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Strategic Management and Business Policy Unit 4

Sikkim Manipal University Page No. 75

Unit 4 Corporate Strategy andCorporate Governance

Structure

4.1 Introduction

4.2 Caselet

Objectives

4.3 Definitions: Corporate Strategy and Corporate Governance

4.4 Growing Importance of Corporate Governance

4.5 Corporate Strategy and Corporate Governance: Complementarityand Conflict

4.6 Code of Best Practice

4.7 Strategic Audit

4.8 Board and CEO Relationship

4.9 Managed Corporation

4.10 Governed Corporation

4.11 Corporate Strategy and Corporate Governance:Need for more Integrative Relationship

4.12 Case Study

4.13 Summary

4.14 Glossary

4.15 Terminal Questions

4.16 Answers

4.17 References

4.1 Introduction

Corporate strategy and corporate governance are two important tools that helpin the functioning of any company. They are not the same, but generally

complementary to each other. Corporate governance is more operational, andno strategy can succeed without operational support. Similarly, no governancecan achieve organizational objectives without a strategy or strategic managementsystem. A close link or relationship also exists between corporate strategy andcorporate governance through the roles of the board of directors and the CEO.Both the board and the CEO have strategic roles to play. The two also have

important roles to play in the governance of a company.

There is, however, a basic difference between the roles of the board and

the CEO and other managers of a company. The board represents the interest

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of the shareholders who are the owners of a company whereas the CEO and

other managers represent the management of the company. The distinction

between ownership and management is very important, because, most of the

issues in the interrelation between corporate strategy and corporate governance

revolve round the relationship, and sometimes, conflict between the two.

Most of the analysis in this unit will be around this theme. In doing so, we

will discuss the definitional aspects of corporate strategy and corporate

governance, growing importance of corporate governance, stakeholders

expectations, major issues between corporate strategy and corporate

governance, code of corporate governance, empowerment of the board, role of

professional directors, code of best practice, strategic audit, boardCEOrelationship, the managed corporation and the governed corporation.

4.2 Caselet

The year 2001-02 saw the collapse of several high-profile and large

corporations, many of which were involved in accounting fraud. These

corporations included Enron and MCI in the US and One. Tel in Australia.

These events attracted the attention of the respective governments on the

issue of corporate governance. While the US government passed the

Sarbanes-Oxley Act in 2002, the CLERP 9 reforms were passed in Australia.Today, any discussion of corporate governance makes reference to

principles raised in three documents released since 1990: The Cadbury

Report (UK, 1992), the Principles of Corporate Governance (OECD, 1998

and 2004), the Sarbanes-Oxley Act of 2002 (US, 2002).

Objectives

After studying this unit, you should be able to:

Explain the conceptual difference between corporate strategy and

corporate governance

Discuss the growing importance of corporate governance

Analyse the complementarities and conflicts between corporate strategy

and corporate governance

Explain the code of best practice, strategic audit, board and CEO

relationship

Distinguish between the managed corporation and the governed

corporation

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4.3 Definitions: Corporate Strategy and Corporate Governance

We had defined corporate strategy in Unit 1. We will now define corporate

governance. Often, corporate governance is equated with corporate

management, which is not correct. As has been pointed out above, corporate

governance is concerned with serving the interest of the owners (stockholders)

and, is much broader in perspective than corporate management. Corporate

management is a part of or can be a useful partner in corporate governance.

There is some confusion about the concept and meaning of corporate

governance. Two definitions given below may give some clarity to the meaningand the role of corporate governance.

Corporate governance ensures that long-term strategic objectives andplans are established and that the proper management structure

(organization, systems and people) is in place to achieve those objectives

while at the same time, making sure that the structure functions tomaintain the corporates integrity, reputation and responsibility to its

various constituencies.1

Corporate governance denotes direction and control of the affairs of

the company. The role of corporate governance is to ensure that thedirectors of a company are subject to their duties, obligations and

responsibilities to act in the best interest of their company, to givedirection and remain accountable to their shareholders, and otherbeneficiaries for their action.2

The Organization for Economic Cooperation and Development (OECD)

describes corporate governance as a system. The complete OECD definition,

which is fairly elaborate, gives some additional perspectives on corporate

governance:

Corporate governance is the system by which business corporations

are directed and controlled. A corporate governance structure specifies

the distribution of rights and responsibilities among different participantsin the corporation such as board members, shareholders and other

stakeholders, and, spells out the rules and procedures for makingdecisions on corporate affairs. By doing this, it also provides the structure

through which company objectives are set and means of attaining those

objectives and monitoring performance are spelt out. OECD (1993).3

If we compare the definitions of governance and corporate strategy (given

in Unit 1), some important aspects of commonness and contrasts between the

two emerge.

