Ch10-1 Chapter 10 Corporate Governance Michael A. Hitt R. Duane Ireland Robert E. Hoskisson ©2000 South-Western College Publishing Ch10-2 Competitiveness Chapter 3 Internal Environment Chapter 2 External Environment The Strategic The Strategic Management Management Process Process The Strategic The Strategic Management Management Process 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 Strategic Inputs Strategic Actions Strategic Outcomes Chapter 10 Corporate Governance Chapter 11 Structure & Control Chapter 12 Strategic Leadership Chapter 13 Entrepreneurship & Innovation Ch10-3 Used in corporations to establish order between the Used in corporations to establish order between the firm’s owners and its top-level managers firm’s owners and its top-level managers Corporate Governance is a relationship among Corporate Governance is a relationship among stakeholders that is used to determine and control the stakeholders that is used to determine and control the strategic direction and performance of organizations strategic direction and performance of organizations Concerned with identifying ways to ensure that Concerned with identifying ways to ensure that strategic decisions are made effectively strategic decisions are made effectively Corporate Governance Corporate Governance Ch10-4 Separation of Ownership and Managerial Control Separation of Ownership and Managerial Control Basis of the modern corporation Basis of the modern corporation Shareholders purchase stock, becoming Shareholders purchase stock, becoming Residual Claimants Residual Claimants Professional managers contract to provide decision- Professional managers contract to provide decision- making making Modern public corporation form leads to efficient Modern public corporation form leads to efficient specialization of tasks specialization of tasks - Shareholders reduce risk efficiently by holding - Shareholders reduce risk efficiently by holding diversified portfolios diversified portfolios - Risk bearing by shareholders - Risk bearing by shareholders - Strategy development and decision-making by - Strategy development and decision-making by managers managers Ch10-5 An agency relationship exists when: An agency relationship exists when: Shareholders Shareholders (Principals) (Principals) Firm Owners Firm Owners Managers Managers (Agents) (Agents) Decision Decision Makers Makers which creates which creates Agency Relationship Agency Relationship Risk Bearing Specialist Risk Bearing Specialist (Principal) (Principal) Managerial Decision- Managerial Decision- Making Specialist Making Specialist (Agent) (Agent) Hire Hire Agency Theory Agency Theory Ch10-6 The The Agency Agency problem occurs when: problem occurs when: - The desires or goals of the principal and agent conflict - The desires or goals of the principal and agent conflict and it is difficult or expensive for the principal to and it is difficult or expensive for the principal to verify that the agent has behaved appropriately verify that the agent has behaved appropriately Solution: Solution: Principals engage in incentive-based performance Principals engage in incentive-based performance contracts, monitoring mechanisms such as the contracts, monitoring mechanisms such as the board of directors and enforcement mechanisms board of directors and enforcement mechanisms such as the managerial labor market to mitigate such as the managerial labor market to mitigate the agency problem the agency problem Example: Example: Overdiversification because increased product Overdiversification because increased product diversification leads to lower employment risk diversification leads to lower employment risk for managers and greater compensation for managers and greater compensation Agency Theory Agency Theory Ch10-7 Risk Risk Level of Diversification Level of Diversification Manager and Shareholder Risk and Diversification Dominant Dominant Business Business Unrelated Unrelated Businesses Businesses Related Related Constrained Constrained Related Related Linked Linked A A B B Managerial (Employment) Risk Profile M Shareholder (Business) Risk Profile S Ch10-8 Example: Example: Boards of Directors have a fiduciary duty Boards of Directors have a fiduciary duty to shareholders to monitor management to shareholders to monitor management Agency Theory Agency Theory Principals may engage in Principals may engage in monitoring monitoring behavior to assess behavior to assess the activities and decisions of managers the activities and decisions of managers However, Boards of Directors are often accused of However, Boards of Directors are often accused of being lax in performing this function being lax in performing this function However, dispersed shareholding makes it difficult and However, dispersed shareholding makes it difficult and and inefficient to monitor management’s behavior and inefficient to monitor management’s behavior Ch10-9 Governance Mechanisms Governance Mechanisms Ownership Concentration Ownership Concentration Boards of Directors Boards of Directors Executive Compensation Executive Compensation Multidivisional Organizational Structure Multidivisional Organizational Structure Market for Corporate Control Market for Corporate Control Ch10-10 Governance Mechanisms Governance Mechanisms Ownership Concentration Ownership Concentration Ownership Concentration Ownership Concentration Large block shareholders have a strong incentive to Large block shareholders have a strong incentive to monitor management closely monitor management closely Their large stakes make it worth their while to spend Their large stakes make it worth their while to spend time, effort and expense to monitor closely time, effort and expense to monitor closely They may also obtain Board seats which enhances They may also obtain Board seats which enhances their ability to monitor effectively (although their ability to monitor effectively (although financial institutions are legally forbidden from financial institutions are legally forbidden from directly holding board seats) directly holding board seats) [...].. .Governance Mechanisms Board of Directors Insiders The firm’s CEO and other top-level managers Related Outsiders Individuals not involved with day-to-day operations, but who have a relationship with the company Outsiders Individuals who are independent of the firm’s dayto-day operations and other relationships Ch10- Governance Mechanisms Board of Directors Recommendations for more effective Board Governance: ... that managers will do the things for which they are rewarded Ch10- Governance Mechanisms Multidivisional Organizational Structure Designed to control managerial opportunism Corporate office and Board monitor managers’ strategic decisions Increased managerial interest in wealth maximization M-form structure does not necessarily limit corporatelevel managers’ self-serving actions May lead to greater rather... product lines makes it difficult for top-level managers to evaluate the strategic decisions of divisional managers Ch10- Governance Mechanisms Market for Corporate Control Operates when firms face the risk of takeover when they are operated inefficiently The 1980s saw active market for corporate control, largely as a result of available pools of capital (junk bonds) Many firms began to operate more efficiently... 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 Ch10- Corporate Governance and Ethical Behavior It is important to serve the interests of multiple stakeholder groups Shareholders are one important stakeholder group, which are served by the Board of... 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 Ch10- International Corporate Governance Japan Obligation, “family” and consensus are important factors Banks (especially “main bank”) are highly influential with firm’s managers Keiretsus are strongly interrelated groups of firms... hostile takeovers was relatively small Changes in regulations have made hostile takeovers difficult Acts as an important source of discipline over managerial incompetence and waste Ch10- International Corporate Governance Germany Owner and manager are often the same in private firms Public firms often have a dominant shareholder too, frequently a bank Medium to large firms have a two-tiered board Vorstand... Board Governance: Increase diversity of board members backgrounds Strengthen internal management and accounting control systems Establish formal processes for evaluation of the board’s performance Ch10- Governance Mechanisms Executive Compensation Salary, Bonuses, Long term incentive compensation Executive decisions are complex and non-routine Many factors intervene making it difficult to establish how... 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 Ch10- . diversification Ch10-15 Governance Mechanisms Governance Mechanisms Market for Corporate Control Market for Corporate Control Market for Corporate Control Market for Corporate Control Operates. absence of external market for corporate control Virtual absence of external market for corporate control Ch10-18 Corporate Governance and Ethical Behavior Corporate Governance and Ethical Behavior It. Structure Multidivisional Organizational Structure Market for Corporate Control Market for Corporate Control Ch10-10 Governance Mechanisms Governance Mechanisms Ownership Concentration Ownership Concentration Ownership