BUSN620 Assignment: Interactive Assignment Chapter 2

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Interactive Assignment Chapter 2
Corporate GovernanceExecutive 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.


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.

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

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


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


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
BUSN620 Assignment: Interactive Assignment Chapter 2
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