the other, they‘re able to creatively resolve the tension between those two

ideas by generating a new one that contains elements of the others but is superior to both.

This process of consideration and synthesis can be termed integrative thinking. It is this

discipline—not superior strategy or faultless execution—that is a defining characteristic of

most exceptional businesses and the people who run them.

b. This is a skill that very few people hone; not a gift shared by an elite few. They seek less

obvious but potentially relevant factors; consider multidirectional and nonlinear relationships

among variables; see problems as a whole; examining how the parts fit together and how

decisions affect one another; Creatively resolve tensions among opposing ideas; generating

innovative outcomes.

c. Conventional thinkers focus only on relevant features, consider one way linear relationships

between variables (in which more of A produces more of B), break problems into pieces and

work on them separately or sequentially, and make either or choices; settling for the best

currently available options.



55. What are some of the most important lessons Peter Drucker left business executives?

a. Establish, maintain, and control the theory of the business. And if they see a theory is

becoming obsolete… they must be able to decisively act, not procrastinate.

b. Manage for Business Effectiveness: There is nothing so wasteful as doing things with great

efficiency what should not be done at all. We need a way to id the areas of effectiveness (of

possible signif results) and a method for concentrating on them. To increase effectiveness

managers should have a plan of attack, a method of analysis, and an understanding of the

tools needed.

c. Learn from Nonprofits: Define clearly the mission and its requirements. This will focus the

org. This will prevent splintering limited resources on things that are interesting or look

profitable rather than concentrating on a very small number of productive efforts.

d. Concentrate efforts on ONE task, diversification destroys the performance capacity of an

organization.

e. Use Activity Based Accounting rather than Cost Accounting to also record the cost of ―not

doing‖ like machine downtown, waiting for a needed part, etc. Gives a much better cost

control and RESULT control.

f. Know your own strengths and weaknesses. (listening or reading?

g. Key to greatness is to look for employees potential and spend time developing it.

h. What makes all sorts of leaders effective is not that they are stereotypical leaders. They are all

over the map in terms of personalities, attitudes, values, strengths, and weaknesses. They

range from extroverted to reclusive from easygoing to controlling, from generous to

parsimonious… but they all follow these policies:

i. They ask what needs to be done

ii. They ask what is right for the enterprise

iii. They develop action plans

iv. They take responsibility for decisions

v. They take responsibility for communicating

vi. They were focused on opportunities rather than problems

vii. They ran productive meetings

viii. They thought and said ―we‖ rather than ―I‖

ix. ***Listen first, speak last***



56. What is meant by the “virtue matrix?”

a. A tool that can help execs understand what generates socially responsible corporate conduct.

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b. Virtue matrix supplies a conceptual framework for addressing questions about corporate

responsibility, including:

i. What drives the market for responsible corporate behavior?

ii. What creates public demand for greater corporate responsibility?

iii. Why does globalization heighten anxiety about corporate responsibility

iv. What are the barriers to increasing responsible corporate behavior?

v. What forces can add to the supply of corporate responsibility?

c. Made up of four quadrants: Bottom 2 are foundation… top 2 are its frontier

i. Lower 2 quadrants: Civil foundation- Choice and Compliance. The common law

of responsible corporate behavior… an accumulation of customs, norms, laws, and

regulations. Promotes conduct that is socially responsible and enhances shareholder

value. Dotted line divides choice from compliance of civil foundation. (The

boundary between the two lines is porous. Some activities enter the civil foundation

through the left quadrant and eventually become so widespread that the norms are

enshrined in laws/regs. (Ex: Only a handful of cos once offered health care benefits

to dependents of e‘ees. B/c ghe goodwill engendered among employees and

customers exceeded the cost of the benefits, more companies copied… eventually

govt regs req‘d most co‘s offering health benefits to extend them to dependents as

well).

1. Left: Conduct that corps engage in by choice, in accordance with norms and

customs

2. Right: Compliance: Responsible conduct mandated by law or regulation (A

dotted line separates the choice side from the compliance side.)

ii. Top 2 quadrants of matrix: Strategic and structural frontiers. Activities whose

motivation tends to be intrinsic and whose value to shareholders is either clearly

negative or not immediately apparent. Strategic and structural frontiers are separated

by a wavy line (intended to suggest that some actions are not clearly beneficial or

detrimental to shareholders. Actions that fall between strategic and structural

frontiers tend to gravitate toward structural frontier. If a corp consensus is that a

particular activity will not accrue to shareholders‘ benefit, no one corporation is

likely to take the initiative to disprove that assumption. Thus, executives‘

commendable concern for their shareholders‘ wealth can sometimes stifle

innovations in corporate social responsibility.

1. Upper Right: Structural frontier: activities that are both intrinsically

motivated and clearly contrary to interests of shareholders. Benefits of corp

conduct in this quadrant accrue principally to society rather than to the

corporation, creating a fundamental structural barrier to corporate action.

(Malden Mills fire… still paying employees while rebuilding plant).

Upper Left: Strategic frontier: may include activities that may add to shareholder value

(become instrumental) by generating positive reactions from customers, employees, or legal

authorities. Actions that fit in this quadrant, though risky, are generated by the conscious

choice of the corp‘s senior mgt as part of their profit making strategy





57. How is Jeffrey Immelt changing GE’s perspective on social responsibility?

a. He believes that businesses today aren‘t admired, size is not respected… it‘s up to GE to use

their platform to be a good citizen. It is business imperative.

b. In 2002 Immelt appointed GE‘s first VP for corporate citizenship. GE audits its suppliers in

the developing world to make sure they comply with labor, environmental, health, and safety

stds. It has performed 3,100 audits since the program began in 2002. The co has opened up

discussions with so-called socially responsible investment funds. Promoted women and

African Americans into executive ranks. Granted domestic-partner benefits to its gay and

lesbian employees. Globalized its philanthropy, by launching an ambitious health-care project

in rural Ghana. In the spring GE will publish its first corporate citizenship report. (Even

though it does no business there) GE wants to be known as a good company – not just in the

US but around the world.

c. Since 2001 GE has purchased a water purification co, a maker of solar energy equipment, and

a wind energy business. Signed an agreement with Shanghai Power Industrial and

22

Commercial Co to supply wind turbines to the first 2 utility scale wind energy projects in

China.



58. What are the implications to corporate America if the American public loses confidence in the

free market system?

a. Americans will invest elsewhere. Corporations will find even more it difficult to raise

investment capital as public confidence wanes.

b. Rapoport – workers will not be able to afford products that the monopolies are selling.





59. What can corporate America do to restore the public’s confidence in businesses?

a. Greater transparency. Auditors and the audit committee need to take their roles seriously and

ensure the accuracy of financial reports.

b. Ethics -- stop with the scandals. Poor judgment and bad decisions have led to all of the

corporate scandals that Sarbanes Oxley and similar legislation is aimed to prevent.

c. Corporate social responsibility. There are now funds that will only invest in ―green‖

companies.

d. S-Ox has proved to be costly. Corporations need to take the lead in their own reform.

Legislation is helpful, but true reform from the businesses and their leaders is necessary.

e. Split the CEO and Chairman positions. Otherwise the CEO has too much power, and the

corporation is more vulnerable to one person‘s greed and ego.

f. Increase the number of independent directors on the board.



