- MGMT430E Business Policy Winter 2006 Session XVI
Ralph Heidl
2
Agenda
Agenda & Admin (3:30 3:40) Review (3:40 4:20) Break (4:20 4:25) Corporate Governance (4:25 5:00) Business Simulation (5:00 5:20)
MGMT 430 E/ WI2006 - Ralph Heidl
3
Administrative Tasks
Case: HP-Compaq
Class Participation Background Management Shareholders
Business Simulation
Peer Evaluations Investment Portfolio Firm Performance Performance Measures Historic Results and Grades
MGMT 430 E/ WI2006 - Ralph Heidl
4
Frogs and Princesses
Many managers were apparently over-exposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toad's body by a kiss from the beautiful princess. Consequently, they are certain that the managerial kiss will do wonders for the profitability of the target company. Such optimism is essential. Absent that rosy view, why else should the shareholders of company A want to own an interest in B at a takeover cost that is two times the market price they'd pay if they made direct purchases on their own? In other words investors can always buy toads at the going price for toads. If investors instead bankroll princesses who wish to pay double for the right to kiss the toad, those kisses better pack some real dynamite. We've observed many kisses, but very few miracles. Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses, even after their corporate backyards are knee-deep in unresponsive toads. -Warren Buffet, 1981 Berkshire Hathaway Annual Report
MGMT 430 E/ WI2006 - Ralph Heidl
Definitions - What are the Differences?
Merger
A strategy through which two firms agree to integrate their operations on a relatively co-equal basis
5
Acquisition
A strategy through which one firm buys a controlling, or 100% interest in another firm with the intent of making the acquired firm a subsidiary business within its portfolio
Takeover
A special type of acquisition when the target firm did not solicit the acquiring firm's bid for outright ownership
MGMT 430 E/ WI2006 - Ralph Heidl
Corporate strategy and M&A's
M&A's are:
dominant means of diversification major strategic action (vs. tactical) significant and unique capital budgeting decision sporadic & idiosyncratic
inability to learn from experience
6
substantial information asymmetry
buying a "lemon"
no dry run -- all money paid up front substantial exit costs (in dollars and reputation) managing integration extremely complex
more difficult than a new business
RISKY!
MGMT 430 E/ WI2006 - Ralph Heidl
7
"Directions" of Diversification
Horizontal
different businesses in similar stage of productionmarketing chain
concentric diversification: businesses are highly related conglomerate: businesses are unrelated
Vertical
extent to which firm owns input assets or output assets forward vs. backward integration make vs. buy
MGMT 430 E/ WI2006 - Ralph Heidl
8
Corporate Governance
Corporate governance is:
A relationship among stakeholders used to determine and control the strategic direction and performance of organizations Concerned with making strategic decisions more effectively Used to establish order between a firm's owners and its top-level managers whose interests may be in conflict
MGMT 430 E/ WI2006 - Ralph Heidl
9
Internal Governance Mechanisms
Executive Compensation
Use of salary, bonuses, and longterm incentives to align managers' interests with shareholders' interests
MGMT 430 E/ WI2006 - Ralph Heidl
10
Internal Governance Mechanisms
Ownership Concentration
Relative amounts of stock owned by individual shareholders and institutional investors
Board of Directors
Individuals responsible for representing the firm's owners by monitoring top-level managers' strategic decisions
MGMT 430 E/ WI2006 - Ralph Heidl
11
External Governance Mechanisms
Market for Corporate Control
Purchase of a firm that is underperforming relative to industry rivals in order to improve its strategic competitiveness
MGMT 430 E/ WI2006 - Ralph Heidl
12
Separation of Ownership and Managerial Control
Basis of the Modern Corporation
Shareholders purchase stock, becoming residual claimants Shareholders reduce risk by holding diversified portfolios Professional managers are contracted to provide decision making
MGMT 430 E/ WI2006 - Ralph Heidl
13
Separating Ownership and Managerial Control
Modern public corporation form leads to efficient specialization of tasks:
Risk bearing by shareholders Strategy development and decision making by managers
MGMT 430 E/ WI2006 - Ralph Heidl
14
An Agency Relationship
Hire
and create
MGMT 430 E/ WI2006 - Ralph Heidl
15
Agency Relationship Problems
Principal and agent have divergent interests and goals Shareholders lack direct control of large, publicly traded corporations Agent makes decisions that result in the pursuit of goals 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
MGMT 430 E/ WI2006 - Ralph Heidl
16
Response to Managerial Opportunism
Principals do not know beforehand which agents will or will not act opportunistically Thus, principals establish governance and control mechanisms to prevent managerial opportunism
MGMT 430 E/ WI2006 - Ralph Heidl
17
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 shareholder of wealth (the primary goal of owner/principals)
MGMT 430 E/ WI2006 - Ralph Heidl
18
Examples of the Agency Problem
Possible Problems
Product diversification Increased size, and relationship of size to managerial compensation Reduction of managerial employment risk
Use of Free Cash Flows
Managers prefer to invest these funds in additional product diversification (see above) Shareholders prefer the funds as dividends so they control how the funds are invested
MGMT 430 E/ WI2006 - Ralph Heidl
19
Agency Costs and Governance Mechanisms
Principals may engage in monitoring behavior to assess the activities and decisions of managers
However, dispersed shareholding makes it difficult and inefficient to monitor management's behavior
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
MGMT 430 E/ WI2006 - Ralph Heidl
20
Governance Mechanisms
Ownership Concentration (a)
Large block shareholders have a strong incentive to monitor management closely:
Their large stakes make it worth their while to spend time, effort and expense to monitor closely They may also obtain Board seats which enhances their ability to monitor effectively
Financial institutions are legally forbidden from directly holding board seats
MGMT 430 E/ WI2006 - Ralph Heidl
21
Governance Mechanisms (cont'd)
Ownership Concentration (b)
The increasing influence of institutional owners (stock mutual funds and pension funds)
Have the size (proxy voting power) and incentive (demand for returns to funds) to discipline ineffective top-level managers Can affect the firm's choice of strategies
MGMT 430 E/ WI2006 - Ralph Heidl
22
Governance Mechanisms (cont'd)
Ownership Concentration (c)
Shareholder activism:
Shareholders can convene to discuss corporation's direction If a consensus exists, shareholders can vote as a block to elect their candidates to the board Proxy fights There are limits on shareholder activism available to institutional owners in responding to activists' tactics
MGMT 430 E/ WI2006 - Ralph Heidl
23
Governance Mechanisms (cont'd)
Ownership Concentration Board of Directors (a)
Board of directors
Group of elected individuals that acts in the owners' interests to formally monitor and control the firm's top-level executives
Board has the power to:
Direct the affairs of the organization Punish and reward managers Protect owners from managerial opportunism
MGMT 430 E/ WI2006 - Ralph Heidl
24
Governance Mechanisms (cont'd)
Ownership Concentration Board of Directors (b)
Composition of Boards:
Insiders: the firm's CEO and other top-level managers Related Outsiders: individuals uninvolved with day-to-day operations, but who have a relationship with the firm Outsiders: individuals who are independent of the firm's day-to-day operations and other relationships
MGMT 430 E/ WI2006 - Ralph Heidl
25
Governance Mechanisms (cont'd)
Ownership Concentration Board of Directors (c)
Criticisms of Boards of Directors include:
Too readily approve managers' selfserving initiatives Are exploited by managers with personal ties to board members Are not vigilant enough in hiring and monitoring CEO behavior Lack of agreement about the number of and most appropriate role of outside directors
MGMT 430 E/ WI2006 - Ralph Heidl
26
...