Corporate Governance
Business Strategy
What is Corporate Governance?
• Corporate governance is concerned with the
structures and systems of control by which
managers are held accountable to those who
have a legitimate stake in an organisation.
Definitions
• “Corporate governance involves a set of relationships
between a company’s management, its board, its
shareholders and other stakeholders ..also the
structure through which objectives of the company
are set, and the means of attaining those objectives
and monitoring performance are determined.”
– Preamble to the OECD Principles of Corporate Governance, 2004
Issues Highlighted
by the Governance Chain
To whom are executives responsible?
Who are the shareholders?
What is the role of institutional investors?
What means of scrutiny and control exist?
Corporate Governance
• Given a choice between two alternatives, man as
rational actor will choose the option that
increases their individual benefit
• This is a key assumption of agency theory
• Rational business owners would prefer to
manage their own companies and reap the
maximum benefit for themselves.
• However, as firms grow, an owner’s inability to
control every aspect of business will lead to the
employment of managers on their behalf(agents)
Why do we need Corporate
Governance?
• As companies grow the will inevitably will
become more complex.
• A business started by its owner for the
purpose of creating wealth for themselves and
also achieving a particular objective is in the
early days very simplistically governed.
Why do we need Corporate
Governance?
• For example Bill Gates co founded Microsoft with
the goal of ensuring that his software would be
used in computers all over the world.
• During the early days of the company the focus
would be on developing their product, it would
invariably involve Bill Gates and a small team of
employees.
• During this period due to the size of the company,
there would be little worry about the
administration and structure of Microsoft.
Why do we need Corporate
Governance?
• However, as Microsoft expanded and took on
more staff. Gates would see his role change.
• He would be unable to be as involved in the
everyday decisions and management that he
would have been involved with during the early
years of the company.
• He would therefore need a system or structure
that would share the work. This would be done
by employing Managers and Directors to take on
this role.
Why do we need Corporate
Governance?
• Gates who would still be overseeing everything as
CEO of the company, would need to delegate
responsibility to these managers.
• These manager would be tasked with achieving
the objectives set by Gates.
• However, the question arises as to whether these
Managers employed by Gates would have the
same drive, determination and indeed motivation
to achieve the goals of the firm.
Corporate Governance
• The separation of ownership an wealth
creates and agency relationship where one
person(s) is engaging another to deliver their
own organisational objectives.
• Agent is morally responsible to maximise
shareholder utility.
• Where principal & agent’s interests converge,
there is no agency problem
Roles and Responsibilities
• Stakeholders of the organisation may include
– Shareholders
– Board of Directors
– CEO
– Management
– Employees
– All are part of the company, but may have
differing objectives
Roles and Responsibilities
Stakeholder
Objectives
Self interest
Shareholders
For the company to be
profitable
Return on Investment
Board of Directors
To protect the interests of the Ensure ROI for shareholders
stakeholders particularly the
shareholders
CEO
To deliver the mission of the
organisation as outlined by
the board
Managers
To deliver the goals set by the Delivery of goals may lead to
CEO
rewards
(financial/promotion)
Employee
To deliver targets set by their
manager
Successful delivery of mission
may bring financial reward,
other opportunities
Delivery of goals may lead to
rewards
(financial/promotion)
Corporate Governance
• Interests Divergence
• Which agents will veer of course? Which ones
will stay loyal?
– Monitoring costs
• Difference in Risk taking
• Objective of agency theory is to reduce agency
costs incurred by the principal
Agency Costs
• Monitoring managers behaviours
– The costs incurred by principal to monitor agents
is an agency cost.
• Incentive schemes
– Principals may seek to offer incentives for Agents
to deliver their goals.
Monitoring Agents
• Boards of directors keep potentially self-serving
managers in check by performing audits and
performance evaluations.
• Boards communicate shareholders’ objectives
and interests to managers and monitor them to
keep agency costs in check.
The Role of Board of Directors
• BOD Typical Responsibilities
– Setting corporate strategy, overall direction , mission
and/or vision
– Succession: Hiring, compensating and firing the CEO and
top management
– Control: monitoring, evaluating, and/or supervising top
management
– Reviewing and approving the use of organizational
resources
– Caring for stockholders’ interest
• In legal terms, BOD’s are required to direct the affairs
of the corporation but not to manage them (act with
due care).
