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									                                    Chapter 4
                     Corporate Governance: Foundational Issues

LEARNING OUTCOMES

After studying this chapter, you should be able to:

1.    Link the issue of legitimacy to corporate governance.
2.    Identify the best practices that boards of directors can follow.
3.    Discuss the problems that have led to the recent spate of corporate scandals and the efforts
      that are currently underway to keep them from happening again.
4.    Discuss the principal ways in which shareholder activism exerted pressure on corporate
      management groups to improve governance.
5.    Discuss the ways in which managers relate to shareholders and the issues arising from
      that relationship.
6.    Discuss the issue of shareholder democracy, its current state, and the trend for the future.


TEACHING SUGGESTIONS

INTRODUCTION – In this chapter the authors explore corporate governance and the ways in
which it has evolved. They first examine the concept of legitimacy and the part that corporate
governance plays in establishing the legitimacy of business. They then explore how good
corporate governance can mitigate the problems created by the separation of ownership and
control, and examine some of the specific challenges facing board members today.

KEY TALKING POINTS – In some sense, discussing corporate governance may seem a bit
premature for business students, especially at the undergraduate level. Most of the students will
not have direct contact with board members of publicly-traded companies and their issues for
quite some time. However, the issues are highly relevant to them in many ways. Some
undergraduates plan to start their own business upon graduation and need to understand the
mechanics and obligations of corporate formation. Further, when starting their own business,
many will operate as owner-managers. They need to understand their various roles in the
corporate form, as well as their legal obligations to other investors should they serve as directors.

Further, as citizens, they should be concerned with the legitimacy of corporations and understand
the power that they hold. As investors, they should realize the impact that boards and CEOs
have on the firm, and be aware of the relationship between the board and senior management.
They will, in all likelihood, understand the theoretical relationship—the board oversees
management activity and has authority over managers. The reality, that the power structure is
inverse to the theory, may come as quite a surprise. Most students will not be familiar with the
proxy process and the agency problems that exist with the corporate form.

As workers, they should be aware of the issues surrounding executive compensation. Executives
are often in the enviable position of setting their own compensation plans, with the board
Business and Society                                                               Chapter Notes


providing only rubber stamp approval. An attitude of self-enrichment at the top of the
organization can have grave consequences for the rest of the employees (e.g., Enron, Tyco,
WorldCom, etc.). Furthermore, they need to understand how different compensation elements
(including stock options) impact their personal financial situation.

As the authors point out, boards are making an effort to wrest control back from management. In
addition to the steps pointed out in the textbook, there are many efforts to ―create‖ better board
members, through education and research. The National Associate of Corporate Directors works
to improve corporate governance in companies ranging from Fortune 100 companies to small,
over-the-counter, closely held, and private firms (http://www.nacdonline.org/). Jeffrey
Sonnenfeld, a professor at Yale University, is well known for his ―CEO College.‖ He has
written several articles about the CEO position and board of directors. Two of his recent articles
are:

Sonnenfeld, J. A. Good governance and the misleading myths of bad metrics. Academy of
     Management Executive, Feb 2004, Vol. 18 Issue 1, p108.

Sonnenfeld, J. A. What Makes Great Boards Great. Harvard Business Review, Sep 2002, Vol. 80
     Issue 9, p106.

Students also may be interested in finding out more about the issue of executive compensation.
Two excellent websites provide a wealth (no pun intended) of information about the topic. The
AFL-CIO (an umbrella labor organization) provides Executive Pay Watch information at
http://www.aflcio.org/corporateamerica/paywatch/. The Institute for Policy Studies and United
for a Fair Economy jointly produce an annual report on CEO pay entitled Executive Excess. The
most recent report, for 2007, is available at
http://www.faireconomy.org/reports/2007/ExecutiveExcess2007.pdf.

Students also may want to explore the recent stock option backdating scandals. Various federal
agencies, including the Department of Justice, the IRS and the SEC, became involved in the
investigation of over 200 companies implicated in the controversy. This is an example of how
breakdowns in corporate governance can lead to serious problems for a company. Essentially,
backdating occurred in many cases due to governance oversights or intentional fraudulent acts.
Many companies lacked the internal governance structures necessary to prevent both inadvertent
and intentional backdating problems. Students can review a list of implicated companies at WSJ
Options Scorecard http://online.wsj.com/public/resources/documents/info-optionsscore06-
full.html.


