Chapter 3 – Corporate Governance in Global Operations: Design and Actions

A. 1. Global operations influence corporate governance

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MNCs have extended their presence all over the globe, conducting a multitude of activities for a multitude purposes. MNCs have had to manage the various forces – geographic, product, market and technology – that interact and become more complex on a global scale.

 

The complexity of an MNC faces is directly related to its geographic dispersion for several reasons including but not limited to its dependence on (a) foreign sales and value creation inputs, (2) the diverse institutional and task environments within which it operates, (3) and increased competitive pressures for cooperation and coordination across geographically distributed operations.

Corporate accountability is concerned with the extent to which a company is transparent in its corporate activities. Central to corporate accounting is the widespread availability of relevant, reliable and accurate information about a firm’s performance, financial position, investment, opportunities, governance, value and risk.

 

  Accountability affects the investment and value of firm’s in three ways:1.  By  identifying  promising  investment opportunities2.  By  guiding  managers  to  direct  resources toward “good” projects and way from those that primarily  benefit  them  over  shareholders  and stakeholders3.  By  reducing  information  asymmetries  among investors and among the various stakeholders

Information-processing theory holds that a firm s are open social systems that interface with internal and environmental sources of complexity and a firm must develop information-processing mechanisms capable of dealing with the resulting complexity.For corporate governance, the ability of the board to vigilantly monitor the CEO is a function of its access to information and its power to exert control. 

• Both  information-processing  and  agency theory  are  ultimately  with  the  efficient organization  and  distribution  of information,  and  thus  with  information reporting    and  decision  making accountability

• Agency  theory  holds  that  organizations can  invest  in  information  system  in order to  enhance  accountability  and  hence control opportunism

Information-processing theory maintains that organizations will be more effective when there is harmony between their information-processing requirements and their information-processing capacity

Information-processing capacity is critical to accountability, which requires the development of a system for gathering, interpreting and synthesizing information in the context of organizational decision making

Globalization Scale and Corporate Governance

Globalization is defined as the level or quantity of an MNC active foreign direct investment (FDI) over which the parent firm maintain control. As globalization scale increases, information processing and agency demands increase as well.

Pfeiffer and Salancik posit that increases in the number of dependencies between a firm and its external environment are likely to lead to increased organization ties.

Sander and Carpenter argue that international firms often handle increased and varied dependencies by adding board members who increase the overall information-processing capacity of the group either because they have valuable experience with the international constituencies or some particular expertise that applies

A subsidiary-level board of directors presumably governs that subsidiary as a legal entity, although there is considerable variation in local and legal requirements and how parent and subsidiary management choose to structure the roles, responsibility and use of such boards

Corporate board frequently establish various specialized committees to fulfill certain specific duties such as auditing, selecting top management, monitoring conducts and ethics, and deciding executive compensation among others.

Board composition (proportion of insider vs. outsider members). Outside directors with strong network backgrounds and with demanded are often a cost effective solution. At the corporate level, outside directors can contribute to the MNC by networking with global suppliers, buyers and distributors; at the subsidiary level, outside directors can network with local regulators, politicians, competitors and other business community members.

C. Foreign Responsiveness and Corporate Governance

Required adaptation or responsiveness to foreign market unique demands or market conditions influences corporate governance and accountability for several ways:1.Increased local responsiveness requirements lead to higher information-processing costs2.Subsidiary executives are essentially agents of the parent; this agency cost increases when required local responsiveness rises3. Local responsiveness may increase the difficulty of maintaining accountability

Required local responsiveness may influence corporate-level board size. Higher required responsiveness is often associated such MNCs that are:1.Pursuing market share and competitive power in host country

2.Establishing presence in different foreign markets and seeking transnational market power

3. Diversifying and financial risk by investing in foreign countries

4. Exploring production factor advantages in various host countries

5. Seizing pre emptive opportunities in emerging market

6. Enhancing learning in partnership with indigenous firms

7. Improving host country-specific experience

8. Gaining footholds by actively participating in local environments

 

The I-R framework holds that required local responsiveness will be effectively fulfilled if an MNC has;

1) superior abilities to reduce risk and manage uncertainties

2) rich international experience

3) competency in local operations and the organizational

expertise needed for such operations

4) interpersonal and inter-organizational networking abilities

with local business communities.

Having  a  larger  board,  especially  one  with directors  who  have  international  experience in  managing  risk  and  uncertainty  and  who have  international  market  knowledge  can significantly  help  an MNC  accommodate  the above  needs  without  losing  corporate governance  effectiveness.  Therefore,  as required  local  responsiveness  increases, corporate level board size is likely to increase.

An increased need for local responsiveness may escalate the activity and independence of an MNC's subsidiary boards for several reasons. First, one of a subsidiary boards most active roles is fostering local responsiveness. Krigers survey (1998) identifies the following common activities in achieving this goal:1.guiding and encouraging management in dealing with local legal conditions2.advising management on local country developments3.Appraising and reviewing local subsidiary operations.44.Helping subsidiary management anticipate necessary strategic changes. reviewing local subsidiary operations.

