Ch 10

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2011 Cengage Learning. All Rights Reserved. May not be scanned,copied or duplicated, or posted to a publicly accessible website, in whole

or in part.

trategic Manage!ent

Part III: Strategic Actions:

Strategy Implementation

Chapter 10: Corporate Governance

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2011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

"he trategic Manage!ent #rocess

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Chapter 10$ Corporate %overnance &C%'

( )verview$ even content areas

*+eine C% and its !onitor-control o !anagersdecisions

*eparation between ownership and !anage!ent

control*Agency relationship and !anagerial opportunis!

*"hree internal governance !echanis!s used to!onitor-control !anage!ent decisions

*/ternal governance !echanis!$ "he !aret or

corporate control* nternational corporate governance

*3ow C% osters ethical strategic decisions

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s C/) #ay )utrageous, rresponsible, or%reedy4

( n 2005$

*10 highest paid C/)s earned 6782.2 !illion and thosewith their co!panies since 2008 saw 29: increase

*)verall corporate peror!ance was bad

*Median C/) salary ; bonus down 5.< percent*C/) direct co!pensation ell =.7 percent

*Median value o pers up about 8 percent

* nternational survey indicates that !ost people thinbusiness eecutives are overpaid

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ntroduction

( Corporate %overnance &C%'

*et o !echanis!s used to !anage the relationships&and conlicting interests' a!ong staeholders, and todeter!ine and control the strategic direction and

peror!ance o organi>ations &aligning strategicdecisions with co!pany values'

( /ective C% is o interest to nations as it relectssocietal standards

*?ir!s shareholders are treated as ey staeholders as

they are the co!panys legal owners*/ective governance can lead to co!petitive advantage

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eparation o )wnership andManagerial Control

( ntroduction

*3istorically, ir!s !anaged by ounder@owners ;descendants

*eparation o ownership and !anagerial control allow

shareholders to purchase stoc, entitling the! toinco!e &residual returns' * i!plies ris or this groupwho !anage their invest!ent ris

*hareholder value relected in price o stoc

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7/342011 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

eparation o )wnership andManagerial Control &Contd'

( ntroduction

*!all ir!s !anagers are high percentage owners,which i!plies less separation between ownership and!anage!ent control

*?a!ily@owned businesses ace two critical issues$( As they grow, they !ay not have access to all needed sills to

!anage the growing ir! and !ai!i>e its returns, so !ayneed outsiders to i!prove !anage!ent

( "hey !ay need to see outside capital &whereby they give upso!e ownership control'

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( Agency relationships

*Relationships between business owners &principals' anddecision@!aing specialists &agents' hired to !anageprincipalsB operations and !ai!i>e returns on

invest!ent.

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( Agency relationships &Contd'

*Managerial )pportunis!$ eeing sel@interest withguile &i.e., cunning or deceit'

( )pportunis!$ an attitude and set o behaviors

*#rincipals establish governance and control !echanis!sto prevent agents ro! acting opportunistically

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An Agency Relationship

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( Agency proble!s$ #roduct diversiication

*Can result in two !anager beneits shareholders dontenDoyE

( 1. ncrease in ir! si>e

( 2. ?ir! portolio diversiication which can reduce topeecutives e!ploy!ent ris &i.e., Dob loss, loss oco!pensation and loss o !anagerial reputation'

*+iversiication reduces these riss because a ir! andits !anagers are less vulnerable to the reduction inde!and associated with a single or li!ited nu!ber o

product lines or businesses

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( Agency proble!s$ ?ir!s ree cash low

*Resources re!aining ater the ir! has invested in allproDects that have positive net present values within itscurrent businesses

*Available cash lows( Managerial inclination to overdiversiy can be acted upon

( hareholders !ay preer distribution as dividends, so they cancontrol how the cash is invested

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Manager and hareholder Risand +iversiication

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( Agency costs and governance !echanis!s

*u! o incentive costs, !onitoring costs, enorce!entcosts, and individual inancial losses incurred byprincipals, because governance !echanis!s cannot

guarantee total co!pliance by the agent( Costs associated with agency relationships, and eectivegovernance !echanis!s should be e!ployed to i!prove!anagerial decision !aing and strategic eectiveness

