Chapter 1 - Corporate Governance in International Business:Concepts and Mechanisms Corporate Governance = (OECD) is the system by which business corporations are directed and control.

= specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholder: spells out the rules and procedures for making decisions on corporate affairs. = requires developing internal processes and structures within a firm to minimize agency costs between shareholders.= structures serve to motivate managers to maximize firm value instead of pursuing personal objectives and to ensure that

minority shareholders receive reliable information about the value of the firm and the company’s managers and large shareholders

do not cheat them out of the value of their investment.

• Effective corporate governance is also important to social welfare. A good corporate governance however goes beyond company standards and effort.

• In modern corporations like United States and in United Kingdom a primary objective of corporate governance is to ensure that the interest of top level managers are aligned with the interest of the shareholders.

Agency Theory = implies that entrepreneurs, shareholders, and managers should always find ways to minimize the loss value that arises from the separation of ownership

= is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work.

Two Main Problems that are Concerns by the Agency Theory

1. The first is the agency problem that arises when:a. The desires or goals of the principal and agent conflictb. It is difficult or expensive for the principal to verify that the agent has behave appropriately

2. Risk-sharing problem that arises when the principal and agent have different attitudes toward risk

Corporate Governance in Publicly Traded MNCs generally contains related Tiers:

1. Parent-level corporate governance - how the parent company’s rights, power and responsibilities are divided and monitored.

2. Subsidiary-level corporate governance – how foreign subsidiaries that have their own board of directors deal with their shareholders and other local stakeholders while simultaneously answering to and integrating with the parent firm.

 

• Subsidiaries with their own board of directors are either independently listed and traded on foreign stock exchanges or they are not listed on exchanges but meet either a host country’s legal requirements or a parent firm’s strategic consideration for establishing such boards.

• Subsidiaries with their own board of directors are generally not wholly owned by the parent MNC.

First–tier governance influences the second-tier through ownership holding, operational coordination, corporate support and performance monitoring.

 Second-tier governance in turn channels

back to the first-tier through advice provision, governance sharing, and information reporting and directorate expansion.

First tier governanceParent level

•Ownership holding•Operational coordination• Corporate support•Performance monitoring

•Advising agents•Governance sharing•Information reporting•Directorate expansion

Second tier governance: Subsidiary level

Corporate governance is not synonymous with organizational governance; it is just part of it. Organizational governance comprises both managerial governance and corporate governance. Corporate governance involves governance and control of affairs while managerial governance emphasizes those internal processes and structures that regulate operational decisions and business activities undertaken by an MNCs various subunits.

Managerial governance includes the system that bring about internal adherence within the corporation to a set of strategic goals designed by top management through using corporate power or authority. It is a more direct intervention involving output monitoring, bureaucratic monitoring and cultural monitoring.

Corporate governance that often uses ownership concentration, board composition, board leadership, and executive compensation.

Main Distinctions between MNCs and Domestic Firms with Respect to Corporate Governance

1. MNCs must deal with more demanding and more diverse global shareholders and stakeholders

2. MNCs have more complex governance structures that are subject to more institutional and strategic constraints

3. MNCs have multi-tier or multi level governance systems which jointly constitute their overall corporate governance framework

4. MNCs must establish and execute a larger number of governance mechanisms and instruments to cope with globalizing needs and cross-country differences in governance norms5. MNCs must configure corporate governance with a multitude of much more complicated strategies, strategies and environments6. MNCs face heterogeneous corporate governance standards institutionalized by different countries in which they invest and operate

Mechanisms of Corporate Governance

1. Market-based governance mechanisms includesa. Ownership Concentration = defined by the number of large-block shareholders as well as by the proportion of share they own. Continued cross-border investment means that international institutional investors become increasingly influential or powerful in shaping board and shareholder meetings.

b. Board Composition = proportion of “inside” directors (executive directors) vs. “outside” directors (non-executive directors), also has strong implications on corporate because the board is essentially the “guardian” of the principal’s interest. Inside directors participate in the decision processes and are able to access inside information and can easily influenced by the CEO in the decision making process. Outside directors can be more effective boards and profound evaluations of strategic decisions and management behavior than inside directors.

In general, outside directors should be competent, committed and have character.

* Competence includes experience and expertise in both business and management.

* Commitment is the availability to fulfill important duties such as learning about the business and company, preparing for meetings and serving on committees.

