ch10 hitt lecture

7/30/2019 Ch10 Hitt Lecture

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PowerPoint slides by:

R. Dennis MiddlemistColorado State University

Copyright 2004 South-Western

All rights reserved.

Chapter 10

CorporateGovernance


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Copyright 2004 South-Western. All rights reserved. 102

Knowledge Objectives

Studying this chapter should provide you with thestrategic management knowledge needed to:

Define corporate governance and explain why it is used tomonitor and control managers strategic decisions.

Explain why ownership has been largely separated frommanagerial control in the modern corporation.

Define an agency relationship and managerial opportunismand describe their strategic implications.

Explain how three internal governance mechanismsownership concentration, the board of directors, andexecutive compensationare used to monitor and controlmanagerial decisions.


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Knowledge Objectives (contd)

Studying this chapter should provide you with thestrategic management knowledge needed to:

Discuss the types of compensation executives receive andtheir effects on strategic decisions.

Describe how the external corporate governancemechanismthe market for corporate controlacts as arestraint on top-level managers strategic decisions.

Discuss the use of corporate governance in internationalsettings, in particular in Germany and Japan.

Describe how corporate governance fosters ethicalstrategic decisions and the importance of such behaviorson the part of top-level executives.


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Figure 1.1

Copyright 2004 South-Western. All rights reserved.

The StrategicManagement

Process


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Corporate Governance

Corporate governance is:

A relationship among stakeholders used todetermine and control the strategic direction andperformance of organizations

Concerned with making strategic decisions moreeffectively

Used to establish order between a firms owners

and its top-level managers whose interests maybe in conflict


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Internal Governance Mechanisms

Ownership Concentration

Relative amounts of stock ownedby individual shareholders andinstitutional investors

Board of Directors

Individuals responsiblefor representing the firms

owners by monitoring top-levelmanagers strategic decisions


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Internal Governance Mechanisms

Executive Compensation

Use of salary, bonuses, andlong-term incentives to alignmanagers interests with

shareholders interests


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External Governance Mechanisms

Market for Corporate Control

Purchase of a firm that isunderperforming relative toindustry rivals in order to

improve its strategiccompetitiveness


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Separation of Ownership and ManagerialControl

Basis of the Modern Corporation

Shareholders purchase stock, becoming residualclaimants

Shareholders reduce risk by holding diversifiedportfolios

Professional managers are contracted to provide

decision making


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Separating Ownership and ManagerialControl

Modern public corporation form leads toefficient 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, publiclytraded corporations

Agent makes decisions that result in the pursuit ofgoals that conflict with those of the principal

It is difficult or expensive for the principal to verify

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 the

maximization of shareholder wealth (theprimary goal of owner/principals)


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Response to Managerial Opportunism

Principals do not know beforehand whichagents will or will not act opportunistically

Thus, principals establish governance and

control mechanisms to prevent managerialopportunism


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Examples of the Agency Problem

Possible ProblemsProduct diversification

Increased size, and relationship of size tomanagerial compensation

Reduction of managerial employment risk

Use of Free Cash Flows

Managers prefer to invest these funds inadditional product diversification (see above)

Shareholders prefer the funds as dividends sothey control 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 Governance Mechanisms

Principals may engage in monitoringbehavior to assess the activities anddecisions of managers

However, dispersed shareholding makes itdifficult and inefficient to monitor managementsbehavior

Boards of Directors have a fiduciary duty to

shareholders to monitor managementHowever, 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, effortand expense to monitor closely

They may also obtain Boardseats which enhances theirability to monitor effectively

Financial institutions arelegally forbidden fromdirectly holding board seats

OwnershipConcentration (a)


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Governance Mechanisms (contd)

The increasing influence ofinstitutional owners (stockmutual funds and pensionfunds)

Have the size (proxy votingpower) and incentive (demandfor returns to funds) todiscipline ineffective top-levelmanagers

Can affect the firms choice of

strategies

OwnershipConcentration (b)


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Shareholder activism:

Shareholders can convene todiscuss corporations direction

If a consensus exists,

shareholders can vote as ablock to elect their candidates tothe board

Proxy fights

There are limits on shareholderactivism available toinstitutional owners inresponding to activists tactics

