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Advantage 1 Chapter 11 Corporate Governance PART IV MONITORING AND CREATING ENTREPRENEURIAL OPPORTUNITIES The Strategic Management Process Corporate Governance Key Terms Corporate ID: 355001

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Slide1

Competing for Advantage

1

Chapter 11 Corporate Governance

PART

IV

MONITORING AND CREATING ENTREPRENEURIAL OPPORTUNITIESSlide2

The Strategic Management ProcessSlide3

Corporate GovernanceKey TermsCorporate governance Set of mechanisms used to manage the relationships among

stakeholders and to determine and control the strategic direction and performance of organizations Slide4
Governance MechanismsSlide5

Separation of Ownership and Managerial ControlOwnership

Management

Founder-OwnersFamily-Owned Firms

Shareholders

Professional Managers

Modern Public CorporationsSlide6
Agency Relationships

Key TermsAgency relationship Relationship which exists when one or more people (principals) hire another person or people (agents

) as decision-making specialists to perform a service

Managerial opportunism Seeking self-interest with guile (i.e., cunning or deceit)Slide7
An Agency Relationship Slide8

The Agency ProblemThe 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 whether

the agent has behaved inappropriately.Slide9

Problems with Separate Ownership and ControlPrincipal and the agent having different interests and goalsShareholders lacking direct control in large publicly traded

corporationsAgent making decisions

which result in actions that conflict with interests of the principalSlide10

Product Diversification as an Agency ProblemInterests of Top ExecutivesIncreased compensationReduced employment riskInterests of Shareholders

Increased value of firmReduced risk of firm failureSlide11

Use of Free Cash FlowsThe managerial inclination to overdiversify can be acted upon when free cash flows are available. Shareholders may prefer that free cash flows be distributed to them as dividends, so they can control how the cash is invested.

Free cash flows are resources remaining after the firm has invested in all projects that have positive net present values within its current businesses. Slide12

Manager and Shareholder Risk and Diversification Slide13

Agency Costs and Governance MechanismsKey Terms Agency costs The sum

of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals, because governance mechanisms cannot guarantee total compliance by the agentSlide14

Regulatory Oversight of Corporate Governance2002 Sarbanes-Oxley (SOX) Act 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) Slide15

Dodd-Frank ProvisionsCreates a Financial Stability Oversight Council headed by the Treasury SecretaryEstablishes a new system for liquidation of certain financial companies

Provides for a new framework to regulate derivativesEstablishes new corporate governance requirements

Regulates credit rating agencies and securitizationsEstablishes a new consumer protection bureau, providing for extensive consumer protection in financial servicesSlide16

Ownership ConcentrationKey Terms Ownership concentrationGovernance mechanism defined by both the number of large-block shareholders and the total percentage of shares they own

Large block shareholders

Shareholders owning a concentration of at least 5 percent of a corporation’s issued sharesSlide17

Effects of Ownership ConcentrationDiffuse ownership produces weak monitoring of managers’ decisions. Ownership concentration is associated with lower levels of firm product diversification.High degrees of ownership concentration improve the probability

that managers’ strategic decisions will increase shareholder value.In general, ownership concentration’s influence on strategies and firm performance is positive. Slide18

Influence of Institutional OwnersKey Terms Institutional owners Financial institutions such as stock mutual funds and pension funds that control large-block shareholder positionsSlide19

Influence of Institutional OwnersBecoming more active in efforts to influence the corporation’s strategic decisionsInitially focused on CEO performance and accountabilityNow targeting ineffective boards of directors and executive compensation policiesGrowing efforts to expand shareholders’ decision rightsSlide20

Board of DirectorsKey TermsBoard of directors Group of shareholder-elected individuals whose primary responsibility is to act in the owners’ interests by formally monitoring and controlling the corporation’s top-level executivesSlide21

Board of Director ResponsibilitiesDirect the affairs of the organizationPunish and reward managers

Protect shareholders’ rights and interestsProtect owners from managerial

opportunismSlide22

Classifications of Boards of Directors’ Members Slide23

Outsider DirectorsEnhance managerial monitoringContribute to strategic directionProvide valuable links to external stakeholdersPromoted by regulatory agencies

Do not guarantee high performance Slide24

Problems with Outsider-Dominated BoardsLimited access to daily operations and critical information May lack insights required to fully and perhaps effectively evaluate manager decisions and initiatives

Tendency to emphasize financial controlsShifts risk to top-level managers

Can increase detrimental managerial actionsSlide25

Trends Among BoardsBackground diversity Formal processes to evaluate board performance“Lead director” role with strong

agenda-setting and oversight powersChanges in compensation packages

Ownership stake requirementsDemand for greater accountability and improved performanceSocial networks with external stakeholdersSlide26

Board EffectivenessBecome engaged in the firm, without trying to micromanage itChallenge the reasoning behind decisions, but be supportive of decisions that are made

Provide an independent perspective on important decisionsSlide27

Executive CompensationKey TermsExecutive compensationGovernance mechanism that seeks to align the interests of top managers and owners through salaries, bonuses, and long-term incentive compensation, such as restricted stock

awards and stock optionsSlide28

Executive Compensation IssuesHigh visibility and controversy surrounding CEO payDownward pressure from shareholders and activistsRelationship to performanceLong-term incentive plansEffective governance mechanism for firms implementing international strategiesSlide29

Executive Compensation for International StrategiesPay levels vary by regions of the world. Owners of multinational corporations may be best served with less uniformity across the firm’s foreign subsidiaries. Multiple compensation plans increase the need for monitoring and other related agency

costs. Complexity and potential dissatisfaction increase as corporations acquire firms in other countries.Slide30

Long-Term Incentive PlansAddress potential agency problemsViewed positively by the stock marketReduce pressure for changes in the board Reduce pressure for outside directorsAssumed to effectively link executive pay with firm performanceSlide31

The Effectiveness of Executive CompensationIt is difficult to evaluate complex and nonroutine strategic decisions

made by top-level managers.

