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Subject 6. Other Board Issues

Board Member Terms

Shareowners should determine whether Board Members are elected annually or whether the Company has adopted an election process that staggers the terms of Board Member elections.

In annual votes, every Board Member stands for re-election every year. Such an approach ensures that Shareowners are able to express their views on individual members' performance during the year and to exercise their right to control who will represent them in corporate governance and oversight of the Company. Companies that prevent Shareowners from electing Board Members on an annual basis limit Shareowners' ability to change the Board composition when, for example, Board Members fail to act on their behalf, or to elect individuals with needed expertise in response to a change in Company strategy.

Staggered Board: A Board of directors only a part of which is elected each year, usually to discourage takeover attempts. In a classified or staggered Board, Board Members are typically elected in two or more classes, serving terms greater than one year. A three-year staggered Board, for example, would have one third of the Board Members or nominees eligible for Shareowner ratification for a three-year period at each annual meeting.

  • Proponents of staggered boards argue that by staggering the election of Board Members, a certain level of continuity and skill is maintained.
  • Staggered terms for Board Members make it more difficult for Shareowners to make fundamental changes to the composition and behavior of the Board by making any challenge to (or change in) board control extremely difficult. In circumstances where a company's performance is deteriorating, this difficulty could result in a permanent impairment of long-term Shareowner value.

Corporate governance best practice guidelines generally supports the annual election of directors as being in the best interest of investors.

Investors should consider whether:

  • Shareowners may elect Board Members every year;
  • Shareowners can vote to remove a Board member under certain circumstances;
  • The size of the Board is appropriate. The Board should be large enough to allow key committees to be staffed by independent, qualified Board Members but small enough to allow all views to be heard and to encourage the active participation of all members.

Related-Party Transactions

Investors should investigate whether the Company engages in outside business relationships with management or Board Members, or individuals associated with them, for goods and services on behalf of the Company.

Related-party transactions involve buying, selling, and other transactions with Board Members, executives, partners, employees, family members, and so on. These are not illegal or necessarily a violation of any kind. Current accounting and auditing standards require the disclosure of these transactions (only if material) but no more.

Board Members are supposed to make independent decisions. Receiving personal benefits from the Company can create an inherent conflict of interest. Board Members should be discouraged from engaging in the following practices, among others:

  • Receiving consultancy fees for work performed on behalf of the Company.
  • Receiving finder's fees for bringing merger, acquisition, or sales partners to the Company's attention.

When reviewing an issue, investors should determine whether:

  • the Company's ethical code or the Board's policies and procedures limit the circumstances in which insiders can accept remuneration from the Company for consulting or other services outside of the scope of their positions as Board Members,
  • the Company has disclosed related-party transactions with existing Board Members, such as finder's fees for their roles in acquisition, and
  • Board Members or executive officers have loaned, leased, or otherwise provided property or equipment to the Company.

Practice Question 1

True or False? A classified board is a good sign of corporate governance.

Correct Answer: False

Staggered terms for board members in a classified board make it more difficult for shareowners to make fundamental changes to the composition and behavior of the board.

Practice Question 2

A staggered board ______

I. provides more flexibility to nominate new board members to meet changes in the marketplace than an annually elected board.
II. may serve as an anti-takeover device.
III. may provide better continuity of board expertise than an annually elected board.

Correct Answer: II and III

Practice Question 3

The drawbacks of a large Board include ______

I. difficulty in coordinating its Members' views.
II. lack of depth of experience and counsel.
III. a potential lack of ability to adequately spread the workload among its Members to operate effectively.
IV. being slower to act.
V. deferring more frequently to management.

Correct Answer: I, IV and V

II and III are possible drawbacks of a small Board.

Practice Question 4

Select the correct statements about related-party transactions.

I. Related-party transactions are illegal.
II. Companies have to disclose related-party transactions even if they are non-material.

Correct Answer: Neither statement is correct.

I. Related-party transactions are not illegal or necessarily a violation of any kind.
II. Current accounting and auditing standards require the disclosure of these transactions only if they are material.

Practice Question 5

Which of the following statements indicate a problem that an effective corporate governance system would mitigate or eliminate?

A. To maintain a certain level of continuity and skill of the board, no board member should be removed from the board under any circumstances.
B. A majority of the board is independent.
C. The Board reports on their activities to Shareowners once a year.

Correct Answer: A

Shareowners should be able to vote to remove a Board Member under certain circumstances. Besides, corporate governance best practices generally support the annual election of Board Members as being in the best interest of investors.

Study notes from a previous year's CFA exam:

6. Other Board Issues