Subsidiary boards should be active in approving budgets and  short  terms  strategies,  monitoring  operation performance,  implementing  corrective  measures, participating  in  developing  the  subsidiaries  strategic plan  and  appraising  and  mitigating  the  political  and economic  risk  inherent  to  local  projects.The  number  of  outside  directors  at  each  subsidiary board  is  also  expected  to  increase  when  there  is  a stronger  demand  for  local  responsiveness.Having  outside  directors  who  have  network  ties  with strategically  related  firms  can  contribute  to  firm performance in an uncertain environment.

Incentive-based  discipline    (IBD)  exist when  the  parent  firm  employs  financial  and non-financial  measures  such  as  bonuses  , shareholding,  name  recognition,  merit adjustment, rewards, promotions  and penalties from  senior  subsidiary  managers  to  improve subsidiary  transparency and accountability. The IBD system links these measures with:1.  Quality  of    subsidiary  reporting,  including   measurement  principles,  timeliness  and credibility of disclosure.

2.  Quality  of  information  dissemination  to headquarters  and  regional  headquarters  as well as corporate members located in other countries and regions

3. Quality of information reporting concerning  the off-the-balance  sheet  activities  such  as  pooled investment    schemes  ,  insider  trading  activities, executives    internal  accounts,  reinvoicing  of intra-corporate  transactions,  transfer  pricing practices,  entertainment  expenses  for government  officials  and    facilitation  fees  for new projects among others.

IBD  becomes  particularly  essential  to  this type of MNC for two reasons: First,  process  and  bureaucratic  controls,  two commonly used  control schemes  are often difficult for  every  global  MNC’s.  process  control  requires direct  personal  surveillance  and  high  levels  of management direction and intervention. Second,  using  them  is  not  realistic  for  financial  , temporal  or  labor  costs  reason.  This  type  of MNC cannot  efficiently  dispatch  internal  teams  to  each individual  subsidiary  abroad  to  conduct  frequent  , thorough and rigorous auditing.

Global competition and corporate governance

Rapid technological development, reduction of cross border  trade  and  non-trade  barriers,  shortened  industry life  cycle,  and  increasingly    sophisticated  global consumption  have  considerably  increased  global competition. This occurs as: (i)  rivals  use  the  same  competitive  strategies    or  place emphasis  on  the  same  competitive  advantage  blocks,  (ii) product,  business  and  market  portfolios  become  more similar as MNC’s globally compete in similar business lines.

Global competition influences corporate governance and accountability in several ways. First,  as  global  competition  increases,  corporate governance  needs  to  foster  a  more  stimulating environment that motivates senior  executives  to strive to excel at global competition. Second,  global  competition  increases  the pressure  to  separate  the  CEO  position  from  the board chairmanship, corporate transparency and accountability  even  more  critical  in  the  eye  of shareholders,  consumers,  creditors,  suppliers, and partners.

Third,  when  global  competition  is  fierce,  the mechanisms  for  monitoring  the  agency’s global organizing and decision making  should be largely output-based, rather than behavior-based.

Finally, global competition   provokes a greater   need for the coordination of the  MNC’s two-tiered governance  system.

An  MNC’s  executive  pay  schemes  are  an important part of corporate governance.

• CEO,  should  be  paid  more  than  other executives  who  do  not  manage  such complexity  arising  from  global  competition because  the  agent’s  ability  is  a  scarce  and valuable  resource.  Corporate  board  may implement  a  ‘’long-term  pay’’  schedule  for the CEO to shape his or her commitment and behavior.  Long-term  pay  for  the  CEO  often works  because  it  ameliorates  the  board’s burden of gathering information in the face of such  geographic  dispersion  of  sales,  assets, capital, investments, and personnel. 

• Long-term  incentive  plans  encourage CEOs  to  monitor  themselves,  converge their  interests  with  the  principal’s interests,  and  streamline  the implementation  of  long  –haul  business strategies  for  more  effective  global competition.

• The  above  logic  applies  to  subsidiary executives as well.

• Higher  pay  and  greater  long-term  incentives offered  to  subsidiary  executives  should make it  less  likely    for  such  executives  to  take personal  advantage  of  the  information asymmetry  resulting  from  diversified  global competition.  Country  managers  have considerable  control  over  local  operations  in competitive  markets,  their  pay  includes significantly greater performance incentives.

Global  competition  may  also  reduce  duality and  inbreeding  in  the  parent-level  governance system. Duality is the situation in which the CEO is also  the  board  chairperson.  Inbreeding    occurs when a retired CEO joins the board.

Global competition increases the duty burden for both the CEO and board chairperson positions.

CEO  is  able  to  concentrate on designing and monitoring viable  strategies for global competition while  the  chairperson  concentrates  on  designing and monitoring corporate governance.

Inbreeding,  may      hinder  the  appropriate governance  needed  for  effective  global competition  because  it  hampers  the  board’s ability  to  detect  and  correct  governance problems  such  as  fraud  and  illicit  activities. Inbreeding  also  increases  emotional dependence    and  attitudinal  dependence  of some board members on key executives.Global  competition  increases,  duality  and inbreeding are likely to diminish.

International experience and corporate governance

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Experience is a prime source   of learning ; it leads to country-specific and/ or international knowledge  that  helps  MNC’s  to  reduce transaction  costs  that  arise  during  global expansion.  Two  types  of  experience  are especially  general    international  operations experience and country –specific experience.