Corporate Governance

Joe Mahoney

Strategic Management and the Role of Business in Society

• The public stock company is the backbone of our economy.

• Four characteristics of public firms:

Limited liability for investors Transferability of investor interest Legal personality Separation of ownership and control

12–2

The Public Stock Company: Hierarchy of Authority

12–3

Strategic Management and the Role of Business in Society

• 21st century already two financial crises

Accounting scandals: Enron, WorldCom, Tyco… Global financial crisis: real estate bubble burst

• Lessons

Managerial actions affect economy Ethical business produces wealth but unethical practices destroy it

Stakeholder management is needed

12–4

Stakeholder Impact Analysis

12–5

The Pyramid of Corporate Social Responsibility

12–6

Corporate Social Responsibility

•Milton Friedman circa 1962: “the only social responsibility of business is

… to increase profits so long as it stays within the rules of the game”

•Today’s businesses tend to do more than just making profits

But does CSR help build competitive advantage?

The answer might depend on where you do business…

UAE, Japan, and India are less interested in CSR

China, Brazil, and Germany are more interested in CSR 12–7

Corporate Social Responsibility

• Shared value-creation framework Expand customer base and bring in non-consumers Expand internal firm value chains by including more

non-traditional partners such as NGOs Focus on creating new regional clusters

• GE recognizes a convergence between shareholders and stakeholders

• Empirical evidence supports that… “firms can do well ($) by doing good (CSR)”

12–8

Corporate Governance

• Corporate governance represents the relationship among stakeholders that is used to determine and control the strategic direction and performance of organizations.

• Agency costs are the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals because it is impossible to use governance mechanisms to guarantee total compliance by the agent.

12–9

Corporate Governance

• Corporate governance Mechanisms to direct and control a firm Ensure the pursuit of strategic goal Address the principal–agent problem

• When corporate governance failed Accounting scandal Global financial crisis Bernard Madoff Ponzi scheme

• Information asymmetry Insider information ImClone and Galleon Group

12–10

Corporate Governance

• Agency theory Views a firm as a nexus of legal contracts

Relationships among shareholders, managers, and hierarchies Firms need to design work tasks

• Adverse selection Misrepresentation of a job

Beyond his/her ability to do things

• Moral hazard Difficulty to ascertain whether the

agent gives his/her best

12–11

Agency Problems

• Berle and Means in The Modern Corporation inquired whether we have “any justification for assuming that those in control of a modern corporation will also choose to operate it in the interests of the stockholders?” (1932: p. 121)

• What are the “institutions of capitalism” which lessen the problem of the separation of (share- holder) ownership (the risk-bearing principals) from control (managerial decision-making agents)?

12–12

Agency Problems

• What are the “institutions of capitalism” that lessen the problem of the separation of ownership from control?

1. Takeovers (the market for corporate control); 2. Recruitment of executives from outside the firm; 3. Monitoring by boards of directors; 4. Compensation heavily weighted toward stock options; 5. Monitoring by institutional investors; 6. Debt (minimize free cash flow; e.g., LBOs); 7. Separate Chairperson and CEO; and 8. Internal control of Multidivisional

--- “miniature capital market”

Board of Directors

• Centerpiece of corporate governance Inside and outside directors General strategic oversight and guidance

Selecting, evaluating, and compensating the CEO

Overseeing CEO succession plan

– Recently problematic at both HP and Apple

Providing guidance on executives and their compensation

Reviewing, monitoring, and approving strategic initiatives

Conducting a risk assessment and mitigation

Ensuring a firm’s audited financial statements

Ensuring a firm’s compliance with laws and regulations

12–14

Other Governance Mechanisms

• Executive compensation Stock options Performance-oriented compensation in recent years

• The market for corporate control External governance mechanism Hostile takeover Corporate raiders and hedge funds

• Auditors, government regulators, and industry analysts Wall Street Journal, Bloomberg Businessweek, Forbes… Credit rating agencies

12–15

Corporate Governance Around the World

• Difference in national institutions and culture

• “Free” market economies? State-directed capitalism (less freedom). Ex: China Free market capitalism (more freedom). Ex: U.S.

• Germany Stakeholder capitalism Kurzarbeit

• France Stakeholder capitalism

• China State-owned enterprises

12–16