MAN 709/808 – Contemporary Management Topics: Corporate Governance and Ethics

1. MAN 709/808 – Contemporary Management Topics: Corporate Governance and Ethics Week 5 Corporate Governance Theories

2. Corporate Governance • Is the set of mechanisms used to manage the relationship among stakeholders hat is used to determine and control the strategic direction and performance of organizations: • CG is concerned with identifying ways to ensure that strategic decisions are made effectively; and • Is the means corporations use to establish order between parties i.e the firm’s owners or shareholders and its top-level managers.

3. AGENCY THEORY(economic approach to governance)MODEL OF MAN (assumptions) • Homo economicus: individualistic, opportunistic, self-serving. • Rational actor who seeks to maximize his individual utility. Both parties are utility maximizers. • As an agent of the principals, an executive is morally responsible to maximize shareholder utility; however, executives accept agent status because they perceive the opportunity to maximize their own utility.

4. Agency relationship

5. Agency relationship • Separation between ownership and managerial control; • Shareholders lack direct control of their publicly traded corporations; • Problem arises when the agent makes decisions that result in the pursuit of goals which are not aligned with that of the principals. • Leads to managerial opportunism: • Seeking self-interest with guile, i.e. cunning or deceit; • Opportunism is an attitude and a set of behaviours. • Principals will not know beforehand that agents will adopt such an attitude and behave in that manner.

6. Improvement measurements In terms of game theory, it involves changing the rules of the game so that the self-interested rational choices of the agent coincide with what the principal desires. Financial and non-financial rewards: Non-financial rewards: Motivational factors of Herzberg Job satisfiers: achievement, recognition, responsibility and advancement. Job dissatisfiers: salary, working conditions and company policy. Financial rewards: Mechanisms: “piece rates, [share] options, discretionary bonuses, promotions, profit sharing, efficiency wages, deferred compensation, and so on.” (Prendergast 1999, 7) Contracts: Informativeness Principle; Incentive-Intensity Principle; Monitoring Intensity Principle, and Equal Compensation Principle.

10. AGENCY THEORYEXECUTIVE COMPENSATION SCHEMES • Financial incentive schemes provide rewards and punishments that are aimed at aligning principal-agent interests. • Such incentive schemes are particularly desirable when the agent has a significant informational advantage and monitoring is impossible.

11. AGENCY THEORYGOVERNANCE STRUCTURES • Boards of directors keep potentially self-serving managers in check by performing audits and performance evaluations. • Boards communicate shareholders’ objectives and interests to managers and monitor them to keep agency costs in check.

12. AGENCY THEORYTHEORETICAL LIMITS • Assumptions made about individualistic utility motivations resulting in principal-agent interest divergence may not hold for all managers. • Agency theory provides a useful way of explaining relationships where the parties’ interests are at odds and can be brought into alignment through proper monitoring and a well-planned compensation system. • Additional theory is needed to explain other types of human behavior, and this is found in literature beyond the economic perspective.

13. STEWARDSHIP THEORYPRINCIPAL (shareholders)-STEWARD (top managers) RELATIONSHIP The steward believes that: • by working toward organizational, collective ends, personal needs are met; • its interests are aligned with that of the corporation and its owners. • Therefore, a steward is motivated to maximize organizational performance, thereby satisfying the interests of shareholders. • Because the steward perceives greater utility in cooperative than in individualistic behavior, and behaves accordingly, this behavior can be considered rational.

14. STEWARDSHIP THEORYPRINCIPAL (shareholders)-STEWARD (top managers) RELATIONSHIP • If the executive’s motivations fit the model of man underlying stewardship theory, empowering governance structures and mechanismsare appropriate. Thus, a steward’s autonomy should be deliberately extended to maximize the benefits of a steward, because he or she can be trusted. In this case, the amount of resources that are necessary to guarantee pro-organizational behavior from an individualistic agent are disminished, because a steward is motivated to behave in ways that are consistent with organizational objectives. Indeed, control can be potentially counterproductive, because it undermines the pro-organizational behavior of the steward, by lowering his or her motivation.

15. STEWARDSHIP THEORYPRINCIPAL (shareholders)-STEWARD (top managers) RELATIONSHIP • Donaldson and Davis (1991) argued that, for CEOs who are stewards, their pro-organizational actions are best facilitated when the corporate governance structures give them high authority and discretion. • Structurally, this situation is attained more readly if the CEO chairs the board of directors. Such a structure would be viewed as dysfunctional under the agency theory model of man. However, under the stewardship model of man, stewards maximize their utility as they achieve organizational rather than self-serving objectives. The CEO-chair is unambiguously responsible for the fate of the corporation and has the power to determine strategy without fear of countermand by an outside chair of the board.

20. PRINCIPAL-STEWARD/AGENT RELATIONSHIP • Managers choose to behave as stewards or agents. Their choice is contingent on their: • psychological motivations and • perceptions of the situation. • Principals also choose to create and agency or stewardship relationship, depending upon their perceptions of: • the situation and • the manager.

22. PRINCIPAL-STEWARD RELATIONSHIP. MANAGERS’ PSYCHOLOGICAL CHARACTERISTICS • Managers • whose needs are based on • growth, • achievement, and • self-actualization; • who are intrinsically motivated; • who identify with their organizations and highly commited to organizational values, are more likely to serve organizational ends.

23. PRINCIPAL-STEWARD RELATIONSHIP. SITUATIONAL (SOCIOLOGICAL) CHARACTERISTICS • Situations in which • the managerial philosophy is based on involvement and trust; • the culture is based on collectivism and low power distance, generally result in principal-steward relationship.