PEDAGOGICAL DEVICES – In this chapter, instructors may utilize a combination of:

Cases:
     HP: The Pretexting Predicament
     Dick Grasso and the NYSE: Is it a Crime to Be Paid Well?
     The Waiter Rule: What Makes for a Good CEO?
     Do as I Say, Not as I Did
Business and Society                                                             Chapter Notes


       Say-on-Pay
       Martha Stewart: Free Trading or Insider Trading?
       Family Business

Ethics in Practice Cases:
      Monitoring the Monitors

Search the Web:
     CEO Paywatch - http://www.aflcio.org/paywatch
     Edgar - http://www.sec.gov

Video clips:
       Executive Pay Days
       CEO Compensation
       Socially Responsible Investing
       Sarbanes-Oxley Act

Power Point slides:
    Visit http://academic.cengage.com/management/carroll for slides related to this and other
    chapters.


LECTURE OUTLINE

I.     LEGITIMACY AND CORPORATE GOVERNANCE
       A. The Purpose of Corporate Governance
       B. Components of Corporate Governance
           1. Roles of Four Major Groups
           2. Separation of Ownership from Control

II.    PROBLEMS IN CORPORATE GOVERNANCE
       A. The Need for Board Independence
       B. Issues Surrounding Compensation
           1. The CEO Pay/Firm Performance Relationship
           2. Excessive CEO Pay
           3. Executive Retirement Plans
           4. Outside Director Compensation
           5. Transparency
       C. The Impact of the Market for Corporate Control
           1. Poison Pill
           2. Golden Parachutes
       D. Insider Trading Scandals

III.   IMPROVING CORPORATE GOVERNANCE
       A. Sarbanes-Oxley
       B. Changes in Boards of Directors
Business and Society                                                                Chapter Notes


      C.    Board Diversity
      D.    Outside Directors
      E.    Use of Board Committees
      F.    The Board’s Relationship with the CEO
      G.    Board Member Liability

IV.   THE ROLE OF SHAREHOLDERS
      A. Shareholder Democracy
      B. Shareholder Activism
      C. The History of Shareholder Activism
      D. Shareholder Resolutions
      E. Shareholder Lawsuits
      F. Investor Relations

V.    SUMMARY


SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

Students should recognize that their answers to these discussion questions should be well
reasoned and supported with evidence. Although some answers will be more correct than others,
students should be aware that simplistic answers to complex questions, problems, or issues such
as these will never be ―good‖ answers.

1.    Corporations at their inception were run by owner-managers who retained full
      responsibility for all functions of the enterprise. As corporations grew (the availability of
      limited liability was a significant impetus in this process), owners’ roles became more
      investor than owner. Berle and Means, in The Modern Corporation and Private Property,
      refer to this change as moving from active property to passive property. In this process,
      the functions of managing the business were divorced from the ownership function,
      leaving managers effectively in charge of the organization. As ―ownership‖ became more
      diluted among many investors, shareholders soon lost any pretense of control over the
      firm. Even the board of directors, designed to oversee the company’s operations for the
      investors, became subservient to management, as many directors have financial,
      relationship and other ties to management, making it difficult for many directors to make
      decisions independent of management. Exacerbating this final problem is the proxy
      process, which effectively turns over to management even the selection of directors. What
      this means in practice is that managers get to choose their own bosses and then tell the
      bosses what to do.

      Congress, various regulatory agencies and shareholders of public companies took a critical
      look at the inherent agency problems present in the corporate form as a result of the
      scandals that erupted in the early 2000s. As Sarbanes-Oxley, the New York Stock
      Exchange and the NASDAQ ramped up independence requirements for publicly-held
      companies, a new trend emerged for publicly-held boards. Many board members became
      more active, taking some control back from management. More independent board
Business and Society                                                                 Chapter Notes


     members began serving on the boards of public companies, as well as the audit and
     nominating committees. Private companies began to follow suit, as creditors, lenders and
     shareholders considered the implementation of an independent board the best practices for
     all companies. Directors also began spending more time on their duties. However, while
     boards became more independent and more focused on corporate responsibilities,
     corporations are still effectively controlled by management in the vast majority of cases.
     Furthermore, the increased focus on corporate governance had an unintended effect: many
     individuals quit board positions or refused appointments in light of the increasing legal
     hassles associated with regulatory investigations and shareholder lawsuits.

