Chapter 12
Corporate Governance and Business Ethics
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Exhibit 12.1 The HP Way
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Exhibit 12.2 HP Stock Performance
Under CEOs Hurd, Apotheker, and Whitman
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12.1 The Shared Value Framework
 Guidance to managers on competitive advantage
• Economic imperative
• Corporate social responsibility (introduced in Ch. 1)
 Creates a larger pie
• Benefits shareholders and other stakeholders
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Public Stock Companies and
Shareholder Capitalism
 Public stock companies are vital in free market
economies.
 Four attractive characteristics of public firms:
1)
2)
3)
4)
Limited liability for investors
Transferability of investor interest
Legal personality
Separation of ownership and control
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Exhibit 12.3 The Public Stock
Company Hierarchy of Authority
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MILTON FRIEDMAN VS. MICHAEL PORTER
Traditional View: (Friedman)
• Shareholder capitalism: shareholders – the providers of the
necessary risk capital and the legal owners of public
companies – have the most legitimate claim on profits.
Shared Value View: (Porter)
• Corporate social responsibility (CSR): obligations extend
beyond the economic responsibility and include legal,
ethical, and philanthropic societal expectations
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Exhibit 12.4 Global Survey of Attitudes
toward Business Responsibility
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Shared Value Framework
 Reestablish the relationship between superior firm
performance and societal progress
• Enable firms to gain and sustain a competitive advantage
• Reshape capitalism and its relationship to society
 Externalities
• Pollution, wasted energy, and costly accidents increase
• Internal costs in lost reputation if not directly on the bottom line
 Porter suggests that the two can be reconciled to create a
larger pie.
 Example: GE ecoimagination initiative
• Generated $25B in sales in 2012
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CONNECTING ECONOMIC AND SOCIETAL NEEDS
 Michael Porter: Managers focus on three things here.
1. Expand the customer base to bring in nonconsumers .
•
Including those at the bottom of the pyramid
2. Expand traditional internal firm value chains to include
more nontraditional partners.
•
For example, nongovernmental organizations (NGOs)
3. Focus on creating new regional clusters.
•
Chilecon Valley and Bangalore
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12.2 Corporate Governance
AGENCY THEORY
• A theory that views the firm as a nexus of legal contracts
BOARD OF DIRECTORS
• The centerpiece of corporate governance, composed of inside
and outside directors who are elected by the shareholders
OTHER GOVERANCE MECHANISMS
• Executive compensation
• The market for corporate control
• Financial statement auditors, government regulators, and
industry analysis
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Corporate Governance (cont’d)
 Corporate governance
• Mechanisms to direct and control a firm
• Ensure the pursuit of strategic goal
• Address the principal−agent problem (introduced in Ch. 8)
 When corporate governance fails
• Accounting scandal
• Global financial crisis
 Information asymmetry
• Insider information: Galleon Group
• On-the-job consumption: Tyco & Merrill Lynch
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Exhibit 12.5 Principal-Agent Problem
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Corporate Governance (cont’d)
 Agency Theory
• Views a firm as a nexus of legal contracts
 Relationships among shareholders, managers, and hierarchies.
 Front-line employees have an advantage over management.
 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
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The Board of Directors
 Centerpiece of corporate governance
• ChapterCase − problems can drain shareholder value
 Different shareholder goals
• Institutional investors
• Individual short-term investors
 Inside directors
• Generally part of the company’s senior management team
 Outside directors
• Not employees of the firm
 Senior executives from other firms or full-time professionals
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FUNCTIONS OF THE BOARD OF DIRECTORS
 Selecting, evaluating, and compensating the CEO
 Overseeing CEO succession plan
• Recently problematic at both HP & Apple





Providing guidance on executives & their compensation
Reviewing, monitoring, & 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
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Strategy Highlight 12.1
GE’s Board of Directors
 16/17 members are independent outside directors
 Comprised of business, academia, & government
 Duality – Jeffrey Immelt, the one inside director, is
both the CEO and chairperson of the board, a declining
practice due to the conflict of interest
 GE’s board has 5 committees.
 Boardroom diversity (28% for GE) in backgrounds and
expertise is considered an asset: More diverse boards
are less likely to fall victim to groupthink.
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Other Governance Mechanisms
Executive Compensation
The Market for Corporate Control
Financial statement auditors, government
regulators, and industry analysis
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EXECUTIVE COMPENSATION
 Salary, bonus, and stock options (long-term
incentives)
 CEO pay - two issues:
1. CEO pay compared to average employee pay
•
•
U.S. ratio 2012: 300 to 1, 1980: 40 to 1
Average CEO pay in Fortune 500 firm: $11 million
2. Firm performance and CEO pay
•
•
McKesson high salary but also high performance
Home Depot, HP….NOT
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Other Governance Mechanisms
(cont’d)
 The market for corporate control
• External governance mechanism
• Hostile takeover
• Corporate raiders and hedge funds
 2013 − Dell’s LBO was a target of Carl Icahn.
 Auditors, government regulators, and
industry analysts
• SEC- GAAP as reported publicly via EDGAR
• The Wall Street Journal, Bloomberg BusinessWeek,
Forbes…
• GovernanceMetrics International (GMI Ratings)
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12.3 Strategy and Business Ethics
 Business ethics
• Agreed-upon explicit code of conduct in business
 Legal conduct vs. Ethical conduct
• Legal (min acceptable standard), but may not be ethical
 Mortgage brokers selling “option ARMs”
• Ethical, but may not be legal
 Pharmaceutical firms discussing pricing to increase affordability
 When facing ethical dilemma:
• Do the actions fall into acceptable norms of professional
behavior?
• Does it feel comfortable explaining and defending the
decision in public?
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Strategy Highlight 12.2
Did Goldman Sachs and the “Fabulous Fab” Commit
Securities Fraud?
 The SEC alleged that Goldman violated its fiduciary
responsibility and defrauded its clients.
 Collateralized Debt Obligation (CDO) such as Abacus
• Roll-up of risky investments into a AAA-rated CDO
 Rating agencies falsely viewed these as safe investments!
 Goldman Sachs settled by paying a $550 million
• Did not admit any wrongdoing
• Mr. Tourre convicted of securities fraud in Aug. 2013
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ORGANIZATIONAL CONTEXT
 Is unethical behavior just a few “bad apples”?
 Research – some organizations have unethical climate
• Ethical decision making depends on the organization
 Enron−creating an inflated share price at any cost
 Employees observed and followed the behavior set by leaders.
 Ethical leadership is critical.
• CEOs at large public firms face increasing scrutiny.
 Mark Hurd fired at HP without proof of illegal behavior
• Formal and informal cultures
 Must be aligned with executive behavior
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Exhibit 12.6 The MBA Oath
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12.4 Implications for the Strategist
 Effective corporate governance and business ethics
• Critical to gaining and sustaining competitive advantage
 Strategic leaders need to take actions with integrity.
 IBM emphasizes its values across the globe.
• Example of an employee falling ill at a training session
• An expectation among IBMers−a “lived” value
 Glaring ethical lapses in the last 10 years call for:
• Ethical values and code of conduct
• Professionalization of management
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ChapterCase 12
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Consider This…
• HP featured in the bestseller Built to Last (1994)
 Much has changed since Mr. Hewlett’s death in 2001.
• HP board’s decisions destroyed $82 billion in
shareholder value.
 Exhibited groupthink in rallying around Mr. Apotheker as CEO
 Full board never met him before hiring him.
 Flawed due diligence process in the Autonomy acquisition
 Lack of an open search to appoint Meg Whitman as CEO
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