Activities for Today

1. Activities for Today • Attendance • Reminder: Simulation Round#4 (Midnight deadline) • CTLT • Personal Strategy Report Guidelines [Managing Oneself (Drucker) - ML]; • Case: Stick to the Core or Go for More? [ML]; • Break • Collaborate with Your Competitors • The New Arsenal of Risk Management • Chapter 10 • Homework • GUEST LECTURE (Volunteer Needed) MQM485/Sp08/Class8

2. Stick to the Core or Go for More? 1. Briefly elaborate the key capabilities that distinguish Advaark from its rivals. 2. Should Advaark stick to its core competence (i.e., core capabilities)?

3. Separation of Ownership and Managerial Control (Cont’d) • Introduction • Small firms’ managers are high percentage owners, which implies less separation between ownership and management control • Usually implies family-owned businesses • This group faces 2 critical issues 1. As they grow, they may not have access to all needed skills to manage the growing firm and maximize its returns, so may need outsiders to improve management 2. May need to seek outside capital (whereby they give up some ownership control)

4. An Agency Relationship

5. Separation of Ownership and Managerial Control (Cont’d) • Agency relationships • Relationships between business owners (principals) and decision-making specialists (agents)hired to manage principals' operations and maximize returns on investment (and focus of this chapter) • Other agency relationship examples: Consultants/clients; insured/insurer; manager/employee

6. Separation of Ownership and Managerial Control (Cont’d) • Agency relationships (Cont’d) • Managerial Opportunism: Seeking self-interest with guile (i.e., cunning or deceit) • Opportunism: an attitude and set of behaviors • Managers don’t know which agents will enact managerial opportunism • Principals establish governance and control mechanisms to prevent agents from acting opportunistically

7. Manager and Shareholder Risk and Diversification

8. Ownership Concentration Governance Mechanisms • Large block shareholders (often institutional owners) have a strong incentive to monitor management closely • Their large stakes make it worth their while to spend time, effort and expense to monitor closely • They may also obtain Board seats which enhances their ability to monitor effectively (although financial institutions are legally forbidden from directly holding board seats)

9. Ownership Concentration Board of Directors Governance Mechanisms • Insiders • The firm’s CEO and other top-level managers • Related Outsiders • Individuals not involved with day-to-day operations, but who have a relationship with the company • Outsiders • Individuals who are independent of the firm’s day-to-day operations and other relationships

10. Ownership Concentration Board of Directors Governance Mechanisms • Recommendations for more effective Board Governance: • Increase diversity of board members’ backgrounds • Strengthen internal management and accounting control systems • Establish formal processes for evaluation of the board’s performance

11. Ownership Concentration Board of Directors Executive Compensation Governance Mechanisms • Salary, bonuses, long term incentive compensation • Executive decisions are complex and non-routine • Many factors intervene making it difficult to establish how managerial decisions are directly responsible for outcomes

12. Ownership Concentration Board of Directors Executive Compensation Governance Mechanisms • Stock ownership (long-term incentive compensation) makes managers more susceptible to market changes which are partially beyond their control • Incentive systems do not guarantee that managers make the “right” decisions, but do increase the likelihood that managers will do the things for which they are rewarded

13. Executive Compensation • Stock options are highly popular • Repricing: strike price value of options is commonly lowered from its original position • Backdating:options grant is commonly dated earlier than actually drawn up to ensure an attractive exercise price

14. Compensation Issueshttp://www.footnoted.org/ • BOD: $200K a year for what can charitably be called a part-time job. • $890,000 Race Car Driving Lessons (for your Kid) • Use of Executive Jet, Guaranteed Consulting Opportunities, Country Club membership, Delivery of flowers to personal apartments, after Retirement • Option to buy your office car and furniture for $1 (after being fired for misreporting and receiving $50 Million sendoff bonus) • $204,000 Rental Allowance (plus couple of Million$) • Administrative Support of $30,000 including home office computer, after Retirement

15. Ownership Concentration Board of Directors Executive Compensation Market for Corporate Control Governance Mechanisms • Firms face the risk of takeover when they are operated inefficiently • Many firms begin to operate more efficiently as a result of the “threat” of takeover, even though the actual incidence of hostile takeovers is relatively small • Changes in regulations have made hostile takeovers difficult • Acts as an important source of discipline over managerial incompetence and waste

16. Managerial Defense Tactics • Designed to fend off the takeover attempt • Increase the costs of making the acquisitions • Causes incumbent management to become entrenched while reducing the chances of introducing a new management team • Tactics • Golden Parachutes - Lucrative contract that is given to top executives in the event that the company is taken over by another corporation and results in job loss. The contract usually includes a large amount of severance pay, stock options, and a bonus. Golden Parachutes are usually a part of an anti-takeover strategy.

17. Managerial Defense Tactics • Staggered Board - A corporate board structure where only a portion of the board of directors is elected each year, usually to discourage takeover attempts • Green Mail - A corporate provision to combat hostile takeovers. When triggered, the poison pill allows shareholders to acquire additional shares at below market price, thereby increasing the number of shares outstanding and making the takeover prohibitively expensive • Super Majority - A supermajority or a qualified majority (e.g. 80% of the vote) is a requirement for a proposal to gain a specified level or type of support which exceeds a simple majority in order to have effect. • Lobbying - Many corporate managers turned to state legislatures to lobby for protection through antitakeover laws. According to Roe (1993: 353), "by calling for political reinforcements, managers won in state-by-state political combat what they could not win in contracts with shareholders. They won freedom, nearly complete, from takeover."

18. CG and Its Effect on the Lives of CEOs • In 2006 record number of CEOs lost jobs • Dismissal • Retirement • Recruitment to another firm • Partly due to increasing scrutiny by • Boards • Governance activists • Increased pressure from the market for corporate control • Media • Trend: decrease in average tenure (current: 18-24 mo.) • Result: CEOs looking at short-term vs. long-term • Might restrictive CEOs (i.e., they won’t take risks)