Managerial Economics and Organizational Architecture, 5e Managerial Economics and Organizational Architecture, 5e Chapter 18: Corporate Governance McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc All Rights Reserved Managerial Economics and Organizational Architecture, 5e Corporate Governance • Describes the organizational structure at the top of the firm • Includes – Top-level incentives – Partitioning of decision rights – Board of directors – Top management – Outside monitors 18-2 Managerial Economics and Organizational Architecture, 5e Corporate Structure • Corporations have the legal standing of an individual • Shareholders elect a board of directors with primary decision control rights • Shareholder-owners have limited liability • Corporations may establish governance procedures within legal boundaries 18-3 Managerial Economics and Organizational Architecture, 5e Corporate Ownership • Stock in closely-held corporations is not freely traded • Stock of publicly-traded corporations may be freely bought and sold – Widely held corporation • No one owner controls more than 10 percent of the shares 18-4 Managerial Economics and Organizational Architecture, 5e Corporate Governance Objectives • Maximizing value • Protecting assets • Production of proper financial statements that meet legal requirements 18-5 Managerial Economics and Organizational Architecture, 5e Separation of Ownership and Control • Incentive issues • Are executive interests aligned with those of stockholders? • Survival of corporations • Despite governance concerns, the corporate form seems both productive and resilient • Benefit of publicly-traded corporations • Ability to raise large amounts of capital 18-6 Managerial Economics and Organizational Architecture, 5e Top-level Architecture US corporations • Decision rights divided among selected stakeholders • • • • Shareholders Governing board Top management External monitors 18-7 Managerial Economics and Organizational Architecture, 5e Government Impacts on Decision Rights • State regulations affect firms incorporated within those states • Federal laws and regulations further stipulate decision rights • Courts have impact through interpretations of laws 18-8 Managerial Economics and Organizational Architecture, 5e Shareholders • Ultimate owners • Limited participation in management – Elect board – Board oversees management – Some ratification rights 18-9 Managerial Economics and Organizational Architecture, 5e Shareholder Incentives • Small shareholders (individuals) have incentive to free ride rather than be actively involved • Institutional investors (e.g pension funds) differ in incentives to challenge management • Blockholders internalize more of the benefits of active involvement 18-10 Managerial Economics and Organizational Architecture, 5e Board Member Incentives • Some stock ownership aligns financial interests with other shareholders • High-profile board members have reputational concerns • Are members independent of top management? – Incentives to back management for selfinterested reasons 18-14 Managerial Economics and Organizational Architecture, 5e Top Management • CEO’s decision authority flows from the board • More decision rights are delegated as firm size and complexity increase • Senior management retains important decision rights – Shape strategic direction – Establish overall architecture – Recruiting and retaining key personnel 18-15 Managerial Economics and Organizational Architecture, 5e Top Management • CEO often deals with investor relations, media, and customers • COO manages internal operations • CFO supervises senior financial managers 18-16 Managerial Economics and Organizational Architecture, 5e Top Management Incentives • Straight salary • Performance-based compensation – Bonuses – Stock options – Stock ownership 18-17 Managerial Economics and Organizational Architecture, 5e External Monitors • Public accounting firms – Annual independent audits increase shareholder confidence • Stock market analysts – May have incentives to promote stocks that use their firm’s banking services • Commercial banks • Credit-rating agencies • Regulatory authorities 18-18 Managerial Economics and Organizational Architecture, 5e International Corporate Governance • Historical emphasis on broader set of stakeholders – Employees – Lenders – Affiliated companies – Broader public • Gradual shift toward US architecture 18-19 Managerial Economics and Organizational Architecture, 5e Monitoring Effect of Market Forces • Management failure opens door to hostile takeover • Management failure closes door to further professional opportunities • Inefficiency places firm’s products at competitive disadvantage 18-20 Managerial Economics and Organizational Architecture, 5e Sarbanes-Oxley Act of 2002 • Establishes Public Companies Accounting Oversight Board • Prohibits certain transactions between companies and managers • Holds CEOs and CFOs accountable for financial statements • Establishes civil and criminal penalties for violations 18-21 Managerial Economics and Organizational Architecture, 5e Chapter 18 Appendix Legal Forms of Organization Managerial Economics and Organizational Architecture, 5e Organizational Form • For profit • Residual claimants • Nonprofit • Nondistribution constraint 18-23 Managerial Economics and Organizational Architecture, 5e For-profit Organizations • • • • • • Individual proprietorships General partnerships Limited liability partnerships Limited partnerships S corporations C corporations 18-24 Managerial Economics and Organizational Architecture, 5e Individual Proprietorships • Resolve owner-top management conflict • Limited ability to raise capital • Income passes through to owner’s tax return 18-25 Managerial Economics and Organizational Architecture, 5e General Partnership • Income passes through to partners’ individual tax returns • Partners exposed individually and jointly to unlimited liability • fosters mutual monitoring • Take advantage of teamwork opportunities 18-26 Managerial Economics and Organizational Architecture, 5e S Corporation • Attractive choice for some small companies • Same tax treatment as proprietorships and partnerships • Limited liability • Entails incorporation fees • Lenders still require personal guarantees 18-27 Managerial Economics and Organizational Architecture, 5e C Corporations • • • • • Attractive for large companies Easier to raise capital Shareholders subject to “double taxation” Limited liability for shareholders Small risk-bearing costs • shareholders have diversified portfolios 18-28 ... Organization Managerial Economics and Organizational Architecture, 5e Organizational Form • For profit • Residual claimants • Nonprofit • Nondistribution constraint 18-23 Managerial Economics and Organizational Architecture, 5e. .. and managers • Holds CEOs and CFOs accountable for financial statements • Establishes civil and criminal penalties for violations 18-21 Managerial Economics and Organizational Architecture, 5e. .. overall architecture – Recruiting and retaining key personnel 18-15 Managerial Economics and Organizational Architecture, 5e Top Management • CEO often deals with investor relations, media, and customers