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First, both corporate governance and corporate strategy start with

organizational objectives. In the case of corporate governance, the objectives

have more governance orientation; in the case of corporate strategy, the

objectives have more strategic focus. Second, corporate governance is primarily

guided by the shareholders. Good governance should result in good returns on

investment of shareholders and their happiness. Corporate strategy focuses

more on market share, long-term growth and development. Third, corporate

governance concentrates on organizational structure, rules, procedures and

systems for better governance. Corporate strategy is also concerned with

structures and systems but focuses more on strategic planning and resource

allocations. Fourth, corporate governance attempts to streamline operationsfor good governance; corporate strategy depends more on strategic functions

(manufacturing, finance, marketing and HR) and strategic implementation. Fifth,

the guiding force behind corporate governance is the shareholders, i.e., the

owners; but, corporate strategy is dictated by the market, competition and

customers. Finally, effectiveness of corporate governance is judged mostly by

financial results (return on investment or profit) in addition to some social

responsibilities; effectiveness or success of a corporate strategy is assessed in

terms of both financial and non-financial indicators or measures of performance

and, also, in terms of a balanced scorecardbalancing financial performance

with strategic performance (discussed in detail later in Unit 16).

Self-Assessment Questions

1. The system by which business corporations are directed and controlled

is called________.

2. Corporate governance is primarily guided by the_______.

3. It is correct to equate with corporate management with corporate

governance. (True/False)

4. Both corporate governance and corporate strategy start with organizational

objectives. (True/False)

4.4 Growing Importance of Corporate Governance

The affairs of a company are directed and controlled through the board of

directors who represent the shareholders of the company. The extent to which

the board discharges its trustee responsibilities and its commitment to run a

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transparent organization depends on many factors, including the roles played

by the more progressive elements within the corporate sector. A strong demand

for evolving a good corporate governance system is emerging from the corporate

sector itself.

Over the years, organizations have witnessed frequent violations of

organizational and governmental regulations, increase in unethical and corrupt

corporate practices and also scams.

Owing to these and related developments, the need for proper corporate

governance is being increasingly felt.

Shareholders are also becoming more demanding and more consciousabout their rights and privileges. They expect efficient management, good

governance, high profit and large dividends. They look for transparency and

public image to maximize shareholders value. In many companies, they are

voicing their concerns in annual shareholders meetings. Also, institutional

investors are becoming an important segment of stockholders and are influencing

company management and corporate governance. Since the 1970s, institutional

investors have been increasing their participation, and are presently holding

more than 50 per cent of many corporate stocks. For example, 63 per cent of

Ford Motor Company stock, 81 per cent of Digital Equipment Corporation, 79

per cent of Kmart and 72 per cent of Citicorp are held by institutions. These

investors like to see the value of their stocks increase. Therefore, they havestarted playing a more active role in governing the companies in which they

hold stocks. After Exxons 1989 oil spill in Alaska, public pension funds persuaded

the company to include an environmentalist on its board.4

If the institutional investors are not happy with corporate performance,

they convey their dissatisfaction to the company management. In 1987, Roger

Smith, chairman, General Motors, had to face a group of institutional investors,

because the group was annoyed that GM had made a $700 million hush mail

payment to H R Perot when he left the GM board. They also reprimanded Smith

for declining profits and market share, weak stock price, low productivity and

big bonuses received by senior executives. Eventually, GM announced a seriesof major policy changes including stock buybacks and capital spending cuts.5

4.4.1 Different Models of Corporate Governance

All this suggests the need for an appropriate corporate governance framework

or system for every company. The corporate governance system should clearly

address the three major issues of an organization: what is the purpose

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corporate objective or philosophy or goal of an organization; whom the

organization should be serving; and, how best to serve their interests. There

are different ways to handle (or manage) these issues, and different companies

in different countries have adopted different models of corporate governance to

address various organizational issues. Some selected corporate governance

models with their strengths and weaknesses are shown in Table 4.1.

Table 4.1Different Corporate Governance Models: Strengths and Weaknesses

Anglo-Saxon Model (US and UK)

Strengths Weaknesses

Dynamic market orientation Fluid capital Internationalization possible approach

Volatility and instability Short-term approach Inadequate governance structure

European Model (Germany)


Long-term industrial strategy Very stable capital Strong governance procedures

Internationalization difficult Vulnerability of companies to global

market

Asian Model (Japan)


Long-term industrial strategy Stable capital Overseas investments

Growth of institutional investor activism Growth of financial speculation Secretive procedures

Source: T Clarke, and E Monkhouse, eds., Re-Thinking the Company, adap. (London:

Financial Times/PitmanPublishing, 1994)


5. The affairs of a company are directed and controlled through the ______

who represent the shareholders of the company.

6. The _____ system should clearly address the three major issues of an

organizationcorporate objective; whom the organization should be

serving; and, how best to serve their interests.

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4.5 Corporate Strategy and Corporate Governance:Complementarity and Conflict

We have mentioned earlier that stakeholders expectations not only warrant

good corporate governance, but also effective corporate strategies. Simultaneous

focus on both is important, because only good governance and effective

strategies can lead to simultaneous achievement of organizational objectives

like profitability, growth and diversification and stakeholders expectations like

high return on their capital, transparency, employee motivation and customer

satisfaction. If we look at the total management activities of modern organizations,

we can clearly see the complementary roles of corporate governance and

strategies in smooth and efficient functioning of organizations. This is shown in

Figure 4.1.

