Strategic management Ch 10 Corporate Governance Lecture
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Transcript of Strategic management Ch 10 Corporate Governance Lecture
8/3/2019 Strategic management Ch 10 Corporate Governance Lecture
http://slidepdf.com/reader/full/strategic-management-ch-10-corporate-governance-lecture 1/34
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Hitt Chapter 10Corporate Governance
MGNT428
Business Policy & StrategyDr. Gar Wiggs,Instructor
8/3/2019 Strategic management Ch 10 Corporate Governance Lecture
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Knowledge Objectives
• Studying this chapter should provide you with the strategic management knowledge needed to:
– Define corporate governance and explain why it is used to monitor and control managers’ strategic decisions.
– Explain why ownership has been largely separated from managerial control in the modern corporation.
– Define an agency relationship and managerial opportunism and
describe their strategic implications. – Explain how three internal governance mechanisms —ownership
concentration, the board of directors, and executive compensation —are used to monitor and control managerial decisions.
8/3/2019 Strategic management Ch 10 Corporate Governance Lecture
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Knowledge Objectives (cont’d)
• Studying this chapter should provide you with the strategic management knowledge needed to:
Discuss the types of compensation executives receive and their effects on strategic decisions.
Describe how the external corporate governance mechanism —the market for corporate control —acts as a
restraint on top- level managers’ strategic decisions. Discuss the use of corporate governance in international
settings, in particular in Germany and Japan.
Describe how corporate governance fosters ethical strategic decisions and the importance of such behaviors on the part of top-level executives.
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Corporate Governance
• Corporate governance is:
– A relationship among stakeholders used todetermine and control the strategic direction
and performance of organizations
– Concerned with making strategic decisionsmore effectively
– Used to establish order between a firm’sowners and its top-level managers whoseinterests may be in conflict
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Internal GovernanceMechanisms
• Ownership Concentration – Relative amounts of stock owned
by individual shareholders and
institutional investors• Board of Directors
– Individuals responsiblefor representing the firm’s
owners by monitoring top-levelmanagers’ strategic decisions
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Internal Governance Mechanisms
• Executive Compensation
– Use of salary, bonuses, andlong-term incentives to align
managers’ interests withshareholders’ interests
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External Governance Mechanisms
• Market for CorporateControl
– Purchase of a firm that is
underperforming relative toindustry rivals in order toimprove its strategic
competitiveness
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Separation of Ownership and
Managerial Control• Basis of the Modern Corporation
– Shareholders purchase stock, becoming
residual claimants
– Shareholders reduce risk by holdingdiversified portfolios
– Professional managers are contracted toprovide decision making
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Separating Ownership and
Managerial Control• Modern public corporation form leads to
efficient specialization of tasks:
– Risk bearing by shareholders
– Strategy development and decision making bymanagers
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An Agency Relationship
Figure 10.1
Hire
and create
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Agency Relationship Problems
• Principal and agent have divergent interests andgoals
• Shareholders lack direct control of large, publicly
traded corporations• Agent makes decisions that result in the pursuit
of goals that conflict with those of the principal
• It is difficult or expensive for the principal toverify that the agent has behaved appropriately
• Agent falls prey to managerial opportunism
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Managerial Opportunism
• The seeking of self-interest with guile(cunning or deceit)
• Managerial opportunism is:
– An attitude (inclination)
– A set of behaviors (specific acts of self-interest)
• Managerial opportunism prevents themaximization of shareholder wealth (theprimary goal of owner/principals)
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Response to ManagerialOpportunism
• Principals do not know beforehand whichagents will or will not act opportunistically
• Thus, principals establish governance andcontrol mechanisms to prevent managerialopportunism
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Examples of the Agency Problem
• Possible Problems – Product diversification
– Increased size, and relationship of size to managerial
compensation – Reduction of managerial employment risk
• Use of Free Cash Flows
– Managers prefer to invest these funds in additionalproduct diversification (see above)
– Shareholders prefer the funds as dividends so theycontrol how the funds are invested
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Manager and Shareholder Risk and
Diversification
Figure 10.2
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Agency Costs and GovernanceMechanisms
• Principals may engage in monitoringbehavior to assess the activities anddecisions of managers – However, dispersed shareholding makes it difficult
and inefficient to monitor management’s behavior
• Boards of Directors have a fiduciary duty
to shareholders to monitor management – However, Boards of Directors are often accused of
being lax in performing this function
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Governance Mechanisms
• Large block shareholdershave a strong incentive tomonitor management
closely: – Their large stakes make it worththeir while to spend time, effort andexpense to monitor closely
– They may also obtain Board seatswhich enhances their ability to
monitor effectively
• Financial institutions arelegally forbidden fromdirectly holding board seats
OwnershipConcentration (a)
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Governance Mechanisms (cont’d)
• The increasing influence ofinstitutional owners (stockmutual funds and pension
funds) – Have the size (proxy voting
power) and incentive(demand for returns to funds)
to discipline ineffective top-level managers
