Corporate Governance and Organizational Architecture FMAChicago Clifford W. Smith SIMON

Corporate Governance and Corporate Governance and Organizational ArchitectureOrganizational Architecture

FMAFMA

ChicagoChicago

Clifford W. Smith

SIMON

OrganizationalOrganizational ArchitectureArchitecture

Allocation of decision rights within the Allocation of decision rights within the organizationorganization

Structure of systems to evaluate Structure of systems to evaluate performanceperformance

Methods of rewarding individualsMethods of rewarding individuals

Our analysis draws heavily Our analysis draws heavily on economicson economics

Differs from much of the management Differs from much of the management literatureliterature

Finance, accounting, organizations Finance, accounting, organizations historically were institutional/normative historically were institutional/normative

Five decades ago, finance began to Five decades ago, finance began to change change

-Positive analysis-Positive analysis

-Empirical evidence-Empirical evidence Three decades ago, accounting Three decades ago, accounting

followedfollowed

Corporate Governance Corporate Governance involvesinvolves

The partitioning of decision rights among The partitioning of decision rights among shareholders, board members, shareholders, board members, management and othersmanagement and others

Systems to monitor and evaluate their Systems to monitor and evaluate their performanceperformance

Methods by which these groups are Methods by which these groups are rewardedrewarded

Corporate Governance is Corporate Governance is Organizational Architecture at the Organizational Architecture at the

Top of the FirmTop of the Firm

InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets

ExternalExternal Legal/Regulatory/TaxLegal/Regulatory/Tax

Corporate Governance thus Corporate Governance thus involves a broad array of involves a broad array of

facetsfacets Some (charter, bylaws, organizational Some (charter, bylaws, organizational

structure, accounting system, budgeting structure, accounting system, budgeting system, HR system and financial system, HR system and financial architecture) are largely chosen internallyarchitecture) are largely chosen internally

Others (oversight agencies, input and Others (oversight agencies, input and output markets and legal/regulatory/tax) output markets and legal/regulatory/tax) are largely external to the firmare largely external to the firm

These various facets are interrelatedThese various facets are interrelated

InternalInternal Charter/BylawsCharter/Bylaws -Ownership Structure-Ownership Structure -Voting Rules-Voting Rules -Anti-Takeover Provisions-Anti-Takeover ProvisionsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter/BylawsCharter/BylawsBoard StructureBoard Structure - Board Composition- Board Composition - Board Compensation- Board Compensation - Committee Structure- Committee StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


Decision Management vs. Decision Decision Management vs. Decision ControlControl

InitiationInitiation RatificationRatification ImplementationImplementation MonitoringMonitoring

InternalInternal Charter/BylawsCharter/BylawsBoard StructureBoard StructureOrganizational StructureOrganizational Structure

-Centralization vs. -Centralization vs. DecentralizationDecentralization

-Business Units: Function vs. -Business Units: Function vs. Product vs. Geography Product vs. GeographyAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational Structure

Accounting SystemAccounting System -Financial Reporting-Financial Reporting -Managerial (cost) accounting-Managerial (cost) accounting -Internal Audit-Internal AuditBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR System -Fixed vs. Incentive Compensation-Fixed vs. Incentive Compensation -Accounting Based vs. Stock Based -Accounting Based vs. Stock Based Incentive Compensation Incentive CompensationFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting System

HR SystemHR SystemFinancial ArchitectureFinancial Architecture -Leverage-Leverage -Contract Structure (Covenants…)-Contract Structure (Covenants…) -Risk Management-Risk Management -Leasing-LeasingOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight Agencies -Public Accounting Firms-Public Accounting Firms -D & O Insurance-D & O InsuranceCapital MarketsCapital MarketsLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital Markets -Exchange Listing-Exchange Listing -Investment Banks-Investment Banks -Institutional Investors, -Institutional Investors, Blockholders, Analysts Blockholders, Analysts -Bond Rating Agencies-Bond Rating Agencies -Mergers/Tender Offers-Mergers/Tender OffersLabor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight Agencies

