Ch11 Discussion Blue

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2004 by South-Western/Thomson Learning 1

Corporate GovernanceCorporate Governance

Robert E. Hoskisson

Michael A. Hitt

R. Duane Ireland

Chapter 11Chapter 11


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Chapter 2Chapter 2

Strategic LeadershipStrategic Leadership

Chapter 4Chapter 4

The InternalThe Internal

OrganizationOrganization

Chapter 6Chapter 6

Competitive Rivalry andCompetitive Rivalry and

Competitive DynamicsCompetitive Dynamics

Chapter 9Chapter 9

International StrategyInternational Strategy

Chapter 1Chapter 1

Introduction toIntroduction to

Strategic ManagementStrategic Management

Chapter 3Chapter 3

The ExternalThe External

EnvironmentEnvironment

Chapter 5Chapter 5

Business-LevelBusiness-Level

StrategyStrategy

Chapter 8Chapter 8Acquisition andAcquisition and

Restructuring StrategiesRestructuring Strategies



Strategic IntentStrategic Intent

Strategic MissionStrategic Mission

Chapter 7Chapter 7

Corporate-Level StrategyCorporate-Level Strategy


Cooperative StrategyCooperative Strategy


Strategic EntrepreneurshipStrategic Entrepreneurship

Strategic

Analysis

Strategic

Thinking

Creating

Competitive

Advantage

Monitoring

And Creating

EntrepreneurialOpportunities

The Strategic Management ProcessThe Strategic Management Process


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Discussion QuestionsDiscussion QuestionsClick

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Here More discussion questions

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1. What is corporate governance? What arethe basic mechanisms that corporateshareholders employ to exercise corporate

governance?2. In an efficient separation between

shareholder and managerial control, whatroles do shareholders and top managers

play?

3. But what problem does this separationcreate?


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Discussion Questions (cont.)Discussion Questions (cont.)

6. How does corporate governance differ

in Germany and Japan?

7. How important is ethics in corporategovernance?


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Discussion Question 1Discussion Question 1

What is corporate governance?

What are the basic mechanisms

that corporate shareholders

employ to exercise corporate

governance?


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Corporate governance is

a relationship among stakeholders that is used

to determine and control the strategic direction

and performance of organizations

concerned with identifying ways to ensure that

strategic decisions are made effectively

used in corporations to establish order between

the firms owners and its top-level managers


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MechanismsMechanismsOwnership concentrationOwnership concentration

relative amounts of stock ownedrelative amounts of stock owned

by individual shareholders andby individual shareholders andinstitutional investorsinstitutional investors

Board of DirectorsBoard of Directors

individuals responsible forindividuals responsible for

representing the firms owners byrepresenting the firms owners bymonitoring top-level managersmonitoring top-level managers

strategic decisionsstrategic decisions

Internal Governance MechanismsInternal Governance Mechanisms


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MechanismsMechanismsExecutive CompensationExecutive Compensation

use of salary, bonuses, and long-use of salary, bonuses, and long-

term incentives to align managersterm incentives to align managersinterests with shareholdersinterests with shareholders

interestsinterests

Monitoring by top-level managersMonitoring by top-level managers

they may obtain Board seats (notthey may obtain Board seats (notin financial institutions)in financial institutions)

they may elect Boardthey may elect Board

representativesrepresentatives

Internal Governance MechanismsInternal Governance Mechanisms


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MechanismsMechanismsMarket for Corporate ControlMarket for Corporate Control

the purchase of a firm that isthe purchase of a firm that is

underperforming relative tounderperforming relative toindustry rivals in order toindustry rivals in order to

improve its strategicimprove its strategic

competitivenesscompetitiveness

External Governance MechanismsExternal Governance Mechanisms

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In an efficient separation between

shareholder and managerial control,what roles do shareholders and top

managers play?


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Return to

DiscussionQuestions

Separation of Ownership andSeparation of Ownership and

Managerial ControlManagerial ControlBasis of the modern corporationBasis of the modern corporation shareholders purchase stock, becomingshareholders purchase stock, becoming

residual claimantsresidual claimants

shareholders reduce risk by holdingshareholders reduce risk by holdingdiversified portfoliosdiversified portfolios

professional managers are contracted toprofessional managers are contracted toprovide decision-makingprovide decision-making

Modern public corporation form leads toModern public corporation form leads toefficient specialization of tasksefficient specialization of tasks risk bearing by shareholdersrisk bearing by shareholders

strategy development and decision-making bystrategy development and decision-making bymanagersmanagers

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But what problem does thisseparation create?