2.   The major criticisms of boards of directors center on their effectiveness. Boards are less
     effective than they should be because too many members are inside directors, they often do
     not put enough time into their positions, they may be paid too much money for the work
     they do, and they may become ―yes men‖ to the CEO.

     The inability to exercise independence is perhaps the most important criticism, especially
     in light of the fact that board members have a legal obligation to act in the best interest of
     shareholders. When directors are unable to separate themselves from management, they
     run the risk of violating their fiduciary duties. In some cases, board members, acting in
     concert with management, pursue their own best interests rather than the company’s best
     interests, which may result in shareholder losses and personal liability for the directors
     involved.

3.   Governance failures like Enron happen primarily because the power relationship between
     the board and top management is inverse. Although the board should have authority over
     top management, the reverse is generally true. Members of top management select who
     will be on the board and continuing to hold a seat is dependent upon rubber stamping top
     management’s decisions. For example, members of the board of directors of Enron
     waived provisions of the company’s code of conduct so that Andy Fastow could serve as
     general partner to certain limited partnerships, which were established for the benefit of
     Enron, and as CFO to Enron. This was an inherent conflict of interest. Board members
     were willing to approve the waiver as the company was a Wall Street darling at the time.
     Further, Enron board members were bringing in large fees for their service to the board.
     Consequently, the board members did not want to displease and/or disagree with
     management, as the loss of the board seat could mean a significant loss of income for these
     individuals.

     Failures like Enron also happen when the lines between the external auditor, management
     and the audit committee are blurred. Sarbanes-Oxley attempts to address this corporate
     governance failure by implementing independence requirements for the audit committee
     and forcing the audit committee to take ownership over the oversight of the external
     auditor.

     To remedy this situation, board members will have to be stronger and stand up to top
     management. It also will require institutional investors to select board members who will
     provide leadership and take back control of the organization. Robert Greenleaf spoke
Business and Society                                                               Chapter Notes


     forcefully of the need for strong leadership from directors (he used the word trustees) in
     Servant Leadership. Finally, there has to be a clear delineation between the roles of
     management, the external auditor and the board.

4.   Several suggestions for improving corporate governance have been made. Most center on
     board composition and performance. Recommended changes in who sits on boards
     include more outside directors, more women, and more people of color. Suggestions for
     changes in activities include more active participation by board committees and getting
     tougher with CEOs.

     The relationship between the external auditor, management and the board also is a key
     element to better corporate governance. Since many investors view the external auditor as
     the ―watchdog‖ of their investment, it is important that any inappropriate ties between the
     external auditor, management and the board are eliminated.

5.   Companies can become more responsive to shareholders by fully disclosing their activities
     and by placing the owners’ interests above the managers’ (although this is probably
     unreasonable to expect from anyone on a consistent basis). There is a significant danger in
     focusing on shareholders’ interests, though. Concentrating on this one narrow topic can
     easily translate into forgetting about other stakeholders such as employees or the
     community.

     While boards are becoming more responsive to shareholders in general, many boards are
     still criticized for their executive compensation practices. Many shareholders believe that
     boards blindly approve compensation packages for executives due to board
     member/management relationships rather than as a result of management performance. In
     2006, the SEC implemented new rules regarding executive compensation disclosure.
     While the SEC stressed that its objective was not wage controls, it did indicate that it
     wanted to focus on wage clarity. Specifically, the SEC had concerns that companies were
     using existing proxy statement disclosure rules to avoid disclosure of certain compensation
     elements. The new rules require companies to disclose a total compensation figure for its
     top executives. In connection with the increased focus on this corporate governance issue,
     shareholder activism over executive compensation rose dramatically in 2007. Specifically,
     many shareholders want to see executive pay tied to performance. If strides are to be made
     in this area, shareholders must continue to hold board members accountable for the pay
     packages that they approve.