1. D omin antl y go vernance acti vi ty 2. D omi na ntl y strateg ic acti vity

3. Mix of governance and strategic activities

PROCESSING

Planning: Understand the company and itsenvironmentDetermine goals and objectives of futureorganizational performanceSelect a course of action to achieve objectivesAllocate corporate resources

INPUTS

Resources andCapabilitiesFinancialHumanTechnologicalMaterialsInformation

Organizing (how to accomplish the plan)Find the appropriate arrangement to assign responsibility to people in the organizationCreate supportive culture and leadershipModify or reorganize if plan changes

ControllingMonitor activities and make corrections if neededUse reporting and control measures

Leading (creating shared vision, culture,and values)Empower employees

Use certain techniques to motivate employees to follow

OutcomeDeliver quality p roducts/ services

Achieve goals and objectives

efficiently and effectively

OUTPUTS

2 2

3 1

1

3

Figure 4.1Management Activities in Modern Organizations: Input-output Chain

Source:A F Alkhafaji, Strategic Management, adap. (2003), 28.

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Figure 4.1 shows all the major management activities in a company (input-

output chain) and relationship among them. Activities like input (resources and

capabilities) management and processing have been shown as dominantly of

governance nature; and, activities like organizing (accomplishing the plan) and

output (outcome) have been classified as mix of both strategic and governance

factors. In fact, even in leading an activity of dominantly governance nature,

use of different motivational techniques involves strategies. Similarly, resource

and capability management, perceived primarily as strategic management of

human and financial resources, has major governance implications.

We can also see the interrelationship or interdependence between

governance and strategy through a chain in the reporting system inorganizations. We can more appropriately call this governance through report

or documentation system. A typical reporting system is shown in Figure 4.2.

Reports received

Beneficiaries

Trustees

Investmentmanagers

Board

Executivedirectors

Seniorexecutives

Managers

Budgets/otheroperating reports

Budgets/qualitative reporting

Budgets/qualitative reporting

AccountsAnalysts' reportsCompany briefings

Limited investmentperformance reports

Limited reports

Figure 4.2Chain of Corporate Governance: Typical Reporting System

Source:G Johnson, and K Scholes, Exploring Corporate Strategy, 6th ed. (Pearson

Education, 2005), 196 (Exhibit 5.2).

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The reporting system/structure in Figure 4.2 shows the linkage between

ultimate beneficiaries of corporate governance or company performance and

the managers who drive the strategic management process. But, the reporting

structure also shows the distance between the two. It is even possible that

many beneficiaries may either be ignorant or indifferent to the details of

managerial activities or strategies of the company. Individual managers and/or

directors may adopt strategies which may mean effective management but,

may not be in the best interests of the beneficiaries. Also, as we have mentioned

above, all beneficiaries or shareholders do not have the same or common

interests; their interests may often clash. All these may lead to conflicts between

corporate governance and strategic actions. Table 4.2 shows some of theseconflicting situations.

Table 4.3Some Common Conflicts Between Corporate Strategyand Corporate Governance Corporate

Strategic Conflict Governance Long-term growth Sacrifice of short-term profitability, cash

flow and pay levels/hikes

Development/diversification to requireadditional funding (share issue or loans)

Financial independence may besacrificed

Expanding capital base: public ownershipof shares

More openness and accountability fromthe management

Cost efficiency through technology ornew investment

Job losses in the organization Expanding into mass market; product and

price strategy Decline in quality standards

Family businesses to grow; induction ofprofessional manager

Owners may lose control

Table 4.3 shows some typical conflict situations between strategy and

governance. These include conflicts between growth and profitability; growth

and control/independence, cost efficiency and jobs; volume/mass production

and quality/specialization; and, the problems of sub-optimization, i.e.,development of one part of an organization at the expense of another.6

Many of these situations also reflect conflicts of stakeholder interests or

expectations. For example, shareholders want cost efficiency, higher productivity

and profit, but, this may lead to job losses and clash with employees interests.

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Activity 1

Take a company of your choice and design the role of corporate governance

in the company. You may describe the corporate governance in terms of

organizational structure, rules, procedures and systems.


7. Corporate governance and strategies play ________ roles in the smooth

and efficient functioning of organizations.

8. The interrelationship or interdependence between governance and

strategy can be seen through a chain in the ______ in organizations.

9. Activities like input (resources and capabilities) management and

processing have been shown as dominantly of _______nature

10. Activities like organizing (accomplishing the plan) and output (outcome)

have been classified as mix of both _____and _____factors.

4.6 Code of Best Practice

In strategic analysis, we consider benchmarking and best practices mostly withreference to securing competitive advantage in the market. In governance

analysis, we not only talk of code of corporate governance, but also of code of

best practice for superior performance. For a company, the code of best

governance practice and best strategic practice may actually complement each

other for improving the overall organizational performance.

The Cadbury Committee has prescribed a code of best practice to serve

as a guideline to those companies which want to achieve higher standards of

corporate governance. The objective of the code of best practice is to balance

responsibility, authority and accountability in the governance process. Three

major constituents of the code prescribed by the Cadbury Committee are:

Separate positions of chairman and CEO:In every company, there should

be a separate CEO and chairman of the board of directors. When the

same person assumes the two roles, it vests too much authority with one

person with very little check on the use of such power. Separate positions

of chairman and CEO help balancing of authority.

