Hypothetical board of directors questions

[En Passant]

I had to write a response paper to each of these questions for one of my law classes, legal issues in corporate governance. I have completed them, but I found them to be very insightful and am interested to know what you people think.

1. Company A has a board of directors made up of nine people. One of board members applying for reelection serves on the board of another company, company B. Every board member of company B has been sued for fraud; however, these are just allegations. A complaint has been filed, but no discovery has been found. When the proxy statement is released for this upcoming year, should it disclose that this board member is a defendant in security fraud litigation case?

Kirk Kerkorian, president and CEO of Tracinda Corporation, has lunched an overture to buy two properties in Las Vegas: The Bellagio Hotel and the still-being-constructed City Center Project. The deal is worth $12 billion dollars. The owner of both the Bellagio Hotel and the City Center project is the MGM Grand. Kekorian also happens to be a member of the board of MGM and is also its largest shareholder. What does the MGM board do?

3. Corporation A is a venture capital backed company that has raised $40 million. Jane Smith, who serves on the board, is a member of a venture capitalist firm. She invested $25 million of the original $40 million. Out of cash and near bankruptcy, Corporation A will shut down in one month if it cannot raise more investment dollars. Jane Smith offers to invest $10 million (which will be enough for the company to operate for one more month) for an 80% stake in the company. They know it’s a related party transaction. Keep in mind she is a majority owner to begin with. What should board do?

[DesertCat]

1. Yes. Disclosure doesn't hurt anything.

2. It depends on what the MGM board wants. First they create an independent committee (i.e. no tracinda people or KK) to hire an investment bank. If the board wants to sell, the investment bank will write a fairness opinion that says they'd be crazy not to take the offer. If they don't want to sell, the investment bank will write a fairness opinion that says they'd be crazy if they take the offer.

3. Try to find a better offer, but assuming one can't be found, take it. It's only one month of breathing room, but Jane Smith's firm is heavily committed, and might figure out how to save the business. The moral is that if you've burned through $40M without creating a self sustaining business and you run out of funding, you've failed and don't deserve your equityany more or any more funding. Who ever wants to pick through your wreckage is going to get any deal they want.

[En Passant]

Can't stump the DesertCat. Well done!

[En Passant]

Here are two more to consider:

1. There is an offer to buy a genetic engineering company that is majority owned by Doctor and Doctor Frankenstein. A human genetic company in Romania wants to buy the genetic engineering company. The Romanian company offers the doctors a premium for their stock of 200% of FMV, while the other shareholders will only get a premium of 50%. The board is asked to approve the transaction, what should the board do.

2.Corporation A needs to build a factory in Philadelphia, Pa. There are five sites available. One of the available sites is owned by an independent director, director x, of this company. The site search committee, which consists only of officers and no directors of the company, determine that the best site is the one owned by director x. The committee does not know the site is owned by director x. They make a recommendation to the board to go with site owned by director x. Even though the committee has determined the fifth site to be the best one, it is the most expensive. The president is going to make a recommendation to board. What should president and board do?

[En Passant]

Side question for DesertCat: when considering to invest in a company, do the committees or lack of committees of the board play a big role? Lets say for example a comany you are thinking about investing in doesn't have an audit committee, how much does this affect your investing decision?

[DesertCat]

[ QUOTE ]
Here are two more to consider:

1. There is an offer to buy a genetic engineering company that is majority owned by Doctor and Doctor Frankenstein. A human genetic company in Romania wants to buy the genetic engineering company. The Romanian company offers the doctors a premium for their stock of 200% of FMV, while the other shareholders will only get a premium of 50%. The board is asked to approve the transaction, what should the board do.


[/ QUOTE ]

I'm assuming that all stock is common stock with the same rights. They board can't approve this, it exposes the board to a lawsuit and huge liabilities, the last thing any board member wants. The deal will get restructured so that the two Drs. will get "employment agreements" paying them huge amounts of money post deal, and all shares will be cashed out at the same price, keeping the board "clean". Though even this approach will be challenged in court by shareholders if the "employment agreements" are too excessive.

