Assignment:
Interactive Assignment Chapter 2
Corporate Governance
Executive compensation in the financial services industry
during the mid-2000s ranks high among examples of failed corporate governance.
Corporate governance at the government-sponsored mortgage giants Fannie Mae and
Freddie Mac was particularly weak. Concepts & Connections 2.4 discusses how
the boards at both enterprises fulfilled their obligations to shareholders.
Although senior managers have lead responsibility for
crafting and executing a company’s strategy, it is the duty of a company’s
board of directors to play a vigilant role in overseeing management’s handling
of a company’s strategy-making, strategy-executing process. A company’s board
is obligated to (1) ensure that the company issues accurate financial reports
and has adequate financial controls, (2) critically appraise and ultimately
approve strategic action plans, (3) evaluate the strategic leadership skills of
the CEO, and (4) institute a compensation plan for top executives that rewards
them for actions and results that serve stakeholder interests, most especially
those of shareholders.
Answer the assignment questions for this exercise after
reading Chapter 2 and Concepts & Connections 2.4. Then read the mini-case
below and answer the questions that follow.
Executive compensation in the financial services industry
during the mid-2000s ranks high among examples of failed corporate governance.
Corporate governance at the government-sponsored mortgage giants Fannie Mae and
Freddie Mac was particularly weak. The politically appointed boards at both
enterprises failed to understand the risks of the subprime loan strategies
being employed, did not adequately monitor the decisions of the CEO, did not
exercise effective oversight of the accounting principles being employed (which
led to inflated earnings), and approved executive compensation systems that
allowed management to manipulate earnings to receive lucrative performance
bonuses. The audit and compensation committees at Fannie Mae were particularly
ineffective in protecting shareholder interests, with the audit committee
allowing the government-sponsored enterprise’s financial officers to audit
reports prepared under their direction and used to determine performance
bonuses. Fannie Mae’s audit committee also was aware of management’s use of
questionable accounting practices that reduced losses and recorded onetime
gains to achieve EPS targets linked to bonuses. In addition, the audit
committee failed to investigate formal charges of accounting improprieties
filed by a manager in the Office of the Controller.
Fannie Mae’s compensation committee was equally ineffective.
The committee allowed the company’s CEO, Franklin Raines, to select the
consultant employed to design the mortgage firm’s executive compensation plan
and agreed to a tiered bonus plan that would permit Raines and other senior
managers to receive maximum bonuses without great difficulty. The compensation
plan allowed Raines to earn performance-based bonuses of $52 million and total
compensation of $90 million between 1999 and 2004. Raines was forced to resign
in December 2004 when the Office of Federal Housing Enterprise Oversight found
that Fannie Mae executives had fraudulently inflated earnings to receive
bonuses linked to financial performance. Securities and Exchange Commission
investigators also found evidence of improper accounting at Fannie Mae and
required it to restate its earnings between 2002 and 2004 by $6.3 billion.
Poor governance at Freddie Mac allowed its CEO and senior
management to manipulate financial data to receive performance-based
compensation as well. Freddie Mac CEO Richard Syron received 2007 compensation
of $19.8 million while the mortgage company’s share price declined from a high
of $70 in 2005 to $25 at year-end 2007. During Syron’s tenure as CEO, the
company became embroiled in a multibillion-dollar accounting scandal, and Syron
personally disregarded internal reports dating to 2004 that warned of an
impending financial crisis at the company. Forewarnings within Freddie Mac and
by federal regulators and outside industry observers proved to be correct, with
loan underwriting policies at Freddie Mac and Fannie Mae leading to combined
losses at the two firms in 2008 of more than $100 billion. The price of Freddie
Mac’s shares had fallen to below $1 by Syron’s resignation in September 2008.
Both organizations were placed into a conservatorship under
the direction of the U.S. government in September 2008 and were provided
bailout funds of nearly $200 billion by 2013.
Sources: Chris Isidore, “Fannie, Freddie Bailout: $153
Billion . . . and Counting,” CNNMoney, February 11, 2011; “Adding Up the
Government’s Total Bailout Tab,” The New York Times Online, February 4, 2009;
Eric Dash, “Fannie Mae to Restate Results by $6.3 Billion Because of Accounting,”
The New York Times Online, www.nytimes.com , December 7, 2006; Annys Shin,
“Fannie Mae Sets Executive Salaries,” The Washington Post, February 9, 2006, p.
D4; and Scott DeCarlo, Eric Weiss, Mark Jickling, and James R. Cristie, Fannie
Mae and Freddie Mac: Scandal in U.S. Housing. (Hauppauge, NY: Nova Publishers,
2006), pp. 266–286.
1.
Corporate governance at Freddie Mac failed the enterprise’s
shareholders and other stakeholders such as taxpayers and homeowners by
failing to establish audit or compensation committees.
allowing agent managers to exploit managerial control to
receive excessive compensation.
overstepping the board of directors’ fiduciary duty to
provide managerial oversight.
allowing the board of directors to impede the implementation
of management’s key strategic initiatives.
making the company’s CEO and CFO primarily responsible for
financial reporting.
2.
Fannie Mae’s board of directors fulfilled which of the following
of its four important obligations to shareholders?
Properly oversaw the company’s financial accounting and
financial reporting practices
Critically appraised the company’s direction, strategy, and
business approaches
Instituted a compensation plan that rewarded actions aimed
at increasing stakeholder value
Fannie Mae’s board of directors did not fulfill any of its
primary obligations to shareholders.
Evaluated the caliber of senior executives’ strategic
leadership skills
3.
Fannie Mae’s compensation committee _______.
adequately ensured that financial performance was reported
fairly and accurately
failed to protect shareholders by approving compensation
packages that encouraged fraud
developed salary and incentive plans for senior management
that rewarded growth in economic value
fulfilled their duty to protect shareholder’s interests
improperly evaluated the leadership skills of senior
management and tried to correct misconduct and fraudulent behavior at the
enterprise
4.
Governance failures at Freddie Mac and Fannie Mae ________.
led to the passage of the Sarbanes-Oxley Act
resulted in all of these.
led to a massive government bailout and had a negative
impact on the stability of the U.S. economy
allowed agent managers to adopt strategies that were overly
focused on long-term performance
resulted because of the large number of inside directors on
the boards of both enterprises
5.
Fannie Mae’s audit committee _______.
adequately ensured that financial performance was reported
fairly and accurately
was hindered in exercising oversight by opportunistic
management
failed to certify to shareholders that the CEO was doing
what the board expected
did all of these things
disregarded information provided by financial control
mechanisms and not exercise effective oversight