Role clarity of chairman and CEO: Chairmans function should be to

manage the affairs of the board, including hiring and firing of the CEO of

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the company. The CEO, on the other hand, is responsible for day-to-day

management of the organization. The day-to-day management function

of the CEO consists of planning, organizing and implementation of

policies, programmes and strategies approved by the board.

Professional inputs from independent directors:Every company should

have non-executive directors, who bring to the board their professional

experience and expertise. The argument is that these experienced

professional directors, already in senior/top executive positions in other

companies or independent consultants, would supplement the efforts of

the fulltime executive directors on the board. Their involvement would

also provide a validity check and balance the ways in which executivedirectors tend to influence governance and strategic decisions at the board

level.7

We will discuss benchmarking and best practices in the strategic

perspective in detail later in Unit 12.


11. The ________has prescribed a code of best practice to serve as a

guideline to those companies which want to achieve higher standards of

corporate governance.

12. One of the constituents of the code prescribed by the Cadbury Committee

are:

(a) Higher pay for directors

(b) Separate positions of chairman and CEO

(c) Greater role of chairman in decision making

(d) Lesser role of chairman in decision making

4.7 Strategic Audit

With increasing pressure on boards from external stakeholders to be more

active, many directors are seeking more practical ways to conduct strategic

overview of company management without getting directly involved in it.

Donaldson (1995) has suggested strategic audit as a new tool for systematic

review of strategy by board members without directly involving themselves with

management of companies.

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Strategic audit is a formal strategic-review process, which imposes its own

discipline on both the board and the management very much like the financial

audit process8. But, it is different from management audit, which is undertaken

in many companies by the senior/top management on the progress and outcome

of important corporate activities. To understand strategic audit in the correct

perspective, one needs to analyse this in terms of its various elements.

Donaldson has specified five elements of strategic audit. These are:

1. Establishing criteria for performance

2. Database design and maintenance

3. Strategic audit committee4. Relationship with the CEO

5. Alert to duty (by board members)

The performance criteria should be simple, well-understood and well-

accepted measures of financial performance. A number of measures of financial

performance are available. One common measure, used by many companies,

is return on investment (ROI). The ROI can be analysed like this: profit per unit

of sales (profit margin); sales per unit of capital employed (asset turnover); and,

capital employed per unit of equity invested (leverage). If these three ratios are

multiplied together, the resultant ratio will give profit per unit of equity. This

criterion would fulfil two objectives: first, sustainable rate of return on shareholderinvestment, and, second, to decide whether the return is less, or equal to or

more than returns on alternative investments with comparable risk, i.e., whether

the companys chosen strategy is justifiable or not.

To calculate different performance ratios and monitor performance criteria,

a proper database is essential. This involves both database design and

maintenance. This has to be a regular and an ongoing process. Data on financial

performance can sometimes be sensitive to the managers/ employees of a

company. It is, therefore, suggested that financial and related data design,

maintenance and analyses should be entrusted to the auditors of the company

or outside consultants.For effective strategic audit, a strategic audit committee should be

constituted. According to Donaldson, outside directors should select three of

their own members to form the committee.

This will impart regularity and more commitment to the strategic audit

process. The committee would decide on the frequency of their meeting,

periodicity of interaction with the CEO or top management of the company and,

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also when they should make presentation to or hold discussion with the full

board.

A sensitive issue is the strategic audit committees relationship with the

CEO. Any CEO would be generally apprehensive of such a committee. The

strategic audit committee needs to create and maintain an atmosphere of

mutuality. It is true that whenever a question or a discussion on the strategic

direction of a company comes up in a board meeting, it is perceived by many

CEOs as an implicit criticism of the current strategy and leadership of the

company. It is also true that regular strategic process involving the CEO reduces

chances of unpleasant or confronting situations. In fact, ideally, the functioning

of the strategic audit committee should be seen as a low-key operation, positivein approach, designed to lend support and credibility to company leadership

and management.

The strategic audit committee and also the board should always be alert

and vigilant to ensure that there are no slippages. Business cycles indicate that

period of success may be followed by a period of slump. The strategic audit

committee and the board should be alert enough to get signals so that they can

act in time. This is necessary because complacence develops after success

both in the board and in the management.

If properly conceived, designed and conducted, strategic audit, more than

management audit, can be a powerful tool for monitoring the strategic processof a company and also strike a good balance between corporate strategy and



13. _________is a new tool for systematic review of strategy by board

members without directly involving themselves with management of

companies.

14. A performance criteria commonly used as a measure by many companies,

is _________.

4.8 Board and CEO Relationship

We have just discussed the sensitivity of the relationship between the board

and the CEO. In fact, this is part of a broader and more significant relationship

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between the two. We have given below three observations on the boards role

and the boardCEO relationship.

The Board is responsible for the successful perpetuation of the corporation.

That responsibility cannot be relegated to management9John G Surale,

non-executive chairman, General Motors (GM).