GROUP PROJECTS

Group Project 1 - Public Disclosure of Corporate Governance Issues

Divide the students into groups of four to five students. Have the students select a publicly-
traded company. The instructor should explain how publicly-traded information can be obtained
from Edgar (www.sec.gov). Specifically, students should learn how to obtain a company’s
annual report (Form 10-K) and proxy statement (Form Def 14A). Students should be
Business and Society                                                                Chapter Notes


encouraged to review these documents to get a better understanding of the company’s corporate
governance structure. The instructor may want to have the students answer specific questions
related to the company’s corporate governance structure, using the company’s annual report and
proxy statement. The following are sample questions:

How many shareholders hold common stock according to the company’s annual report?

What is the date of record for determining shareholders entitled to receive notice and to vote at
the annual meeting?

How are directors elected? What are the voting requirements for the election of directors? How
would a shareholder propose a candidate for nomination to the board of directors?

Who serves on the board of directors? What are their qualifications?

How many directors are independent? Indicate which directors are ―inside‖ directors and which
directors are ―outside‖ directors. Is this an appropriate mix? Are there any obvious conflicts of
interest?

What board committees does the company have? Describe the function(s) of each committee as
described in the company’s proxy statement.

Who is the audit committee financial expert? What are his or her qualifications?

What internal controls framework does the company use?

Did management determine that the internal control over financial reporting was effective?

Did the auditor find that management’s assessment of the effectiveness of the company’s internal
controls was fairly stated?

Where will the company disclose waivers to the Code of Ethics for the Senior Officers?

Students should be encouraged to assess the corporate governance structure of the group’s
selected company and note any deficiencies or suggestions that they may have for improvement
in a short presentation to the entire class.


Group Project 2 – Executive Compensation

Divide the students into groups of four to five students. Have the students select a publicly-
traded company. The instructor should explain how publicly-traded information can be obtained
from Edgar (www.sec.gov). Specifically, students should learn how to obtain a company’s
annual report (Form 10-K) and proxy statement (Form Def 14A). Students should be
encouraged to review these documents (specifically the proxy statement) to get a better
understanding of the company’s compensation structure, philosophy and objectives. The
Business and Society                                                                  Chapter Notes


instructor may want to have the students answer specific questions related to executive
compensation, using the company’s annual report and proxy statement. The following are
sample questions:

What is the total compensation for the three highest paid officers (including the value of stock
options and other benefits)?

What are the company’s compensation philosophy and objectives? How does the company set
executive compensation?

What are the components of the company’s compensation program (i.e., what ―mix‖ of salary,
benefits, stock, etc. does the company use to compensate its executives)? Do you think that the
company is using the appropriate compensation incentives? According to the compensation
committee, is the current compensation of the top executive(s) justified based on the company’s past
and/or current performance?

Review the Management’s Discussion and Analysis of the Financial Condition and Results of the
Operations (the MD&A) in the company’s annual report. Based on the information in the MD&A, is
the compensation to top executives justified? Is it consistent with the compensation committees’
analysis?

Based on the information in the proxy statement and the annual report, would any of the other
executive officers be an appropriate replacement for the CEO? If not, who would you recommend as
an outside candidate (hint: you might review the profiles of top management in competitors’ annual
reports)?

Locate the company’s employment agreement with the CEO (usually listed as an Exhibit 10 in the
10-K). Describe any noncompete and severance arrangements in the employment agreement.

Students should be encouraged to assess the executive compensation structure of the group’s
selected company and note any issues, deficiencies or suggestions that they may have for
improvement in a short presentation to the entire class.
Business and Society                                                                Chapter Notes



BOARD SELECTION AND FIDUCIARY DUTY SIMULATION

Students should be assigned the following roles: The CEO, Director 1, Director 2, Director 3,
Director 4, Director Candidate A, Director Candidate B, Director Candidate C, Director
Candidate D, Director Candidate E, and Director Candidate G. Name tags should be distributed
so that each student can print his/her role on the name tag and other students can identify who is
playing which role.

Instructors should allow 45-60 minutes for this simulation.

PART 1

Each student should read the background information for his/her role. After reading the
background information, the nominating committee (including the CEO and Directors 1, 2, 3 &
4) should discuss who should be nominated to serve on the Board of Directors for Murray
Rentals, Inc. from the potential candidates. The nominating committee should articulate the
basis for its decisions regarding potential candidates.

PART 2

Once the nominating committee decides who they would like to nominate for the board, they
should ―recruit‖ these candidates for board membership. The candidates should ask appropriate
questions to determine whether they want to pursue board membership.

PART 3

Part 3 concludes with a simulated board meeting.

