Corporate Governance

1. Chapter 11 Corporate Governance Robert E. Hoskisson Michael A. Hitt R. Duane Ireland ©2004 by South-Western/Thomson Learning

2. The Strategic Management Process Chapter 1 Introduction to Strategic Management Chapter 2 Strategic Leadership Strategic Thinking Chapter 3 The External Environment Chapter 4 The Internal Organization Strategic Intent Strategic Mission Strategic Analysis Chapter 5 Business-Level Strategy Chapter 6 Competitive Rivalry and Competitive Dynamics Chapter 7 Corporate-Level Strategy Creating Competitive Advantage Chapter 8 Acquisition and Restructuring Strategies Chapter 9 International Strategy Chapter 10 Cooperative Strategy Monitoring And Creating Entrepreneurial Opportunities Chapter 11 Corporate Governance Chapter 12 Strategic Entrepreneurship

3. Discussion Questions • What is corporate governance? What are the basic mechanisms that corporate shareholders employ to exercise corporate governance? • In an efficient separation between shareholder and managerial control, what roles do shareholders and top managers play? • But what problem does this separation create? Click Here Click Here Click Here Click Here More discussion questions

4. Discussion Questions (cont.) • How does the agency problem relate specifically to diversification strategy? How does it relate to managerial risk taking in general? • How do governance devices (shareholder concentration, institutional shareholders, boards of directors and managerial compensation, and market for corporate control) relate to controlling the agency problem? Are there tradeoffs among these devices? Click Here Click Here Click Here More discussion questions

5. Discussion Questions (cont.) • How does corporate governance differ in Germany and Japan? • How important is ethics in corporate governance? Click Here Click Here

6. Discussion Question 1 What is corporate governance? What are the basic mechanisms that corporate shareholders employ to exercise corporate governance?

7. Corporate Governance • Corporate governance is • a relationship among stakeholders that is used to determine and control the strategic direction and performance of organizations • concerned with identifying ways to ensure that strategic decisions are made effectively • used in corporations to establish order between the firm’s owners and its top-level managers

8. The Firm Corporate Governance Mechanisms Internal Governance Mechanisms Ownership concentration • relative amounts of stock owned by individual shareholders and institutional investors Board of Directors • individuals responsible for representing the firm’s owners by monitoring top-level managers’ strategic decisions

9. The Firm Corporate Governance Mechanisms Internal Governance Mechanisms Executive Compensation • use of salary, bonuses, and long-term incentives to align managers’ interests with shareholders’ interests • Monitoring by top-level managers • they may obtain Board seats (not in financial institutions) • they may elect Board representatives

10. The Firm The Firm Corporate Governance Mechanisms External Governance Mechanisms Market for Corporate Control • the purchase of a firm that is underperforming relative to industry rivals in order to improve its strategic competitiveness Return to Discussion Questions Click Here

11. Discussion Question 2 In an efficient separation between shareholder and managerial control, what roles do shareholders and top managers play?

12. Separation of Ownership and Managerial Control Return to Discussion Questions Click Here • Basis of the modern corporation • shareholders purchase stock, becoming residual claimants • shareholders reduce risk by holding diversified portfolios • professional managers are contracted 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

13. Discussion Question 3 But what problem does this separation create?

14. Shareholders (Principals) Agency Relationship: Owners and Managers • Firm owners

15. Managers (Agents) Shareholders (Principals) Agency Relationship: Owners and Managers • Firm owners • Decision makers

16. An Agency Relationship Managers (Agents) Shareholders (Principals) Agency Relationship: Owners and Managers • Firm owners • Decision makers • Risk bearing specialist (principal) pays compensation to • A managerial decision-making specialist (agent)

17. Agency Theory Problem Return to Discussion Questions Click Here • The 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 inappropriately • Solution: • principals engage in incentive-based performance contracts • monitoring mechanisms such as the board of directors • enforcement mechanisms such as the managerial labor market to mitigate the agency problem

18. Discussion Question 4 How does the agency problem relate specifically to diversification strategy? How does it relate to managerial risk taking in general?

19. S M A B Manager and Shareholder Risk and Diversification Shareholder (business) risk profile Managerial (employment) risk profile Risk Dominant Business Related Constrained Related Linked Unrelated Businesses Diversification

20. Agency Theory Conflicts • Principals may engage in monitoring behavior to assess the activities and decisions of managers However, dispersed shareholding makes it difficult and inefficient to monitor management’s behavior • Boards of Directors have a fiduciary duty to shareholders to monitor management However, Boards of Directors are often accused of being lax in performing this function Return to Discussion Questions Click Here

21. Discussion Question 5 How do governance devices (shareholder concentration, institutional shareholders, boards of directors and managerial compensation, and market for corporate control) relate to controlling the agency problem? Are there tradeoffs among these devices?

22. 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)

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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 • May require asset restructuring • Institutional investors oppose the use of defense tactics Return to Discussion Questions Click Here

29. Discussion Question 6 How does corporate governance differ in Germany and Japan?

30. International Corporate Governance: Germany • Owner and manager are often the same in private firms • Public firms often have a dominant shareholder, frequently a bank • Frequently there is less emphasis on shareholder value than in U.S. firms, although this may be changing

31. International Corporate Governance: Germany • Medium to large firms have a two-tiered board • vorstand monitors and controls managerial decisions • aufsichtsrat selects the Vorstand • employees, union members and shareholders appoint members to the Aufsichtsrat

32. International Corporate Governance: Japan • Obligation, “family” and consensus are important factors • Banks (especially “main bank”) are highly influential with firm’s managers • Keiretsus are strongly interrelated groups of firms tied together by cross-shareholdings

33. International Corporate Governance: Japan • Other characteristics: • powerful government intervention • close relationships between firms and government sectors • passive and stable shareholders who exert little control • virtual absence of external market for corporate control Return to Discussion Questions Click Here

34. Discussion Question 7 How important is ethics in corporate governance?

35. Capital Market Stakeholders The Firm Corporate Governance and Ethical Behavior It is important to serve the interests of the firm’s multiple stakeholder groups! • In the U.S., shareholders (in the capital market stakeholder group) are viewed as the most important stakeholder group • which are served by the board of directors • Hence, the focus of governance mechanisms is on the control of managerial decisions to ensure that shareholders’ interests will be served

36. Capital Market Stakeholders Product Market Stakeholders The Firm Corporate Governance and Ethical Behavior It is important to serve the interests of the firm’s multiple stakeholder groups! • Product market stakeholders (customers, suppliers and host communities) and organizational stakeholders (managerial and non-managerial employees) are also important stakeholder groups

37. Capital Market Stakeholders Product Market Stakeholders The Firm Organizational Stakeholders Corporate Governance and Ethical Behavior It is important to serve the interests of the firm’s multiple stakeholder groups! • Although the idea is subject to debate, some believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders’ interests • Importance of maintaining ethical behavior through governance mechanisms is seen in the example of Enron and Arthur Andersen