60. What type of ethical breaches requires a board to terminate a CEO?



a. These are difficult questions for governance because breaches require a swift response, but

expressions of doubt over a top exec‘s tenure can send shares plummeting. So board

responses to alleged ethical missteps often remain opaque, even in era of supposedly greater

transparency.

b. Boeing CEO fired b/c of affair w/ employee and inappropriate email

c. Veritas software ceo resigned after found to have lied about having an MBA from Stanford.

i. But Bausch and Lomb CEO got to stay even though he incorrectly claimed he had an

MBA.

d. If a director isn‘t truthful about academic credentials, you cant trust him with anything. Bad

for shareholder value.



61. What are the differences between governing a for-profit and a not-for-profit organization?



Lee Walker, Chairman of Bd of Capital Metro

 Nonprofit & profit have a lot in common

 Differences:

o Transparency: Cap Metro is not for profit and after 20 yrs has always charged 50 cents.

Non profits are much more transparent. When they consider price increase everyone

came in and got their 3 minutes.

o Connection: town hall style meetings;

 In profit companies, people vote w/shares b/c they sell when displeased

 Here, everyone has a voice; ex: they had thousands of people go through an

exercise to pick what central TX should look like in 30 yrs.

o Trans-Generation – non profit looks long term, profit looks at same-quarter profits.

 Looking 15 yrs ahead doesn‘t mater to profit, but it‘s not until 15 yrs pass that

non-profit thinking starts to get interesting.

o Money: the for profit guys wouldn‘t stay with it for a minute if the money was gone.

The non-profit people do it for the ―cause.‖









23

a. Like their corporate counterparts, not-for-profit directors are charged with overseeing the

financial health of their organizations, charting a strategic plan to achieve organizational

goals, selecting top management and pitching in with advice and practical aid during a crisis.

Further, they are accountable to those who have a vested interest in their organization.

However, while corporate directors are accountable to shareholders, nonprofit directors are

accountable to the recipients of the organization’s services (e.g. hungry people being fed,

audiences at the symphony, students at the university, or sick people whose disease the

institution is trying to eradicate.) It is thus imperative that nonprofit directors be dedicated to

their organization‘s cause.

b. Perhaps the most obvious distinction between governing a for-profit and a not-for-profit

organization is the fact that directors of not-for-profit organizations do not take the job

expecting to receive compensation for their services. In fact, in most instances, they are

asked to give money to the organization they serve. Roughly 1/3 of nonprofits have a formal

policy requiring an annual financial gift from their board members; the actual dollar amount

differs depending on the organization‘s mission – high-end arts and cultural centers typically

expect directors to give more. The rule of thumb is that you either give or get; if you cannot

personally donate, then you have to find an outside donor to ante up.

c. A nonprofit boardroom has a much different feel than a for-profit boardroom. There are more

voices weighing in (a typical nonprofit board has 19 directors; larger nonprofits can have up

to 50 directors) and fewer insiders setting the agenda (only 8% of chief executives of

nonprofit organizations are members of their own boards.) There is also greater diversity

with regard to the gender, race, profession, and economic background of directors than one

would find in a typical corporate boardroom.

d. At the most basic level, serving on a nonprofit board offers a director experience in fields

outside his or her normal realm. For example, there is a great deal of politics involved on

nonprofit boards and with regard to nonprofit activities. Pursuing the organization‘s mission

may require someone with a technology background to focus on relationship management

with city, state or even national leaders. As noted earlier, directors are not chosen merely on

the basis of their professional background, but because of their dedication to the

organization‘s cause and their willingness to give their talents and time to pursuing the

nonprofit‘s goals.

e. Because a little less than 50% of directors on an average nonprofit board have no business

experience whatsoever, it is not uncommon for such boards to take a long time coming to

decisions about their organization. As frustrating as that reality may be, slow decision-

making processes that involve the balance of diverse opinions can also be character-building.

Serving on a nonprofit board is likely to teach directors a more collegial way of reaching

decisions and different ways of processing information. Nonprofit boards tend to work

longer at building consensus and trying to find solutions that don‘t produce real winners and

losers.

f. While one may think that serving on a nonprofit board is a great way to network with other

community leaders and to gain individual prestige that is the exception rather than the rule.

Nonprofits are not just looking for famous and powerful people to serve on their boards; they

are looking for directors who are dedicated to their organization’s cause.









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62. Why has SWA been successful when many of its competitors have found it impossible to avoid

bankruptcy?

a. Key to its initial success was impeccable timing when it came to the company‘s hedging

program. Southwest locked in low fuel expenses just as the price of oil blasted skyward.

With a low-cost approach and little meaningful competition (in the low-cost niche market),

the hedges allowed the carrier to recognize profits while other major airlines were reporting

huge losses.

b. However, it is the company‘s culture that has helped it to remain a leader in the marketplace

despite the fact that its hedging benefits have started to erode. The company has found a way

to set itself apart and to offer something that none of its competitors has: its people-friendly

culture. Southwest has taken a humanistic approach to business since it was started in 1971.

This approach has generated some of the most loyal employees in the industry.

c. Southwest has always believed that it, like any other business, is in the business of customer

service. In order to be the best when it comes to customer service, you have to begin with the

company‘s employees. They are to be valued as individuals, not just as workers. As Herb

Kelleher said, ―‘the business of business is people‘ and employees (not the customer) come

before everyone else.‖

d. Southwest believes that what sets it apart is the fact that is has the best employees in the

marketplace. These employees have produced the most efficient, most profitable airline with

the best customer service.

e. Employee input is welcomed. Southwest has a hiring process whereby current employees are

given the chance to interview and select new employees with whom they will be working.

For example, current flight attendants help to hire new flight attendants. They know what it is

that will work best with the company‘s culture, so their participation in the process is of the

utmost importance.



25

f. The people-friendly culture pervades all levels of the company. Executives maintain an open-

door policy and are always willing to listen to both employees and customers when it comes

to either complaints or recommendations. In fact, to show support for all levels of

employment and to maintain a sense of collegiality, executives spend one day each year out in

the field. They work behind ticket counters, handle baggage, etc. to better interact with,

support and get to know their fellow employees.

g. Southwest has managed to implement its corporate strategy without compromising its culture.

Even as it expands into new areas, adds more flights and deals with the challenges posed by

high commodity prices, it continues to focus on maintaining its culture.



63. What is meant by culture and why is SWA's culture so important to management?



Corporate culture as defined by Wikipedia: Organizational culture, or corporate culture, comprises the

attitudes, experiences, beliefs and values of an organization. It has been defined as "the specific collection of

values and norms that are shared by people and groups in an organization and that control the way they interact

with each other and with stakeholders outside the organization. Organizational values are beliefs and ideas

about what kinds of goals members of an organization should pursue and ideas about the appropriate kinds or

standards of behavior organizational members should use to achieve these goals. From organizational values

develop organizational norms, guidelines or expectations that prescribe appropriate kinds of behavior by

employees in particular situations and control the behavior of organizational members towards one another".

Senior management may try to determine a corporate culture. They may wish to impose corporate values and

standards of behavior that specifically reflect the objectives of the organization. In addition, there will also be

an extant internal culture within the workforce. Work-groups within the organization have their own

behavioral quirks and interactions which, to an extent, affect the whole system. Task culture can be imported.