( arbanes@)ley Act

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)wnership Concentration

( ntroduction$ Fey concepts

*)wnership Concentration$ %overnance !echanis!deined by both the nu!ber o large@bloc shareholdersand the total percentage o shares they own

*Large Gloc hareholders$ hareholders owning aconcentration o at least < percent o a corporationsissued shares

* nstitutional )wners$ ?inancial institutions such as stoc!utual unds and pension unds that control large@bloc

shareholder positions

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)wnership Concentration &Contd'

( ntroduction$ Fey concepts* nstitutional )wners &Contd'

( "he growing inluence o institutional owners

* #rovides si>e to inluence strategy and the incentive to disciplineineective !anagers

* ncreased shareholder activis! supported by /C rulings in support oshareholder involve!ent and control o !anagerial decisions

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"he Goard o +irectors &G)+'

( ntroduction

*%roup o shareholder@elected individuals &usually calleddirectors' whose pri!ary responsibility is to act in theowners interests by or!ally !onitoring and controlling

the corporations top@level eecutives

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"he Goard o +irectors &G)+' &Contd'

( As stewards o an organi>ationBs resources, aneective and well@structured board o directors caninluence the peror!ance o a ir!

*)versee !anagers to ensure the co!pany is operated

in ways to !ai!i>e shareholder wealth*+irect the aairs o the organi>ation

*#unish and reward !anagers

*#rotect shareholders rights and interests

*#rotect owners ro! !anagerial opportunis!

( "hree director classiications$ nsider, relatedoutsider and outsider

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( 3istorically, G)+ do!inated by inside !anagers

*Managers suspected o using their power to select andco!pensate directors

*HI/ i!ple!ented an audit co!!ittee rule reJuiring

outside directors to head audit co!!ittee &a responseto /Cs proposal reJuiring audit co!!ittees be !adeup o outside directors'

*arbanes@)ley Act passed leading to G)+ changes

*Corporate governance beco!ing !ore intense through

G)+ !echanis!*G)+ scandals led to trend o separating roles o C/)

and Goard Chairperson

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( )utside directors

* !prove wea !anagerial !onitoring and control thatcorresponds to inside directors

*"end to e!phasi>e inancial controls, to the detri!ent o

ris@related decisions by !anagers, as they do not haveaccess to daily operations and a high level oinor!ation about !anagers and strategy

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( )utside directors &Contd'

*Large nu!ber o outsiders can create proble!s

*Li!ited contact with the ir!s day@to@day operationsand inco!plete inor!ation about !anagers K.

( K.results in ineective assess!ents o !anagerial decisionsand initiatives

( K. Leads to an e!phasis on inancial, as opposed to strategic,controls to gather peror!ance inor!ation to evaluateperor!ance o !anagers ; business units, which couldreduce R;+ invest!ents, increase diversiication, and pursue

higher co!pensation to oset their e!ploy!ent ris

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( /nhancing G)+ eectiveness

* ncreased diversity in board !e!bers bacgrounds

*/stablish!ent and consistent use o or!al processes toevaluate the boards peror!ance

*Creation o a lead directorE role that has strongagenda@setting and oversight powers

*Modiied co!pensation o directors

*ReJuires that directors own signiicant staes in theco!pany in order to eep ocused on shareholder

interests

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/ecutive Co!pensation &/C'

( /ecutive co!pensation &/C'$

*+eined$ %overnance !echanis! that sees to align theinterests o top !anagers and owners through salaries,bonuses, and long@ter! incentive co!pensation, suchas stoc awards and stoc options

*"hought to be ecessive and out o line withperor!ance

*Align!ent o pay and peror!ance$ co!plicated boardresponsibility

*"he eectiveness o pay plans as a governance!echanis! is suspect

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/ecutive Co!pensation &/C' &Contd'

( "he eectiveness o eecutive co!pensation

*Co!plicated, especially long@ter! incentive co!p

( "he Juality o co!ple and nonroutine strategic decisions thattop@level !anagers !ae is diicult to evaluate

( +ecisions aect inancial outco!es over an etended period,!aing it diicult to assess the eect o current decisions oncorporation peror!ance