It is difficult to assess the long-term strategic effect of current decisions which affect financial performance outcomes over an extended period.Multiple external factors affect a firm’s performance other than top-level managerial decisions and

behavior.Slide32

The Effectiveness of Executive CompensationPerformance-based (incentive) compensation plans are imperfect in their ability to monitor and control managers.Conflicting short-term and long-term objectives have a complex effect on managerial decisions and behaviors.

Excessive compensations correlate with weak corporate governance.Slide33

Executive Compensation – A Question of Stock Issue EffectivenessManager wealth v. high stock prices

Earnings manipulationsRisk takingRepricing

BackdatingSlide34

Market for Corporate ControlKey TermsMarket for corporate control An external governance mechanism which is composed of individuals and firms that buy ownership positions in or take over potentially undervalued corporations so they can form new divisions in established diversified companies or merge two previously separate firmsSlide35

Market for Corporate ControlAddresses weak internal corporate governanceCorrects suboptimal performance relative to competitorsDisciplines ineffective or opportunistic managersSlide36

Hostile Takeover Defense StrategiesSlide37

Market for Corporate ControlMay not be entirely efficientLacks the precision of internal governance mechanismsCan be an effective constraint on questionable manager motivesSlide38

International Corporate GovernanceSimilarities among governance structures in industrialized nations are increasing.Firms using an international strategy must understand the dissimilarities in order to operate effectively in different international markets.

Traditional governance structures in foreign nations, like Germany and Japan, are being affected by global

competition.Slide39

Corporate Governance in GermanyConcentration of ownership is strong.Banks exercise significant power as a source of financing for firms.Two-tiered board structures, required for larger employers, place responsibility for monitoring and controlling managerial decisions and actions with separate groups.Power sharing includes representation from the community as well as unions.Slide40

Corporate Governance in JapanCultural concepts of obligation, family, and consensus affect attitudes toward governance.Close relationships between stakeholders and a company are manifested in cross-shareholding and can negatively impact efficiencies.

Banks play an important role in financing and monitoring large public firms.Despite the counter-cultural nature of corporate takeovers, changes in corporate governance have introduced this practice. Slide41

Global Corporate GovernanceRelatively uniform governance structures are evolving in developed countries.These structures are moving closer to the U.S. model of corporate governance.Although implementation is slower, this merging with U.S. practices is occurring even in transitional economies. Slide42

Corporate Governance and Ethical Behavior

In the U.S., shareholders (in the capital market stakeholder group) are viewed as the most important stakeholder group served by the board of directors.

Hence, the focus of governance mechanisms is on the control of managerial decisions to ensure that shareholders’ interests will be served.

Capital Market

Stakeholders

The FirmSlide43

It is important to serve the interests of the firm’s multiple stakeholder groups.

Corporate Governance and Ethical Behavior

The Firm

Product market stakeholders (customers,

suppliers,

and host communities) and organizational stakeholders (managerial and non-managerial employees) are also important stakeholder groups.

Product Market

Stakeholders

Organizational

StakeholdersSlide44

It is important to serve the interests of the firm’s multiple stakeholder groups.

Corporate Governance and Ethical Behavior

The Firm

Although the idea is subject to debate, some believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders’ interests.

Importance of maintaining ethical behavior through governance mechanisms is seen in the

examples

of

recent corporate scandals.

Product Market

Stakeholders

Organizational

Stakeholders

Capital Market

StakeholdersSlide45

Corporate Governance and Ethical BehaviorDesign CEO pay structure with long-term focusActively set boundaries for ethical behaviorActively define organization’s valuesClearly communicate expectations to all stakeholdersFoster an ethical culture of accountability Promote CEOs as positive role modelsMonitor ethical behavior of top executivesDo not stifle manager flexibility and entrepreneurship

45Slide46

Ethical Question Do managers have an ethical responsibility to push aside their own values with regard to how certain stakeholders are treated (i.e., special interest groups) in order to maximize shareholder returns?Slide47

Ethical Question What are the ethical implications associated with owners assuming that managers will act in their own self-interest?Slide48

Ethical Question What ethical issues surround executive compensation? How can we determine whether top executives are paid too much?Slide49

Ethical Question Is it ethical for firms involved in the market for corporate control to target companies performing at levels exceeding the industry average? Why or why not?Slide50

Ethical Question What ethical issues, if any, do top executives face when asking their firm to provide them with a golden parachute?Slide51

Ethical Question How can governance mechanisms be designed to ensure against managerial opportunism, ineffectiveness, and unethical behaviors?