PUJA
h6000
cap_10_hitt.pptx
PART 3: STRATEGIC ACTIONS:
STRATEGY IMPLEMENTATION
CHAPTER 10 CORPORATE GOVERNANCE
Authored by:
Marta Szabo White, PhD.
Georgia State University
THE STRATEGIC MANAGEMENT PROCESS
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KNOWLEDGE OBJECTIVES
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
● Define corporate governance and explain why it is used to monitor and control top-level managers’ decisions.
● Explain why ownership is largely separated from managerial control in organizations.
● Define an agency relationship and managerial opportunism and describe their strategic implications.
● Explain the use of three internal governance mechanisms to monitor and control managers’ decisions.
KNOWLEDGE OBJECTIVES
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
● Discuss the types of compensation top-level managers receive and their effects on managerial decisions.
● Describe how the external corporate governance mechanism—the market for corporate control—restrains top-level managers’ decisions.
● Discuss the nature and use of corporate governance in international settings, especially in Germany, Japan, and China.
● Describe how corporate governance fosters the making of ethical decisions by a firm’s top-level managers.
CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT?
■ Corporate governance can destroy or create value for a firm.
■ It is concerned with:
1. strengthening the effectiveness of a company’s board of directors
2. verifying the transparency of a firm’s operations
3. enhancing accountability to shareholders
4. incentivizing executives
5. maximizing value-creation for stakeholders and shareholders
OPENING CASE
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CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT?
■ Given recent criticisms, boards’ actions in nations throughout the world are being more carefully scrutinized and regulated.
■ In the U.S., that after being fired by their firm, a number of CEOs still remain as members of other firms’ boards of directors, is drawing close attention.
■ Corporate governance is weak in many Chinese firms and there is concern about the validity and reliability of some auditors’ work and the quality of companies’ financial statements.
OPENING CASE
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CORPORATE GOVERANCE: WHAT IS ALL THE FUSS ABOUT?
■ The reason there is a “fuss” about corporate governance is that these activities are critical to globally signaling transparency coupled with strategic competitiveness.
■ Corporate governance fundamentals:
Corporate Directors should:
● Focus on creating long-term value for shareholders
● Use performance-related pay to attract and retain senior management
● Exercise sound business judgment to evaluate opportunities and manage risk
● Communicate with key shareholders
OPENING CASE
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CORPORATE GOVERNANCE
Corporate governance: a set of mechanisms used to manage the relationships (and conflicting interests) among stakeholders, and to determine and control the strategic direction and performance of organizations (aligning strategic decisions with company values)
When CEOs are motivated to act in the best interests of the firm—particularly, the shareholders—the company’s value should increase.
Successfully dealing with this challenge is important, as evidence suggests that corporate governance is critical to firms’ success.
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
CORPORATE GOVERNANCE
Corporate Governance Emphasis
Two reasons:
Apparent failure of corporate governance mechanisms to adequately monitor and control top-level managers’ decisions during recent times
Evidence that a well-functioning corporate governance and control system can create a competitive advantage for an individual firm
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
CORPORATE GOVERNANCE
Corporate Governance Concern
Effective corporate governance is of interest to nations as it reflects societal standards:
Firms’ shareholders are treated as key stakeholders as they are the company’s legal owners
Effective governance can lead to competitive advantage
How nations choose to govern their corporations affects firms’ investment decisions; firms seek to invest in nations with national governance standards that are acceptable
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL
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SHAREHOLDERS
MANAGERS
Professional managers contracted to provide decision making
Shareholders purchase stock
Entitled to income (residual returns)
Strategy development and decision making by managers
Risk bearing by shareholders—firm’s expenses may exceed revenues
Investment risk is managed through a diversified investment portfolio
SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL
FIGURE 10.1
An Agency Relationship
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SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL
AGENCY RELATIONSHIPS
Managerial opportunism: seeking self-interest with guile (i.e., cunning or deceit)
Opportunism: an attitude and set of behaviors
Decisions in managers’ best interests, contrary to shareholders’ best interests
Decisions such as these prevent maximizing shareholder wealth
Principals establish governance and control mechanisms to prevent agents from acting opportunistically.
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AGENCY COSTS AND GOVERNANCE MECHANISMS
AGENCY COSTS: the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals, because governance mechanisms cannot guarantee total compliance by the agent
● Principals may engage in monitoring behavior to assess the activities and decisions of managers
● However, dispersed shareholding makes it difficult and inefficient to monitor management’s behavior.
