corporategovernance (1)

7/29/2019 CorporateGovernance (1)

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Transparency 10-1

Chapter 10

Corporate Governance

Michael A. HittR. Duane Ireland

Robert E. Hoskisson

1999 South-Western College Publishing


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Competitiveness

Chapter 3

Internal

Environment

Chapter 2

External

EnvironmentThe Strategic

Management

Process

Strategic Intent

Strategic Mission

Strategic

Competitiveness

Above Average

Returns

Feedback

Strategy Formulation

Chapter 4

Business-Level

Strategy

Chapter 5

Competitive

Dynamics

Chapter 6

Corporate-Level

Strategy

Chapter 8

International

Strategy

Chapter 9

Cooperative

Strategies

Chapter 7

Acquisitions &

Restructuring

Strategic

Inputs

Strategic

Actions

Strategic

Outcomes


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Competitiveness

Chapter 3

Internal

Environment

Chapter 2

External

EnvironmentThe Strategic

Management

Process

Strategic Intent

Strategic Mission

Strategic

Competitiveness

Above Average

Returns

Feedback

Strategy Formulation

Chapter 4

Business-Level

Strategy

Chapter 5

Competitive

Dynamics

Chapter 6

Corporate-Level

Strategy

Chapter 8

International

Strategy

Chapter 9

Cooperative

Strategies

Chapter 7

Acquisitions &

Restructuring

Chapter 10

Corporate

Governance

Chapter 11

Structure

& Control

Chapter 12

Strategic

Leadership

Chapter 13

Entrepreneurship

& Innovation

Strategic

Inputs

Strategic

Actions

Strategic

Outcomes


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Corporate Governance is a relationship amongstakeholders that is used to determine and control the

strategic direction and performance of organizations



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Concerned with identifying ways to ensure that

strategic decisions are made effectively



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Used in corporations to establish order between thefirms owners and its top-level managers



Concerned with identifying ways to ensure that

strategic decisions are made effectively



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Separation of Ownership and Managerial Control



Basis of the modern corporation




Basis of the modern corporationShareholders purchase stock, becoming...

Residual Claimants





- Shareholders reduce risk efficiently by holdingdiversified portfolios

Shareholders purchase stock, becoming...

Residual Claimants







Residual Claimants

Professional managers contract to provide decision-

making







Residual Claimants


making

Modern public corporation form leads to efficient

specialization of tasks






making

- Risk bearing by shareholders

- Strategy development and decision-making bymanagers



Residual Claimants

Modern public corporation form leads to efficient

specialization of tasks




Agency Theory

An agency relationship exists when:




Shareholders

(Principals)

Firm Owners

Agency Theory




Shareholders

(Principals)

Firm Owners

Managers(Agents)

Decision

Makers

Hire

Agency Theory




Shareholders

(Principals)

Firm Owners

Agency Relationship

Risk Bearing Specialist

(Principal)

Managers(Agents)

Decision

Makers

which creates

Managerial Decision-Making Specialist

(Agent)

Hire

Agency Theory



The Agency problem occurs when:

- The desires or goals of the principal and agent conflict

and it is difficult or expensive for the principal to

verify that the agent has behaved appropriately

Agency Theory







Example:Overdiversification because increased product

diversification leads to lower employment risk

for managers and greater compensation

Agency Theory


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Solution: Principals engage in incentive-based performance

Example:Overdiversification because increased product

diversification leads to lower employment risk

for managers and greater compensation

contracts, monitoring mechanisms such as the

board of directors and enforcement mechanisms

such as the managerial labor market to mitigate

the agency problem

Agency Theory


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Risk

Level of Diversification

Manager and Shareholder Risk and Diversification


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Risk



Dominant

Business

Unrelated

Businesses

Related

Constrained

Related

Linked


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Risk



Dominant

Business

Unrelated

Businesses

Related

Constrained

Related

Linked

Shareholder

(Business)

Risk ProfileS

A


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Risk



Dominant

Business

Unrelated

Businesses

Related

Constrained

Related

Linked

Shareholder

(Business)

Risk Profile

Managerial

(Employment

) Risk ProfileS

M

AB


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Principals may engage in monitoringbehavior to assessthe activities and decisions of managers

- However, dispersed shareholding makes it difficult andand inefficient to monitor managements behavior

Agency Theory


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Principals may engage in monitoringbehavior to assessthe activities and decisions of managers

- However, dispersed shareholding makes it difficult andand inefficient to monitor managements behavior

For example: Boards of Directors have a fiduciary

duty to shareholders to monitor

management

- However, Boards of Directors are often accused ofbeing lax in performing this function

Agency Theory


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Governance Mechanisms

Ownership Concentration

Boards of Directors

Executive Compensation

Market for Corporate Control

Multidivisional Organizational Structure


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Ownership Concentration- Large block shareholders have a strong incentive to

monitor management closely



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Ownership Concentration- Large block shareholders have a strong incentive to


