Corporate Governance: First American Corp - Report Example

of Topic: Corporate Governance Research Project - First American Corp Introduction This paper seeks to provide an overall assessment of the corporate governance of First American Financial Corp (or “FAF)”, formerly known as First American Corp based on available information and to discuss a specific governance issues that company has dealt or is current dealing with. 2.1 The concept corporate governance and its importance Corporate governance is meant to deliver long-term success of a corporation in terms of value generation for shareholders. Such value should be correctly referred to as long term and not just a temporary thing that may happen to an organization. Based on this premise, the purpose of corporate governance is a journey and putting said corporate governance into reality would be the more interesting challenge for corporations like FAF. Incidentally, the concept of corporate governance has close relevance to stakeholder theory and agency theory as would be explained latter. Different laws from different countries on corporate governance imply a number of purposes but the most controversial of these would include leadership and need to maintain accountability of certain individuals to stakeholders. Related with these purpose is the problem created from principal-agent relationship that would require emphasis on how should the board of directors be structured and organized and how to promote efficiency for the benefit of shareholders or investors to the companies. Part of this corporate governance encompasses the role played by government in regulation, thus giving rise to the renewed attentiveness in the US for corporate governance. This course becomes more interesting after a series of corporate scandals have affected the country including the failures of companies to manage their risks in relation to the financial crisis of 2008 to 2009. Some big corporations were part of significant accounting frauds that had amount to millions of dollars. Having affected the investors trust on the efficiency of the capital market and the related regulation, decision makers could only have to look at how corporate governance be improved. History could not forget the cases of the Enron Corporation and WorldCom debacles, the consequences of which could not be underestimated. The risky investments entered into by Lehman Brothers that has contributed to its downfall in 2007 could only be lessons to be learned from a corporate governance perspective. The extent of the damage done to the economy by considering the effects to number of investors to have distrusted investment in the stocks of corporations could only be felt by the response that the present stock markets are presently getting. The same could be more obvious with the very high unemployment level both in the United States (US) and the United Kingdom. The fall of companies like Enron and WorldCom could easily be related with the passage of Sarbanes-Oxley Act (SOX) in 2002 under the federal law of U.S. government. The obvious purpose was of course to restore public confidence so that they could invest again their resources or savings in stocks. This act of government may be viewed as promising of not only putting to jail those may do wrong in defrauding investors again but more so in protecting investors because of the added regulatory requirements of the SOX. This should seal the argument that government regulation is part of corporate governance in the US. The downfall of the Lehman Brothers in 2007 despite the passage of the Sox in 2002 does not necessarily imply a complete failure of the SOX but rather a signal for better ways to improve corporate governance as business gets more complex with the changes in technology and human sophistry. 2.1.1 Corporate governance principles To guide the decision makers the corporate governance has principles as foundation. These are leadership, effectives, accountability, remuneration and relation with shareholders under the UK Code of Corporate Governance.1 To attain the objective of corporate governance which is long-term success of the business organization, the principles must be observed. In case of FAF, the above principles must be observed in evaluation the validity of its corporate governance. As could be observed from the guiding principles, leadership comes ahead of the other principles. Leadership would refer to who could be at the control of the corporation as organizations. Effectiveness would deal on attaining the objectives at least cost. Otherwise stated, corporations need to attain acceptable level of productivity. As a principle, accountability embraces fraud prevention and having managers prevented to make suboptimal-value decisions to shareholders while remuneration would include the kind and level of compensation that should prudently move the managers’ behavior in working towards desired organizational objections. Relations with shareholder involve bringing the board and shareholders to have to dialogue for mutual understanding.2 The governance principles are better understood if the real owners of the corporation are identified. In this context, the shareholders are the real owners but would require them to elect the directors who would form part of the board as a collegial body to manage the corporation for them. Intrinsically, the directors are considered as agents while the shareholders as the principals. From this principal-agent relationship, a concept of responsibility of each comes into the picture that if viewed from a corporate context, problems could arise. This relationship therefore created the agency problems since the agents may give preference to their interest as against that of the shareholders. This would therefore bring the corporate concept of agency cost that must be managed. To achieve a well-managed agency cost, the same would involve properly rewarding or compensating directors based on their performance as to their implied duty to increase the wealth of the shareholders.3 The need for the proper behavior of the directors in the corporation under the principles of corporate governance entails deciding how it should be structured. Giving them unwarranted position with conflicts of interest may be ways to reward wrongly. Should all of them be part of the officers or the executive function at the same time? Should any director be a member of member of the created committees in the board like those on audit, ethics, and compensation? These are questions that are fortunately answered one way or the other by the US SOX and UK Corporate Governance Code. The said law or rules regulate the relationship between the shareholders and the board. 