Corporate Governance Flashcards

Question 1

What is the basic meaning of corporate governance in a company?

Accepted Answer

Corporate governance is the set of rules, processes, and relationships used to direct and control a company. It defines who has authority to make decisions, how those decisions are monitored, and how managers and directors are held accountable to shareholders. Good governance aims to protect investors and keep the company within legal limits.

Question 2

What is the principal-agent problem in corporate governance?

Accepted Answer

The principal-agent problem arises when one party, the agent, makes decisions on behalf of another party, the principal, but their interests are not aligned. In a company, shareholders are principals and managers are agents. Managers may pursue personal goals, so governance tools align incentives with owners.

Question 3

What is stakeholder theory and how does it differ from shareholder primacy?

Accepted Answer

Stakeholder theory holds that a company should consider the interests of all groups affected by its activities, including employees, customers, suppliers, communities, and creditors. Shareholder primacy, by contrast, holds that the company's main duty is to maximize value for shareholders. Many governance codes blend the two by asking boards to weigh stakeholder interests.

Question 4

Why do companies have a board of directors instead of being run directly by shareholders?

Accepted Answer

Companies use a board of directors because large numbers of shareholders cannot manage daily operations. The board is elected by shareholders to oversee management on their behalf, set strategic direction, appoint and dismiss senior executives, and approve decisions. This separation of ownership from control lets managers run the business while the board monitors them.

Question 5

What is the difference between a unitary board and a two-tier board structure?

Accepted Answer

A unitary board combines executive and non-executive directors in a single board that oversees and manages the company. A two-tier board separates a supervisory board, which monitors, from a management board, which runs daily operations. Two-tier structures are common in several continental European countries, such as Germany.

Question 6

What does the term fiduciary duty mean for company directors?

Accepted Answer

Fiduciary duty is a legal obligation requiring directors to act in good faith and in the best interests of the company. The two core duties are care, requiring informed and diligent decisions, and loyalty, prohibiting self-dealing. Breaches can create personal liability for directors.

Question 7

Why is board independence considered important for effective oversight?

Accepted Answer

Board independence matters because directors who have no material ties to management are better placed to challenge executives and judge performance objectively. Independent directors can question proposals, review executive pay, and oversee audits without fear of retaliation. Many governance codes therefore recommend that a substantial share of directors be independent.

Question 8

What is a related-party transaction, and why do governance rules scrutinize it?

Accepted Answer

A related-party transaction is a deal between a company and an insider, such as a director, executive, or major shareholder. Such deals can be fair, but insiders may benefit at the company's expense. Governance rules therefore usually require disclosure, independent approval, and sometimes exclusion of the conflicted person from voting.

Question 9

What are the main board committees, and what does each one usually oversee?

Accepted Answer

The three committees most commonly used are audit, compensation, and nominating or governance committees. The audit committee oversees financial reporting, internal controls, and the external auditor. The compensation committee sets executive pay, and the nominating committee recommends new directors and evaluates board effectiveness.

Question 10

What does it mean for a director to be non-executive?

Accepted Answer

A non-executive director is a board member who does not hold a full-time management role in the company. Non-executive directors bring outside perspective, challenge management proposals, and help monitor performance. Their independence depends on whether they have financial or personal ties to the company.

Question 11

Why do many governance codes recommend separating the roles of chair and chief executive?

Accepted Answer

Separating the chair and chief executive roles helps prevent any one person from holding unchecked power over the board. The chair leads the board and ensures its oversight is effective, while the chief executive runs daily operations. When one person holds both roles, a board may find it harder to challenge management.

Question 12

What makes a board's composition diverse, and why do governance codes discuss diversity?

Accepted Answer

Board diversity refers to differences among directors in areas such as gender, ethnicity, age, professional background, and perspective. The main argument is that groups with varied experience may identify risks and alternatives that a homogeneous group overlooks. Many codes ask boards to explain how they consider diversity when appointing directors.

Question 13

What is the role of a lead independent director?

Accepted Answer

A lead independent director is a senior independent board member who coordinates the work of the other independent directors. This role is useful when the chair is also the chief executive or is not independent. The lead director often presides over sessions without management and serves as a point of contact for shareholders.

Question 14

How do board evaluations help improve board effectiveness?

Accepted Answer

Board evaluations are structured reviews of how well the board and its committees perform their duties. They may use questionnaires, interviews, or external facilitators to assess skills, processes, and boardroom dynamics. Findings help the board identify gaps, plan training, and refresh its membership over time.

