Ch10-HIH-[street07]

Ch10-HIH-[street07] - CHAPTER 10 STRATEGIC ACTIONS:...

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Unformatted text preview: CHAPTER 10 STRATEGIC ACTIONS: STRATEGY IMPLEMENTATION Corporate Governance KNOWLEDGE OBJECTIVES Studying this chapter should provide you with the strategic management knowledge needed to: 1. Define corporate governance and explain why it is used Define to monitor and control managers’ strategic decisions. to 2. Explain why ownership has been largely separated from Explain managerial control in the modern corporation. managerial 3. Define an agency relationship and managerial Define opportunism and describe their strategic implications. opportunism 4. Explain how three internal governance mechanisms— ownership concentration, the board of directors, and ownership executive compensation—are used to monitor and control managerial decisions. control 10–2 KNOWLEDGE OBJECTIVES (cont’d) Studying this chapter should provide you with the strategic management knowledge needed to: 1. Discuss the types of compensation executives receive Discuss and their effects on strategic decisions. and 2. Describe how the external corporate governance Describe mechanism—the market for corporate control—acts as a restraint on top-level managers’ strategic decisions. restraint 3. Discuss the use of corporate governance in Discuss international settings, in particular in Germany and Japan. Japan. 4. Describe how corporate governance fosters ethical Describe strategic decisions and the importance of such behaviors on the part of top-level executives. behaviors 10–3 Corporate Governance • Corporate governance is: A relationship among stakeholders that is used to relationship determine and control the strategic direction and performance of organizations. performance Concerned with identifying ways to ensure that Concerned strategic decisions are made more effectively. strategic Used in corporations to establish order between the Used firm’s owners and its top-level managers whose interests may be in conflict. interests 10–4 Internal Governance Mechanisms • Ownership Concentration Relative amounts of stock owned Relative by individual shareholders and institutional investors institutional • Board of Directors Individuals responsible Individuals for representing the firm’s owners by monitoring top-level managers’ strategic decisions managers’ 10–5 Internal Governance Mechanisms (cont’d) • Executive Compensation The use of salary, bonuses, and The long-term incentives to align managers’ interests with shareholders’ interests. shareholders’ • Market for Corporate Control The purchase of a firm that is The underperforming relative to industry rivals in order to improve its strategic competitiveness. its 10–6 Separation of Ownership and Managerial Control • Basis of the modern Basis corporation corporation Shareholders purchase Shareholders stock, becoming residual claimants. claimants. Shareholders reduce risk Shareholders by holding diversified portfolios. portfolios. Professional managers are Professional contracted to provide decision making. decision • Modern public corporation Modern form leads to efficient specialization of tasks: specialization Risk bearing by Risk shareholders shareholders Strategy development and Strategy decision making by managers managers 10–7 FIGURE 10.1 An Agency Relationship 10–8 Agency Relationship Problems • Principal and agent have divergent interests and goals. • Shareholders lack direct control of large, publicly traded Shareholders corporations. corporations. • Agent makes decisions that result in the pursuit of goals Agent that conflict with those of the principal. that • It is difficult or expensive for the principal to verify that the It agent has behaved appropriately. agent • Agent falls prey to managerial opportunism. 10–9 Managerial Opportunism • The seeking of self-interest with guile (cunning or The deceit) deceit) • Managerial opportunism is: An attitude (inclination) A set of behaviors (specific acts of self-interest) • Managerial opportunism prevents the Managerial maximization of shareholder wealth (the primary goal of owner/principals). goal 10–10 Response to Managerial Opportunism • Principals do not know beforehand which agents Principals will or will not act opportunistically. will • Thus, principals establish governance and Thus, control mechanisms to prevent managerial opportunism. opportunism. 