2.2 Overall assessment of the FAF’s corporate governance To assess the overall corporate governance FAF is to use a benchmark. This paper uses the guidelines on UK companies earlier in combination with those used by the Board Analyst.4 It is admitted that most corporate governance rating rely heavily on compliance with set of standards or benchmarks that represent someone’s idea of what are “best practices”.5 Such standards have been promulgated by a number of different groups and organizations, including in this country the Organization for Economic Collaboration and Development (OECD), the International Corporate Governance Network (ICGN), The Council for Institutional Investors (CII), and the Bureau Roundtable.6 White the First American Company is in the US for, which it could only be subjected primarily to requirements of SOX. This paper uses of Board Analyst’s framework of Corporate Library which essentially combines the best practices of corporate governance in the world for purposes of evaluating FAF. One negative point that could lower FAF’s corporate governance profile is having its CEO and Chairman of the board in one person. Corporate Library admits two standards for these. It claimed that it is commonly held best practice standard contends that the roles of CEO and Chairman of the Board should always be held by different individuals to insure overall board independence.7 This is consistent with UK Corporate Governance Code but the same is not prohibited by the SOX.8 What the SOX prescribed as way to address this seeming conflict on interest of putting the CEO and Chairman is the appointment of a lead director.9 This researcher believes that this would not completely solve the problem as in the case of Enron, which failed partly because of the lack of the principle of check and balance in the power of a single person for two critical functions of the corporation. This would literally make the Chair and CEO a dictator as if he has both executive and legislative power at the same time. In terms of American politics, the person can be likened to be occupying the positions of the President of the United States and the Senate President at the same time. The possible abuse of power is therefore evident and this is something that must be looked upon if corporate governance of the company has to be strengthened. Corporate Library in the case of FAF agreed in adopting the principle of just putting the two positions for separate individuals. This may be also the logical reason why some institutional investors have enacted their own standards although they may differ substantially from US standards.10 In relation to independence, Board Analyst has also marked many nominally independent outside directors as "Outside Related", in order to highlight the various special relationships that are often involved in director appointments.11 This means independence in name does not mean real independence. Directors are judged by what they do and not what they say. Another negative point that could be made for FAF is Director’s tenure. The Board Analyst of the Corporate Library has actually given a red flag rating on the corporate board of FAF. According to the rater, its rating is not based principally on board actions and decision-making which would mean that the board may have made correct decision in the past like the undeniable profitability of the corporation in the fast but what is more important is the quality of the persons making the decision. It cannot be assumed that directors could continuously or indefinite serve the board to their liking. Corporate Library has asserted that directors can valuable assets to almost every board due to experience that they have but in certain situations, these long-tenured directors can become serious liabilities to the company. 12 This would occur particularly when as a small number of long-staying directors join forces to dominate the board decision-making for their own personal agenda. This researcher agrees that advocating for director term limits is not the point, but rather the recognition of a good balance between long and short-tenured directors. Corporate Library deemed it a worst combination to have a board that comprising about 33% to 50% of which are similarly long-tenured directors with some of them has served over 15 years while not with no recently elected new directors.13 A potential danger indeed is foreseeable and this researcher could only agree. This must be further understood with one instance of recent CEO turnover that would imply domination by the old folks in the corporate board of FAF. The age of FAF’s director is also seen as problem. Having too many long-staying directors in the board may produce effects as to cause the board to be stuck in a “particular mode of thinking” or one that would organize them under a “structure that “will rarely turn out for the best.”.14 Another problematic situation in the present board is FAF’s practice of having active and former CEO on Board. The Board Analyst found that FAF’s board composing of too many active or former CEOs, from especially boards of indexed companies. These directors could only be categorized or branded by their being substantially over-commitment that could actually cause the board to have more problems.15 The overall board rating as determined by Board Analyst is D, which has the equivalent of raising a serious concern for the user of the information. This logically connects with its finding of having high in FAF’s overall governance risk assessment. The findings by the Board Analyst on FAF’s board composition are material and strong enough to support the conclusion of high risk level for FAF’s corporate governance. These findings include having more than one potentially conflicted director on the board, having more than three directors who have served more than 15 years and more than three directors of old age of over seventy years.16 Thus, this researcher gives confirms a high risk level to be assigned to FAF’s corporate governance based on negative findings mentioned. The other criteria to evaluate corporate governance aside from leadership and accountability becomes of less important if the problem on board composition is not resolved by FAF. 2.2.1 Reason for Adopting Corporate Library’s model or benchmark To have one-size-fits all aspects of the best practices as benchmark is matter of judgement but there is basis for establishing its validity. The claim by Board Analysts about its Board Effectiveness Ratings using an exclusive “set of statistically proven, dynamic indicators”17 may be given due consideration as this researcher found no general inconsistency with the provision of SOX and UK Corporate Governance Code. Since best practices approach can serve as a helpful mutual baseline against which to compare different boards to assessment corporate governance of companies, the benchmark based on best practice by Board Analyst lends credibility