For example, computer technicians will have expertise, language and behaviors gained independently of the

organization, but their presence can influence the culture of the organization as a whole.

http://en.wikipedia.org/wiki/Organizational_culture



Culture is important to management because Southwest‘s culture is what sets it apart from its competition.

Although low-cost imitation carriers have entered the marketplace in the past few years (Jet Blue, for

example), Southwest remains unmatched with regard to its people. The company‘s culture is focused on

retaining and rewarding its people and continuing to be the best customer service provider in the market.



64. How has the SWA board evolved over time?



When Southwest first entered the market, it was the only low-cost/low-fare airline so it could afford to be

more patient when it came to making decisions about competitive strategy. Today, it faces competition from a

number of other carriers. Furthermore, it no longer reaps the benefits provided by its early hedges so

Southwest has had to refocus its strategy to manage high commodity prices without losing its customer base

and without compromising its culture. The board has become much more aggressive than it used to be because

it can no longer afford to be overly patient. It has accelerated its attacks on struggling high-cost competitors,

formed alliances beneficial to its own strategy, vigorously attacked a federal law limiting flights from its home

base (at Dallas Love Field) and ―ditched the decades-old policy of ‗passionate neutrality‘‖ that it had practiced.

Much of this change coincides with the transition of CEOs in 2005 (Parker to Kelly.) Under Kelly‘s

leadership, Southwest ―appears to be permanently shifting the balance of power to low-cost carriers‖.

(Southwest: Dressed To Kill...Competitors)

Southwest‘s board is seizing opportunities made available because of industry duress, expanding into new

cities in a steady and manageable manner, pushing for higher productivity from its employees, and capitalizing

on its core strengths. It is no longer approaching business as an underdog, but is competing fiercely.

For all the changes brought on by new executive management and a more aggressively-minded board, one

thing remains – maintaining the company‘s culture is still a top priority. Southwest is not completely shifting

its strategy and mission; rather, it is reacting as necessary to changes in the marketplace, capitalizing on

opportunities that present themselves and making sure to always promote the culture that sets it apart from its

competition.

a. First board included the two founders, two regional IBankers, two texas commercial bankers,

and one prominent wealthy Texas venture capitalist. Kellerher had a predominantely outsider

board and knew only about 6 of the 16 directors … so he looked for the kinds of directors that

he would need

26

b. They needed a quick moving board… so they trimmed the board from 16 to between 7 and 9

members. Added two entrepreneurs to the board. Also added a national Ibanker. (Realized

they would need more money from frequent public offerings on a national basis.

Understanding that regulatory issues and political issues would continue, they looked for

people who were politically sagacious and experienced as well as pragmatic. Looked for

prosepective directors who had demonstrated entrepreneurialism and who had a longer term

perspective.

c. After SOX and after 9/11 they made a few adjustments. They had their audit committee

meeting on the afternoon prior to the meeting and the audit committee meeting takes longer

than it did in the past. After 9/11 they decided that having a lot of experienced directors who

were supposed to retire from the board leave the board would not be a good idea. They

decided to slow down their retirements and bring addtl people on the board. So for the time

they had a larger board. Basically the new people are going through on the job training to

replace the old people

d. He stresses picking people for the board that you‘re uncomfortable with, not b/c of their

personality, but b/c they know things that you‘re going to need to know.

e. Chairman Herb Kellerher is still firmly in charge of strategy and route plans as he was when

Parker (Kelly‘s predecessor) was CEO.





65. What role do lobbyists play in Washington?

a. CEOs, directors and politicians are equally encumbered with ego. Each group

disdains the other, and they don’t speak the same language. A good lobbyist

translates.”

b. Lobbyists are serving as principal fund-raisers for lawmakers they're trying to sway

c. lobbyists increasingly cooperate with the public-relations and advertising industries to

execute comprehensive plans for their clients.

d. Over the years he has built personal relationships with dozens of key members of

Congress on both sides of the aisle, so that when a client needs help, he can target

exactly the right lawmakers for assistance. He greases the skids by fund-raising for

more than 100 political candidates in both parties every election cycle; he and

members of his firm also personally make campaign contributions and soft-money

donations

e. Our first step is to tell someone whether what he or she wants is doable. Then we

work on how to get the problem solved in the federal system. You need to know the

agencies, such as the Federal Trade Commission. You have to know the members

of Congress and their personalities. And you need to know the rules. Half the

members of Congress don’t know the rules, because they haven’t been there very

long.

f. developing sophisticated fund-raising and public-relations strategies

g. lobbyists agree that their industry now supplies the raw materials that enable

government to function. In addition to campaign cash, they provide polling data (to

tell lawmakers what the voters think), the nuts and bolts of draft legislation (to help

them turn wishes into law), and even institutional memory (to instruct them on how to

get bills passed)



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66. Should lobbyists sponsor fundraising projects for elected officials?

a. Advocates of change argue that lawmakers who rely on lobbyists become unduly

beholden to them, and thus more willing to help their clients.

b. Campaign finance reform took money away from the system, so that labor or oil

couldn’t finance a campaign.” Cumulatively, these changes meant that corporations

needed to connect to a wider range of lawmakers, while congressmen had to tap

broader sources of campaign cash. Lobbying firms obligingly stepped into the breach

as middlemen, eventually developing sophisticated fund-raising and public-relations

strategies.



67. Should former government officials be permitted to lobby once they have left the government?

a. Yes, the experience with the system and the contacts made during their former

careers is what makes them so useful as lobbyists.

b. As David Sibley, former state senator told us, he feels like his insider knowledge is

very beneficial to what to what he does. He knows what politicians want ton see in a

lobbyist. Ex: he never wanted to listen to a lobbyist who didn’t deal w/intregity &

play by rule. He uses a lot of this to his advantage now.

c. He is experienced w/system & has many contracts.

d. Also, a lot of former government officials would do it on the sly if they were not

permitted to…so to prevent this practice they should be allowed to legally.









68. What role should a "consultant" play in helping its multinational clients win contracts in

developing countries? I don’t really like our answer with this one … the article spun them as

being very very negative… but I don’t feel like that answers the question… oh well.

a. This is a murky and controversial industry. Multinational cos often turn to consultants for

help navigating perplexing markets and cultures, esp in the developing world. They can bring

language skills, local knowledge, and valuable contacts. This is often done through bribery.

b. Multinational companies often turn to consultants for help navigating perplexing

markets and cultures, especially in the developing world. Such hired guns can bring

language skills, local knowledge and valuable contacts



69. What can a CEO of a privately held company do to help insure that the transition of power

from one generation to the next goes smoothly?

a. Family-first companies are selecting from a tiny list of candidates. ''There is no reason to

think that you can look at one of your three or four kids and think that this is the best you can

do,'' he said. ''It is likely you could have found a more talented pool from a larger sample.''

b. Experts on family businesses view an inability to step aside, despite advancing age, as the

greatest potential pitfall for entrepreneurial founders

c. Founders often do not view themselves as mentors grooming ideal successors, but as judges

of invariably flawed candidates failing in trial assignments



a. First he should ask if it‘s really in the company‘s best interests to hand the firm down to a

family member – after all the subset from which to pick a new CEO is significantly narrowed.

