Corporate Governance Paper 2

(b) The requirement is to identify the form of compensation that would encourage management to take on excess risk. Answer (b) is correct because with a bonus based on current period net income, management has an incentive to take on excessive risk to maximize its bonuses. Answer (a) is incorrect because a fixed salary encourages management to take on little risk. Answers (c) and (d) are incorrect because stock options that cannot be exercised for 10 years and restricted stock encourage management to be concerned about the longterm viability of the firm.

(c) The requirement is to identify the item that is typically a duty reserved for the board of directors. Answer (c) is correct because this duty is typically reserved for the shareholders. Answers (a), (b), and (d) are incorrect because these are all typically duties of the board of directors.

(b) The requirement is to identify the legal rule that prevents directors from being held liable for making bad decisions if they act with good faith, loyalty, and due care. Answer (b) is correct because this is referred to as the business judgment rule. Answers (a), (c), and (d) are incorrect because they are not terms used to describe this legal rule.

(c) The requirement is to identify the item that is not a requirement of the NYSE regarding corporate governance of listed companies. Answer (c) is correct because the rules do not prohibit the CFO from serving on the board of directors. Answers (a), (b) and (d) are all requirements of the NYSE.

(d) The requirement is to identify the organization or group that does not act as an external corporate governance mechanism. Answer (d) is correct because directors are internal corporate governance mechanisms regardless of whether or not they are independent. Answers (a), (b), and (c) are incorrect because they all act as external corporate governance mechanisms.

(c) The requirement is to identify the characteristic that must apply to at least one member of the audit committee. Answer (c) is correct because Sarbanes-Oxley requires that at least one member of the audit committee be a financial expert. Answer (a) is incorrect because all audit committee members should be independent. Answer (b) is incorrect because the chief financial officer is not independent and should not be on the audit committee. Answer (d) is incorrect because while a CPA would generally qualify as a financial expert, it is not required that the financial expert be a CPA.

(b) The requirement is to identify the item that is not a statutory requirement for publicly held corporations registered with the SEC. Answer (b) is correct because there is no requirement to have a compensation expert on the compensation committee. Answers (c) and (d) are incorrect because they are requirements of the Sarbanes-Oxley Act. Answer (a) in incorrect because it is a requirement of the Dodd-Frank Act.

(b) The requirement is to identify the understanding that is a necessary to be an audit committee financial expert according to the criteria specified in the Sarbanes-Oxley Act of 2002. Answer (b) is correct because it is one of the items required to meet the criteria. Answers (a), (c), and (d) are incorrect because they are not part of the criteria.

(d) The requirement is to identify the item that is not a requirement of the Wall Street Reform and Consumer Protection Act. Answer (d) is correct because the Act does not require all members of the audit committee to be financial experts. The Sarbanes-Oxley Act requires one member of the audit committee to be a financial expert. Answers (a), (b), and (c) are incorrect because they are all requirements of the Act.

(b) The requirement is to identify the most effective external monitoring device. Answer (b) is correct because external auditors audit the financial statements and internal controls of a publicly held corporation. Answer (a) is incorrect because internal auditors are an internal monitoring device. Answer (c) is incorrect because the SEC relies upon external auditors to audit the corporation’s financial statements and internal controls. Answer (d) is incorrect because attorneys only advise management on legal issues. They cannot take action if management does not take their advice.