Distribute the Following for Parts 1 & 2 to the CEO and Nominating Committee

The Nominating Committee – The CEO and Directors 1, 2, 3 & 4

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc. has
asked you to serve on the board of directors of the company. The CEO also has asked you to
serve on the nominating and corporate governance committee. The CEO has asked three other
individuals to serve on the board and nominating and corporate governance committee at this
point. Ideally, the CEO would like for the board to have between 8-12 directors, including the
four current members and the CEO.

The following director nominees have been proposed to you. Each of these directors is presently
available in the room. Consider the following questions: Who do you choose and why? What
Business and Society                                                              Chapter Notes


do you need to do to fill the board? Once you decide who should be nominated, you should
―recruit‖ these members for board membership.

Director Candidate A

Candidate A has been the president of a local bank since 1999. Candidate A has been in the
banking industry for over 25 years and has specifically served the western Kentucky area for 20
of those years. Prior to attaining the position of President, Candidate A focused on commercial
and residential mortgages.

Director Candidate B

Candidate B owns his/her own real estate agency and has been a local real estate agent for over
30 years. Candidate B’s company closed over $8 million dollars in sales last year. Candidate B
supervises a staff of 15 people. His/Her company rarely brokers real estate leases but
occasionally has become involved in high-level commercial sale-leasebacks and residential
leases for ―high-powered‖ clientele.

Director Candidate C

Candidate C has been the senior Vice President of a large local manufacturer for 8 years. Prior
to moving to Murray, Candidate C lived in Nashville for 5 years working for a competitor.
Candidate C goes to First Church of Murray.

Director Candidate D

Candidate D is the Chief Financial Officer of Murray Rentals, Inc. Prior to joining Murray
Rentals, Candidate D served as the controller of Paducah Realty, Inc. for 10 years. Candidate D
moved to Murray to accept the CFO position. Candidate D had lived in Paducah for over 20
years prior to moving to Murray.

Director Candidate E

Candidate E is the CEO’s spouse. Candidate E has an accounting degree and has worked as a
CPA for over 15 years. In the course of his/her work as a CPA, she/he has primarily focused on
personal and corporate taxes.

Director Candidate F

Candidate F is a senior at Murray State University. Candidate F has lived in Racer Place for the
last two years. Candidate F plans to get his/her MBA at Murray State next year. Candidate F
also has worked at Murray Place for the last year.
Business and Society                                                                 Chapter Notes


Director Nominee G

Candidate G is a local restaurant owner. Candidate G has recently entered into a two-year lease
with Murray Rentals, Inc. for a property located on Main Street in Murray. Candidate G is
pleased with the space so far, but would move at the end of the two-year lease if he/she could
find a better deal or if he/she is unable to negotiate favorable terms with the company.

Distribute the Following for Part 2 to the Respective Director Candidates

Director Candidate A

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You have been the president of a local bank since 1999 and have been in the banking industry for
over 25 years. You have specifically served the western Kentucky area for 20 of those years.
Prior to attaining the position of President, you focused on commercial and residential
mortgages.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity but are wondering about the time commitment involved. You would
definitely be willing to serve on the board as long as it doesn’t impair your ability to do your job
at the bank.

Director Candidate B

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You own your own real estate agency and have been a local real estate agent for over 30 years.
Your company closed over $8 million dollars in sales last year. You supervise a staff of 15
people. Your company rarely brokers real estate leases but occasionally has become involved in
high-level commercial sale-leasebacks and residential leases for ―high-powered‖ clientele.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity but are worried that this might create a conflict of interest for you.
Although you are rarely involved in lease agreements, you would not want to be obligated to
―push‖ Murray Rental’s properties when you do engage in lease transactions. However, as a
director, you would want to see the company succeed. You would definitely be willing to serve
on the board as long as it doesn’t create a conflict of interest for you.
Business and Society                                                              Chapter Notes



Director Candidate C

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You have been the senior Vice President of a local manufacturer for 8 years. Prior to moving to
Murray, you lived in Nashville for 5 years working for a competitor. You go to the First Church
of Murray.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity and would really like to serve on the board (especially since the
company has corporate memberships to both country clubs and you’re an avid golfer).