* Character involves possessing a good personality, vision, enthusiasm, moral integrity, and interpersonal skills.

c. Market Discipline = it is an external mechanisms, namely an open market for corporate control, which becomes active when a firms internal control fail, its performance is poor, and /or its management is ineffective. For example, poor market performance as well as weak corporate governance of Peoples of led to Oracles $9.2 billion hostile takeover bid in 2004. a more globalized company is likely to be watched by more companies around the world.

Put alternatively, there will be more potential buyers interested in taking over this poor performing firm. Despite its poor financial performance for years some powerful companies from other countries may initiate a hostile takeover to acquire the company in trouble. Such takeover could be a more cost effective way for foreign companies to acquire some strategic assets of other company in a target host country. 

d. Board Chairmanship = involves whether or not a firm’s CEO is also the board of directors chairperson. The central role of the chairperson is to monitor top management behavior, this sort of CEO “duality” is likely to seriously hinder management accountability and may inhibit the board’s ability to function properly as an independent body. Agency theory advocates the separation of these two positions to protect shareholder.

 

Implications of Chairmanship in International Expansion:

• As an MNC globalizes, a board chairperson’s international experience becomes more important

• As an MNC’s global operations become significantly complex, there will be a greater pressure the MNC’s CEO from board chairmanship

e. Board Size = Drawbacks when boards are either too small or too large. Too small implies a higher agency cost since CEO is better able to influence board meetings and decisions; the board also suffers from a shortage of services and expertise. When a board is too large, despite having a bigger and more diversified pool of expertise and resources, it is also more likely to have factions that increase group conflict.

f. Management Remuneration = can be either behavior-based or outcome-based. Behavior-based performance is a governance mechanism that seeks to align the interests of managers and owners through salaries, bonuses, and long-term incentive compensations such as stock awards and option. Outcome-based compensation plans that reward the agent’s performance instead of action are preferred.

Agreed Compensation Standards Across Countries:• Executive remuneration should reflect

executive responsibilities• Remuneration should be reasonable and

comparable with market standards• Incentives schemes should be clearly

linked to performance benchmarks

Culture-based governance• Market-based governance mechanisms are

necessary but instilling the right culture to support corporate governance is essential. Culture-based governance which comprises (i)governance culture (ii) corporate integrity, sets the moral tone for governance and accountability.

• Governance culture refers to the statements, visions, slogans, values, role models and social rituals that are unique to, and used by, an MNC board members and key executive.

• Vision and commitment from key executive and board members also play a significant role in improving governance and accountability.

• Ethical leadership sets moral standards for the organization.

• Role models sets a positive ethical climate because humans as social beings are influence by the other humans and generally strive to ‘fit in’.

• Governance and accountability also necessitate corporate integrity which is concerned with the disposition and behavior directed at realizing the wholeness of the organization. Apart from a formal structure to educate, detect and rectify illicit behaviors, an organization may also established committees to improved governance and transparency; these committees can draft codes of conduct and educate and train on compliance procedures. Lastly, transparency throughout an entire organization reduces the opportunity for employees to engage in illicit behaviors.

Discipline based governance It comprises the following:(i) executive penalty(ii) internal auditing(iii) conduct code(iv) ethics program first, executive compensation is not enough

to monitor and control agents action, it also requires an executive penalty scheme. Financial or non financial penalties for non performance can be alternatives or supplements to incentive schemes.

•Penalties may include base salary reduction or freeze, bonus elimination, fine payment, power downsizing and most harshly total dismissal. With such penalties in place, agents are less likely to gamble with the firms assets. Thus, penalties can help better align the interest of shareholders and management

• Independent auditing of corporate affairs is a prerequisite for discipline-based governance: internal and external independent auditing can identify misconduct that can be penalized. External auditors should be appointed not by the management but by shareholders in their general meeting. The auditing committee should monitor the integrity of the financial statements, review significant financial reporting judgments and attempt to identify any misconduct beyond financial statements.

• Conduct codes make expectations about legal and ethical behavior clear, increase the likelihood of detection, assure the punishments of transgressions, reward desire behaviors and discipline those who engage in illegal behavior.• Codes may contain general precepts, mandate specific practices, provide clearly stated provisions to address legalities, deal with ethical concerns and stipulate methods of investigation.

• Lastly, ethics program are organizational control systems that encourage shared ethical goals and rule compliance. It is important not to delegate too much discretionary authority offshore executive in case they are prone to engaging in misconduct. For a reporting mechanism to be effective it should be accompanied by adequate policies on confidentially and non realization in order to foster open communication when ordinary channels fail.