and objectivity for evaluating FAF 2.3 Corporate Governance issue dealt by FAF -- Shake up of the Board The company’s corporate governance may be described to have passed some of the criteria but it failed on material part. There is a need to address the issue on the composition of its corporate governance or its stock value will continue to decline (See Figure A). This must be the reason why First American Corp. (FAF) has announced in April 2010 a shake-up of its board base on the recommendations of its largest unaffiliated shareholder. Although Highfields Capital Management LP (HCMLP) owned only about 10% of the company’s shares, it took the courage to tell what the problem with the company is. The nature of the relationship of HCMLP and First American must be something that draws attention to ordinary shareholders as it could imply that need for independent mind to see what is wrong with FAF’s corporate governance. The power of 10% ownership was listened to by the board and the recommendation of HCML caused the election of five new members of FAF.18 The new directors are five in number. One interesting part of the story is the departure from the board of Donald Kenney who is the grandson of the FAF’s founder C.E. Parker and the father the present CEO Parker Kennedy. The changes in the board brought the number of board members into 17 while the FAF is in the process of spinning off its core title business into a separate company (Insurance day, 2010). The action was of course intended for the shareholders more wealth given the declining share price of the company in the stock market. See Appendix A for stock price graph of the company.19 Understanding how FAF would enhance its corporate governance which was found to have negative finding to justify a high risk level for its corporate governance mainly because of the poor rating on board composition would seem to be the better approach to discuss its dealing with such an issue. To enhance the FAF’s value for the purpose of this paper should mean achieving a long-term success for the company at it satisfies he needs of its stakeholders under the stakeholder theory with particular emphasis to the shareholders. Long-term success should necessarily to exclude the quick-fix rich thinking or the idea that success would just come overnight and that FAF’s stock price could become too high and for so short a time and then it could just then be dissolved and liquidated to profit from the temporary high price. To benefit from corporate governance FAF should adopt corporate governance whose principles recognized statistically proven standards or benchmarks. Thus bottom line should be whether the real or ultimate purpose of corporate governance is being attained by corporations like FAF. Some work of researchers found no relationship between the current measure of corporate governance for some firms in Australia and enhancement of value, contradicting previous claims of past researchers. Examining however the definition of how Ali and Gregoriou measured value enhancement deserve a second look.20 Otherwise, it would imply be an exercise in futility to comply with present requirements for corporate governance. That companies are adopting corporate governance not only as a matter of choice but as present laws compel its use such as SOX of the US and Corporate Governance Code of the UK, it could also be safely assumed that the direction is to have a corporate governance that would accomplish the objective of long-term health or success of a business organization. It must be noted also that corporate governance requires the participation of governments from which this corporate are organized or established as in the case of US and UK. However each type of stakeholder is viewed differently by different cultures in terms of priority over the other stakeholders. While the US and UK may consider that shareholders be given priority before others, France, Germany and Japan do not necessarily agree.21 This would therefore imply that corporate governance rules must take into consideration the laws to the country from which corporations get organized or established. However when European companies go the US stock market, they have to comply with the requirements of SOX. In the case of FAF, it just has to comply legally with SOX as it does go outside US stock exchange. However as used in this paper, following the best practices of corporate governance extends beyond the US. 3. Conclusion This paper has found the corporate governance of First American Corp to have failed in its board composition in relation to corporate governance taken as a whole. The company was found to have questionable policy or practice on the tenure of its directors, the holding of the positions of the CEO and Chairman to one person, the overstaying directors, the over age directors and the over-committed ones who are board members of other corporations. The weak part of the company’s corporate governance is more readily noticeable on the issues of corporate shakeup as recommended by a group of stockholders in the company. The 2010 shakeup of the board was very important as management has the ultimate responsibility on what will happen to the company and to all the shareholders. The company may have passed in the other criteria in an evaluation by Corporate Library in 2005, but if it did not effect change its corporate board members to reduce the perception of conflict of interest in 2010, the company might have to suffer more in the long run. That good corporate governance can enhance value is a documented reality and unless the corporation does not want more value, there is no use to fix its corporate governance issues. However, it would be abnormal for corporations like FAF not to build value based on corporate governance hence the very reason for its existence is to satisfy the shareholders which have risked their resources and definitely want to expect not just return to their money but more than enough to compensate them for their opportunity cost. Works Cited: Ali and Gregoriou. International corporate governance after Sarbanes-Oxley. John Wiley and Sons, 2006 Allen et al. “Stakeholder Capitalism, Corporate Governance and Firm Value”, 2007, 1 November 2011 Brigham, E. and Houston, J. Fundamentals of Financial Management, London: Thomson South-Western, 2002 Corporate Library. 2006 “Corporate Governance Profile of First American Corp” “First American Shareholder Shakes Up Board” 2010. Insurance Day. 1 November 2011 http://www.insuranceday.org/first-american-shareholder-shakes-up-board/ “Stock Price Graph of FAF”. 2011. Reuters. 1 Nov 2011 < http://www.reuters.com/finance/stocks/chart?symbol=FAF.N> “UK Corporate Governance Code”. Financial Reporting Council. (2010). 1 November 2011 Appendix A – Stock Price Graph of First American22 Read More