Director Candidate D

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You are the Chief Financial Officer of Murray Rentals, Inc. Prior to joining Murray Rentals, you
served as the controller of Paducah Realty, Inc. for 10 years. You moved to Murray to accept the
CFO position. You lived in Paducah for over 20 years prior to moving to Murray.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity but are worried that it might be difficult to exercise your own
opinion when your boss also is serving on the board. However, as the CFO, you also feel like
you have a lot to offer the board and could provide some important insights to the board
regarding the management of the company.

Director Candidate E

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You are the CEO’s spouse. You have an accounting degree and have worked as a CPA for over
15 years. In the course of your work as a CPA, you have primarily focused on personal and
corporate taxes.
Business and Society                                                                 Chapter Notes



Your spouse mentioned that he/she would like you to serve on the board of directors for Murray
Rentals. You are flattered by the opportunity but are worried that it might be difficult to exercise
your own opinion when your spouse, who is also the CEO, is serving on the board. After all, it is
his/her company, and you don’t want to create problems at home over work. However, you also
feel like you have a lot to offer the board based on your tax experience and believe that you
could help build a more successful company.

Director Candidate F

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You are a senior at Murray State University. You have lived in Murray Place for the last two
years. You plan to get your MBA at Murray State next year. You have also worked at Racer
Place for the last year.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity but are worried that you do not have sufficient expertise to make a
meaningful contribution to the board. Also, you are afraid that it will interfere with your studies.
However, it would be excellent experience (especially since you are getting your MBA) and it
could add much needed funds to your meager cash flow (since there is a cash stipend for board
service).

Director Candidate G

Murray Rentals, Inc. is a new, privately-held company that owns and operates buildings for
commercial lease and apartments and homes for residential lease in western Kentucky. The
residential leases range from executive home rentals on two major lakes to college apartments,
including one of the largest collegiate rentals, Racer Place. The CEO of Murray Rentals, Inc.
will serve as a member of the board.

You are a local restaurant owner. You have recently entered into a two-year lease with Murray
Rentals, Inc. for a property located on Main Street. You are pleased with the space so far, but
would move at the end of the two-year lease if you could find a better deal or if you are unable to
negotiate favorable terms with the company.

You recently learned that Murray Rentals, Inc. is considering you for a board position. You are
flattered by the opportunity but are worried that this might create a conflict of interest. While
you believe that you would have a lot to contribute to the board from the perspective of a tenant,
you do not want to feel obligated to extend your lease at the end of the two-year period.
However, as a local business owner, you realize that fostering relationships in the community
Business and Society                                                              Chapter Notes


enhances your own profitability and that service on this type of board could help you keep your
finger on the pulse of the local economy.

Distribute the Following for Part 3 to the Respective Participants

Note to the Instructor: Students should conduct a simulated board meeting based on their
respective roles (as provided below). This section assumes that each director candidate was
selected for board membership. This may not be the case. If so, you will not need to distribute
the information for non-selected directors. However, these individuals should observe the board
meeting. Another student should serve as the Senior Vice President of Operations for Murray
Rentals, Inc.

The CEO

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You are the chair of the board and are in charge of today’s meeting. You have asked Director 1,
the chair of the nominating committee, to give the nominating committee report, Director 3, the
chair of the audit committee, to give the audit committee report and your Senior Vice President
of Operations to give the current operations report.

You also would like to see Murray Rentals extend its property holdings to include the property
called ―Murray Mall‖ by the locals. This property is currently leased by the following tenants:
Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many others. The current
purchase price for the ―Murray Mall‖ is $7 million dollars. You would have to finance the
purchase with a fairly heft loan, but you believe that the income stream could help you ―break
even‖ on the mortgage for the first few years.

Director 1

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting
Business and Society                                                              Chapter Notes



   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You are the chair of the nominating committee and must report the recent selection of board
nominees and whether or not they were successfully elected by the shareholders.

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Director 2

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Director 3

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties
Business and Society                                                              Chapter Notes



You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

You are the chair of the audit committee and will need to give the audit committee report. The
audit committee recently met with the external auditor where it learned that there were some
problems with internal controls. Specifically, the CEO can access the cash management system
of Murray Rentals, Inc. without the proper checks and balances. Obviously, the committee is
concerned. You need to discuss this with the entire board but recognize that it could be awkward
since the CEO is on the board.