10–11 Examples of the Agency Problem • The Problem of Product Diversification Increased size, and the relationship of size to Increased managerial compensation managerial Reduction of managerial employment risk • Use of Free Cash Flows Managers prefer to invest these funds in additional Managers product diversification (see above). product Shareholders prefer the funds as dividends so they Shareholders control how the funds are invested. control 10–12 FIGURE 10.2 Manager and Shareholder Risk and Diversification 10–13 Agency Costs and Governance Mechanisms • Agency Costs The sum of incentive costs, monitoring costs, The enforcement costs, and individual financial losses incurred by principals, because governance mechanisms cannot guarantee total compliance by the agent. the • Principals may engage in monitoring behavior to Principals assess the activities and decisions of managers. assess However, dispersed shareholding makes it difficult However, and inefficient to monitor management’s behavior. and 10–14 Agency Costs and Governance Mechanisms (cont’d) • Boards of Directors have a fiduciary duty to Boards shareholders to monitor management. shareholders However, Boards of Directors are often accused of However, being lax in performing this function. being 10–15 TABLE 10.1 Corporate Governance Mechanisms 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 toplevel managers’ strategic decisions Executive Compensation • Use of salary, bonuses, and long-term incentives to align managers’ interests with shareholders’ interests External Governance Mechanism Market for Corporate Control • The purchase of a company that is underperforming relative to industry rivals in order to improve the firm’s strategic competitiveness 10–16 Governance Mechanisms Ownership Concentration (a) • Large block shareholders have a Large strong incentive to monitor management closely: management Their large stakes make it worth Their their while to spend time, effort and expense to monitor closely. expense They may also obtain Board seats They which enhances their ability to monitor effectively. monitor • Financial institutions are legally Financial forbidden from directly holding board seats. board 10–17 Governance Mechanisms (cont’d) Ownership Concentration (b) • The increasing influence of The institutional owners (stock mutual funds and pension funds) funds Have the size (proxy voting power) Have and incentive (demand for returns to funds) to discipline ineffective topfunds) level managers. Can affect the firm’s choice of Can strategies. strategies. 10–18 Governance Mechanisms (cont’d) Ownership Concentration (c) • Shareholder activism: Shareholders can convene to Shareholders discuss corporation’s direction. discuss If a consensus exists, shareholders If can vote as a block to elect their candidates to the board. candidates Proxy fights. There are limits on shareholder There activism available to institutional owners in responding to activists’ tactics tactics 10–19 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors (a) • Board of directors Group of elected individuals that Group acts in the owners’ interests to formally monitor and control the firm’s top-level executives firm’s • Board has the power to: Direct the affairs of the organization Punish and reward managers Protect owners from managerial Protect opportunism opportunism 10–20 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors (b) • Composition of Boards: Insiders: the firm’s CEO and other top-level managers top-level Related Outsiders: individuals uninvolved with day-to-day operations, but who have a relationship with the firm relationship Outsiders: individuals who are independent of the firm’s day-to-day operations and other relationships operations 10–21 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors (c) • Criticisms of Boards of Directors Criticisms include: include: Too readily approve managers’ selfserving initiatives Are exploited by managers with Are personal ties to board members personal Are not vigilant enough in hiring and Are monitoring CEO behavior monitoring Lack of agreement about the Lack number of and most appropriate role of outside directors. role 10–22 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors (d) • Enhancing the effectiveness of Enhancing boards and directors: boards More diversity in the backgrounds More of board members of Stronger internal management and Stronger accounting control systems accounting More formal processes to evaluate More the board’s performance the Adopting a “lead director” role. Changes in compensation of Changes directors. directors. 10–23 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors Executive Compensation (a) • Forms of compensation: Salaries, bonuses, long-term Salaries, performance incentives, stock awards, stock options awards, • Factors complicating executive Factors compensation: compensation: Strategic decisions by top-level Strategic managers are complex, non-routine and affect the firm over an extended period. extended Other variables affecting the firm’s Other performance over time. performance 10–24 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors Executive Compensation (b) • Limits on the effectiveness of Limits executive compensation: executive Unintended consequences of stock Unintended options options Firm performance not as important Firm than firm size than Balance sheet not showing Balance executive wealth executive Options not expensed at the time Options they are awarded they 10–25 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors Executive Compensation Market for Corporate Control (a) • Individuals and firms buy or Individuals take over undervalued corporations. corporations. Ineffective managers are usually Ineffective replaced in such takeovers. replaced • Threat of takeover may lead Threat firm to operate more efficiently. firm • Changes in regulations have Changes made hostile takeovers difficult. made 10–26 Governance Mechanisms (cont’d) Ownership Concentration Board of Directors Executive Compensation Market for Corporate Control (b) • Managerial defense tactics Managerial increase the costs of mounting a takeover takeover • Defense tactics may require: Asset restructuring Changes in the financial structure Changes of the firm of Shareholder approval • Market for corporate control Market lacks the precision of internal governance mechanisms. governance 10–27 TABLE 10.2 The General Environment: Segments and Elements Category Preventive Popularity Effectiveness among firms as a defense High Medium Medium Medium Very low Low Medium High Very low Low Low Medium Low Medium Stockholder wealth effects Positive Negative Negligible Positive Negative Negative Inconclusive Defense strategy Poison pill Corporate charter Preventive amendment Golden parachute Preventive Litigation Greenmail Standstill agreement Capital structure change Reactive Reactive Reactive Reactive Source: J. A. Pearce II & R. B. Robinson, Jr., 2004, Hostile takeover defenses that maximize shareholder wealth, Business Horizons, 47(5): 15–24. 10–28 International Corporate Governance • Germany Owner and manager are often Owner the same in private firms. the Public firms often have a Public dominant shareholder, frequently a bank. frequently Frequently there is less Frequently emphasis on shareholder value than in U.S. firms, although this may be changing. may 10–29 International Corporate Governance (cont’d) Germany: Two­tiered Board Vorstand Responsible for the functions Responsible of direction and management Responsible for appointing members to the Vorstand members Aufsichtsrat Union members members Shareholders Shareholders Responsible for appointing Responsible members to the Aufsichtsrat members 10–30 International Corporate Governance (cont’d) • Japan Important governance factors: • Obligation • “Family” • Consensus Keiretsus: strongly interrelated Keiretsus: groups of firms tied together by cross-shareholdings. cross-shareholdings. Banks (especially “main bank”) are Banks highly influential with firm’s managers managers 10–31 International Corporate Governance (cont’d) • Japan (cont’d) Other governance characteristics: • Powerful government intervention • Close relationships between firms and government Close sectors sectors • Passive and stable shareholders who exert little Passive control control • Virtual absence of external market for corporate Virtual control control 10–32 International Corporate Governance (cont’d) • Global Corporate Governance Organizations worldwide are adopting a Organizations relatively uniform governance structure. relatively • Boards of directors are becoming smaller, with Boards more independent and outside members. more • Investors are becoming more active. • In rapidly developing market economies, minority In shareholder rights are not protected by adequate governance controls. governance 10–33 Governance Mechanisms and Ethical Behavior It is important to serve the interests of It the firm’s multiple stakeholder groups! the Capital Market Stakeholders Product Market Stakeholders Organizational Stakeholders • Shareholders (in the capital market stakeholder group) are viewed as the most important stakeholder group. • The focus of governance mechanisms is on the control of managerial decisions to assure shareholder interests. • Interests of shareholders is served by the Board of Directors. 10–34 Governance Mechanisms and Ethical Behavior (cont’d) It is important to serve the interests of It the firm’s multiple stakeholder groups! the Capital Market Stakeholders Product Market Stakeholders Organizational Stakeholders • Product market stakeholders (customers, suppliers and host communities) and organizational stakeholders may withdraw their support of the firm if their needs are not met, at least minimally. 10–35 Governance Mechanisms and Ethical Behavior (cont’d) It is important to serve the interests of It the firm’s multiple stakeholder groups! the Capital Market Stakeholders Product Market Stakeholders Organizational Stakeholders • Some observers believe that ethically responsible companies design and use governance mechanisms that serve all stakeholders’ interests. • Importance of maintaining ethical behavior is seen in the examples of Enron, WorldCom, HealthSouth and Tyco. 10–36 ...
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This note was uploaded on 11/08/2010 for the course STMN 012 taught by Professor Hoogover during the Spring '10 term at E. Kentucky.

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