The success of the non-executive chairman arrangement is heavily

dependent on the chairmans relationship with the CEO. If the chemistry

is not good, the relationship isnt going to work10Sir Denys Henderson,

former chairman and CEO of Imperial Chemical Industries (ICI) and

presently non-executive chairman.How can outside directors constructively review managements strategy

if they dont have a deep knowledge of the business?11Bernard Marcus,

Chairman, the Home Depot (a retail chain in the US).

Managers and directors in most companies agree that the board should

be an effective watchdog without undermining the managements ability to run

the business. They also feel that boards should determine/decide how to distance

themselves from their CEOs in the course of normal management of business,

but at the same time, maintain a constructive and positive relationship with

them. This means striking a balance between management strategy and

governance of a company. In connection with this, directors and CEOs haveraised many fundamental questions or issues. Some of the major questions or

issues are mentioned below.

Should the CEO be involved only with management of a company, or

should he (she) be also concerned with governance?

What role should the board (dominated by outside directors) play in

formulating and reviewing a companys strategy?

What are the advantages and disadvantages of splitting chairmans and

CEOs job instead of entrusting them to one person?

Should outside directors obtain information about the companyits

management and governanceon their own bypassing the CEO?

What should be the right mechanism for boards to evaluate management,

particularly the CEO?

How does a board ensure that its members have the necessary expertise

to judge managements performance or evaluate the strategic decision-

making process?

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We shall try to give some possible answers to these questions in terms of

thoughts, guidelines and practices in General Motors. The board of General Motors

has developed several guidelines which cover boardCEO relationship and, also

answer some of the issues raised above. These guidelines have evolved out of

GM boards interactions with the management during the last few years and, not

issued by the board for taking control over the management or the company.

GM guidelines clearly stipulate that the management of the company is

separate from the board. The board does not involve itself in management

decisions. The management team led by Jack Smith has full authority and, of

course, also the responsibilities for day-to-day operations of General Motors.

Activity 2

Choose a company that you are familiar with and design on double (CEO

and chairman) or single (either CEO or chairman) role of the chief executive.

Students should choose any other company and compare with Nestle.


15. The Board is not responsible for the successful perpetuation of the

corporation.

16. The board should be an effective watchdog without undermining the

managements ability to run the business. (True/False)

4.9 Managed Corporation

The debate also implies the managed corporation and the governed corporation.

Pound (1995) analyses both the managed corporation and the governed

corporation, makes a comparison between the two and, suggests the governed

corporation as a model of successful corporate governance. We shall first discuss

the managed corporation and then the governed corporation.

The managed corporation is more like the traditional model of a company

or corporation. This is the model of governance where focus is on power

equations between management and control, boardCEO relationship or strategy

and governance conflict. In the managed corporation, senior managers are

responsible for leadership and decision making. Board function is to hire the

top-level managers, monitor them and fire them if they do not perform.

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Shareholders role is to throw out the board if the company or the corporation

does not perform.12

Emergence and growth of the managed corporation can be traced in two

factors; first, change in the shareholding patterndispersion or distribution of

ownership among many shareholders (including the public) and, second,

emergence of a new class of professionals who were neither major stockholders

nor founders nor owners of companies. Because shareholders were dispersed,

they could not be directly involved in formulating corporate policy and strategy.

Therefore, there was the need for managers and leaders who could formulate

policies and strategies and promote organizational growth. The managed

corporation has dominated the corporate arena for decades. The managedcorporation model can be found in any modern organization; only the actual

form may vary from one organization to another.

In the managed corporation, boards and shareholders are kept away from

strategy formulation and policy making. A significant business proposal or a

major investment project may be discussed at the board level but, the managers

would be given the freedom to formulate and implement business strategies.

Board members are expected to intervene in business policies and strategies if

there is performance failure or the managers are found incompetent or corrupt.

If this happens, that is, if the directors have to get involved in corporate strategies,

may be it is time for the board to look for a new CEO.If the major cause of corporate failure is management incompetence, the

governance system in the managed corporation may work. But, many

performance failures or crises are not results of incompetence, but are failures

of judgement. Managers tend to be biased towards strategies and decisions

which reflect their individual strengths. Managers also make mistakes. The

managed corporation model permits or ignores mistakes to go uncorrected till

they lead to major crisis or catastrophes. In the US, throughout the 1980s,

boards allowed flawed retail strategy to be followed in spite of clear evidence

that managers lacked retail skills. Some board members later admitted that it

was a mistake to allow company managements to pursue incorrect retail policiesand strategies. But, they did not intervene because they were following the

managed corporation model.

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Box 4.1: Nestl Debate: Double C or Single C

One aspect of the debate on the boardCEO relationship is whether the

positions of both CEO and chairman should be combined in one person.

The Nestl debate is one of the latest to throw contrasting views on this.

Nestl shareholders voted Peter Brabeck Letmathe, the CEO, to the

chairmanship of the company as an additional responsibility. The majority

shareholders rejected the arguments of those who opposed a dual role for

Brabeck.