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Firm ownersFirm owners

Agency Relationship:Agency Relationship: Owners andOwners andManagersManagers

ShareholdersShareholders

(Principals)(Principals)


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Decision makersDecision makers


ManagersManagers

(Agents)(Agents)





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Risk bearing specialist (principal)Risk bearing specialist (principal)

pays compensation topays compensation to

A managerial decision-makingA managerial decision-making

specialist (agent)specialist (agent)


An AgencyAn Agency

RelationshipRelationship

ManagersManagers

(Agents)(Agents)



Decision makersDecision makers



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Agency Theory ProblemAgency Theory Problem The agency problem occurs when:The agency problem occurs when:

the desires or goals of the principal and agentthe desires or goals of the principal and agentconflict and it is difficult or expensive for theconflict and it is difficult or expensive for theprincipal to verify that the agent has behavedprincipal to verify that the agent has behaved

inappropriatelyinappropriately Solution:Solution:

principals engage in incentive-based performanceprincipals engage in incentive-based performancecontractscontracts

monitoring mechanisms such as the board ofmonitoring mechanisms such as the board ofdirectorsdirectors

enforcement mechanisms such as the managerialenforcement mechanisms such as the manageriallabor market to mitigate the agency problemlabor market to mitigate the agency problem

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DiscussionQuestions

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How does the agency problem

relate specifically to diversificationstrategy? How does it relate tomanagerial risk taking in general?


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Manager and Shareholder RiskManager and Shareholder Risk

and Diversificationand Diversification

RiskRisk

DiversificationDiversification

DominantDominant

BusinessBusiness

UnrelatedUnrelated

BusinessesBusinesses

RelatedRelated

ConstrainedConstrained

RelatedRelated

LinkedLinked

ManagerialManagerial

(employment)(employment)

risk profilerisk profile

BB

ShareholderShareholder

(business)(business)

risk profilerisk profileSS

AA

MM


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Agency Theory ConflictsAgency Theory Conflicts

Principals may engage in monitoring behavior toPrincipals may engage in monitoring behavior to

assess the activities and decisions of managersassess the activities and decisions of managers

However, dispersed shareholding makes itHowever, dispersed shareholding makes it

difficult and inefficient to monitor managementsdifficult and inefficient to monitor managementsbehaviorbehavior

Boards of Directors have a fiduciary duty toBoards of Directors have a fiduciary duty to

shareholders to monitor managementshareholders to monitor management

However, Boards of Directors are often accusedHowever, Boards of Directors are often accusedof being lax in performing this functionof being lax in performing this function


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How do governance devices (shareholder

concentration, institutional shareholders,

boards of directors and managerial

compensation, and market for corporate

control) relate to controlling the agency

problem? Are there tradeoffs among these

devices?


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Governance MechanismsGovernance Mechanisms

OwnershipOwnership

ConcentrationConcentration

Large block shareholders (oftenLarge block shareholders (ofteninstitutional owners) have a stronginstitutional owners) have a strongincentive to monitor managementincentive to monitor managementcloselyclosely

Their large stakes make it worthTheir large stakes make it worththeir while to spend time, effort andtheir while to spend time, effort andexpense to monitor closelyexpense to monitor closely

They may also obtain Board seatsThey may also obtain Board seats

which enhances their ability towhich enhances their ability tomonitor effectively (althoughmonitor effectively (althoughfinancial institutions are legallyfinancial institutions are legallyforbidden from directly holdingforbidden from directly holding

board seats)board seats)


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OwnershipOwnership


Board ofBoard of

DirectorsDirectors

InsidersInsiders The firms CEO and other top-levelThe firms CEO and other top-level

managersmanagers

Related OutsidersRelated Outsiders Individuals not involved with day-Individuals not involved with day-to-day operations, but who have ato-day operations, but who have a

relationship with the companyrelationship with the company

OutsidersOutsiders Individuals who are independent ofIndividuals who are independent of

the firms day-to-day operationsthe firms day-to-day operations

and other relationshipsand other relationships


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OwnershipOwnership


Board ofBoard of

DirectorsDirectors

Recommendations for more effectiveRecommendations for more effectiveBoard Governance:Board Governance:

Increase diversity of boardIncrease diversity of boardmembers backgroundsmembers backgrounds

Strengthen internal managementStrengthen internal managementand accounting control systemsand accounting control systems

Establish formal processes forEstablish formal processes forevaluation of the boardsevaluation of the boards

performanceperformance


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OwnershipOwnership


Board ofBoard of

DirectorsDirectors

ExecutiveExecutive

CompensationCompensation

Salary, bonuses, long term incentiveSalary, bonuses, long term incentivecompensationcompensation

Executive decisions are complex andExecutive decisions are complex andnon-routinenon-routine

Many factors intervene making itMany factors intervene making itdifficult to establish how managerialdifficult to establish how managerialdecisions are directly responsible fordecisions are directly responsible foroutcomesoutcomes