They should have competence and commitment.





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b. These companies should have more independent members on their boards, as they seem to do

better when under a lot of scrutiny.

c. The CEO should give the subsequent generation confidence right from the beginning that

they should be able to speak up and suggest things to the company. (Brian Roberts of

Comcast at age 12 noticed one of the charts was read backwards when reviewing a draft of

the offering document and was able to speak up).

d. These companies often have far more long term oriented strategies than companies with

professional management bc they want to preserve the company for future generations.





70. What can a major news organization do to insure that it reports the news in a fair and accurate

manner?



 News requires conflict. News is a cycle; It has to be moving or it is no longer news. Hillary messed

up in the debate & that made it news. Not messing up isn‘t news. A story that McCain‘s campaign is

floundering is old news but beginnings of comeback are news. Wayne Slater wrote a story abut

Richardson‘s speech and only talked about his answer to question about UFOs.

 What can they do about story to make sure its fair?

o You shouldn‘t have to represent all sides or else you‘d have to talk about moon being green,

but you do have to make effort to show the different reasonable sides to the story.

 When you get a call from a reporter about a lawsuit or something bad, return the call!

o Good reporters try to get both sides in so help reporter to do that and expect reporter to have

your side in the paper even if it is just a little blurb in a big story.

 Rule of Reciprocity: this is the rule in news reporting that reporters should show both sides of issue to

be fair, so long as it‘s not a moon being green situation

 Rule of the Oscillating Narrative: This is the rule that reporters will only have a story that is ―news‖ if

action is going on, and characters oscillate, meaning that reporters break someone down just to build

them back up to keep it interesting.







71. What can be done to help "old media" survive and prosper in the future? Be specific about the

various forms of old media.



 Newspaper companies are no longer traditional newspaper companys. Instead newspaper is just

one channel; internet procudes 10% of revenues. New is a big business. The Dallas News is

considering coming out with a paper called ―Quick‖ to appeal to 18-30: small newspaper w/quick

info that this group would be interested in



Network News:

1) Allow the viewer behind the screen: tearing down the façade of how the news is made; post

unedited versions or behind the scene clips.

2) Broadcast beyond the TV: web, deliver to mobile devices

3) Create Overseas Alliances: strategic alliances, instead of sending someone to Indonesia, let

someone there broadcast who knows the territory

Network TV:

1) Cut prime time to 15 hrs (22 is impossible to fill)

2) Make it easier for workers to see show at their desk

3) Make time for independent and upstart production companies (Muppet Show)

Newspapers:

1)Focus not so much on circulation, but on content. Same stories should not be posted on the web that

you can readallow for blogs and comments.

2) Let reader customize their newspaper by allowing them to narrow down to the content they want to

seee.

3) Ad executives think a crucial element of newspapers' future will be alerts sent to Web-surfing

cellphones and pocket-pinging BlackBerries.

Advertising

1) Tailor to the audience viewing

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2) Instead of producing straightforward commercial campaigns, ad agencies would create entertaining

programming around brand names -- things that viewers want to tune in, download or read for their

own sake. For instance, Crispin helped Burger King stage a fight between two actors dressed as

chickens, meant to symbolize two TenderCrisp sandwiches the fast-food chain offered.

3) Advertise where least expected

Book Publishers

1) Meet and greet: send authors into public schools to create future readers

2) Don‘t get bound to paper: audio books on ipods

3) Learn a new language: not only expand into new languages, but also their cultures

Movies

1) Expand the role of the multiplex: don‘t just show movies, but live feed concerts and sporting

events. Need to up the luxury to compete with home entertainment.

2) Move beyond thinking about DVDsgoing to be replaced by hard drive storage

3) Send movies home earlier by making customers pay a premium

Music

1) Give online sharing network license to distribute

2) Go mobile

3) Don‘t sell music, sell musicians



72. Should a newspaper or other news organization be able to protect their sources such that they

can not be identified even to a prosecutor in a criminal case?

a. I think that depends on the nature of the facts – if a reporter knows the identity of a serial

killer, it would seem like obstruction of justice not to disclose to the authorities. If a reporter

is just using a source for commentary on some corporate issue, I think the source should be

protected. It seems like any sort of attempt to regulate this area would result in a slippery

slope, but there are certain circumstances where justice would be best served by forcing the

reporter to disclose.



A lot of people are unwilling to speak without the promise of confidentiality, so forcing a journalist to

reveal their source could make it impossible for them to gather news, especially about the government. The

law is very clear, however, that reporters do not have an absolute right or even a qualified privilege to resist

subpoena in criminal case. Branford case in 1972 says that this is not an abridgment of 1st. Thre are guidelines

however: prosecutors must have exhausted all sources, reasonable belief that a crime is involved, etc.



73. How much "fact checking" should a publisher be expected to do?

a. Publishers historically have never been bound by the kinds of fact checking duties imposed

on journalists, even for nonfiction books they publish. Instead, they rely on honesty of

authors and their legal staff to identify any potential for libel suits. A recent incident

involving the revelation that ―A Million Little Pieces‖ was in fact partially fictional may

change the whole process – publishers will have to scrutinize what they publish much more

thoroughly, especially memoirs. It seems unfair to put the legal responsibility on the

publisher when they are not the ones responsible for the misrepresentations, not to mention

the amount of resources that would be required to check thousands of nonfiction books each

year. I think the liability should rest with the author who tries to pass off fabrications as

nonfiction. And maybe I am not taking this seriously enough, but… who the hell cares if

there are some embellishments in the ―nonfiction‖ book they are reading? Seems like a

victimless crime, and a waste of resources to litigate over.



Publishers say that it has never been in their purview to verify the information in nonfiction books as

true. They simply don‘t have the funds to fire fact checkers; instead, they rely on authors to be honest and their

legal staff to avoid libel suits. In addition, some publishers claim that it would be a very daunting tasks since

publishers often publish 1,00s of books, several hundred pages in length each. But now there is a call to make

a reasonable investigation or inquiry regarding the truthfulness or accuracy in the wake of ―A Million Little

Pieces‖ (calling it a breach of ethics).

Suggestions for reform include adding an author‘s warranty section to their contracts, stating to the best of

their knowledge the facts in the book are true.



74. How should a CEO respond to the media concerning a crisis in his or her company?

30

a. Thinking back to the crisis management exercise we did in class with the PR guy, the CEO of

MSNBC made some good decisions – he drafted an apology to the community on behalf of

MSNBC, but made it clear that Don Imus‘ show was produced by a different company and

thus was not his responsibility.

b. The story is going to run regardless of whether or not the CEO chooses to comment, so the

company is better off by getting its version of the story to the public. Companies can issue

statements to give their version of the facts and to foreclose any further questioning.

c. CEO should make sure he shows community & state holders that he has attempted to find a

way to correct the crisis. Make people aware of this attempt.

d. Ex: if you have an oil spill go quickly to location & show that you care what‘s going on. At

trial this response is very important to the jury if the case gets that far!

e. Never lie about crisis, be short & sweet.

f. CEO‘s are very smart to just order a short & sweet statement that will not render him

susceptible to follow up questions.