Capital MarketsCapital MarketsLabor MarketsLabor Markets -Managerial-Managerial -Board-BoardInput MarketsInput MarketsProduct MarketsProduct Markets


InternalInternal Charter and BylawsCharter and BylawsBoard StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR SystemFinancial ArchitectureFinancial ArchitectureOversight AgenciesOversight AgenciesCapital MarketsCapital MarketsLabor MarketsLabor Markets

Input MarketsInput MarketsProduct MarketsProduct Markets

Legal/Regulatory/TaxLegal/Regulatory/Tax -State Incorporation-State Incorporation -Federal/State Securities-Federal/State Securities -Sarbanes-Oxley -Sarbanes-Oxley

External External -Williams Act -Williams Act

InternalInternal Charter and BylawsCharter and Bylaws-Antitakeover provisions-Antitakeover provisions

Board StructureBoard StructureOrganizational StructureOrganizational StructureAccounting SystemAccounting SystemBudgeting SystemBudgeting SystemHR SystemHR System

-Golden parachutes-Golden parachutesFinancial ArchitectureFinancial Architecture

-Antitakeover debt covenants-Antitakeover debt covenantsOversight AgenciesOversight AgenciesCapital MarketsCapital Markets

-Tender Offers-Tender Offers-Investment Banks-Investment Banks-Bond Rating Agencies-Bond Rating Agencies

Labor MarketsLabor MarketsInput MarketsInput MarketsProduct MarketsProduct MarketsLegal/Regulatory/TaxLegal/Regulatory/Tax

ExternalExternal -Williams Act-Williams Act

Corporate Governance is an integrated system—For example, if a hostile takeover is contemplated:

ConclusionsConclusions

Despite widely reported governance failures Despite widely reported governance failures (Enron, Tyco, WorldCom, Adelphia) thousands of (Enron, Tyco, WorldCom, Adelphia) thousands of firms uniformly have avoided such problemsfirms uniformly have avoided such problems

-This extensive press coverage reflects the -This extensive press coverage reflects the rarity of rarity of the eventsthe events

-Governance failures are like commercial -Governance failures are like commercial airplane airplane crashescrashes


Private incentives exist within the contracting Private incentives exist within the contracting process to resolve these problems in the least process to resolve these problems in the least costly mannercostly manner


The most rapid, effective, and flexible response to The most rapid, effective, and flexible response to a corporate control failure is within the internal a corporate control failure is within the internal systems of the organizationsystems of the organization

-Is this problem occurring in my firm?-Is this problem occurring in my firm?

-Can we do anything to reduce the likelihood -Can we do anything to reduce the likelihood of a of a similar failure?similar failure?

-Can we credibly convince external parties -Can we credibly convince external parties that such that such a failure is unlikely? a failure is unlikely?

ConclusionsConclusions Regulation imposes costsRegulation imposes costs

-Direct compliance costs have been discussed -Direct compliance costs have been discussed more extensively but I believe represent the more extensively but I believe represent the smaller componentsmaller component

-Opportunity costs are large and will grow-Opportunity costs are large and will grow

-Some regulation (Williams Act, antitakeover -Some regulation (Williams Act, antitakeover statutes) reduce the effectiveness of the statutes) reduce the effectiveness of the

corporate control process corporate control process

-Regulation limits firm’s abilities to craft -Regulation limits firm’s abilities to craft customized policies reflecting their specific customized policies reflecting their specific circumstances circumstances

-Regulation limits experimentation-Regulation limits experimentation

Corporate Governance and Corporate Governance and Organizational ArchitectureOrganizational Architecture

FMAFMA

ChicagoChicago

Clifford W. Smith

SIMON

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Corporate Governance and Organizational Architecture FMAChicago Clifford W. Smith SIMON