Question 15

What is the purpose of a nominating committee in board succession planning?

Accepted Answer

A nominating committee identifies, evaluates, and recommends candidates for board seats and key leadership roles. Succession planning ensures that the company has ready replacements when directors or executives retire, resign, or are unable to serve. A structured process reduces reliance on informal networks and supports a balance of skills over time.

Question 16

What is a board skills matrix and how is it used?

Accepted Answer

A board skills matrix is a table that compares each director's expertise with the skills the board needs, such as finance or risk. It helps the nominating committee spot gaps and set priorities when recruiting new members. Boards often review it annually so that composition keeps pace with changing strategy.

Question 17

What are the basic rights that common shareholders usually hold?

Accepted Answer

Common shareholders usually have the right to vote on major matters, such as electing directors and approving mergers. They also typically have the right to receive dividends when declared, to inspect certain company records, and to sell their shares. Specific rights depend on the jurisdiction and the company's charter and bylaws.

Question 18

What is one share, one vote, and why do some companies use dual-class structures?

Accepted Answer

One share, one vote means each ordinary share carries equal voting power, aligning voting with economic ownership. Dual-class structures issue shares with unequal votes, often giving founders or insiders more voting control than their economic stake. Supporters argue this protects long-term vision, while critics say it weakens accountability to outside investors.

Question 19

How does proxy voting allow shareholders who cannot attend a meeting to vote?

Accepted Answer

Proxy voting lets a shareholder appoint someone else, called a proxy, to vote on their behalf at a meeting. Shareholders usually submit a proxy form or electronic instruction before the meeting, specifying how to vote on each resolution. Many shareholders vote this way because most hold shares through intermediaries and cannot attend in person.

Question 20

What is a majority voting standard for electing directors?

Accepted Answer

A majority voting standard requires a director to receive more votes for than against to be elected. Under a plurality standard, by contrast, the nominee with the most votes wins even if most votes were withheld. Majority standards give shareholders a more meaningful way to reject unsatisfactory candidates.

Question 21

What is the difference between a proxy contest and a takeover bid?

Accepted Answer

A proxy contest is an effort by shareholders to replace directors or change policy by persuading other shareholders to vote for their candidates. A takeover bid is an offer to buy enough shares to gain control of the company itself. Proxy contests work through voting, while takeover bids work through purchasing ownership.

Question 22

What is a say-on-pay vote and what does it allow shareholders to do?

Accepted Answer

A say-on-pay vote is a non-binding shareholder vote on the compensation paid to a company's executives. It gives shareholders a formal way to express approval or disapproval of pay policies and specific awards. Because the vote is advisory, boards may respond by revising pay practices or engaging with investors.

Question 23

Why do shareholder proposals matter even when they usually fail to pass?

Accepted Answer

Shareholder proposals are formal requests that shareholders place on the company's proxy materials for a vote. Most proposals receive low support, but they can still signal investor concerns, prompt dialogue with management, and influence policy changes. Their influence often depends more on the level of support than on the final outcome.

Question 24

What is the role of an institutional investor in corporate governance?

Accepted Answer

An institutional investor is an organization that invests money on behalf of others, such as pension funds and mutual funds. Because these investors hold large stakes, they can influence governance by voting, engaging with boards, and publishing voting policies. Their stewardship activity is often seen as a key check on management.

Question 25

What are the main components of executive compensation?

Accepted Answer

Executive compensation typically includes a base salary, an annual bonus tied to performance targets, and long-term incentives such as stock options or performance shares. Many packages also include retirement benefits and perquisites, such as company cars or security. Boards aim to balance fixed pay with variable pay linked to measurable results.

Question 26

What is the difference between pay mix and pay level?

Accepted Answer

Pay level refers to how much total compensation an executive receives compared with peers. Pay mix refers to how that total is divided among salary, short-term bonus, and long-term incentives. A company can have the same pay level with very different mixes, which changes the risk executives bear.

Question 27

Why do boards use performance conditions in long-term incentive plans?

Accepted Answer

Performance conditions tie vesting of long-term awards to measurable goals, such as total shareholder return or earnings growth. This linkage rewards executives only when defined results are achieved, reducing the chance of pay for mediocre performance. Boards must choose metrics carefully, since poorly designed targets can encourage short-term thinking or excessive risk.