– Can affect the firm’s choice of
strategies
OwnershipConcentration (b)
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Governance Mechanisms (cont’d)
• Shareholder activism:
– Shareholders can convene todiscuss corporation’s direction
– If a consensus exists,shareholders can vote as ablock to elect their candidatesto the board
– Proxy fights – There are limits on
shareholder activism availableto institutional owners in
responding to activists’ tactics
OwnershipConcentration (c)
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Governance Mechanisms (cont’d)
• Board of directors – Group of elected individuals that
acts in the owners’ interests to
formally monitor and control the
firm’s top-level executives
• Board has the power to:
– Direct the affairs of the organization
– Punish and reward managers
– Protect owners from managerialopportunism
OwnershipConcentration
Board of Directors
(a)
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Governance Mechanisms (cont’d)
• Composition of Boards: – Insiders: the firm’s CEO and
other top-level managers
– Related Outsiders: individuals
uninvolved with day-to-dayoperations, but who have arelationship with the firm
– Outsiders: individuals who
are independent of the firm’sday-to-day operations andother relationships
OwnershipConcentration
Board of Directors(b)
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Governance Mechanisms (cont’d)
• Criticisms of Boards ofDirectors include: – Too readily approve managers’ self -
serving initiatives
– Are exploited by managers withpersonal ties to board members
– Are not vigilant enough in hiring andmonitoring CEO behavior
– Lack of agreement about the
number of and most appropriaterole of outside directors
OwnershipConcentration
Board of Directors(c)
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Governance Mechanisms (cont’d)
• Enhancing the effectivenessof boards and directors: – More diversity in the backgrounds
of board members – Stronger internal management and
accounting control systems
– More formal processes to evaluatethe board’s performance
– Adopting a “lead director” role – Changes in compensation of
directors
OwnershipConcentration
Board of Directors(d)
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Governance Mechanisms (cont’d)
• Forms of compensation: – Salary, bonuses, long-term
performance incentives, stockawards, stock options
• Factors complicatingexecutive compensation: – Strategic decisions by top-level
managers are complex, non-routine
and affect the firm over an extendedperiod
– Other variables affecting the firm’s
performance over time
OwnershipConcentration
Board of Directors
Executive
Compensation (a)
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Governance Mechanisms (cont’d)
• Limits on the effectivenessof executive compensation:
– Unintended consequences ofstock options
– Firm performance not asimportant than firm size
– Balance sheet not showingexecutive wealth
– Options not expensed at thetime they are awarded
OwnershipConcentration
Board of Directors
Executive
Compensation (b)
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Governance Mechanisms (cont’d)
• Individuals and firms buy ortake over undervaluedcorporations – Ineffective managers are usually
replaced in such takeovers
• Threat of takeover maylead firm to operate moreefficiently
• Changes in regulationshave made hostiletakeovers difficult
OwnershipConcentration
Board of Directors
Executive
Compensation
Market forCorporate Control (a)
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Governance Mechanisms(cont’d) • Managerial defense tactics
increase the costs ofmounting a takeover
• Defense tactics mayrequire:
– Asset restructuring
– Changes in the financialstructure of the firm
– Shareholder approval
• Market for corporate
control lacks the precision
OwnershipConcentration
Board of Directors
Executive
Compensation
Market forCorporate Control (b)
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International Corporate
Governance
• Germany – Owner and manager are often
the same in private firms
– Public firms often have a
dominant shareholder,frequently a bank
– Frequently there is lessemphasis on shareholder value
than in U.S. firms, although thismay be changing
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Responsible for the functionsof direction and management
Responsible for appointingmembers to the Vorstand
Responsible for appointingmembers to the Aufsichtsrat
International Corporate Governance
Vorstand
Aufsichtsrat
Employees Unionmembers
Shareholders
Germany: (Two-tiered Board)
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International Corporate Governance:
• Japan – Important governance factors:
• Obligation
• “Family” • Consensus
– Banks (especially “main
bank”) are highly influential with
firm’s managers
– Keiretsus: strongly interrelated
groups of firms tied together bycross-shareholdings
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International Corporate Governance
• Japan (cont’d)
– Other governance characteristics:
• Powerful government intervention
• Close relationships between firms andgovernment sectors
• Passive and stable shareholders who exert
little control• Virtual absence of external market for
corporate control
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Capital Market
Stakeholders
Governance Mechanisms and
Ethical BehaviorIt is important to serve the interests of thefirm’s multiple stakeholder groups!
• Shareholders in this group are
viewed as the most importantstakeholder group
• The focus of governancemechanisms is to control
managerial decisions to assureshareholder interests
• Interests of shareholders isserved by the Board of Directors
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Product MarketStakeholders
Governance Mechanisms andEthical Behavior (cont’d)
• Product market stakeholders
(customers, suppliers and hostcommunities) andorganizational stakeholdersmay withdraw their support of
the firm if their needs are notmet, at least minimally
Capital Market
Stakeholders
It is important to serve the interests of thefirm’s multiple stakeholder groups!
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Organizational
Stakeholders
Governance Mechanisms andEthical Behavior (cont’d)
• Some observers believe that
ethically responsible companiesdesign and use governancemechanisms that serve allstakeholders’ interests
• Importance of maintainingethical behavior is seen in theexamples of Enron, WorldCom,HealthSouth, Tyco, Adelphi, andAhold NV
Product MarketStakeholders
Capital Market
Stakeholders
It is important to serve the interests of thefirm’s multiple stakeholder groups!