CFE Corporate Governance 5 — Questions and Answers
Question 1: Which of the following BEST describes 'clawback' provisions in executive compensation plans?
- Provisions that accelerate vesting upon a change of control
- Requirements that executives return previously paid compensation if fraud is discovered (Correct answer)
- Mechanisms to cap total executive pay at a multiple of median worker pay
- Deferral arrangements that delay bonus payments by three years
Correct answer: Requirements that executives return previously paid compensation if fraud is discovered
Clawback provisions allow a company to recover incentive compensation paid to executives when it is later determined to have been based on fraudulent or restated financial results.
Question 2: A related-party transaction must typically be disclosed and approved because it creates a risk of:
- Excessive regulatory scrutiny of routine business
- Conflict of interest that could harm the company for a director or officer's personal benefit (Correct answer)
- Triggering mandatory external audit requirements
- Violating stock exchange listing standards on board composition
Correct answer: Conflict of interest that could harm the company for a director or officer's personal benefit
Related-party transactions involve parties with pre-existing relationships with the company and carry inherent conflict-of-interest risk that could result in unfavorable deal terms.
Question 3: The Caremark standard holds that a board can be liable for fraud losses if it:
- Failed to establish any system to monitor legal compliance (Correct answer)
- Approved a high-risk business strategy that later failed
- Hired an external auditor who missed fraud indicators
- Compensated executives with stock options rather than salary
Correct answer: Failed to establish any system to monitor legal compliance
Under the Caremark doctrine, directors face liability if they utterly failed to implement information and reporting systems to detect illegal conduct.
Question 4: Which practice BEST demonstrates that a board is exercising effective oversight of management-prepared financial information?
- Accepting financial reports without questions to maintain a cooperative culture
- Meeting privately with the external auditor without management present (Correct answer)
- Delegating all financial review to the CFO
- Limiting the scope of internal audit to reduce operating costs
Correct answer: Meeting privately with the external auditor without management present
Private (executive) sessions between the audit committee and external auditors without management present allow candid communication about management's integrity and reporting quality.
Question 5: Which of the following represents an example of 'tunneling' in a corporate governance context?
- A board secretly conducting merger negotiations
- A controlling shareholder transferring corporate assets to entities they privately own (Correct answer)
- Management inflating earnings to meet analyst forecasts
- Directors approving excessive charitable donations
Correct answer: A controlling shareholder transferring corporate assets to entities they privately own
Tunneling refers to controlling shareholders extracting company value for personal benefit, often to the detriment of minority shareholders.
Question 6: When evaluating an anti-fraud program, the ACFE recommends that a hotline be managed by:
- The company's human resources department
- Senior management to ensure swift resolution
- An independent third party to encourage reporting (Correct answer)
- The external auditor as part of the annual audit
Correct answer: An independent third party to encourage reporting
Third-party-managed hotlines increase employee confidence in anonymity and independence, leading to higher reporting rates.
Question 7: Which of the following best illustrates the concept of 'regulatory capture' as it relates to corporate governance?
- A company successfully lobbying for favorable tax legislation
- A regulator becoming so aligned with the industry it oversees that it no longer serves the public interest (Correct answer)
- Shareholders using proxy votes to block a board nominee
- Management capturing control of the board through strategic director appointments
Correct answer: A regulator becoming so aligned with the industry it oversees that it no longer serves the public interest
Regulatory capture occurs when the regulating agency advances the interests of the regulated industry rather than the public, weakening external governance controls.
CFE Corporate Governance 5
Which of the following BEST describes 'clawback' provisions in executive compensation plans?