Question 28

What is clawback, and when is it typically triggered?

Accepted Answer

A clawback is a provision that allows a company to recover incentive pay already awarded or paid to executives. It is typically triggered by a financial restatement, misconduct, or a material error that inflated the performance results used to calculate pay. Clawback policies protect shareholders from rewards based on results that later prove unreliable.

Question 29

What is the problem with excessive risk-taking in executive incentive design?

Accepted Answer

Incentive plans with large payouts tied to short-term results can encourage executives to take risks that threaten long-term company health. Executives who hold large unvested equity may focus on share price rather than sustainable performance. Governance responses include deferred payouts, holding requirements, and risk review by the compensation committee.

Question 30

What is a stock ownership guideline for executives?

Accepted Answer

A stock ownership guideline requires executives to build and hold a minimum value of company shares, often expressed as a multiple of base salary. Its purpose is to align executives' personal wealth with the experience of long-term shareholders. Guidelines often apply until a specified level is reached and may restrict selling shares.

Question 31

What is a pay ratio, and why do investors and regulators pay attention to it?

Accepted Answer

A pay ratio compares the total annual pay of a chief executive with the median pay of the company's employees. It is a simple indicator of pay dispersion within an organization. Investors and regulators watch it because very high ratios may raise questions about fairness, internal equity, and whether pay reflects broader workforce conditions.

Question 32

Why is pay for performance a central principle in executive compensation design?

Accepted Answer

Pay for performance means that a significant share of executive reward varies with measurable results. It is central because it links the interests of executives with those of shareholders. Critics note that metrics can be manipulated, so boards also rely on judgment and peer comparison.

Question 33

What is the difference between internal audit and external audit?

Accepted Answer

External audit is performed by an independent outside firm that examines whether financial statements fairly present the company's financial position. Internal audit is performed by the company's own staff to assess controls and risk management. External audit serves shareholders, while internal audit supports management and the audit committee.

Question 34

What is the purpose of an audit committee's oversight of external auditors?

Accepted Answer

The audit committee oversees the external auditor by selecting the firm, approving fees, and reviewing its work. This oversight protects auditor independence, since auditors report to the committee rather than to executives. Committees also monitor auditor rotation and non-audit services that could threaten objectivity.

Question 35

What is an internal control system, and what are its main objectives?

Accepted Answer

An internal control system is the set of policies and procedures that safeguard assets and support reliable reporting. Its main objectives include operational effectiveness, accurate financial reporting, and compliance with applicable laws. Controls such as segregation of duties and authorization limits help reduce errors and fraud.

Question 36

Why does segregation of duties matter in financial controls?

Accepted Answer

Segregation of duties means that no single person controls all the stages of a financial transaction. Splitting these tasks makes it harder for one person to commit or conceal errors and fraud without another person noticing. It is a basic safeguard that boards and auditors look for when assessing controls.

Question 37

What is enterprise risk management and how does the board oversee it?

Accepted Answer

Enterprise risk management is an integrated approach to identifying, assessing, and managing risks across an entire organization. The board oversees it by setting risk appetite, reviewing major exposures, and confirming controls are effective. Many boards assign specific risk duties to a committee, such as an audit or risk committee.

Question 38

What does a company's code of conduct accomplish within governance?

Accepted Answer

A code of conduct sets out the ethical standards and behavior expected of directors, executives, and employees. It gives people clear guidance on conflicts of interest, gifts, confidentiality, and compliance with law. Effective codes are enforced through training, reporting channels, and consistent consequences for violations.

Question 39

How do whistleblower channels support accountability inside a company?

Accepted Answer

Whistleblower channels are confidential ways for employees and others to report suspected misconduct without fear of retaliation. They help boards learn about problems early, before small issues become major scandals or legal failures. Good governance requires that reports reach an appropriate committee, usually the audit committee, and that investigations are handled independently.

Question 40

What is the board's responsibility when a company faces a serious crisis or scandal?

Accepted Answer

The board must act promptly to understand the facts, protect stakeholders, and ensure that management responds appropriately. This often includes forming a special committee of independent directors, retaining outside advisers, and overseeing public disclosure. Directors must document their deliberations, since their conduct may later be reviewed by regulators or courts.

Corporate Governance Flashcards

1Foundations of corporate governance

2Board composition and committees

3Shareholder rights and voting

4Executive pay and incentives

5Accountability, audits and risk oversight

Learning Resources