In a statement before the Annual General Meeting (AGM), Nestl said itsought the double C-level status for Brabeck in the interest of the investors

as it assured strategic continuity and long-term value. According to the

company, the Austrian-born Brabeck, who had spent his entire working life

with Nestl, was the best person for the charimans job.

But some institutions had an opposite view. The Ethos Foundation, which

represents 83 Swiss pension funds in campaigning for good corporate

governance and the US-based Institutional Shareholder Services had

protested against the plan to combine the double power in one person at

the worlds biggest food group. They and others, who opposed the move,

said that a double mandate was acceptable in special cases, such asturnaround processes where prompt action was needed but, that was not

the case with Nestl.

However, unlike Britain, where separation of the two top jobs is the norm,

in Switzerland, a combined top role is not uncommon. For example, heads

of drug companies Novartis and Roche hold dual positions of CEO and

chairman.

Brabeck assumed the dual role after his predecessor, Rainer Gut, retired.

I accept this mandate with a bit of disappointment because of the

circumstance in which it has been bestowed on me, Now, Brabecks main

challenge lies in making the company grow amidst the upheaval andcontroversy that has surrounded him. Only time can tell whether the double

C is justified in case of Brabeck or not.

Source: Adapted from C D Team, Just Two Much, Economic Times (Corporate

Dossier), (April 29, 2005).

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17. The governed corporation has dominated the corporate arena for decades.

(True/False)

18. Managers tend to be biased towards strategies and decisions which reflect

their individual strengths. (True/False)

4.10 Governed Corporation

The answer to problems of corporate failure in the managed corporation lies inthe governed corporation. In the governed corporation, the focus is not on

powernot monitoring or controlling the managersbut, on improving decision

making. The objective is to minimize chances of mistakes; and, even if they

occur, to mutually work out effective ways to rectify the mistake rather than fire

the management. The result is a positive change in the way companies discuss,

decide and review policy.

Major differences in approach between the managed corporation and the

governed corporation in terms of boards role, characteristics and policies are

shown in Table 4.3. To create the governed corporation, companies should start

rethinking about the role of directors, and, also, of shareholders. Both thedirectors and shareholders should be proactive, and, not reactive in the policy-

making process. Managers will continue to play their roles. This means that

there are three critical constituents of the governed corporation: the board or

directors, the managers and shareholders. Directors should guide managers to

take best possible decisions; major shareholders should be able to communicate

directly with the senior managers/CEO and, also the directors about what they

think of corporate policies and decisions. With shareholders and board/ directors

participating in policy and decision making, and, the managers already involved,

the corporation is governed rather than managed because all the three critical

constituents (managers, directors and shareholders) have a voice in the

governance of the company.13

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Table 4.3 The Managed Corporation vs the Governed Corporation: BoardsRole, Characteristics and Policies

The Managed Corporation The Governed Corporation

Boards Role Boards role is to hire, monitor and, when

necessary, change failed management.

Board Characteristics Power sufficient to control the CEO and

the performance-evaluation process.

Independence to ensure that the CEO is

impartially evaluated and that directors arenot compromised or co-opted bymanagement.

Board methods and procedures to allowoutside directors to evaluate managersindependently and effectively.

Policies

Separate the CEO and chairman (or leadoutside director).

Board meeting may take place withoutCEO being present.

Committee of independent directors toevaluate the CEO.

Independent financial and legal advisorsavailable to outside directors.

Measurable norms or yardsticks forjudging CEOs performance.

Boards Role Boards role is to foster effective decisions

and monitor and reverse failed policies.

Board Characteristics Expertise sufficient to allow the board to

add value to the decision-making processand performance.

Incentives to ensure that the board is

committed to create organizational value.

Methods and procedures to foster opendebate and keep theboard apprised ofshareholders concerns.

Policies

Vital areas of expertise must berepresented on the board such as coreindustry and finance.

Minimum time commitment by the boardmembers (may be two days in a month).

Designated committee to evaluate newpolicy proposals.

Regular meetings shareholders with largeshareholders.

Board members free to ask forinformation from any employee.

Source:Adapted from J Pound, The Promise of the Governed Corporation, Harvard

Business Review (MarchApril, 1995)

Pound has suggested five major changes in the managed corporation for it

to evolve into a governed corporation. First, board members should be experts,

i.e., well versed with the companyits products, structure, functioning, policies

and practicesthe industry and environmental influences and governmental

regulations; second, board meetings should focus on discussions on new policies,decisions and strategies, and not just on reviews of past performance; third,

directors should have better access to information on products, customers,

competitors, market conditions and critical strategic and organizational issues;

fourth, directors should devote a significant proportion of their professional time

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to the company or the corporation to have more meaningful and effective

involvement in decision making; fifth, board members should have proper incentive

to develop and show the right commitment to the company. Directors cannot be

expected to take serious interest in formulation and implementation of company

policies and strategies unless they are sufficiently compensated for it.

The transition from the managed corporation to the governed corporation

may be slow. Such change may take years, particularly in companies which are

governed by individuals (managers, CEOs and directors) who have been

subscribing to the managed philosophy for decades. But, changes are taking

place. Many companies are moving in the right direction. Companies like General

Motors, IBM, Compaq Computer and Westinghouse have already taken stepsto become governed corporations.14


19. In the governed corporation, the focus is not on powernot monitoring or

controlling the managersbut, on ___________.

