Transcript Strategic Management: Competitiveness and Globalization

Governance
• Knowledge objective
– Understand corporate governance ...
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as a system of ownership and stakeholder interests
as an “agency problem” in terms of TMT incentives
in relation to value creation
in terms of markets for corporate control
in relation to international
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Corporate Governance
Mechanisms
Internal Governance Mechanisms
Ownership concentration
– relative amounts of stock owned by
individual and institutional investors
Board of Directors
– individuals responsible for
representing the firm’s owners by
monitoring top-level managers’
strategic decisions
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Separation of Ownership and Control
• Basis of the modern corporation
– shareholders purchase stock, becoming residual
claimants who bear residual risk
– shareholders reduce risk by holding diversified
portfolios
– professional managers are contracted to provide
decision-making
• Modern public corporation form leads to
efficient specialization of tasks
– risk bearing by shareholders
– strategy development and decision-making by
managers
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Agency Theory
Basic Terms
Organizations:
series of contractual relationships
between agents and principals
Principals:
owners (shareholders) of a firm
Agents:
people hired by the owners to run the
firm (managers and workers)
Agency
Costs: costs associated with monitoring
agent behavior and enforcing contracts
Goal:
efficient arrangement (lowest agency costs)
of agent-principal relationships.
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Agency Relationship:
Owners and Managers
Shareholders
(Principals)
• Firm owners
• Decision makers
Managers
(Agents)
• A specialist in risk-bearing (the
principal) pays compensation to
• A specialist in managerial decisionmaking specialist (the agent)
Agency
Relationship
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Principal-Agent Theory
The heart of principal-agent theory is the
trade-off between
(a) the cost of measuring behavior and
(b) the cost of measuring outcomes and
transferring risk to the agent.
Information is asymmetrically distributed
between principals and agents
(Eisenhardt, 1989)
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Examples
Problem of Product Diversification
Increased size, and the 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
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are invested.
Agency Theory: Conflicts
• Principals engage in monitoring behavior to assess
the activities and decisions of managers
But … dispersed shareholding makes it difficult and
inefficient to monitor management’s behavior
• Boards of Directors have a fiduciary duty to
shareholders to monitor top management
However, Boards of Directors are often accused of
being lax in performing this function
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Agency Theory Problem
• Problem: cost of measuring behavior
– the desires or goals of the principal and agent
conflict and it is difficult or expensive for the
principal to verify that the agent has behaved
appropriately
• Solution: Measure outcomes, transfer risk to the
agent
– principals create incentive-based performance
contracts
– principals monitor contract performance
(e.g.,
BOD)
– Markey supply of managerial know-how (CEOs)
mitigate the agency problem
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Corporate Governance
Mechanisms
Internal Governance Mechanisms
Executive Compensation
– use of salary, bonuses, and long-term
incentives to align managers’ interests
with shareholders’ interests
• Monitoring by top-level managers
– they may obtain Board seats (not in
financial institutions)
– they may elect Board representatives
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Governance Mechanisms
Executive
Compensation
 Stock ownership (long-term
incentive compensation)
» managers more susceptible to
market changes which are partially
beyond their control
 Incentive systems do not
guarantee that managers make the
“right” decisions, but do increase
the likelihood that managers will do
the things for which they are
rewarded
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Risk
Manager and Shareholder Risk
and Diversification
Shareholder
(business)
S risk profile
Managerial
(employment)
risk profile M
A
Dominant
Related
Business Constrained
Related
Linked
B
Diversification
Unrelated
Businesses
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Some research findings
• Management controlled firms maximize CEO pay, s.t.
legitimacy, externally controlled firms minimize CEO
pay, s.t.CEO labor market (Hambrick & Finkelstein,
1995)
• Antitakeover defenses increase the premium for a
hostile takeover by ~40%
• Directors usually have only a nominal equity interest
in the firm, but may receive substantial reputational
or monetary benefits from CEO nominations
• Compensation consultants - accent performancebased incentives when results are good, and peerbased incentives when results are bad (Murphy,
1999)
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• Stealth” compensation ...
Agency Theory Conflicts
Agency Problem exists elsewhere among
stakeholders, e.g., between shareholders and
debtholders
Debtholders often limit dividend payments
(covenants) – Why?
If the firm pays all excess cash to shareholders,
there may not be enough left for debtholders.
Dividends are a means that shareholders can
use to expropriate wealth from debtholders.
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Corporate Governance
Mechanisms
External Governance Mechanisms
Market for Corporate Control
– the purchase of a firm that is
underperforming relative to
industry rivals in order to
improve its strategic
competitiveness
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External Control
External control mechanisms:
SEC, External auditors;
Bondholders and lenders (banks);
Financial analysts and credit rating agencies;
Mergers and acquisitions;
Institutional investors- pension funds, mutual
funds;
Stock prices;
Labor markets.
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Governance Mechanisms
Ownership
• Large block shareholders have a
Concentration
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 (although
financial institutions are legally
forbidden from directly holding
board seats)
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Governance Mechanisms
Boards of
Directors
Insiders
• The firm’s CEO and other toplevel 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 day-to-day
operations and other
relationships
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Governance Mechanisms
Boards of
Directors
Recommendations for more
effective 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
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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
managerial decisions are directly
responsible for outcomes
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Governance Mechanisms
Market for
Corporate Control
• Firms face the risk of takeover
when they are operated
inefficiently
• Many firms begin to operate
more efficiently as a result of
the “threat” of takeover, even
though the actual incidence of
hostile takeovers is relatively
small
• Changes in regulations have
made hostile takeovers difficult
• Acts as an important source of
discipline over managerial
incompetence and waste
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International Corporate
Governance:
• Owner and manager are often the same in
private firms
• Public firms often have a dominant
shareholder, frequently a bank
• Frequently there is less emphasis on
shareholder value than in U.S. firms, although
this may be changing
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International Corporate Governance:
Germany
• Medium to large firms have a two-tiered
board
– vorstand monitors and controls managerial
decisions
– aufsichtsrat selects the Vorstand
– employees, union members and shareholders
appoint members to the Aufsichtsrat
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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 tied together by cross-shareholdings
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International Corporate Governance:
Japan
• Other characteristics:
– 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
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