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Strategic Management
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11-1 © 2006 by Nelson, a division of Thomson Canada Limited.
Corporate Governance
Chapter Eleven
11-2 © 2006 by Nelson, a division of Thomson Canada Limited.
The Strategic Management Process
Chapter 8:Acquisition & Restructuring
Chapter 9:International
Strategy
Chapter 10:Cooperative
Strategy
Strategy Formulation
Chapter 11:Corporate
Governance
Ch. 12: Org. Structure & Controls
Chapter 13:Strategic
Leadership
Chapter 14:Org. Renewal & Innovation
Strategy Implementation
StrategicActions
Chapter 3:The External Environment
Strategic Competitiveness
Strategic Mission & Strategic Intent
Strategic Objectives & Inputs
Chapter 1: Strategic
ManagementStrategic
Competitiveness Ch. 2: Strat. Mgmt . &
Performance
Chapter 3:The External Environment
Chapter 3:The External Environment
Chapter 4:The Internal Environment
Chapter 5: Bus.-Level Strategy
Chapter 6:Competitive Dynamics
Chapter 7:Corp.-Level
StrategyChapter 11:Corporate
Governance
11-3 © 2006 by Nelson, a division of Thomson Canada Limited.
Corporate GovernanceKnowledge objectives:1. Define corporate governance & explain why it is used to
monitor & control managers’ strategic decisions.2. Explain how ownership came to be separated from
managerial control in the modern corporation.3. Define an agency relationship & managerial opportunism
& describe their strategic implications.4. Explain how the 3 internal governance mechanisms are
used to monitor & control managerial decisions.5. Discuss trends among the 3 types of compensation
executives receive & their effects on strategic decisions6. Describe how the external corp. governance mechanism
acts as a restraint on top level managers decisions.7. Describe how corp. governance fosters ethical decisions
& the importance of such behaviours from executives.
11-4 © 2006 by Nelson, a division of Thomson Canada Limited.
Corp. Governance is a relationship among stake-holders 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 the firm’s owners and its top-level managers
Corporate Governance
11-5 © 2006 by Nelson, a division of Thomson Canada Limited.
Ten most admired & respected Corporations in Canada
Firm• RBC Financial Group• BCE Inc.• CIBC• TransCanada Pipelines
2003 2002 1 1 2 3 3 6 4 7 • BMO Financial Group
• EnCana Corporation• Bombardier Inc.• Bank of Nova Scotia
4 5 5 10 6 6 7 8
• TransAlta Corporation• Suncor Energy Inc.• Canadian National Railway• Manulife Financial Corp.
8 12 9 10 9 9 10 4
11-6 © 2006 by Nelson, a division of Thomson Canada Limited.
Separation of Ownership & ControlBasis of the modern corporation
Shareholders purchase stock, becoming Residual Claimants
Professional managers contract to provide decision-making.
Modern public corporation form leads to efficient specialization of tasks.
Shareholders reduce risk efficiently by holding diversified portfolios.
Risk bearing by shareholders.Strategy development and decision-makingby managers.
11-7 © 2006 by Nelson, a division of Thomson Canada Limited.
Agency Relationship
Risk Bearing Specialist(Principal)
Managers (Agents)
DecisionMakers
which createswhich creates
Managerial Decision-Making Specialist
(Agent)
Hire
An agency relationship exists when:
Shareholders (Principals)
Firm Owners
Agency Theory
11-8 © 2006 by Nelson, a division of Thomson Canada Limited.
The Agency problem occurs when: The desires or goals of the principal & agent conflict and it is difficult or expensive for the principal to verify that the agent has behaved appropriately.
Example: Over - diversification: Greater product diversification leads to lower management employment risk & greater compensation.
Solution: Principals engage in incentive-based perform- ance contracts, monitoring mechanisms like the board of directors & enforcement mechanisms like managerial labour market to mitigate agency problems.
Agency Theory
11-9 © 2006 by Nelson, a division of Thomson Canada Limited.
Product Diversification as an example of an Agency Problem
• Diversification usually increases the size of the firm; therefore complexity and an opportunity for top executives to increase their compensation.
• Diversification usually reduces top executives’ employment risk.
• Top executives have control over free cash flow and may invest in in products not associated with the firm’s current lines of business.
11-10 © 2006 by Nelson, a division of Thomson Canada Limited.
Ris
k
Level of Diversification
DominantBusiness
UnrelatedBusinesses
RelatedConstrained
RelatedLinked
Managerial(Employment)
Risk ProfileM
B
Shareholder (Business) Risk ProfileS
A
Manager & Shareholder Risk & Diversification
11-11 © 2006 by Nelson, a division of Thomson Canada Limited.
