Strategic Management Ch11

11-1 © 2006 by Nelson, a division of Thomson Canada Limited.

Corporate Governance

Chapter Eleven


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 4:The Internal Environment

Chapter 5: Bus.-Level Strategy

Chapter 6:Competitive Dynamics

Chapter 7:Corp.-Level

StrategyChapter 11:Corporate

Governance


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.


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


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


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.


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


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 performance contracts, monitoring mechanisms like the board of directors & enforcement mechanisms like managerial labour market to mitigate agency problems.

Agency Theory


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.


Ris

k

Level of Diversification

DominantBusiness

UnrelatedBusinesses

RelatedConstrained

RelatedLinked

Managerial(Employment)

Risk ProfileM

B

Shareholder (Business) Risk ProfileS

A

Manager & Shareholder Risk & Diversification


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


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



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


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




• 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



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


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.


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


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.


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)


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.


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


Strategic Competitiveness

Strategic Mission & Strategic Intent

Strategic Objectives & Inputs

Chapter 1: Strategic

ManagementStrategic

Competitiveness Ch. 2: Strat. Mgmt . &

Performance



Chapter 4:The Internal Environment

Chapter 5: Bus.-Level Strategy

Chapter 6:Competitive Dynamics

Chapter 7:Corp.-Level

StrategyChapter 11:Corporate

Governance

Education

Strategic Management Ch11