12 Corporate Governance, Business Ethics, and Strategic Leadership

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
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
Stakeholder Impact Analysis
The Pyramid of Corporate Social Responsibility
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
Japan, and India are less interested in CSR
Brazil, and Germany are more interested in CSR
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
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
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
 Wall Street Journal, Bloomberg Businessweek, Forbes…
 Credit rating agencies
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