75. Should a CEO be proactive with the media?

The CEO should ensure that the company‘s side of the story is displayed to the public. This may

require a CEO to take a proactive role with members of the media.

a. I think so. If the CEO doesn‘t tell their story and give the media something to go by, the

media will just make up its own version and fill in the blanks on their own.





76. When should a CEO not take a call from the media?



 Virtually never!

 When you get a call from a reporter about a lawsuit or something bad, return the call!

o Good reporters try to get both sides in so help reporter to do that and expect reporter to have

your side in the paper even if it is just a little blurb in a big story.

 Rule of Reciprocity: this is the rule in news reporting that reporters should show both sides of issue to

be fair, so long as it‘s not a moon being green situation

 Rule of the Oscillating Narrative: This is the rule that reporters will only have a story that is ―news‖ if

action is going on, and characters oscillate, meaning that reporters break someone down just to build

them back up to keep it interesting.

 Other side: However, other side of the coin is that CEO shouldn‘t give out any info that he is unsure

of, or thinks could come back to bite him. Never make statement too soon, or take up for mgmt too

soon. So under certain circumstances putting off a statement is a good idea.



77. What is meant by "off the record" and "for background only?"



 The main thing to remember is that people do have different definitions of these terms so when you

are talking to the media you need to make sure that you know what the interviewer means if he uses

these terms – don‘t count on him to tell you. He may be risking a little, but you are risking a lot. If he

publishes something you say, you can‘t take that back, period.

o ―off the record‖: Information that the recipient agrees will not be used for publication, even if

not attributed to the source. The journalist may not even use the information as a "lead" to an

alternate source, though this does not preclude use of identical information entirely derived

from another source.

o ―for background only‖: Information provided to a writer or editor on condition that it not be

directly used in print. However, all such information is on the record unless and until the

recipient has agreed to other status. Also, if information that is provided as background only

is independently obtained from an alternate source, material from the latter may be used.

Mostly applicable to investigative reporting





78. How should CBS and NBC have dealt with Don Imus?

b. It seems like the networks had little choice but to cancel his show – all the major advertisers

had pulled funding, and they had come under major criticism. While it seems unfair that 2

words ruined his network career, I think the way they handled it was the only acceptable way.

31

a. CBS needed to have had a monitoring program already in place since it knew the show was

centered on crude and outrageous remarks about risky subjects, such as race, gender, and sex.

Although it is important to stand by your employees, CBS and NBC needed to have taken prompt

and decisive action. Instead, the two broadcasters merely held conferences to discuss the matter

by phone. His apology need to be more well thought out an directed by executives. For example,

his use of the words ―you people‖ was careless. In addition, executives need to take preemptive

action with advertisers in addressing the scandal and possible effects. CBS needed to have had

clear communication and collaborative effort amongst all of its affiliates as to how to deal with

the matter affirmatively. Instead, each section decided how to react separately, with some pulling

the show earlier than others. This disorganization led to some thinking that the broadcasters still

supported Imus.



79. What was the theory behind Ken Lay's defense?

a. Ken Lay‘s decision to speak out on his own behalf, both publicly and by testifying at trial,

runs counter to the advice of most criminal defense experts. However, the strategy was

justified by the benefit of having Mr. Lay maintain his relationship with the community,

humanizing him in the face of demonization by the media.

b. His actual defense strategy was to proclaim his innocence, even to felony charges he had

already pled guilty to. According to his attorneys, Ken Lay pled guilty because of the

enormous pressure of the government investigation  basically they are claiming that Lay

was coerced, and that no crimes were committed at Enron.

c. He says as CEO he could not be accountable for illegal activities that he was not aware of.



It focused on their claim that no one at Enron committed any crimes; thus, his defense team tried to show

that even people who pleaded guilty to crimes didn‘t actually commit any crimes. The defense alleged that

the other defendants pleaded guilty to crimes out of pressure due to the enormous government

investigation. The large defense costs plus risk of long prison sentences caused many of the defendants to

plead guilty according to Lay‘s defense team. The defense team suggested that some defendants in the

Enron case pleaded guilty rather than risk greater exposure. This theory was fashioned on Lay‘s continued

belief that he was innocent and that Enron‘s downfall was caused by panic and negative coverage. Lay

described it as a classic ―run on the bank‖ rather than anything illegal, and he blamed media outlets like

the Wall Street Journal for negative coverage. Mr. Lay‘s lawyer also tried to put a human angle on him by

telling stories of how he was raised by a farmer, etc. Lay‘s defense team also focused on the hard line

tactics of the government and attempted to persuade the jury that the government was too aggressive in

pursuing Lay. The defense theory also centered on placing some of the blame on Fastow for bringing

down Enron.



80. How did the theory behind Lay's defense differ from the theory behind Skilling's defense?





Mr. Lay was charged with crimes that he engaged in a conspiracy to deceive investors and employees about

Enron's financial troubles just before it collapsed. While Skilling, faced additional counts, including lying to

auditors and insider trading. [Note: the rest of this answer was not from the assigned readings because I did not

find anything else in the readings on this question. Instead, I looked through NYT and WSJ articles on Lexis].

Skilling‘s defense focused more on his personal problems with depression. His lawyer claimed that he suffered

from depression and alcohol problems, but that this did not make him guilty of fraud. Since he had already

suffered enough, his lawyer said that the jury should send him home. The defenses also differed from each

other in that Lay tried to portray himself as more of a figurehead of Enron who was constantly traveling around

and not familiar with the day-to-day operations of the company, while Skilling was the one who actually

managed the company. Lay also tried to draw distinctions between his management style and that of Skilling.

While Lay and Skilling did not turn on each other because they pursued a joint defense, some interpreted Lay‘s

depiction of Skilling as a way to deflect blame from himself.





81. Should Lay and Skilling have testified in their own defense?

Testifying in your own defense is always a risky tactic; Lay himself acknowledged that others would

probably be more credible than him. Lay held a lot of potential to testify on his own behalf because of his

32

folksy-style charm that could have been appealing to jurors. Skilling‘s decision to testify on his behalf might

have been riskier as he was often thought of as more arrogant and snappy (i.e., when he called the analyst an

asshole in The Smartest Guys in the Room). However, it can be important for defendants to testify on their own

behalf as this is often the only way for jurors to hear the defendant‘s side of the story. During testimony, Lay

was unable to show his grandfatherly-style to jurors and instead lost his cool on numerous occasions. He was

openly accusatory to the prosecutor and at times raised his voice in anger. Skilling faired a little better on the

stand but he too lost his cool a few times.

Note: the answer to this question could go either way:

 CONS:

o Possibility for conflicting stories if both of them testify

o Possibility that they will start pointing fingers at each other

o Prosecutors might find facts in a common defense

 PROS:

o Jury will relate more to them

o Can express remorse/sympathy

o To sit silent might appear counterintuitive

 RESULT: They should not have

o Jurors believed they had a negative view of them after testified.

o Many of them questions Lay‘s character

o Jurors found that Skilling knew way too much about very technically complicated charts

& how the charts worked… meaning he probably knew what was going on.

o Also, Skilling spoke out a LOT which gave prosecutors a lot to search through for

possible contradictions that could have destroyed him.

o Although they have great attorneys, prosecutors are some of the best as well, very

dangerous for these men to testify.





