Chapter 12
Corporate Governance and Business Ethics
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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Chapter Outline
12.1 The Shared Value Framework
12.2 Corporate Governance
• Agency Theory
• The Board of Directors
• Other Governance Mechanisms
12.3 Strategy and Business Ethics
12.4 Implications for the Strategist
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ChapterCase 12
©ChinaFotoPress via Getty Images
HP’s Boardroom Soap Opera Continues
 $120 billion in sales
• “The HP Way” – an admired corporate culture (1938)
 Mark Hurd became CEO in 2005.
• Good financial results – lower costs & higher sales
 18-month period, HP’s market value dropped 80%
• $105 billion (April ‘10) to $23 billion (November ‘12)
 Leo Apotheker became CEO in Fall 2010.
 Meg Whitman became CEO in Fall 2011.
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ChapterCase 12
HP’s Boardroom Soap Opera Continues
 2006 First Stage – HP-initiated unethical surveillance
to uncover a suspected leak.
 2010 (summer) Second Stage – Jodie Fisher, a former
adult-movie actress, filed a lawsuit against CEO Mark
Hurd.
 2010 (fall) Third Stage – (new) CEO Leo Apotheker
overpaid for British software company Autonomy
($11B).
• HP took nearly $9 billion write-down for this within a year!
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Strategy Smart Videos
Governance Gone Wrong – The Case of Tyco
https://www.youtube.com/watch?v=8rcxO6urHTE/
4:29 Minutes
Dennis Kozlowski on 60 Minutes
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12.1 The Shared Value Framework
 Guidance to managers on competitive
advantage, balancing Agency & Shareholder
perspectives
• 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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MILTON FRIEDMAN VS. MICHAEL PORTER/ARCHIE CARROLL
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. Argues that
managers are obligated to maximize returns to stockholders as
the legitimate owners of the firm.
Shared Value View: (Porter/Carroll)
• Corporate social responsibility (CSR): obligations extend
beyond the economic responsibility to stockholders and include
legal, ethical, and philanthropic obligations to other stakeholder
groups and society as a whole.
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CSR of Business
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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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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
• Primary responsibility to “monitor & control” actions of
CEO & TMT – Legal obligation
 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, but not always “outsiders”
 Senior executives from other firms or full-time professionals
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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
 CEO 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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EXECUTIVE COMPENSATION
 Interest aligned through “monitoring & control and/or
compensation (Stewardship Theory)
 Salary, bonus, perks, and stock issuance/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: $11.7 million
2. Firm performance and CEO pay
•
•
•
McKesson high salary but also high performance
Home Depot, HP….NOT
Why do CEOs make so much?
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Other Governance Mechanisms
 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 an 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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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:
• Consistent International ethical values & code of conduct
• Professionalization of management
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ChapterCase 12
©ChinaFotoPress via Getty Images
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.
 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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