- Their large stakes make it worth their while to spend

time, effort and expense to monitor closely



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time, effort and expense to monitor closely

- Large block shareholders have a strong incentive to

- Their large stakes make it worth their while to spend

- They may also obtain Board seats which enhancestheir ability to monitor effectively (although financial

institutions are legally forbidden from directly holding

board seats)



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Boards of Directors



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Boards of Directors- Insiders

- Related Outsiders

- Outsiders



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Boards of Directors

- Review and ratify important decisions

- Insiders

- Related Outsiders

- Outsiders



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Boards of Directors


- Set compensation of CEO and decide when to

replace the CEO

- Insiders

- Related Outsiders

- Outsiders



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Boards of Directors


- Set compensation of CEO and decide when to

replace the CEO

- Lack contact with day to day operations

- Insiders

- Related Outsiders

- Outsiders



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Recommendations for more effectiveBoard Governance



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Recommendations for more effective

Board Governance

- Increase diversity of board members backgrounds

- Strengthen internal management and accounting

control systems

- Establish formal processes for evaluation of theboards performance



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Salary, Bonuses, Long term incentive compensation




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- Executive decisions are complex and non-routine

- Many factors intervene making it difficult to establish

for outcomeshow managerial decisions are directly responsible


- In addition, stock ownership (long-term incentive

market changes which are partially beyond their control

compensation) makes managers more susceptible to



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- Executive decisions are complex and non-routine

- Many factors intervene making it difficult to establish

for outcomeshow managerial decisions are directly responsible


- In addition, stock ownership (long-term incentive

market changes which are partially beyond their control

compensation) makes managers more susceptible to

Incentive systems do not guarantee that managers

make the right decisions, but they do increase the

likelihood that managers will do the things for which

they are rewarded



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Designed to control managerial opportunism




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- Corporate office and Board monitor business-unit

- Increased managerial interest in wealth maximization

managers strategic decisions




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- Corporate office and Board monitor managers


strategic decisions



M-form structure does not necessarily limit corporate-

level managers self-serving actions


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strategic decisions




- May lead to greater rather than less diversification



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strategic decisions




- 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



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G M h i


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Operates when firms face the risk of takeover when

they are operated inefficiently


G M h i


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- Changes in regulations have made hostile takeovers difficult

- Many firms began to operate more efficiently as a result of

- The 1980s saw active market for corporate control, largely

as a result of available pools of capital (junk bonds)

the threat of takeover, even though the actual incidence of

hostile takeovers was relatively small


G M h i


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The market for corporate control acts as an important

source of discipline over managerial incompetence and

waste

- Changes in regulations have made hostile takeovers difficult

- Many firms began to operate more efficiently as a result of

- The 1980s saw active market for corporate control, largely

as a result of available pools of capital (junk bonds)

the threat of takeover, even though the actual incidence of

hostile takeovers was relatively small


I t ti l C t G


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International Corporate Governance

Germany

I t ti l C t G


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Germany

Owner and manager are often the same in private firms

Public firms often have a dominant shareholder too,

frequently a bank


I t ti l C t G


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Germany


Medium to large firms have a two-tiered board


frequently a bank

- Vorstand monitors and controls managerial decisions

- Aufsichtsrat selects the Vorstand

- Employees, union members and shareholders appointmembers to the Aufsichtsrat


I t ti l C t G


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Germany


Medium to large firms have a two-tiered board


frequently a bank

- Vorstand monitors and controls managerial decisions

- Aufsichtsrat selects the Vorstand

- Employees, union members and shareholders appointmembers to the Aufsichtsrat

Frequently there is less emphasis on shareholder value

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


I t ti l C t G


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Japan


International Corporate Go ernance


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Japan

Obligation, family and consensus are important factors




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Japan

Keiretsus are strongly interrelated groups of firms tied

together by cross-shareholdings

Banks (especially main bank) are highly influential

with firms managers





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Japan

Keiretsus are strongly interrelated groups of firms tied

together by cross-shareholdings

Banks (especially main bank) are highly influential

with firms managers

- Powerful government intervention

- Close relationships between firms and government sectors

- Passive and stable shareholders who exert little control

- Virtual absence of external market for corporate control

Other characteristics:



Corporate Governance and Ethical Behavior


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It is important to serve the interests of multiple

stakeholder groups




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Shareholders are one important stakeholder group,

which are served by the Board of Directors


stakeholder groups




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Product market stakeholders (customers, suppliers and

host communities) and Organizational stakeholders

(managerial and non-managerial employees) are also

important stakeholder groups




stakeholder groups




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Product market stakeholders (customers, suppliers and

host communities) and Organizational stakeholders

(managerial and non-managerial employees) are also

important stakeholder groups



Although controversial, some believe that ethically

responsible firms should introduce governance

mechanisms which serve all stakeholders interests


stakeholder groups


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