Director 4

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Director A

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties
Business and Society                                                               Chapter Notes


You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

You will learn in the course of the meeting that the CEO would like to see Murray Rentals
extend its property holdings to include the property called ―Murray Mall‖ by the locals. This
property is currently leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s
Sports Bar, Maurice’s and many others. The current purchase price for the ―Murray Mall‖ is $7
million dollars. Murray Rentals would have to finance the purchase with a fairly heft loan, but
the CEO believes that the income stream could help the company ―break even‖ on the mortgage
for the first few years.

As the president of the local bank, you would like to see the bank have the opportunity to finance
this mortgage. However, you are concerned with conflict of interest problems and whether the
federal authorities might be concerned that your objectivity was impaired (due to your dual
position) in connection with any loan that your bank might extend to Murray Rentals. At this
point, you are not convinced that this is a good move for the company and that this could be a
successful endeavor for the company. You need to be convinced.

Director B

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Director C

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
Business and Society                                                               Chapter Notes


   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

However, since joining the board, you have become good friends with the CEO. You guys have
become great golfing buddies.

Director D

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

You are aware that the CEO would like to see Murray Rentals extend its property holdings to
include the property called ―Murray Mall‖ by the locals. This property is currently leased by the
following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar, Maurice’s and many
others. The current purchase price for the ―Murray Mall‖ is $7 million dollars. Murray Rentals
would have to finance the purchase with a fairly heft loan, but the CEO believes that the income
stream could help the company ―break even‖ on the mortgage for the first few years.

You are concerned that the CEO’s projections on the revenue stream from the tenants are not
accurate. Furthermore, many of the tenants have one-year leases with the option to renew for an
additional year, but it is not a ―sure thing‖ that each tenant will renew on an ongoing basis. At
this point, you are not convinced that this is a good move for the company and that this could be
a successful endeavor for the company. You need to be convinced, but you do not want to upset
your boss. However, if this acquisition is successful, it could take Murray Rentals to the next
level.
Business and Society                                                               Chapter Notes


Director E

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

You are aware that your spouse, the CEO, would like to see Murray Rentals extend its property
holdings to include the property called ―Murray Mall‖ by the locals. This property is currently
leased by the following tenants: Office Deport, Goody’s, Dawhares, Nick’s Sports Bar,
Maurice’s and many others. The current purchase price for the ―Murray Mall‖ is $7 million
dollars. Murray Rentals would have to finance the purchase with a fairly heft loan, but the CEO
believes that the income stream could help the company ―break even‖ on the mortgage for the
first few years.

At this point, you are not convinced that this is a good move for the company and that this could
be a successful endeavor for the company. You need to be convinced, but you do not want to
upset your spouse or create problems at home.

Director F

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties
Business and Society                                                               Chapter Notes


You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Director G

You serve on the board of directors for Murray Rentals, Inc. You previously received notice in
accordance with the bylaws that a board meeting was schedule for today at 12:30. You received
the following agenda in connection with the notice:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

You ask appropriate questions when necessary and aim to fulfill your fiduciary duties as a
director.

Senior Vice President of Operations

You are the Senior Vice President of Operations for Murray Rentals, Inc. Murray Rentals, Inc. is
a new, privately-held company that owns and operates buildings for commercial lease and
apartments and homes for residential lease in western Kentucky. The residential leases range
from executive home rentals on two major lakes to college apartments, including one of the
largest collegiate rentals, Racer Place.

The CEO has asked you to attend a board meeting which is scheduled for today at 12:30. You
received the following agenda for the meeting:

Agenda for Board Meeting

   I.        Quorum
   II.       Approval of Past Board Minutes
   III.      Nominating Committee Report
   IV.       Audit Committee Report
   V.        Current Operations Reports
   VI.       Acquisition of New Properties

The CEO has asked you to give the Operations Report for Murray Rentals. At the end of the
most recent quarter, Murray Rentals had 27 commercial units with 24 of these units occupied.
Of the 24 occupied units, 18 units have three to five year leases. The remaining 6 occupied units
have one year leases. The company has 14 residential units, including 2 apartment buildings.
Twelve of the fourteen residential units are occupied. Four hundred twenty apartments are
Business and Society                                                           Chapter Notes


rented in an apartment complex that has 500 apartment units. The other apartment complex has
275 units, 263 of which are rented.

								
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