Agency theory & Strategic
Management -Corporate Governance
• Influence of board of directors
– Board is monitoring and controlling device
– Oversee managers
– Act and protects owners interests
• Monitoring capacity of investors
– Capacity to monitor?
• Setting Executive Compensation
– Compensation to align managerial interests with those of the owners
– Long term vs. short term incentives
• Market for Corporate Control
– Hostile takeover: sign of managerial underperformance (agency
problem)
The Role of Board of Directors
• Role of BOD in the strategic management process
– Monitor:
• Keep abreast of developments both outside & inside the
company
• Bring to management’s attention developments it might have
overlooked.
– Evaluate and influence:
• Examine mgt’s proposals, decisions, & actions.
• Agree or disagree with them; give advice, offer suggestions &
outline alternatives (if any).
– Initiate and determine:
• Delineate a company’s mission & vision; and specify strategic
options to management.
The Role of Board of Directors
• Degree of involvement is dependent on
extent to which it perform the three tasks:
– Monitoring (LOW LEVEL OF INVOLVEMENT)
– Evaluating and influencing (MEDIUM LEVEL OF
INVOLVEMENT)
– Initiating and determining (HIGH LEVEL OF
INVOLVEMENT)– e.g., GM, Mead Corp.
• BOD involvement is a continuum
The Role of Board of Directors
• The BOD Continuum
Low
Degree of involvement
Monitor (40%)
•Permit officers to make
all decisions.
•Formally reviews
selected issues
•Votes as officers
recommend on actions.
High
Evaluate & Influence
(30%)
Initiate & Determine
(30%)
•Involved in review of
selected key decisions,
indicators or programs of
management
•Approve, question & makes
final decisions on mission,
objectives strategy & policies.
•Perform fiscal & mgt audits.
•Take leading role in
establishing & modifying
mission, objectives, strategy &
policies.
•Has very active strategic
committees
Composition of Board of
Directors
• Most publicly-owned corporations are
composed of
– Inside directors (management directors)
• Officers & executives employed by the firm
• About 20%/60% in large/small US firms
– Outside directors
• Executives of other firms but not employees of
board’s firm
• Can be affiliated to firm – legal or insurance client,
retired executive of firm, family, etc.
• About 80%/40% in large/small us firms
The Role of Top Management
• Top management function is usually
performed by CEO in coordination with
– Chief Operating Officer (COO) or President
– Chief Financial Officer (CFO)
– Chief Information Officer (CIO)
– Executive Vice Presidents (VP’s) and VP’s of
divisions & functional areas
The Role of Top Management
• Top management is primarily responsible for
the strategic management of the firm
– Responsible for every decision & action of every
organizational employee
– Responsible for providing effective strategic
leadership
– Strategic leadership is the ability to anticipate,
envision, maintain flexibility, think strategically,
and work with others in an organization to initiate
changes that will create a viable and valuable
future for the organization
The Role of Top Management
• The CEO, must perform two functions
crucial to the SM of corporations:
– Provide executive leadership
• Articulate a strategic vision for the firm
• Present a role for other to identify with and follow
(e.g., behavior, attitude, values, etc)
• Communicate high performance standards & show
confidence in followers’ abilities to meet these
standards
– Manage the strategic planning process
• Evaluate division/units to make sure they fit
together into an overall corporate plan
The Role of Top Management
• The whole top management’s strategic
leadership responsibilities involves
– Determining the firm’s mission, vision, and
objectives
– Exploiting & maintaining the firm’s resources,
core competencies & capabilities
– Creating & sustaining a strong organizational
culture
– Emphasizing ethical decision & practices
– Establishing appropriately balance
organizational control
Corporate Social Responsibility
• The corporation is a mechanism established to allow
different parties to contribute capital, expertise and
labour for their mutual benefit.
– Investors/Shareholders – capital providers
– Management – expertise & labour providers for running of
company
• Board of directors (BOD) elected by shareholders to
protect their interest.
• Corporate governance – relationship among BOD,
management, and shareholders
Reasons for Imperfect Operation
of the Governance Chain
Lack of clarity on end beneficiaries
Unequal division of power
Different levels of access to inform
Self-interest among agents
Measures and targets reflect agent selfinterests rather than those of end
beneficiaries
Benefits and Disadvantages of
Governance
Guidelines for Boards
Operate independently of management
Be competent to scrutinise the activities of
management
Have time to do job properly
Behave appropriately given expectations
for trust, role fluidity, collective
responsibility, and performance