20. _________ has suggested five major changes in the managed corporation

for it to evolve into a governed corporation.

4.11 Corporate Strategy and Corporate Governance:Need for more Integrative Relationship

The analysis so far has focused on different aspects or characteristics of corporate

strategy and corporate governance, the way they are differentiated and, also,

areas of complementarities and some possible conflicts between the two.

The starting point of both are the same, i.e., achievement of organizational

objectives. But, it is also here that some difference begins between the two and

also is the source of some possible conflict. The most important objective of

corporate governance is to protect the interests of the stockholders whose

primary concern is maximization of return on investment or short-term profitability.

The objective of corporate strategy is more to focus on long-term growth and

profitability, which gives sustenance to the company. This, however, is a common

organizational conflict in many companies, i.e., matching or balancing the short-

term and long-term goals of the organization.

Balancing the stockholder interests and stakeholder expectations is another

issue. This also relates to strategygovernance relationship. Stakeholders include,

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as a governed company. This is the optimal way to serve both the stockholders

and the interest of the larger group of stakeholders.


21. The starting point of both corporate strategy and governance are the

same, i.e., achievement of organizational objectives. (True/False)

22. In corporate governance, there is a growing emphasis on inclusiveness

or inclusive governance, i.e., focusing on the society, community and

environmental development. (True/False)

4.12 Case Study

Gray Line Corporation: Role of Ethics in Governance*

Corporate values and ethics are in a state of f lux today, in India as well as

globally, which is illustrated by this case of Gray Line Corporation:

When S. Khopekar, the regional manager, had joined Gray Line Corporation

as the purchase manager, he had gone through the discipline and conduct

guidelines of the companys purchase department. A clause against

acceptance of gifts by staff of the purchase department had attracted hisattention. The clause read as follows:

Purchase department employees shall not accept gifts from vendors. This

is to ensure that no vendor is given any special treatment and employees

work only in the best interest of the firm at all times. Any deviation from the

above will be dealt with severely and can mean dismissal from the firm.

Khopekar made a note of this.

Months passed by and the New Year, a time for gifts, was approaching. The

rule in Gray Line was that no gift worth more than `50 should be accepted by

any employeepresumably an old rule that had not been revised.

One day, one of the vendors brought three wall clocksone for theManaging Director (MD), one for the Vice-president (VP) procurement, and

one for Khopekar. The vendor, who had a long association with Gray Line,

was aware of the companys rule. He explained that the cost of the clocks

was `50 each, and therefore, there should be no problem in accepting

them as gifts. Khopekar found it very hard to believe that the clocks would

cost only `50 each. He decided to take the matter to the MD. The MD had

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a look at the clock and asked his secretary to hang it on the wall in his

office. He asked Khopekar to distribute the other two as desired by the

vendor. He also mentioned that the clocks could cost `50 each if bought in

bulk. As per the MDs instruction, Khopekar sent one to the VP and took

one home and put it up in his living room.

Khopekar later accepted many gifts in Gray Line which were of different

values, but always presented as costing not more than `50. Gradually, he

also stopped feeling uneasy or bad about receiving the gifts. In fact, he was

getting used to it and, also started looking forward to the New Year. He,

however, knew very well that none of the gifts were worth less than `2000.

The next new year, Natarajan, executive secretary to the MD, came to

Khopekar. He wanted to know if gifts had started coming.

Natarajan clarified that it had been the practice with the earlier purchase

managers also to accept gifts from vendors and distribute them among

important officials of the company. He cautioned against discussing the

gifts with the MD, who would be annoyed and take action against him.

Khopekar thought about integrity and ethics, but a bigger test was waiting

for him.

Within few days, a vendor came with six baskets, each with bottles of Scotch

whisky, return air tickets for two to any destination in India and three-night

stay at a five-star hotel. The total value of each of the gift baskets was not

less than `1 lakh. The MDs secretary told Khopekar that such gifts were

not unusual. Khopekar was faced with a dilemma: to get reconciled to such

practices or look for a change? It is not an easy decision to make for any

manager in todays volatile business environment.

* Based on U C Mathur, Case study 24, (Textbook of Strategic Management)

(New Delhi: Macmillan India, 2005), 337. Names have been changed because of

the sensitive nature of the subject.

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4.13 Summary

Let us recapitulate the important concepts discussed in this unit:

Corporate strategy and corporate governance are the two important tools

of functioning of any company. Corporate governance has more to do

with ownership of a company; corporate strategy has more to do with

management of a company. They are generally complementary to each

other, but, there can be conflicts between the two.

In companies, simultaneous focus on good corporate governance and

effective corporate strategies is important, as only this can lead tosimultaneous achievement of organizational objectives like profitability,

growth and diversification and stakeholder expectations like high return

on their capital, transparency, employee motivation and customer

satisfaction.

To resolve the conflicts between corporate strategy and corporate

governance, empowerment of the board may be a useful tool. The board,

by virtue of its position, is the single entity which can influence both

corporate strategy and corporate governance and try to strike a balance

between their conflicting demands.