82. What impact will the guilty verdict in Enron, Tyco, WorldCom, etc. have on corporate

America?

In the wake of corporate scandals, Congress passed the Sarbanes-Oxley Act and President Bush appointed

a Corporate Fraud Task Force at the Justice Department. The justice department obtained hundreds of

convictions with sentence lengths which were unheard of in the wave of corporate scandals in the 1980s.

Major Wall Street firms also got caught up in civil litigation with settlements ultimately topping out at

over $1 billion. The effects of all these scandals are widespread and will likely continue for some time into

the future. Changes seen in corporate America include shorter tenures for CEOs, more power for the

board, different accounting standards, increased activism by institutional investors, and a general distrust

for corporate leadership. Lay‘s downfall also sends a strong message to other CEOs to keep a close watch

on subordinates because they might face liability. Some might argue that the guilty verdicts will make

officers and directors more risk averse given the possibility of criminal liability. At a minimum, directors

and officers will probably be much more mindful of corporate governance before making corporate

decisions.



83. Who are the modern shareholder activists and how should the firm deal with them?

The modern shareholder activists are hedge funds (S.A.C.), traditional investors (Legg Mason), large

institutional investors (Calpers), and well-capitalized individual investors (Carl Icahn). They publicly put

pressure on management to change their ways in order to improve stock prices. Many times the activism itself

bumps the price (in the short-term), regardless of whether management makes a change.



NOTE: Not essential to the question, but good background - (There has always been investor activism. What

has changed is that hedge funds now manage an estimated $1 trillion, up from $400 million five years ago. So

they are banding together to take on large companies, improving their chances of bringing change compared

with activists in the past.



To deal with activist investors, the firm can:

1. Take on debt or payout dividends (to get rid of or tie up cash)

2. Lobby the SEC to decrease (opposing the present trend) shareholder rights

3. Go private

4. Run more efficiently (reign in exorbitant executive pay, cut fat, avoid scandal, etc.)

33

Firms should not take a reflexive defensive position. They should sit down and negotiate with activists and

hear what they have to say

Don‘t want to set up adversarial relationships that could damage your relationship with the shareholders

Plus, often activists have something reasonable to say that could be good for the company.



84. How is Calpers trying to impact corp gov? IS it likely to be successful?



By withholding support for the re-election of certain directors on the boards of about 90% of its American

companies, the California Public Employees' Retirement System (Calpers), is returning to its activist roots.



It is focusing on whether directors are doing enough to look out for shareholders, especially in how they

select the accounting firms that audit their companies' books. Most of the directors targeted by Calpers this

year approved of accounting firms serving as auditor when they also did consulting work for a company --

this could encourage auditing firms to approve questionable accounting.



The Securities and Exchange Commission considers a new rule to make it easier for large shareholders to

nominate their own directors. Calpers's burst of activism is intended to put pressure on the SEC to adopt the

rule allowing greater shareholder democracy.



Calpers should be successful if other large institutional investors follow suit (which is questionable) and the

SEC adopts the new rule mentioned.



a. Cali Public Employees‘ Retirement System is withholding support for re-election of certain

directors on the boards of about 90 percent of its American companies. Targeting directors it

says don‘t act in the best interests of the shareholders. Ex: Auditors who are not independent,

and Apple‘s entire board bc it failed to implement a shareholder approved proposal on options

accounting.

b. Focusing on whether directors are doing enough to look out for shareholders, especially in

how they select the accounting firms that audit their companies‘ books.

c. Senior investment officer at Calpers told the companies in letters that it would withhold votes

from such directors, but the decision came so late in the proxy season that Calpers voted

against directors at only about ½ of the number of companies it is targeting this year.

d. In today‘s environment Calpers has a much better shot at influencing cos than they did five

years ago. The effort will definitely take time.

e. Some big business groups think withholding votes from directors at 2700 cos is absolutely

overkill. It‘s wasting shareholders‘ money bc companies have to fight these things.





85. Are institutional investors playing a positive role as corporate activists?





Institutional investors can both positively and negatively affect share prices. Their activism can:



1. Cost companies significant sums, which could unintentionally hurt shareholder value

2. Agitate change that is not in companies‘ long-term interests -- in effect mortgaging companies‘ future

profits for short-term gains that only benefit short-term investors

3. Be valid and appropriately push management in the right direction.



There is no conclusive data on how much net shareholder value has been created or destroyed in aggregate.





f. They are trying to express displeasure with how execs at many companies are managing their

businesses and allocating their capital. Their goal is to increase share price, so in this respect

institutional investors are playing a positive role as activists.

g. Ariz State Univ Professor Gillan predicts that recent activism from hedge funds is more likely

to create positive wealth effect than past shareholder activism. However, companies may

prove harder to pressure in the months ahead.

34

h. Institutional investors like hedge funds now manage so much money that they are able to

band together to take on large companies… in the past they did not have enough standing

(managed assets) do so this.

Some of their hot topics that they have been successful with:

 ―Say on pay‖: The number of proposals more than tripled in 2007, demanding annual advisory votes

on exec compensation

Pay por Performance

 Seeking to require that companies pay incentives based on performing relative to peers

 Number of proposals increased from 7 in 2006 to over 40 in 2007!

So in these two circumstances shareholder activism paid off. (From Cunningham‘s day 1 slide)





86. What should mutual funds report to their investors with respect to the mutual funds votes on

proxy issues?



i. I think mutual funds should provide enough easily accessible information directly in their

reports because given that the fund‘s shareholders are indirect owners of the stocks in that

fund they may well have an opinion about how those shares should be voted.

j. SEC requires funds to disclose their policies guiding how they vote shares of the cos they

invest in. However a recent review of funds‘ guidelines for proxy voting shows wide

differences in how much information the funds divulge.

k. Firms should at least give investors guidance on how they approach the hottest topics (like

proposals that seek to improve bod accountability by holding annual elections)

l. Although SEC requires the guidelines to be published only in a relatively obscure filing called

the Stmt of Addtl Info, many funds now have links to their SAIs on their websites, and some

even have the proxy voting guidelines on the bottom of the fund‘s homepage.

m. Some cos (vanguard for ex) provide a summary of how they voted the previous year that goes

beyond the SEC requirements.



This can be an important issue, given that a fund's shareholders are indirect owners of the stocks in that fund

and may well have an opinion about how those shares should be voted.



Firms should:

1. Give investors guidance on how the fund approaches the hottest topics such as proposals that seek to

improve board-of-director accountability

2. Overview of issues the fund generally supports and those it opposes

3. Provide a window into the decision-making process

4. Provide a summary of how they voted in the previous year

5. Outline votes on important issues such as the length of directors' terms in office or allowing companies to

reincorporate outside the U.S.







