Chapter 10 Corporate Governance

Chapter 10Corporate GovernanceMichael A. HittR. Duane IrelandRobert E. Hoskisson©2000 South-Western College PublishingCompetitivenessChapter 3InternalEnvironmentChapter 2ExternalEnvironmentThe StrategicManagementProcessStrategic IntentStrategic MissionStrategicCompetitivenessAbove AverageReturnsFeedbackStrategy FormulationChapter 4Business-LevelStrategyChapter 5CompetitiveDynamicsChapter 6Corporate-LevelStrategyChapter 8InternationalStrategyChapter 9CooperativeStrategiesChapter 7Acquisitions &RestructuringStrategicInputsStrategicActionsStrategic OutcomesChapter 10CorporateGovernanceChapter 11Structure& ControlChapter 12StrategicLeadershipChapter 13Entrepreneurship & InnovationUsed in corporations to establish order between the firm’s owners and its top-level managersCorporate Governance is a relationship among stakeholders that is used to determine and control the strategic direction and performance of organizationsConcerned with identifying ways to ensure that strategic decisions are made effectivelyCorporate GovernanceSeparation of Ownership and Managerial ControlBasis of the modern corporationShareholders purchase stock, becoming Residual ClaimantsProfessional managers contract to provide decision-makingModern public corporation form leads to efficient specialization of tasks- Shareholders reduce risk efficiently by holdingdiversified portfolios- Risk bearing by shareholders- Strategy development and decision-making bymanagersAn agency relationship exists when:Shareholders (Principals)Firm OwnersManagers (Agents)DecisionMakerswhich createsAgency RelationshipRisk Bearing Specialist(Principal)Managerial Decision-Making Specialist(Agent)HireAgency TheoryThe Agency problem occurs when:- The desires or goals of the principal and agent conflict and it is difficult or expensive for the principal to verify that the agent has behaved appropriatelySolution: Principals engage in incentive-based performance contracts, monitoring mechanisms such as the board of directors and enforcement mechanisms such as the managerial labor market to mitigate the agency problemExample: Overdiversification because increased product diversification leads to lower employment risk for managers and greater compensation Agency TheoryRiskLevel of DiversificationManager and Shareholder Risk and DiversificationDominantBusinessUnrelatedBusinessesRelatedConstrainedRelatedLinkedABManagerial(Employment) Risk ProfileMShareholder (Business) Risk ProfileSExample: Boards of Directors have a fiduciary duty to shareholders to monitor managementAgency TheoryPrincipals may engage in monitoring behavior to assess the activities and decisions of managersHowever, Boards of Directors are often accused of being lax in performing this functionHowever, dispersed shareholding makes it difficult and and inefficient to monitor management’s behaviorGovernance MechanismsOwnership ConcentrationBoards of DirectorsExecutive CompensationMultidivisional Organizational StructureMarket for Corporate ControlGovernance MechanismsOwnership ConcentrationLarge block shareholders have a strong incentive to monitor management closelyTheir large stakes make it worth their while to spend time, effort and expense to monitor closelyThey may also obtain Board seats which enhances their ability to monitor effectively (although financial institutions are legally forbidden from directly holding board seats)Governance MechanismsBoard of DirectorsInsidersThe firm’s CEO and other top-level managersRelated OutsidersIndividuals not involved with day-to-day operations, but who have a relationship with the companyOutsidersIndividuals who are independent of the firm’s day-to-day operations and other relationshipsRecommendations for more effective Board Governance:Governance MechanismsBoard of DirectorsIncrease diversity of board members backgroundsStrengthen internal management and accounting control systemsEstablish formal processes for evaluation of the board’s performanceGovernance MechanismsExecutive CompensationSalary, Bonuses, Long term incentive compensationExecutive decisions are complex and non-routineMany factors intervene making it difficult to establish how managerial decisions are directly responsible for outcomesIn addition, stock ownership (long-term incentive compensation) makes managers more susceptible to market changes which are partially beyond their controlIncentive systems do not guarantee that managers make the “right” decisions, but they do increase the likelihood that managers will do the things for which they are rewardedGovernance MechanismsMultidivisional Organizational StructureDesigned to control managerial opportunismM-form structure does not necessarily limit corporate-level managers’ self-serving actionsBroadly diversified product lines makes it difficult for top-level managers to evaluate the strategic decisions of divisional managersCorporate office and Board monitor managers’ strategic decisionsIncreased managerial interest in wealth maximizationMay lead to greater rather than less diversificationGovernance MechanismsMarket for Corporate ControlOperates when firms face the risk of takeover when they are operated inefficientlyActs as an important source of discipline over managerial incompetence and wasteChanges in regulations have made hostile takeovers difficultMany firms began to operate more efficiently as a result of the “threat” of takeover, even though the actual incidence of hostile takeovers was relatively smallThe 1980s saw active market for corporate control, largely as a result of available pools of capital (junk bonds)GermanyInternational Corporate GovernanceVorstand monitors and controls managerial decisionsAufsichtsrat selects the VorstandEmployees, union members and shareholders appoint members to the AufsichtsratOwner and manager are often the same in private firmsPublic firms often have a dominant shareholder too, frequently a bankMedium to large firms have a two-tiered boardFrequently there is less emphasis on shareholder value than in U.S. firms, although this may be changingJapanInternational Corporate GovernanceObligation, “family” and consensus are important factorsBanks (especially “main bank”) are highly influential with firm’s managersKeiretsus are strongly interrelated groups of firms tied together by cross-shareholdingsOther characteristics:Powerful government interventionClose relationships between firms and government sectorsPassive and stable shareholders who exert little controlVirtual absence of external market for corporate controlCorporate Governance and Ethical BehaviorIt is important to serve the interests of multiple stakeholder groupsShareholders are one important stakeholder group, which are served by the Board of DirectorsProduct market stakeholders (customers, suppliers and host communities) and organizational stakeholders (managerial and non-managerial employees) are also important stakeholder groupsAlthough controversial, some believe that ethically responsible firms should introduce governance mechanisms which serve all stakeholders’ interests