Corporate Governance

Transparency 10-1
Chapter 10
Corporate Governance
Michael A. Hitt
R. Duane Ireland
Robert E. Hoskisson
1999 South-Western College Publishing
Transparency 10-2
Competitiveness
Chapter 3
Internal
Environment
Chapter 2
External
Environment
The 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
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Transparency 10-3
Competitiveness
Chapter 3
Internal
Environment
Chapter 2
External
Environment
The 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
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Transparency 10-4
Corporate Governance is a relationship among
stakeholders that is used to determine and control the
strategic direction and performance of organizations
Transparency 10-5
Concerned with identifying ways to ensure that
strategic decisions are made effectively
Transparency 10-6
Used in corporations to establish order between the
firms owners and its top-level managers
Concerned with identifying ways to ensure that
strategic decisions are made effectively
Transparency 10-7
Separation of Ownership and Managerial Control
Transparency 10-8
Basis of the modern corporation
Transparency 10-9
Shareholders purchase stock, becoming...
Residual Claimants
Transparency 10-10
- Shareholders reduce risk efficiently by holding
diversified portfolios
Residual Claimants
Transparency 10-11
Residual Claimants
Professional managers contract to provide decision-
making
Transparency 10-12
Residual Claimants
making
Modern public corporation form leads to efficient
specialization of tasks
Transparency 10-13
making
- Risk bearing by shareholders
- Strategy development and decision-making by
managers
Residual Claimants
Modern public corporation form leads to efficient
specialization of tasks
Transparency 10-14
Agency Theory
An agency relationship exists when:
Transparency 10-15
Shareholders
(Principals)
Firm Owners
Agency Theory
Transparency 10-16
Shareholders
(Principals)
Firm Owners
Managers
(Agents)
Decision
Makers
Hire
Agency Theory
Transparency 10-17
Shareholders
(Principals)
Firm Owners
Agency Relationship
Risk Bearing Specialist
(Principal)
Managers
(Agents)
Decision
Makers
which creates
Managerial Decision-
Making Specialist
(Agent)
Hire
Agency Theory
Transparency 10-18
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
Transparency 10-19
Example: Overdiversification because increased product
diversification leads to lower employment risk
for managers and greater compensation
Agency Theory
Transparency 10-20
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
Transparency 10-21
R
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s
k

Level of Diversification
Manager and Shareholder Risk and Diversification
Transparency 10-22
R
i
s
k

Dominant
Business
Unrelated
Businesses
Related
Constrained
Related
Linked
Transparency 10-23
R
i
s
k

Dominant
Business
Unrelated
Businesses
Related
Constrained
Related
Linked
Shareholder
(Business)
Risk Profile
S
A
Transparency 10-24
R
i
s
k

Dominant
Business
Unrelated
Businesses
Related
Constrained
Related
Linked
Shareholder
(Business)
Risk Profile
Managerial
(Employment
) Risk Profile
S
M
A
B
Transparency 10-25
Principals may engage in monitoring behavior to assess
the activities and decisions of managers
- However, dispersed shareholding makes it difficult and
and inefficient to monitor managements behavior
Agency Theory
Transparency 10-26
Principals may engage in monitoring behavior to assess
the activities and decisions of managers
- However, dispersed shareholding makes it difficult and
and 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 of
being lax in performing this function
Agency Theory
Transparency 10-27
Governance Mechanisms
Ownership Concentration
Boards of Directors
Executive Compensation
Market for Corporate Control
Multidivisional Organizational Structure
Transparency 10-28
Transparency 10-29
- Large block shareholders have a strong incentive to
monitor management closely
Transparency 10-30
- Their large stakes make it worth their while to spend
time, effort and expense to monitor closely
Transparency 10-31
time, effort and expense to monitor closely
- Their large stakes make it worth their while to spend
- They may also obtain Board seats which enhances
their ability to monitor effectively (although financial
institutions are legally forbidden from directly holding
board seats)
Transparency 10-32
Boards of Directors
Transparency 10-33
Boards of Directors
- Insiders
- Related Outsiders
- Outsiders
Transparency 10-34
Boards of Directors
- Review and ratify important decisions
- Insiders
- Related Outsiders
- Outsiders
Transparency 10-35
Boards of Directors
- Set compensation of CEO and decide when to
replace the CEO
- Insiders
- Related Outsiders
- Outsiders
Transparency 10-36
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
Transparency 10-37
Recommendations for more effective
Board Governance
Transparency 10-38
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 the
boards performance
Transparency 10-39
Transparency 10-40
Salary, Bonuses, Long term incentive compensation
Transparency 10-41
- Executive decisions are complex and non-routine
- Many factors intervene making it difficult to establish
for outcomes
how 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
Transparency 10-42
- Executive decisions are complex and non-routine
- Many factors intervene making it difficult to establish
for outcomes
how 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
Transparency 10-43
Transparency 10-44
Designed to control managerial opportunism
Transparency 10-45
- Corporate office and Board monitor business-unit
- Increased managerial interest in wealth maximization
managers strategic decisions
Transparency 10-46
- Corporate office and Board monitor managers
strategic decisions
M-form structure does not necessarily limit corporate-
level managers self-serving actions
Transparency 10-47
strategic decisions
- May lead to greater rather than less diversification
Transparency 10-48
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
Transparency 10-49
Transparency 10-50
Operates when firms face the risk of takeover when
they are operated inefficiently
Transparency 10-51
- 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
Transparency 10-52
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
Transparency 10-53
International Corporate Governance
Germany
Transparency 10-54
Germany
Owner and manager are often the same in private firms
Public firms often have a dominant shareholder too,
frequently a bank
Transparency 10-55
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 appoint
members to the Aufsichtsrat
Transparency 10-56
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 appoint
members to the Aufsichtsrat
Frequently there is less emphasis on shareholder value
than in U.S. firms, although this may be changing
Transparency 10-57
Japan
Transparency 10-58
Japan
Obligation, family and consensus are important factors
Transparency 10-59
Japan
Keiretsus are strongly interrelated groups of firms tied
together by cross-shareholdings
Banks (especially main bank) are highly influential
with firms managers
Transparency 10-60
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:
Transparency 10-61
It is important to serve the interests of multiple
stakeholder groups
Corporate Governance and Ethical Behavior
Transparency 10-62
Shareholders are one important stakeholder group,
which are served by the Board of Directors
stakeholder groups
Transparency 10-63
Product market stakeholders (customers, suppliers and
host communities) and Organizational stakeholders
(managerial and non-managerial employees) are also
important stakeholder groups
stakeholder groups
Transparency 10-64
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

Corporate Governance

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