OwnershipConcentration (c)


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Board of directors Group of elected individuals that

acts in the owners interests to

formally monitor and control thefirms top-level executives

Board has the power to:

Direct the affairs of theorganization

Punish and reward managers

Protect owners from managerialopportunism

OwnershipConcentration

Board of Directors(a)


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Composition of Boards:

Insiders:the firms CEO andother top-level managers

Related Outsiders: individuals

uninvolved with day-to-dayoperations, but who have arelationship with the firm

Outsiders: individuals who areindependent of the firms day-to-

day operations and otherrelationships


Board of Directors(b)


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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 hiringand monitoring CEO behavior

Lack of agreement about thenumber of and most appropriaterole of outside directors


Board of Directors(c)


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Enhancing the effectivenessof boards and directors:

More diversity in thebackgrounds of board members

Stronger internal managementand accounting control systems

More formal processes toevaluate the boards performance

Adopting a lead director role

Changes in compensation ofdirectors


Board of Directors(d)


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Forms of compensation: Salary, bonuses, long-term

performance incentives, stockawards, stock options

Factors complicatingexecutive compensation:

Strategic decisions by top-levelmanagers are complex, non-routine and affect the firm over

an extended period Other variables affecting the

firms performance over time


Board of Directors

Executive

Compensation (a)


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Limits on the effectiveness ofexecutive compensation:

Unintended consequences ofstock options

Firm performance not asimportant than firm size

Balance sheet not showingexecutive wealth

Options not expensed at the time

they are awarded


Board of Directors

Executive

Compensation (b)


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Individuals and firms buy ortake over undervaluedcorporations

Ineffective managers are usually

replaced in such takeovers

Threat of takeover may leadfirm to operate moreefficiently

Changes in regulations havemade hostile takeoversdifficult


Board of Directors

Executive

Compensation

Market forCorporate Control (a)


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Managerial defense tacticsincrease the costs ofmounting a takeover

Defense tactics may require:

Asset restructuring

Changes in the financialstructure of the firm

Shareholder approval

Market for corporate controllacks the precision of internalgovernance mechanisms


Board of Directors

Executive

Compensation

Market forCorporate Control (b)


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International Corporate Governance

GermanyOwner and manager are often

the same in private firms

Public firms often have adominant shareholder,frequently a bank

Frequently there is less

emphasis on shareholdervalue than in U.S. firms,although this may bechanging


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Responsible for the functionsof direction and management

Responsible for appointingmembers to the Vorstand

Responsible for appointingmembers to the Aufsichtsrat


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 firms

managers

Keiretsus: strongly interrelatedgroups of firms tied together bycross-shareholdings


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Japan (contd)

Other governance characteristics:

Powerful government intervention

Close relationships between firms andgovernment sectors

Passive and stable shareholders who exertlittle control

Virtual absence of external market forcorporate control


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Capital Market

Stakeholders

Governance Mechanisms andEthical BehaviorIt is important to serve the interests of thefirms multiple stakeholder groups!

Shareholders in this group are

viewed as the most importantstakeholder group

The focus of governance

mechanisms is to control

managerial decisions to assureshareholder interests

Interests of shareholders is served

by the Board of Directors


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Product MarketStakeholders

Governance Mechanisms andEthical Behavior (contd)

Product market stakeholders

(customers, suppliers and hostcommunities) and organizational

stakeholders may withdraw their

support of the firm if their needs

are not met, at least minimally

Capital Market

Stakeholders

It is important to serve the interests of thefirms multiple stakeholder groups!


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Copyright 2004 South-Western All rights reserved 1035

Organizational

Stakeholders

Governance Mechanisms andEthical Behavior (contd)

Some observers believe that

ethically responsible companiesdesign and use governance

mechanisms that serve all

stakeholders interests

Importance of maintaining ethicalbehavior is seen in the examples

of Enron, WorldCom, HealthSouth

and Ahold NV

Product MarketStakeholders

Capital Market

Stakeholders

It is important to serve the interests of thefirms multiple stakeholder groups!

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