Chapter Three: The External Environment

1. 0 Chapter Eleven: Corporate Governance Chapter Three: The External Environment Chapter Three: The External Environment Hitt, Ireland, Hoskission, Rowe & Sheppard Strategic Management N o t e s Competitiveness & Globalization

2. The Strategic Management Process Strategic Objectives & Inputs Ch. 1: Strat. Mgmt. & Com-petitiveness Chapter 3: The External Environment Strategic Competitiveness Strategic Mission & Strategic Intent Chapter 4: The Internal Environment Ch. 2: Strat. Mgmt . & Performance Strategy Implementation Chapter 13: Strategic Leadership Chapter 14: Org. Renewal & Innovation Strategy Formulation Ch. 12: Org. Structure & Controls Chapter 6: Competitive Dynamics Chapter 5: Bus.-Level Strategy Chapter 11: Corporate Governance Chapter 7: Corp.-Level Strategy Chapter 8: Acquisition & Restructuring Chapter 9: International Strategy Chapter 10: Cooperative Strategy Strategic Actions Chapter 11: Corporate Governance

3. Corporate Governance Knowledge objectives: • Explain how corp. governance is used to monitor & control strategic decisions. • Note the separation of ownership & control the strategy implications of agency & managerial opportunism. • Explain how the 3 internal governance mechanisms are used to monitor & control managerial decisions. • Discuss trends among the 3 types of executive compensation & their effects on strategic decisions. • Show how external corp. governance mechanisms act as restraints on top management decisions. • Describe how corp. governance fosters ethical decisions & the importance of such behaviours.

4. Some Basics for Corp. Governance Corp. Governance is a relationship among stakeholders that is used to determine and control the strategic direction & performance of organizations. Concerned with identifying ways to ensure that strategic decisions are made effectively. Used in corporations to establish order between a firm’s owners and its top-level managers. Some Basics of Governance

5. Separation of Ownership & Control Basis of the modern corporation. Shareholders purchase stock, becoming Residual Claimants. Shareholders reduce risk efficiently by holding diversified portfolios. Professional managers contract to provide decision-making. Modern public corporation form leads to efficient specialization of tasks: Risk bearing by shareholders; Strategy development and decision-making by managers. Separation of Ownership & Control

6. Agency Theory Agency Relationship Shareholders (Principals) Risk Bearing Specialist (Principal) Firm Owners Hire Managers (Agents) Decision Makers which creates An agency relationship exists when: Managerial Decision-Making Specialist (Agent) Agency Theory

7. Agency Theory The desires or goals of the principal & agent conflict & it is difficult for the principal to verify the agent has behaved appropriately. The Agency problem occurs when: Example: Over - diversification: Greater product diversification leads to lower management employment risk & greater compensation Solution: To mitigate agency problems, principals engage in incentive-based systems & monitoring mechanisms to be discussed. Agency Theory

8. Agency Theory Product Diversification as an example of an Agency Problem • Diversification usually increases size of the firm; therefore complexity & an opportunity for top executives to increase their compensation. • Diversification usually reduces top executives’ employment risk. • Top management have control over free cash flow & may invest in products not associated with the firm’s current lines of business. Agency Theory

9. Agency Theory Managerial (Employment) Risk Profile Shareholder (Business) Risk Profile M S B A Related Linked Dominant Business Related Constrained Unrelated Businesses Level of Diversification Manager & Shareholder Risk & Diversification Risk Agency Theory

10. Agency Costs & Governance Mechanisms • Managerial interests may prevail when governance mechanisms are weak. • If the board of directors controls managerial autonomy, the firm’s strategies should better reflect the interests of the shareholders Agency Costs & Governance

11. Ownership Concentration Boards of Directors Executive Compensation Multidivisional Organizational Structure Relative amounts of stock owned by individual shareholders & institutional investors. Folks responsible for representing a firm’s owners by monitoring top-level managers’ strategic decisions. Use of salary, bonuses, and long term incentives to align manager’s interests with shareholders’ interests. Creation of individual business divisions to closely monitor top-level managers’ strategic decisions. Internal Governance Mechanisms Internal Governance

12. Ownership Concentration -Large block shareholders have a strong incentive to monitor management closely. In Canada such shareholders account for 65% to 70% of publicly traded stocks (59% in the U.S.). Their large stakes make it worth their while to spend time, effort & expense to monitor closely. - Institutional owners are financial institutions such as stock mutual funds and pension funds that control large-block shareholder positions. Internal Governance Mechanisms Internal Governance

13. Boards of Directors - Formally monitor & control top-level execs. - Set compensation of CEO & decide when to replace a CEO. - May lack contact with daily operations. Insiders Related Outsiders Outsiders Internal Governance Mechanisms A firm’s CEO & other top-level managers. Individuals not involved with a firm’s day-to-day operations, but who have a relationship with the company. Individuals independent of a firm’s daily operations & other relationships. Internal Governance

14. Internal Governance Mechanisms Accountability of Board Members • Increased diversity of board members. • The strengthening of internal management & accounting control systems. • The establishment & consistent use of formal processes to evaluate board’s performance. • Directors being required to own significant equity stakes as a prerequisite to holding a board seat. Internal Governance

15. Internal Governance Mechanisms Stock options:A mechanism which links the executive’s performance to the performance of the company. Executive compensation:A governance mechanism aligning the interests of managers & owners through salaries, bonuses & long term incentives such as stock options. Internal Governance

16. Multidivisional Organizational Structure - Corporate office and Board monitor business-unit managers’ strategic decisions. - Increased managerial interest in wealth maximization. - M-form structure does not necessarily limit corporate-level managers’ self-serving actions. - May lead to greater rather than less diversification. Broadly diversified product lines makes it difficult for top-level managers to evaluate the strategic decisions of divisional managers. Internal Governance Mechanisms Designed to control managerial opportunism: Internal Governance

17. External Governance Mechanisms Market for Corporate Control • Purchase of a firm that is under-performing relative to industry rivals to improve its strategic competitiveness. Basic Management Defence Tactics Increases cost of takeover & entrenches current exec.s. Golden Parachute: Raises cost of making changes at target due to need to pay fired exec.s large severance packages. Greenmail: Where Corp. money is used to repurchase stock from a corporate raider to avoid takeover. Poison Pill: When a takeover target does something to make itself unpalatable to the suitor (e.g. assume a large amount of debt and then issue dividends with the money). External Governance

18. Governance Mechanism & Ethical Behaviour • Shareholders are recognized as a company’s most significant stakeholders. • The minimum interests or needs of all stakeholders must be recognized through the firms actions. • A firm’s strategic competitiveness is enhanced when its governance mechanisms take into consideration the interests of all stakeholders. • Only if proper corp. governance is used can strategies be formulated & implemented that will help firms gain strategic competitiveness & above average returns. Governance & Ethical Behaviour

19. The Strategic Management Process Strategic Objectives & Inputs Ch. 1: Strat. Mgmt. & Com-petitiveness Chapter 3: The External Environment Strategic Competitiveness Strategic Mission & Strategic Intent Chapter 4: The Internal Environment Ch. 2: Strat. Mgmt . & Performance Strategy Implementation Chapter 13: Strategic Leadership Chapter 14: Org. Renewal & Innovation Strategy Formulation Ch. 12: Org. Structure & Controls Chapter 6: Competitive Dynamics Chapter 5: Bus.-Level Strategy Chapter 11: Corporate Governance Chapter 7: Corp.-Level Strategy Chapter 8: Acquisition & Restructuring Chapter 9: International Strategy Chapter 10: Cooperative Strategy Strategic Actions Chapter 11: Corporate Governance