Strategic Control and Corporate Governance

1. Strategic Control and Corporate Governance chapter 9

2. Learning Objectives After reading this chapter, you should have a good understanding of: LO9.1 The value of effective strategic control systems in strategy implementation. LO9.2 The key difference between “traditional” and “contemporary” control systems. LO9.3 The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general environments.

3. Learning Objectives LO9.4The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries. LO9.5 The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of directors. LO9.6 The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of shareholders from both the United States and international perspectives.

4. Strategic Control Consider… Once strategy is formulated, it must be implemented, and part of implementation is establishing a mechanism for monitoring and correcting organizational performance. This control mechanism must be consistent with the strategy the firm is following. How does a firm make sure all key stakeholders are moving in the right direction?

5. Strategic Control • Strategic controlinvolves monitoring performance toward strategic goals and taking corrective action when needed via effective systems: • Informational control systems • Behavioral control systems • Corporate governance

6. Strategic Control: Traditional Approach • The traditional approach to strategic controlis sequential • Strategies are formulated, goals are set • Strategies are implemented • Performance is measured against goals Exhibit 9.1 Traditional Approach to Strategic Control

7. Strategic Control: Traditional Approach • Control = feedback loop from performance measurement to strategy formulation • Involves lengthy time lags, “single-loop” learning • Most appropriate when • Environment is stable and relatively simple • Objectives can be measured with certainty • Little need for complex measures of performance

8. Strategic Control: Contemporary Approach • Relationships between strategy formulation, implementation, & control are highly interactive, utilizing • Informational control • Behavioral control Exhibit 9.2 Contemporary Approach to Strategic Control

9. Strategic Control: Contemporary Approach • Informational control = concerned with whether or not the organization is “doing the right things” • Behavioral control = concerned with whether or not the organization is “doing things right” in the implementation of its strategy • Both types of control are necessary, but not sufficient, conditions for success

10. Question? • Top managers at ABC Company meet every Friday to review daily operational reports and year-to-date data. This is an example of • behavioral control. • informational control. • strategy formulation. • strategy implementation.

11. Informational Control • Informational control deals with both the internal & external environment • Do the organization’s goals and strategies still “fit” within the context of the current strategic environment? • Two key issues: • Scan & monitor the external environment • Continuously monitor the internal environment

12. Informational Control • Informational control = ongoing process of organizational learning • Focus on constantly changing information - continuous monitoring, testing, review • Updates & challenges assumptions, so • Time lags are shortened • Changes are detected earlier • Speed & flexibility of response is enhanced

13. Question? • Which of the following is not one of the characteristics of a contemporary control system? • It is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans. • It must focus on constantly changing information that is strategically important. • It circumvents the need for face-to-face meetings among superiors, subordinates, and peers. • It generates information that is important enough to demand regular and frequent attention.

14. Behavioral Control • Behavioral control = focused on implementation – “doing things right” • Influences the actions of employees via: • Culture • Rewards • Boundaries Exhibit 9.3 Essential Elements of Behavioral Control

15. Behavioral Control: Culture • Organizational culture is a system of • Shared values (what is important) • Beliefs (how things work) • Organizational culture shapes a firm’s • People • Organizational structures • Control systems • Organizational culture produces • Behavioral norms (the way we do things around here)

16. Behavioral Control: Culture • Organizational culture sets implicit boundaries regarding: • Dress • Ethical matters • The way an organization conducts its business • A strong culture • Leads to greater employee engagement • Provides a common purpose and identity • Reduces monitoring costs

17. Behavioral Control: Culture • Effective organizational cultures must be • Cultivated • Encouraged • Fertilized • Organizational cultures can be maintained by • Storytelling • Rallies or pep talks by top executives

18. Behavioral Control: Rewards • Reward systems & incentive programs: • Powerful means of influencing an organization’s culture • Focus efforts on high-priority tasks • Motivate individual & collective task performance • Can be an effective motivator & control mechanism

19. Behavioral Control: Rewards • Potential downside: • Individual actions are not related to compensation; employees are rewarded for the wrong things • Different business units have differing rewards systems • Behavior reinforced within subcultures may reflect value differences in opposition to the dominant culture • Reward systems may lead to information hoarding, working at cross purposes

20. Behavioral Control: Rewards Exhibit 9.4 Characteristics of Effective Reward and Evaluation Systems

21. Behavioral Control: Boundaries • Boundaries and constraints can be useful • Focusing individual efforts on strategic priorities • Providing short-term objectives and action plans to channel efforts • Specific, measurable, including a specific time horizon for attainment • Achievable, yet challenging enough to motivate • Individual managers held accountable for implementation

22. Question? • Rules and regulations, rather than culture or rewards, would probably be used for strategic control at what type of company? • Software developer • Stock brokerage firm • Manufacturer of mass-produced products • High-tech research facility

23. Behavioral Control: Boundaries • Boundaries and constraints can also • Improve efficiency and effectiveness through rule-based controls, appropriate when • Environments are stable and predictable • Employees are largely unskilled and interchangeable • Consistency in product and services is critical • The risk of malfeasance is extremely high • Minimize improper and unethical conduct via • Anti-bribery policies • Regulations and sanctions – i.e. Sarbanes-Oxley