[ QUOTE ]

2.Corporation A needs to build a factory in Philadelphia, Pa. There are five sites available. One of the available sites is owned by an independent director, director x, of this company. The site search committee, which consists only of officers and no directors of the company, determine that the best site is the one owned by director x. The committee does not know the site is owned by director x. They make a recommendation to the board to go with site owned by director x. Even though the committee has determined the fifth site to be the best one, it is the most expensive. The president is going to make a recommendation to board. What should president and board do?

[/ QUOTE ]

This is a tough one. The first goal of a board member is to CYA. This doesn't sound like a situation where the board can redo the search by hiring an independant firm (in a process director x is recused from) to validate the choice. Even if you could find a firm with the proper skills, you are over-riding what's essentially an internal management decision. This seems a little over the line, it would mean the board is actually making management decisions, which no good board wants to do.

My guess is that we'd get a fairness opinion stating that the price paid for the site is reasonable. Second, document that management was not influenced by director x's ownership (or at least claims it wasn't). I think that cover's everyone's behind as best as possible.

[DesertCat]

[ QUOTE ]
Side question for DesertCat: when considering to invest in a company, do the committees or lack of committees of the board play a big role? Lets say for example a comany you are thinking about investing in doesn't have an audit committee, how much does this affect your investing decision?

[/ QUOTE ]

I typically don't pay attention to this stuff, except in certain limited circumstances, i.e. if I suspect fraud. But if I suspect fraud I'm not investing in the first place.

Our current public boards are horribly compromised because of how they are composed. Shareholders have little ability to pick directors, almost every vote for board members is as rigged as a Soviet election. The company tells you who to vote for, and doesn't allow you to propose other candidates except through an arduous, expensive and uncertain process.

So boards end up being picked by boards, and management, and have little personal financial stake in the business. Over time, successful CEO's can control their own boards as they influence the new board member process, which is a horrible outcome. So when you invest in publicly held companies, you have to accept these facts. Your best ally is that board members don't want liability exposure, so they'll typically do the basic stuff right. But they'll almost always overpay the CEO and be slow to fire them.

Right now boards just have checklists of things to do ("governence guidelines") given to them by lawyers to stay out of trouble, but following the checklists doesn't make them good board.

I like companies where the CEO and board have big stakes (not options, actual shares) and treat shareholders like partners, not irritants. CEO's who don't make big paychecks, whose net worth is tied up in the business, who don't get stock options, are much less likely to commit fraud. Boards with financial stakes are going to be much more engaged and active, and wary. But it's hard to find many companies that meet this description.

I always hope that someday the SEC will mandate that companies allow committed shareholders (say 5% holders) to propose their own board slates. That would eliminate the need for all this governance bureaucracy, and radically change CEO compensation norms, and make public companies more valuable. But I'm not holding my breath. In the mean time private equity and activists hedge funds will reap the benefits of this system.

[Brad1970]

[ QUOTE ]
Side question for DesertCat: when considering to invest in a company, do the committees or lack of committees of the board play a big role? Lets say for example a comany you are thinking about investing in doesn't have an audit committee, how much does this affect your investing decision?

[/ QUOTE ]

IMO, the presence or absence of a certain committee, audit committee in this case, may or may not mean anything. Desert Cat has wrote a nice piece & I'm not gonna try to compete with that but several years ago I used to be an auditor at a large company & can tell you from experience that audit committees are generally for show only. They usually have no real power...there are exceptions though. In the past, audit reports from outside auditors (from the big five accting firms) were nothing more than a farce in a lot of cases. They were crafted to read exactly as the company management wanted them to read. Two prime examples of this were Enron & WorldCom. The underlying tone to the auditors from the company management/board of director's was "give me the report I want or I will find somebody who will". You basically were buying a good audit report to submit to the SEC. I would imagine that since that time, that mentality has changed!!! [img]/images/graemlins/wink.gif[/img]