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

A. 1. Global operations influence corporate governance

 [

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 opportunities

• 2. By guiding managers to direct resources toward “good” projects and way from those that primarily benefit them over shareholders and stakeholders

• 3. 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 costs

2. Subsidiary executives are essentially agents of the parent; this agency cost increases when required local responsiveness rises

3. 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

competency in local operations and the organizational expertise

needed for such operations

1) 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 developments.3.Appraising and reviewing local subsidiary operations.4.Helping subsidiary management anticipate necessary strategic changes. reviewing local subsidiary operations.4.Helping subsidiary management anticipate necessary strategic changes.

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 siilar 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 competiton 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

•

• 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.

• t