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The ecosystem of executive threats: A conceptual overview

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Abstract

Executive risk, which is concerned with threats confronting directors and officers of business organizations, is a practically important but theoretically neglected aspect of corporate governance; this article re-conceptualizes this notion in a more theoretically complete context of ‘executive threats’. The Ecosystem of Executive Threat model captures dyadic interactions between business organizations and seven distinct stakeholder groups, in addition to also accounting for the interaction-shaping influence of three distinct (stakeholder) expectation- and norm-shaping forces. Furthermore, the ecosystem conceptualization expressly differentiates between upside and downside threats, as well as non-estimable uncertainty, probabilistic risks and defined liability, with the goal of enabling a more comprehensive assessment of individual threats. Altogether, the ecosystem-based conceptualization supports ta more thorough forward-looking assessment of the totality of threats confronting directors and officers of business organizations by expressly contemplating not-yet-materialized but theoretically plausible dangers, in addition to those with established recurrence patterns.

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Notes

  1. The exact definition of ‘executive officer’ may vary across countries (for example, in the United States, the top executive officer is typically known as the Chief Executive Officer, whereas in the United Kingdom the title of Managing Director is more commonly used) as well as states (in the United States, since US corporate law is rooted in state law). Furthermore, the line of demarcation separating executive officers from other corporate managers may also vary across jurisdictions, as some base the distinction on job titles (for example, only those referred to as ‘chief’, such as Chief Executive or Chief Financial Officers), while others use compensation (for example, California defines ‘executive officers’ as the top five most highly compensated corporate officers).

  2. Though manifestly bearing the same name as the public/political leadership selection process, the process of ‘electing’ corporate directors is considerably less democratic for a number of reasons, not the least of which is that shareholders rarely, if ever, have adequate informational basis for voting for or against individual candidates. In terms of procedure, directors are usually nominated by the executive management and then typically voted on during the annual shareholder meeting; considering that relatively few shareholders attend those meetings, in practice, corporate directors are effectively selected by firms’ executive managers and legitimized by proxy votes (or the holders of those votes, often fund managers).

  3. Most notably, the Securities Act of 1933 and the Securities Exchange Act of 1934.

  4. Estimate based on analyses of 2010–2015 annual public filings as reported by Standard & Poor’s Compustat database.

  5. Although that is beginning to change as some other countries, such as the United Kingdom, Germany and France, have all taken limited steps in that direction, at the time of this research the United States is the only developed country that allows large-scale – that is, class action – shareholder suits.

  6. http://www.sec.gov/spotlight/optionsbackdating.htm

  7. Option backdating is the act of granting an option to purchase a security that is dated before the date of the grant itself, which means that the exercise price of the granted option can be set at a lower price than that of the company’s stock at the granting date, thus ensuring that the granted option is of value to the holder. The concept, first put forth in 2005 by Erik Lie, a researcher at the University of Iowa, in a paper titled ‘On the Timing of CEO Stock Option Awards’ (Management Science, Vol. 51(5), pp. 802–812), ultimately led to about 2 dozen shareholder class action suits.

  8. It is worth noting that representatives of individual states drafted the Uniform Business Corporations Act in 1928 with the goal of creating a country-wide set of standards, though only three states adopted it. In 1950, the American Bar Association drafted the Model Business Corporation Act, which has been revised numerous times, most recently in 2005, with the majority of states adopting some or all of the Model Act. The State of Delaware, where the majority of large US corporations are incorporated, continues to be the single most important source of corporate regulations.

  9. For a full list, see www.usa.gov/directory/federal/index.shtml

  10. Technically, the legislative, executive and judicial branches of the US government are not independent of one another because of a system of checks and balances set up by the US Constitution; however, in the context used in this research, the two branches considered here (legislative and judicial) produce expectation-shaping outcomes in a manner that is essentially independent.

  11. As reported for an industry research firm ISS, the all-time largest settlement stands as the one by Enron (2010) at $7.42 billion, followed by (all figures in $ billion) WorldCom (2012) at $6.194, Cendant Corp. (2000) at $3.319, Tyco International (2007) at $3.2, AOL Time Warner (2006) at $2.5, Bank of America (2013) at $2.425, Nortel Networks (2006) at $1.443, Royal Ahold (2006) at $1.143, Nortel Networks (2006 – separate from above) at $1.074, and McKesson HBOC (2008) at $1.052.

  12. Gimbel v. Signal Cos, 316 A2d 599, 608 (Del. Ch. 1974). The business judgment rule originated in a 1945 shareholder action (Otis & Co. v. Pennsylvania R. Co., 61 F. Supp. 905 (D.C. Pa. 1945)), in which the plaintiff alleged that corporate directors failed to obtain the best price available in the sale of securities by dealing with only one investment house.

  13. Corporate directors can – and typically do – establish a defense of ‘due diligence’, which is that he or she made a good faith effort to ascertain the correctness of the reported information. Whether or not corporate directors did enough due diligence to meet the good faith effort standard is typically determined by circumstances of individual cases – it is important to note, however, that the securities laws make no distinction between cases where management has committed deliberate fraud (that is, took affirmative steps to hide the truth) and cases where reported information merely contains misstatements that could have been discovered in the course of due diligence.

  14. Although commonly referred to as risk transfer, commercial insurance is more correctly described as a post-event compensatory mechanism, as purchase of an insurance policy does not change the likelihood or the severity of an adverse event.

  15. ROI, or return on investment, is a measure of the profitability of an investment, computed by dividing revenue by expenses; ROE, or return on equity, is a measure of a corporation’s profitability, computed by dividing net income by shareholder’s equity.

  16. One of the earliest known examples of shareholder activism dates back to the early 1900s, when Henry Ford chose to cancel a special dividend to instead spend those funds on advancing social causes; dissident shareholders sued and won, forcing the company to reinstate the dividend.

  17. Exemplified by several former executives of Tyco, Enron, WorldCom or Adelphia, whose actions precipitated criminal proceedings brought against them by federal prosecutors (for clarity – criminal charges entail possible imprisonment, while civil charges do not; in general, the basic distinction between a criminal and a civil offense is that the former pertains to transgressions against public order or people as a whole, while the latter is an offense against private individuals).

  18. For clarity, I should point out that administrative law only has legal force because of enabling statutes enacted by federal or state legislatures, which is to say that the former could be viewed as a specific manifestation of the latter. That said, its importance should not be underestimated – in an average year, the US Congress enacts about 300 laws, while federal administrative agencies, as a whole, write about 10 000 individual regulations.

  19. The difference between regulatory commissions and agencies is not always clear – in general, in the United States commissions are created by Congress to oversee executive agencies (that is, those created by the executive branch of the government that operate independently of the legislature (as a part of the system of checks and balances)); regulatory agencies, on the other hand, tend to be a part of the executive branch, but tend to derive their rule-making powers from specific legal statutes.

  20. Based on the analysis of annual filings (US SEC form 10-K) by publicly traded companies.

  21. Although it is difficult to pinpoint its exact beginning, the publication of Rachel Carson’s book Silent Spring in 1962 (which ultimately led to a 1973 ban on most uses of the chemical DDT) is considered by many to mark the beginning of modern consumer activism.

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    Andrew D Banasiewicz

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Banasiewicz, A. The ecosystem of executive threats: A conceptual overview. Risk Manag 17, 109–143 (2015). https://doi.org/10.1057/rm.2015.7

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