Pound has distinguished between the managed corporation and thegoverned corporation. The managed corporation is more like the traditional

model of a company or corporation. This is the model of governance

where the focus is on the power equations between management and

control, boardCEO relationship or strategy and governance conflict.

4.14 Glossary

Best practice:A technique or methodology that, through experience and

research, has been proven to reliably lead to a desired result.

Corporate governance:The framework of rules and practices by whicha board of directors ensures accountability, fairness, and transparency in

a company's relationship with its all stakeholders.

Corporate strategy:The overall scope and direction of a corporation

and the way in which its various business operations work together to

achieve particular goals

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Inclusive governance: Governance that focuses on the society,

community and environmental development

Strategic analysis: Considers how an organization attempts to best

combine its own capabilities with the opportunities in the marketplace in

seeking to accomplish its overall objectives.

Strategic audit: A new tool for systematic review of strategy by board

members without directly involving themselves with management of

companies.

Strategic governance:The technique by which companies are directed

and managed. It means carrying the business as per the stakeholdersdesires.

4.15 Terminal Questions

1. What is corporate governance? Explain the difference between corporate

strategy and corporate governance.

2. Discuss the growing importance of corporate governance.

3. Explain the complementarities and conflicts between corporate strategy

and corporate governance.

4. What is strategic audit? Explain its relevance to corporate strategy and


5. What is a managed corporation? Illustrate the main features of a managed

corporation.

6. Define a governed corporation. Distinguish between the managed

corporation and the governed corporation in terms of boards role, major

characteristics and policies of a company.

4.16 Answers

Answers to Self-Assessment Questions

1. Corporate governance

2. Shareholders

3. False

4. True

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5. board of directors

6. corporate governance

7. Complementary

8. reporting system

9. governance

10. Strategic, governance

11. Cadbury Committee

12. (b)

13. strategic audit

14. return on investment (ROI)

15. False

16. True

17. False

18. True

19. improving decision making

20. Pound

21. True22. True

Answers to Terminal Questions

1. Corporate governance is concerned with serving the interest of the owners

(stockholders) and, is much broader in perspective than corporate

management. Refer to Section 4.3 for further details.

2. A strong demand for evolving a good corporate governance system is

emerging from the corporate sector itself. Refer to Section 4.4 for further

details.

3. As stakeholders expectations not only warrant good corporate

governance, but also effective corporate strategies, simultaneous focus

on both is important. Refer to Section 4.6 for further details.

4. Donaldson (1995) has suggested strategic audit as a new tool for

systematic review of strategy by board members without directly involving

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themselves with management of companies. Refer to Section 4.7 for

further details.

5. The managed corporation is more like the traditional model of a company

or corporation. Refer to Section 4.9 for further details.

6. There are major differences in approach between the managed corporation

and the governed corporation in terms of boards role, characteristics

and policies. Refer to Section 4.10 for further details.

4.17 References

1. Donaldson, G. A New Tool for Boards; Strategic Audit. Harvard Business

Review, JulyAugust, 1995.

2. Harvard Business Review on Corporate Governance, 2000. Boston:

Harvard Business School Press.

3. Johnson, G and K Scholes. 2005. Exploring Corporate Strategy. 6th edn.

Pearson Education.

4. Kumar, S. 2000. Corporate Governance: A Question of Ethics. New Delhi:

Galgotia Publishing Co.

5. Lorsch, J W. Empowering the Board.Harvard Business Review, January

February, 1995.

6. Mathur, U C. 2005. Corporate Governance and Business Ethics: Text

and Cases. New Delhi: Macmillan India.

7. Pound, J. The Promise of the Governed Corporation, Harvard Business

Review, MarchApril, 1995.

Endnotes

1 Definition given by the Advisory Board of the National Association of Corporate Directors(NACD) New Delhi, reproduced in S Kumar, Corporate Governance (2000), 3

2 Definition given by Chandratre reproduced in S Kumar, Corporate Governance (2000), 4.3

Reproduced in U C Mathur, Corporate Governance and Business Ethics: Text and Cases(New Delhi: Macmillan India, 2005), 4.

4 J H, Dobrzynski, M Schroeder, G L Miles, and J Weber, Taking Charge, Business Week3113 , (1989): 66.

5 A F Alkhafaji, Strategic Management (2003), 27.6 G Johnson, and K Scholes, Exploring Corporate Strategy, 4 th ed. (New Delhi: Prentice

Hall of India, 1999), 195.7 U C Mathur, Corporate Governance and Business Ethics: Text and Cases (2005),

6163.

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8 G Donaldson, A New Tool for Boards: Strategic Audit, Harvard Business Review (July August, 1995).

9 Harvard Business Review on Corporate Governance (Harvard Business School Press,2000), 188.

10 Ibid .11 Ibid.12 J Pound, The Promise of the Governed Corporation, Harvard Business Review (March

April, 1995).13 J Pound, The Promise of the Governed Corporation , Harvard Business Review (March

April,1995).14 J Pound, The Promise of the Governed Corporation, Harvard Business Review (March

April, 1995).

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