87. Why is EBITDA not a good measure of a firm's performance?

a. ―Earnings before interest, taxes, depreciation, and amortization.‖ The fact that taxes and

interest are included, which are real cash items that should be analyzed in valuing a firms

performance. Also, EBITDA does not exclude all noncash items, only depreciation and

amortization. Among the noncash items not adjusted for in EBITDA are bad debt allowances,

inventory write downs, and the cost of stock options granted.

b. Also, stock options are noncash charges that could be a significant expense in many young

technology based businesses. To have any use EBITDA should take account of stock options.

c. Also, unlike proper measures of cash flow, it ignores changes in working capital. (Very

troubling in cases of fast growing cos that require increased investment in receivables and

inventories to convert their growth potential into cash.

d. Worst of EBITDA‘s flaws is that it is vulnerable to the same accounting games found on the

income statement (except for games related to taxes and depreciation). Even if you correct for

distortions in TD A, the E is unreliable. If a co has over or under reserved for warranty costs,



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restructuring expenses, bad debt allowances, its earnings will be skewed and EBITDA

misleading.

e. As an estimate of cash flow, EBITDA suffers from fatal conceptual flaws. Besides, it‘s

unnecessary. If you want to know the cash flow from operations, you should (carefully and

skeptically) examine the cash-flow statement. That‘s what it‘s there for.

f. The standard line on Wall Street is that you can fake revenue and profits, but you can‘t fake

cash. That‘s true – sort of.

i. Assuming that there are financial controls and the internal & external audit staffs are

honest, all cash on the cash-flow statement is real, but the cash-flow statement isn‘t

immune to deception.

ii. In most US & Europe accounting regimes, cash falls in 3 categories: operations,

investment, and financing – most important category for valuing a business is cash

from operations. – that‘s the # investors & lenders look at to asses a co‘s ability to

cover capital expenditures & pay dividends. It can be in co‘s interest to make # look

big & there are ways to do that using nonrecurring items or cash that shouldn‘t be

considered cash from operations.

iii. Cash is king, but cash-flow statement doesn‘t always present fair pictures. When

looking at cash, we must keep eye out for murky or unhelpful footnotes & masked or

combined transactions that could suggest a more positive cash-flow trajectory than is

realistic. And for goodness‘ sake, keep an eye on those options.



88. Why has Southwest Airlines been able to maintain its profitability?

35 yrs of profit!

 Fuel Hedging: For one thing they have a high percentage of fuel hedged… this has really helped

them b/c their competitors for the most part didn‘t do this. Their hedging couldn‘t have happened

at a better time: they hedged right as fuel skyrocketed. SWA‘s biggest costs is Salary & wages

7& benefits while all other airlines‘ biggest expenses is the cost of fuel.

 Commitment to original idea: of providing the good flight at a cheap price so that more people

can fly with less hassle. This meant customer service, short flights, on time luggage, not offering

the frills but really serving their customers.

 Culture: Herb represents the culture that the company has. He keeps it fun w/the arm wrestling

deal a few years ago. You also need a cultural guro w/real power. Keep culture in mind w/new

hires; hire ―fighters w/ a good servant‘s heart‖ & a fun loving attitude. Bad attitudes stink; one

can mess up a whole dept get rid of them! ―No assholes need apply!‖ You know culture when

you see it like w/ ―Band of Brothers.‖ ―Toothpaste breaks up marriages.‖

 Value People: hire people to be themselves & really appreciate and care for your employees and

past-employees. Have execs spend ―day in the life of x, y, z.‖

 They don‘t follow conventional wisdom: they don‘t call it ―Human Resources,‖ they call it the

―people dept.‖

 A big Q in business classes for a long is ―who comes first: shareholders, workers or customers?‖

Herb says that the answer should always be the employees, b/c if they are happy so will be the

customers and then they‘ll come back again and again and profits will go up and shareholders will

be happy.



89. What are the primary responsibilities of the CFO?



 ROLE:

o Must Have a Great Team!

o Set Financial Targets for co, communicate them & measure them (agreed to w/CEO)

 Fiduciary duty to shareholders

 Challenges it always balancing long term good vs. short term good

 Return on investment capital is 15% & Net income margin is 8% (easier to

understand for employees to have goal); Financial Leverage (below 50%)

o Prepare annual operating & capital plan (budget) & long term financial plan

 Budget adjusted every quarter.

 Hold depts. Accountable, etc. Cost control,

o Key role in defining the strategic business plan



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 Ex: SWA has very changing competitive front w/new competitors like Jet Blue &

also w/fuel prices, etc.

o Other duties:

 Risk management; fleet planning

 Shareholder relations: now they have to makme sure and give no info unless to

everyone

 Keep the back office running (boring but must be done, like keeping everyone paid!)

 Key constituents:

o CEO & Chairman: bd of directors & audit committee; wallstreet & analysists & industries;

o External Auditors; internal auditors; rating agencies;

o Gen Council; employees & feel officers;

o Regulators

 Other duties listed by Ashley:

o Certify SEC riling under SOX

o Officer primarily responsible for managing financial risks of co

o Financial planning & record keeping, and communication of financial data to CEO; also

sometimes communications w/analysts and media

o Due diligence w/regard to mergers & acquisitions

o Tax planning

o Fraud investigations



90. What can be done to help give women a reasonable chance to succeed in business?



a. Create reduced hour jobs

i. Many women will not quit if part time jobs are available

b. Provide Flexibility in the day

i. Work around family schedules etc.

c. Provide flexibility in the arc of a career

i. Get rid of the ―up or out‖ mentality‖

d. Remove the stigma

i. In some environments where corporations have negative stigmas associated with

requesting alternative work arrangements, women would rather resign.

e. Stop Burning Bridges

i. Only 5 percent of highly qualified women looking for onramps are interested in

rejoining the companies they left! Corps should maintain a connection with off

ramped employees.

f. Provide outlets for altruism

i. Many women on an off ramp want to rejoin a not for profit sector… so private

employers should provide these opportunities

g. Nurture ambition

i. By providing networking opportunities where women can hone their leadership

abilities.

h. Also, look at Laura Burke, CFO of SWA: she has been a huge success in business & feels

that her co treats everyone the same… she doesn‘t feel like it is any diff w/her being a

woman. Further, she thinks that w/the amount of time she works she values her time w/her

family. To spend more time w/family she hires help to do all the necessities so that her time

at home is quality time.



91. What can be done to help women get back on the fast track if they have left their careers?

Stay in touch during their time out. Help them maintain connections that will allow them to return.

Allow/help them to attain nec skills & experiences & appropriately recognize achievement in order ot nurture

ambition.

Most important: adopt a formal on route: possibly through some sort of formal alumni process.



92. What alternatives exist to fund most small businesses?

 Most business owners, after exhausting personal savings as well as resources from family and friends,

automatically turn to traditional commercial lenders like their local bank. However, some people cant

get these b/c of their credit scores, etc.

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 Alternative funding options include loans and grants geared toward specific demographic groups, such

as female and disabled entrepreneurs, to ―micro-loan‖ programs aimed at the smallest businesses

 However, before a startup goes looking for money, it needs to determine the very difficult Q of ―how

much?‖

o One study put median price tag at $6k for solo start-up and $20k for team-based venture.

o Startups must estimate their expected future expenses including the one-time start up

expenses and reoccurring ones like rent, bills, etc.

o Small business borrowing: 46% personal credit card, 34% business credit card, 28% line of

credit, 21% vehicle loan, 14% owner loan, 13% mortgage loan, 11% lease, 10% equipment

loan, 10% other.

o A good first step is to conduct ―break-even analysis‖ to determine the amount required to

break-even prior to profit.

o Common mistake is to expect sales to be higher than reality and expenses lower. People are

afraid to ask for more $ b/c they fear bank will refuse, but you should add 10% for

miscellaneous.

o People frequently forget insurance, taxes, fees, licenses, legal fees, incorporation fees, etc.

o Most people borrow just enough money to fail.

