Wiley CPAexcel Exam Review 2014 Focus Notes: Business Environment and Concepts

Focus on: Corporate Governance, Internal Control, and Enterprise Risk Management—Module 40

CORPORATE GOVERNANCE AND ENTERPRISE RISK MANAGEMENT

Corporate Governance: Establish Incentives and Monitoring

• Owners separate from management
• Agency problem: Will managers act in owners’ interest?

Incentives to Defeat Agency Problem

Forms of Executive Compensation

• Base salary and profit: Usually based on accounting measures
  • May lead to earnings manipulation or taking excessive risk
• Stock options: align shareholders’ and managers’ interest in increasing share prices
  • Differences in timing horizons (management short term?)
  • Underwater options provide no incentive
• Restricted stock: force managers to think long term

Monitoring Devices

• Boards of directors
  • Independent nominating/corporate governance committee
  • Independent audit committee (AC) under Sarbanes-Oxley (SOX)
    • At least one financial expert
    • External auditors must report directly to AC
    • AC appoints, determines compensation, and oversees external auditor
• Stock exchange rules
  • Majority independent directors
    • Provide information to investors as to who is independent
  • Have and make available code of conduct
  • Have an independent AC (required by SOX)
  • Have an independent compensation committee (required by Dodd-Frank)
  • Clawback rules that require executives to pay back incentive compensation when there is an accounting restatement (required by Dodd-Frank)
  • Nonbinding shareholder votes on executive compensation and golden parachutes (required by ...