CHAPTER 12 Corporate Governance, Business Ethics, and Strategic Leadership McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Part 3 Strategy Implementation LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader. ChapterCase 12 HP’s CEO Mark Hurd Resigns amid Ethics Scandal • Mark Hurd CEO of HP after Carly Fiorina Low profile, no-nonsense, strategy execution forte • Highly successful Increasing market shares for computers and printers Stock rose 110% (well above that of NASDAQ) • 2010 sexual harassment scandal Forced to resign With $45 million severance package Hired by Oracle 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 EXHIBIT 12.1 The Public Stock Company: Hierarchy of Authority 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 EXHIBIT 12.2 Honesty and Ethics Ranking of Different Professions “How would you rate the honesty and ethical standards of people in different fields?” EXHIBIT 12.3 Stakeholder Impact Analysis EXHIBIT 12.4 The Pyramid of Corporate Social Responsibility LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader. 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 make 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 EXHIBIT 12.5 Global Survey of Attitudes toward Business At least somewhat agree that… “the social responsibility of business is increasing profits” 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)” 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. 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 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 Agency Problems • Berle and Means in The Modern Corporation inquired whether we have “any justification 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 (shareholder) ownership (the risk-bearing principals) from control (managerial decision-making agents)? for Agency Problems • What are the “institutions of capitalism” that lessen the problem of the separation of ownership from control? 1. 2. 3. 4. 5. Takeovers (the market for corporate control); Recruitment of executives from outside the firm; Monitoring by boards of directors; Compensation heavily weighted toward stock options; 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 STRATEGY HIGHLIGHT 12.1 GE’s Board of Directors • Diversity of GE’s board of directors (17 members) Business, academia, politicians 4 women, 2 ethnic minorities 15 board members are independent outside directors Less likely to fall victim to groupthink Organized into committees to function • The separation of CEO/Board Chair duality Due to recent global financial crisis 1–21 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 CEO Compensation Dan Ariely Video 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 LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader. EXHIBIT 12.7 Roles that Strategic Leaders Play EXHIBIT 12.8 Strategic Leaders: The Level 5 Pyramid Take-Away Concepts LO 12-1 Describe and critically evaluate the relationship between strategic management and the role of business in society. The public stock company is the institutional backbone of any modern free-market economy. Four characteristics of the public stock company make it an attractive corporate form: limited liability for investors, transferability of investor interests (the trading of stocks), legal personality, and separation of ownership and control. In the first decade of the 21st century, accounting scandals and the global financial crises eroded the public’s trust in business as an institution and free-market capitalism as an economic system. Effective stakeholder management is necessary to ensure the continued survival of the firm and to sustain any competitive advantage . Take-Away Concepts LO 12-2 Conduct a stakeholder impact analysis. Stakeholder impact analysis considers the needs of different stakeholders, which enables the firm to perform optimally and to live up to good citizenship. In a stakeholder impact analysis, managers pay particular attention to three important stakeholder attributes: power, legitimacy, and urgency. Stakeholder impact analysis is a five-step process that answers the following questions: 1. Who are our stakeholders? 2. What are our stakeholders’ interests and claims? 3. What opportunities and threats do our stakeholders present? 4. What economic, legal, and ethical responsibilities do we have to our stakeholders? 5. What should we do to effectively address the stakeholder concerns? Take-Away Concepts LO 12-3 Critically evaluate the relationship between corporate social responsibility (CSR) and competitive advantage. A majority of empirical research studies support the notion that firms can do well (financially) by doing good (through CSR). Some studies, however, found that the relationship is reversed: Superior financial performance allows firms to engage in CSR ( to buy good will). Although there seems to be a positive relationship between CSR and firm financial performance, it is not entirely clear what causes what. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. Corporate governance is about checks and balances, about asking the tough questions at the right time. Corporate governance attempts to address the principal–agent problem, which describes any situation in which an agent performs activities on behalf of a principal. Take-Away Concepts LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. The principal–agent problem is a core tenet in agency theory, which views the firm as a nexus of legal contracts. The principal—agent problem concerns not only the relationship between owners (shareholders) and managers, but also cascades down the organizational hierarchy. The risk of opportunism on behalf of agents is exacerbated by information asymmetry: Agents are generally better informed than the principals. The board of directors is the centerpiece of corporate governance. Other important corporate mechanisms are: executive compensation, the market for corporate control, and financial statement auditors, government regulators, and industry analysis. Take-Away Concepts LO 12-5 Describe and evaluate the relationship between business strategy and ethics. The ethical pursuit of competitive advantage lays the foundation for long-term superior performance. Law and ethics are not synonymous; obeying the law is the minimum that society expects of a corporation and its managers. A manager’s actions can be completely legal, but ethically questionable. The following questions can help managers make sound ethical decisions. 1. Does the intended course of action fall within the acceptable norms of professional behavior? 2. Would the manager feel comfortable explaining and defending the decision in public? 3. How would the media report the particular business decision if it became public? 4. How would the company’s stakeholders feel about it? Take-Away Concepts LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader. Strategic leaders play three different roles: interpersonal, informational, and decisional. To become an effective strategic leader, a manager needs to develop a set of skills to move sequentially through five different leadership levels. At Level 5, the executive is able to build enduring greatness for the company through a combination of will power and humility. At that level, ambition is primarily for the organization, rather than for the self.