( /ternal actors aect a ir!s peror!ance in addition to top@level !anage!ent decisions and behavior

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( "he eectiveness o eecutive co!pensation &Contd'

*#eror!ance@based co!pensation used to !otivatedecisions that best serve shareholder interest arei!perect in their ability to !onitor and control!anagers

* ncentive@based co!pensation plans intended toincrease ir! value, in line with shareholderepectations, subDect to !anagerial !anipulation to!ai!i>e !anagerial interests

*Many plans see!ingly designed to !ai!i>e !anagerwealth rather than guarantee a high stoc price thataligns the interests o !anagers and shareholders

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( "he eectiveness o eecutive co!pensation &Contd'

*toc options are highly popular

( Repricing$ strie price value o options is co!!only loweredro! its original position

( Gacdating$ options grant is co!!only dated earlier thanactually drawn up to ensure an attractive eercise price

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Maret or Corporate Control

( Maret or Corporate Control

*+einition$ eternal governance !echanis! consistingo a set o potential owners seeing to acJuireundervalued ir!s and earn above@average returns ontheir invest!ents

( Geco!es active when a ir!s internal controls ail

*Heed &or eternal !echanis!s' eists to$

( address wea internal corporate governance

( correct subopti!al peror!ance relative to co!petitors,

( discipline ineective or opportunistic !anagers.

*/ternal !echanis!s are less precise than internalgovernance !echanis!s

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Maret or Corporate Control

( Managerial deense tactics

*3ostile taeovers are the !aDor activity

( Hot always due to poor peror!ance

( ConseJuent to tactics are the deenses

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nternational Corporate %overnance

( Corporate %overnance in %er!any*Concentration o ownership is strong

*Gans eercise signiicant power as a source oinancing or ir!s

*"wo@tiered board structures, reJuired or larger

e!ployers, place responsibility or !onitoring andcontrolling !anagerial decisions and actions withseparate groups

*#ower sharing includes representation ro! theco!!unity as well as unions

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nternational Corporate %overnance &Contd'

( Corporate %overnance in apan*Cultural concepts o obligation, a!ily, and consensus

aect attitudes toward governance

*Close relationships between staeholders and aco!pany are !aniested in cross@shareholding, and can

negatively i!pact eiciencies*Gans play an i!portant role in inancing and

!onitoring large public ir!s

*+espite the counter@cultural nature o corporatetaeovers, changes in corporate governance have

introduced this practice

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( Corporate %overnance in China

*ndergone !aDor changes over the past decade

*#rivati>ation o business and the develop!ent andintegrity o eJuity !aret

*"he state do!inates the strategies that !ost ir!s

e!ploy.*?ir!s with higher state ownership have lower !aret

value and !ore volatility than those with less

( +ue to the act that the state is i!posing social goals on theseir!s and eecutives are not trying to !ai!i>e shareholderwealth

*Moving toward a Nestern@style !odel

( Chinese eecutives are being co!pensated based on ir!inancial peror!ance

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( %lobal Corporate %overnance

*Relatively unior! governance structures are evolving

*"hese structures are !oving closer to the ..corporate governance !odel

*Although i!ple!entation is slower, !erging with ..practices is occurring even in transitional econo!ies

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%overnance Mechanis!s and/thical Gehavior

( t is i!portant to serve the interest o the ir!s!ultiple staeholder groups

( n the .., shareholders &in the capital !aretstaeholder group' are the !ost i!portant

staeholder group served by the board o directors( %overnance !echanis!s ocus on control o

!anagerial decisions to protect shareholdersinterests

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%overnance Mechanis!s and/thical Gehavior &Contd'

( #roduct !aret staeholders &custo!ers, suppliersand host co!!unities' and organi>ationalstaeholders &!anagerial and non@!anageriale!ployees' are also i!portant staeholder groups

( Although the idea is subDect to debate, so!ebelieve that ethically responsible co!panies designand use governance !echanis!s that serve allstaeholders interests

( !portance o !aintaining ethical behaviorthrough governance !echanis!s * Dust re!e!ber/nron and Arthur AndersenO

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Ch 10