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AGENCY COSTS AND GOVERNANCE MECHANISMS
● Boards of Directors have a fiduciary duty to shareholders to monitor management
● However, Boards of Directors are often accused of being lax in performing this function
● Costs associated with agency relationships, and effective governance mechanisms should be employed to improve managerial decision making and strategic effectiveness
● In response, U.S. Congress enacted:
▪ Sarbanes-Oxley (SOX) Act in 2002
▪ Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in mid-2010
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AGENCY PROBLEMS GOVERNANCE MECHANISMS
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GOVERNANCE MECHANISMS
AGENCY RELATIONSHIPS
AGENCY PROBLEMS
GOVERNANCE MECHANISMS
Internal Governance Mechanisms
Ownership Concentration
• Relative amounts of stock owned by individual shareholders and institutional investors
Board of Directors
• Individuals responsible for representing the firm’s owners by monitoring top-level managers’ strategic decisions
Executive Compensation
• Use of salary, bonuses, and long-term incentives to align managers’ interests with shareholders’ interests
External Governance Mechanism
Market for Corporate Control
• The purchase of a company that is underperforming relative to industry rivals in order to improve the firm’s strategic competitiveness
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OWNERSHIP CONCENTRATION
Ownership
Concentration
Governance mechanism defined by both the number of large-block shareholders and the total percentage of shares owned
Large block shareholders: shareholders owning a concentration of at least 5 percent of a corporation’s issued shares
Large block shareholders have a strong incentive to monitor management closely
They may also obtain Board seats, which enhances their ability to monitor effectively
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
Group of shareholder-elected individuals (usually called ‘directors’) whose primary responsibility is to act in the owners’ interests by formally monitoring and controlling the corporation’s top-level executives
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
As stewards of an organization's resources, an effective and well-structured board of directors can influence the performance of a firm:
Oversee managers to ensure the company is operated in ways to maximize shareholder wealth
Direct the affairs of the organization
Punish and reward managers
Protect shareholders’ rights and interests
Protect owners from managerial opportunism
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
Three director classifications: Insider, related outsider, and outsider:
Insiders: the firm’s CEO and other top-level managers
Related outsiders: individuals uninvolved with day-to-day operations, but who have a relationship with the firm
Outsiders: individuals who are independent of the firm’s day-to-day operations and other relationships
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
Historically, BOD dominated by inside managers:
Managers suspected of using their power to select and compensate directors
NYSE implemented an audit committee rule requiring outside directors to head audit committee (a response to SEC’s proposal requiring audit committees be made up of outside directors)
Sarbanes-Oxley Act passed leading to BOD changes
Corporate governance becoming more intense through BOD mechanism
BOD scandals led to trend of separating roles of CEO and Board Chairperson
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
Enhancing the effectiveness of the Board of Directors:
Increase the diversity of the backgrounds of board members (e.g., public service, academic, scientific; ethnic minorities and women; different countries)
Strengthen internal management and accounting control systems
Establish and consistently use formal processes to evaluate the board’s performance
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
BOARD OF DIRECTORS
Ownership
Concentration
Board of Directors
Enhancing the effectiveness of the Board of Directors:
4. Modify the compensation of directors, especially reducing or eliminating stock options as part of their package
5. Create the “lead director” role that has strong powers with regard to the board agenda and oversight of non-management board member activities
6. Require that directors own significant equity stakes in the firm to keep focus on shareholder interests
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EXECUTIVE COMPENSATION
Ownership
Concentration
Board of Directors
Executive
Compensation
Governance mechanism that seeks to align the interests of top managers and owners through salaries, bonuses, and long-term incentive compensation, such as stock awards and stock options
Thought to be excessive and out of line with performance
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MARKET FOR CORPORATE CONTROL
Ownership
Concentration
Board of Directors
Executive
Compensation
Market for
Corporate Control
External governance: a mechanism consisting of a set of potential owners seeking to acquire undervalued firms and earn above-average returns on their investments
Becomes active only when internal controls have failed
Ineffective managers are usually replaced in such takeovers
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MARKET FOR CORPORATE CONTROL
Ownership
Concentration
Board of Directors
Executive
Compensation
Market for
Corporate Control
Managerial defense tactics increase the costs of mounting a takeover
Defense tactics may require:
Asset restructuring
Changes in the financial structure of the firm
Shareholder approval
External mechanism is less precise than the internal governance mechanisms
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INTERNATIONAL CORPORATE GOVERNANCE
Global Corporate Governance
Relatively uniform governance structures are evolving
These structures are moving closer to the U.S. corporate governance model
Although implementation is slower, merging with U.S. practices is occurring even in transitional economies
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GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR
It is important to serve the interests of the firm’s multiple stakeholder groups!
Capital Market
Stakeholders
Product Market
Stakeholders
Organizational
Stakeholders
In the U.S., shareholders (in the capital market group) are the most important stakeholder group served by the Board of Directors
Governance mechanisms focus on control of managerial decisions to protect shareholder interests
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR
It is important to serve the interests of the firm’s multiple stakeholder groups!
Capital Market
Stakeholders
Product Market
Stakeholders
Organizational
Stakeholders
Product market stakeholders (customers, suppliers, and host communities) and organizational stakeholders (managerial and non-managerial employees) are also important stakeholder groups and may withdraw their support of the firm if their needs are not met, at least minimally
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR
It is important to serve the interests of the firm’s multiple stakeholder groups!
Capital Market
Stakeholders
Product Market
Stakeholders
Organizational
Stakeholders
Some observers believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders’ interests
Importance of maintaining ethical behavior is seen in the examples of Enron, Arthur Andersen, WorldCom, HealthSouth and Tyco
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GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR
● For 2014, some of World Finance’s “Best Corporate Governance Awards” by country were given to:
◘ Intact Financial Corporation(Canada)
◘ Vestas Wind Systems A/S (Denmark)
◘ BSF AG (Germany)
◘Grupo Financiero Banorte (Mexico) ◘ American Express(United States)
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GOVERNANCE MECHANISMS AND ETHICAL BEHAVIOR
● These awards are determined by analyzing a number of corporate governance issues:
◘ Board accountability/financial disclosure
◘ Executive compensation
◘ Shareholder rights
◘ Ownership base
◘ Takeover provisions
◘ Corporate behavior
◘ Overall responsibility exhibited by firm
©2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