24. Behavioral Control Systems Exhibit 9.5 Organizational Control: Alternative Approaches

25. Behavioral Control Systems • Rewards and incentives, plus a strong culture, reduce the need for external controls, IF organizations • Hire the right people • Train people in the dominant cultural values • Have managerial role models • Have reward systems clearly aligned with organizational goals and objectives

26. Example: Building a Strong, Rewarding Culture • Zappos hires only one out of 100 applicants - a hiring process that is weighted 50% on job skills & 50% on the potential to mesh with Zappos’ culture. • Call center reps are measured based on how much time they spend with customers, not how many calls they take • Rewards include Zollars (Zappos dollars) given by peers to peers for deserving behaviors • Because Zappos has a strong culture they can… • Run primarily using recognition with few “incentive” programs • Eschew traditional programs – use what works for them

27. Corporate Governance • Corporate governance controls focus on relationships between • The shareholders • The management (led by the Chief Executive Officer - CEO) • The Board of Directors • How can corporations succeed (or fail) in aligning managerial motives with • The interests of the shareholders • The interests of the board of directors

28. Corporate Governance • The separation of owners (shareholders) & management in a modern corporation • Shareholders (investors) have limited liability & can participate in the profits without taking direct responsibility for operations • Management can run the company without personally providing any funds • The Board of Directors are elected by shareholders & have a fiduciary obligation to protect shareholder interests

29. Corporate Governance: Agency Theory • Agency theory deals with the relationship between principals & agents • What to do when the goals of the principals and agents conflict? • What to do when it is difficult or expensive for the principal to verify what the agent is actually doing? • What happens when the principal and the agent have different attitudes and preferences toward risk?

30. Corporate Governance Mechanisms • Corporate governance mechanisms: aligning the interests of owners and managers through • A committed and involved Board of Directors • Shareholder activism • Managerial rewards and incentives • Contract-based outcomes • CEO duality – should the CEO also be chairman of the board of directors?

31. Corporate Governance Mechanisms • Duties of the Board of Directors • Regularly evaluate, and, if necessary, replace the CEO; determine management compensation; review succession planning. • Review & approve financial objectives, major strategies, and plans of the Corporation. • Provide advice and counsel to top management. • Select & recommend candidates for the Board of Directors; evaluate board processes. • Review the adequacy of all compliance systems.

32. Corporate Governance Mechanisms • An effective Board of Directors should • Become active, critical participants • Ensure that strategic plans undergo rigorous scrutiny • Evaluate managers against high performance standards • Take control of the succession process • Practice director independence • No interlocking directorships • Insist that directors own significant stock in the company

33. Corporate Governance Mechanisms • Individual shareholders have rights: • To sell stock, vote the proxy, bring suit for damages, get information, receive residual rights following the company’s liquidation • Collectively, shareholders have power: • To direct the course of corporations, file shareholder action suits, demand key issues be brought up for proxy votes • Institutional investors can be aggressive: • By reviewing performance, requesting changes in the firm’s governance structure, filing court action, becoming major shareholders

34. Corporate Governance Mechanisms • Boards are responsible for managerial rewards and incentives • Boards can require that CEOs become substantial owners of company stock • Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and penalties for poor performance • Dismissal for poor performance should be a realistic threat

35. Corporate Governance Mechanisms: CEO Duality? Unity of Command: (in favor of) Duality Agency Theory: (in favor of) Separation • Provides clear focus • Eliminates confusion and conflict • Enhances a firm’s responsiveness • Enables quick decisions based on first-hand knowledge • Safeguards against corruption or incompetence • Removes conflict of interest, especially regarding CEO succession • Improves perceptions of legitimacy OR?

36. Corporate Governance Mechanisms • External governance control mechanisms • The market for corporate control • The takeover constraint • Auditors • Enron, WorldCom? • Banks and analysts • Lehman Brothers, Countrywide? • Regulatory bodies • Securities and Exchange Commission (SEC) • The Sarbanes-Oxley Act • Media and public activists • Bloomberg Businessweek, Ralph Nader

37. Example: Corporate Governance & Stakeholder Groups • AIG(American International Group) paid $218 million in bonuses to its financial services division employees AFTER receiving an $85 billion bailout from the U.S. government • The U.S. House of representatives complained • AIG leadership caved in • AIG financial services managers were left without an income • Many AIG financial services managers were AIG shareholders • Was corporate governance effective? Were external governance control mechanisms inappropriate?

38. International Corporate Governance • Principal – principal conflicts (vs principal – agent conflicts) involve • Concentrated ownership, or family ownership • Motivation to engage in expropriation of minority shareholders for personal gain • Business groups who can take coordinated action • Japanese keiretsus, Korean chaebols • Few external regulatory constraints

39. International Corporate Governance Exhibit 9.9 Principal-Agent Conflicts and Principal-Principal Conflicts: A Diagram Source: Young, M.N., Peng, M.W., Ahlstrom, D., Bruton, G.D., & Jiang, 2008. Principal-Principal Conflicts in Corporate Governance. Journal of Management Studies 45(1):196-220; and Peng, M.V. 2006. Global Strategy. Cincinnati: Thomson South-Western. We are very appreciative of the helpful comments of Mike Young of Hong Kong Baptist University and Mike Peng of the University of Texas at Dallas.