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OwnershipOwnership


Board ofBoard of

DirectorsDirectors

ExecutiveExecutive


Stock ownership (long-termStock ownership (long-termincentive compensation) makesincentive compensation) makesmanagers more susceptible tomanagers more susceptible tomarket changes which are partiallymarket changes which are partially

beyond their controlbeyond their control Incentive systems do not guaranteeIncentive systems do not guaranteethat managers make the rightthat managers make the rightdecisions, but do increase thedecisions, but do increase thelikelihood that managers will do thelikelihood that managers will do thethings for which they are rewardedthings for which they are rewarded


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OwnershipOwnership


Board ofBoard of

DirectorsDirectors

ExecutiveExecutive


Market forMarket for

Corporate ControlCorporate Control

Firms face the risk of takeoverFirms face the risk of takeoverwhen they are operated inefficientlywhen they are operated inefficiently

Many firms begin to operate moreMany firms begin to operate moreefficiently as a result of the threatefficiently as a result of the threat

of takeover, even though the actualof takeover, even though the actualincidence of hostile takeovers isincidence of hostile takeovers isrelatively smallrelatively small

Changes in regulations have madeChanges in regulations have madehostile takeovers difficulthostile takeovers difficult

Acts as an important source ofActs as an important source ofdiscipline over managerialdiscipline over managerialincompetence and wasteincompetence and waste


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Managerial Defense TacticsManagerial Defense Tactics

Designed to fend off the takeover attempt Increase the costs of making the

acquisitions

Causes incumbent management tobecome entrenched while reducing thechances of introducing a newmanagement team

May require asset restructuring Institutional investors oppose the use of

defense tactics


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How does corporate governancediffer in Germany and Japan?


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International CorporateInternational Corporate

Governance:Governance:Owner and manager are often the same inOwner and manager are often the same in

private firmsprivate firms Public firms often have a dominantPublic firms often have a dominant

shareholder, frequently a bankshareholder, frequently a bank Frequently there is less emphasis onFrequently there is less emphasis on

shareholder value than in U.S. firms,shareholder value than in U.S. firms,although this may be changingalthough this may be changing

GermanyGermany


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Governance:Governance:Medium to large firms have a two-tieredMedium to large firms have a two-tiered

boardboard vorstand monitors and controls managerialvorstand monitors and controls managerial

decisionsdecisions aufsichtsrat selects the Vorstandaufsichtsrat selects the Vorstand

employees, union members and shareholdersemployees, union members and shareholdersappoint members to the Aufsichtsratappoint members to the Aufsichtsrat

GermanyGermany


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Governance:Governance:Obligation, family and consensus areObligation, family and consensus are

important factorsimportant factorsBanks (especially main bank) are highlyBanks (especially main bank) are highly

influential with firms managersinfluential with firms managersKeiretsus are strongly interrelated groupsKeiretsus are strongly interrelated groups

of firms tied together by cross-of firms tied together by cross-shareholdingsshareholdings

JapanJapan


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Governance:Governance:Other characteristics:Other characteristics:

powerful government interventionpowerful government intervention

close relationships between firms andclose relationships between firms and

government sectorsgovernment sectors

passive and stable shareholders who exertpassive and stable shareholders who exert

little controllittle control

virtual absence of external market forvirtual absence of external market for

corporate controlcorporate control

JapanJapan


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Corporate Governance andCorporate Governance and

Ethical BehaviorEthical Behavior

In the U.S., shareholders (in the capitalIn the U.S., shareholders (in the capitalmarket stakeholder group) are viewed asmarket stakeholder group) are viewed asthe most important stakeholder groupthe most important stakeholder group

which are served by the board ofwhich are served by the board ofdirectorsdirectors

Hence, the focus of governanceHence, the focus of governancemechanisms is on the control ofmechanisms is on the control ofmanagerial decisions to ensure thatmanagerial decisions to ensure thatshareholders interests will be servedshareholders interests will be served

It is important to serve the interestsIt is important to serve the interestsof the firms multiple stakeholderof the firms multiple stakeholdergroups!groups!

Capital MarketCapital Market

StakeholdersStakeholders


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Product market stakeholders (customers,Product market stakeholders (customers,suppliers and host communities) andsuppliers and host communities) andorganizational stakeholders (managerialorganizational stakeholders (managerialand non-managerial employees) are alsoand non-managerial employees) are alsoimportant stakeholder groupsimportant stakeholder groupsProduct MarketProduct Market





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Although the idea is subject to debate,Although the idea is subject to debate,some believe that ethically responsiblesome believe that ethically responsiblecompanies design and use governancecompanies design and use governancemechanisms that serve all stakeholdersmechanisms that serve all stakeholdersinterestsinterests

Importance of maintaining ethicalImportance of maintaining ethicalbehavior through governancebehavior through governancemechanisms is seen in the example ofmechanisms is seen in the example ofEnron and Arthur AndersenEnron and Arthur Andersen

Product MarketProduct Market


OrganizationalOrganizational




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Ch11 Discussion Blue