Agency Costs & Governance Mechanisms
• Managerial interests may prevail when
governance mechanisms are weak
• If the board of directors control managerial
autonomy, the firm’s strategies should better
reflect the interests of the shareholders
11-12 © 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms
Ownership Concentration
Boards of Directors
Executive Compensation
Multidivisional Organizational Structure
• Relative amounts of stock owned by individual
shareholders and institutional investors
• Individuals responsible for representing the 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
11-13 © 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms
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
11-14 © 2006 by Nelson, a division of Thomson Canada Limited.
Insiders
Outsiders
Boards of Directors
- Set compensation of CEO & decide when to replace the CEO.
- Formally monitor & control top-level execs.
- May lack contact with day to day operations.
A firm’s CEO & other top-level managers
RelatedOutsiders
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 day-to-day operations and other relationships
Internal Governance Mechanisms
11-15 © 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms
• Increased diversity amongst 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
Accountability of Board Members
11-16 © 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms
Executive compensation: A governance
mechanism aligning the interests of managers
& owners through salaries, bonuses and long
term incentives such as stock options.
Stock options: A mechanism which links the
executive’s performance to the performance of
the company.
Executive Compensation
11-17 © 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance MechanismsExecutive Compensation (2002)
Frank Stronach, Chair Robert Burton, C2 Richard George, CEO Conrad Black, C2
Pierre Lessard, CEO
Magna International Moore Corp Ltd Suncor Energy Inc Hollinger International Metro Inc
$52,124,000 20,926,946 16,273,375 15,836,628 15,275,200
0%0%
22%12%92%
Exec. Name Title Company Tot. Earnings Option %
Gwyn Morgan, CEO Travis Engen, CEO Peter Godsoe, C2 Gordon Nixon, CEO Joe Houssian, C2
EnCana Corp Alcan Inc Bank of Nova Scotia Royal Bank of Canada Intrawest Corp
13,133,116 11,356,775 10,446,908
9,706,233 9,371,629
33%60%44%40%26%
Paul Tellier, CEOJean Monty, C2 Vic De Zen, C2 Tony Comper, C2
Dom.D'Alessandro,CEO
CDN National Railway BCE Inc Royal Group Tech. Bank of Montreal Manulife Financial
9,333,588 8,832,730 8,541,548 8,423,530 8,321,400
74%74%28%61%56%
© 2006 by Nelson, a division of Thomson Canada Limited.
Internal Governance Mechanisms
Designed to control managerial opportunismMultidivisional Organizational Structure
- Increased managerial interest in wealth maximization
- Corporate office and Board monitor business-unit managers’ strategic decisions
- M-form structure does not necessarily limitcorporate-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
11-19 © 2006 by Nelson, a division of Thomson Canada Limited.
External Governance Mechanisms
Market for Corporate Control
The purchase of a firm that is under-
performing relative to industry rivals in
order to improve its strategic
competitiveness.
11-20 © 2006 by Nelson, a division of Thomson Canada Limited.
Basic Management Defence TacticsIncrease the costs of mounting a takeover in
order to entrench current management
Greenmail Where company money is used to repurchase stock from a corporate raider to avoid takeover
Golden Parachute Raises the cost of making changes at a take-over target due to the need to pay fired executives large severance packages
Poison Pill When the 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)
11-21 © 2006 by Nelson, a division of Thomson Canada Limited.
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 when the proper corporate governance is exercised can strategies be formulated & implemented that will help the firm achieve strategic competitiveness & earn above average returns.
11-22 © 2006 by Nelson, a division of Thomson Canada Limited.
The Strategic Management Process
Chapter 8:Acquisition & Restructuring
Chapter 9:International
Strategy
Chapter 10:Cooperative
Strategy
Strategy Formulation
Chapter 11:Corporate
Governance
Ch. 12: Org. Structure & Controls
Chapter 13:Strategic
Leadership
Chapter 14:Org. Renewal & Innovation
Strategy Implementation
StrategicActions
Chapter 3:The External Environment
Strategic Competitiveness
Strategic Mission & Strategic Intent
Strategic Objectives & Inputs
Chapter 1: Strategic
ManagementStrategic
Competitiveness Ch. 2: Strat. Mgmt . &
Performance
Chapter 3:The External Environment
Chapter 3:The External Environment
Chapter 4:The Internal Environment
Chapter 5: Bus.-Level Strategy
Chapter 6:Competitive Dynamics
Chapter 7:Corp.-Level
StrategyChapter 11:Corporate
Governance
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