 Founder of GloFish had a somewhat different suggestion which apparently was encouraged by

Cunningham. He told the class that when you start a business you only need to keep getting enough

money to take you company to the next step. He said that when you start your company is almost

worthless, so you don‘t have any business getting 2million, partly because you have to give away

huge chunks of the company to get that money up front. Instead wait until you move up in steps,

because at each step the company is worth more, and then you only have to give away small bits of the

company and you get more cash. You have to live off of a shoe string at times and have guts, but in

the end you can own more of your company. However, I do not think that he would suggest that you

set yourself up for failure either, clearly at certain points acquiring capital is very important, like when

he offered Cunningham 10% to get him to be a Board Member ASAP.



93. Why do most entrepreneurs fail to make the transition from successful entrepreneurs to senior

executive in a medium to large corporation?

 W/a few notable exceptions, Founders of successful ventures tend to flounder as the venture gets off

its feet. No real explanation for this, but it‘s assumed that there‘s an entrepreneurial personality and

an executive personality and they are very different.

 Most founders can learn to scale up into a successful long-term exec if they are willing to take a step

back and admit to themselves that their old ways no longer work.

 4 tendencies that help entrepreneur but may hurt an exec as time goes on:

o Loyalty to Comrades – the small band that has been there all along; in the beginning it helps

to lead like your in charge of a small battle unit, but these comrades can become liabilities

later

o Task Orientation- focusing on the job at hand is critical to driving toward say a big product

launch, but excessive attention to detail can cause a large org to lose its way

o Single Mindedness – is an important attribute in a visionary who wants to unleash something

revolutionary on the world, but this quality can harden into tunnel vision if leader can‘t

become more expansive as the company grows

o Working in Isolation- is fine when you‘ve got a brilliant idea that you are figuring out how to

make work, but its disastrous for a leader whose burgeoning org must really on people to do

work, buy product, etc.

 Leaders who scale overcome these tendencies by self-discipline, listening to and seeking input from

others and being willing to shift outlook; they weed out non-performers; deal with probs honestly; see

past distractions and establish strategic priorities. They make co‘s continuing health the top concern.

 What are “Serial-Reneuers?”

 Serial-reneurs: A new breed of entrepreneurs who don‘t spend their whole lives developing 1 product

or become a household brand name, but instead fly under the radar, hitting one start-up home run after

another. ―Some people are kind of entrepreneurial adrenaline freaks.‖ ―They really get their kicks by

starting up businesses.‖

o Mr. Stewart‘s 2000 study found that of 664 entrepreneurs, only 12% fell into category of

having operated 3 or more businesses. They scored higher in propensity for risk, innovation

& achievement. They‘re less scared of failure, and more able to recover when they did fail.

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o Also, they have tactical advantages, pulling from experience, contacts, personal, etc from

previous successes.

o The reason serial entrepreneurs continue to start over after achieving success is b/c their main

job is the act of creation.





94. How does the role of a corporate board vary over time as a firm matures from the start-up to a

well established public company?

Board are more hands on for start ups, constantly examining the markets & looking for how to develop

their products to appeal to those growing markets. They have more strategic decisions to make w/long term

implications b/c theya re directing where the co will go from scratch. More mature public company bds

traditionally engage in the same sorts of governance activities… generally giving management more leeway

for decisions. (not sure about this answer).



95. What are the real costs for a firm when it "goes public?"



Firms must comply w/SOX when they go public. This means (insert al SOX stuff here). It will have to

satisfy all of its fiduciary duties to shareholders. Further, it is important to note that Joe Aragona told us that

SOX disproportionately affects smaller companies. Mohsen Soni of Freudenberg NOK told us that private

firms enjoy several advantages that will not continue when the firms go public. Ex: Private firms generally

are able to keep long term orientation w/out struggling for short term profits in financial statements that could

ultimately prove detrimental for the co in the long run. The bureaucracy v. value equation favors private firms

and private firms find it easier to be responsive to the wills of the owners.





96. How does a young public company attract directors?

Alan Blake of Glo Fish told us that he believes that it‘s important to convince at least one good business

person that you have a good idea & that it will be a profitable business. Often the potential director will know

other people are qualified to be good directors. Establishing credibility as a young company is key. Since the

co is public it is important that you have adequate D&O insurance in place for your potential directors. W/out

this it is unlikely they‘ll agree to serve





97. How can large corporations be more creative in building new businesses?

a. When companies create new businesses the new businesses frequently have very different

cultures and business models which can eventually lead to clashes w/parent company

b. The distinctive features of new businesses present 3 challenges

i. First, emerging businesses usually lack hard data which established company thrives

on

ii. Second, new businesses require innovation which may be difficult under umbrella of

conventional company

iii. Third, there is often a poor fit between new businesses and old system

c. Most new ventures set up by established businesses fail.

i. Companies adopt 1 of 2 extreme approaches to corporate entrepreneurship each w/its

flaws. Some firms house new ventures in isolated divisions; when these firms later

try to integrate struggles erupt between the separate groups. Other companies charge

all managers w/nurturing innovative ides, but preoccupied w/existing business,

managers neglect new projects that they consider diversions.

ii. Garvin & Levesque suggest a balanced approach of these elements and claim that

striking the right balance between new and old sweetens odds that innovative venture

will work.

d. Guidelines for a balanced approach

i. Balance Trial & Error w/ Discipline

1. Narrow range of choices of ideas before going deeper

2. Closely observe small groups of consumers to id their needs

3. use prototypes to test assumptions

4. use non-financial milestones to measure progress

5. know when & on what basis to pull the plug on new business

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ii. Balance Experience w/inventiveness

1. Appoint ―mature turks‖ as leaders of emerging businesses

2. Win veterans over by asking them to serve on new business‘ oversight

bodies.

3. Consider acquiring select capabilities instead of developing everything from

scratch

a. Consider time required to develop skills internally, availability of

needed new skills in open market & ease which outsiders can be

integrated

4. Force old and new businesses to share operational responsibilities

iii. Balance Integration & Autonomy

1. Assign both corporate executives and manages from divisions as sponsors of

new ventures

2. Stipulate criteria for handing new business over to existing businesses

3. mix formal oversight w/informal support by creatively combining dotted-

and solid-line reporting relationships

4. Establish criteria in advance for handoffs

a. New ventures protected by corporate sponsorship often prefer to

stay in corporate umbrella, where they enjoy privileged treatment &

looser controls. To ease eventual integration into existing business-

unit structure, agree in advance on handoff criteria, such as revenue

thresholds or number of customers



98. Why do some entrepreneurs succeed in a variety of ventures, while others are unable to do so?

 The answer to this Q is mostly contained in Q1;

 Many entrepreneurs don‘t want to walk away from their first idea, their passion and want to dedicate

the rest of their life on that one great idea. Serial entrepreneurs have to be willing to walk away from

previous successes and start over again.









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