Corporate Governance & Strategic Management

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Structure of Todays Session:

1. Completing Corporate Governance Topic Concepts & Cases

2. Case Where Have All the Good Directors Gone? Refer page no. 240
of your textbook

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Corporate Governance & Strategic Management:

Introduction:

Firms success and corporate governance

A weak corporate governance impacts on shareholders, board of directors, top

managers and the overall company

Compensation of CEOs They should be motivated to work in the best

interest of the company, especially the shareholders

CEOs getting massive compensation Does this indicate a weak corporate

governance?

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Corporate Governance & Strategic Management:

So what is corporate governance?

Corporate governance is the set of mechanisms used to manage the
relationship among stakeholders and to determine and control the strategic
direction and performance of organizations (Hitt et al., 2016: 231)

OR

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

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Corporate Governance & Strategic Management:

Why corporate governance is important?

1. Separation of ownership and control of companies Companies operate
within a hierarchy, or chain of governance

2. Corporate scandals since 1990s and significance of corporate governance

Nature of relationships between the different important entities of a company

3. Need to be more visibly accountable and/or responsive for the interest of

company and society Safeguarding corporate interest and social interest

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Corporate Governance & Strategic Management:

The central theme is to make sure that the strategic decisions are effective
Key stakeholders are shareholders whose value should be maximum

Governance mechanisms aim to maintain harmony between different entities

Avoid conflicting interests
It is all about alignment of interests

Different countries have different models of corporate governance

Is this all about ethical behaviour of companies?

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Corporate Governance & Strategic Management:

How to achieve alignment of interests?

Using corporate governance, companies can oversee areas wherein owners,
managers and board of directors may have conflicts of interest

These areas can be CEO pay, election of directors, director pay, strategic
direction and structure of the company

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Corporate Governance & Strategic Management:

What is a governance chain?

A chain that exhibits the roles and relationships of different groups involved in
the governance of a company

This chain is simple in a small family business Shareholders are family

members, the board of directors is made up of some family members and even
managers can be family members

In contrast, a governance chain for a large business is complex There are

extra layers of management
Given the complexity, there can be a negative impact on the management
of strategy

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Corporate Governance & Strategic Management:

Kinds of governance mechanism Three internal governance mechanism and

one external governance mechanism

Three internal governance mechanisms:

1. Ownership Concentration
2. Board of Directors
3. Executive Compensation

External governance mechanism:

Market for corporate control Potential owners that want to acquire
undervalued firms

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Corporate Governance & Strategic Management:

Managerial Revolution Growth of firms and separation of ownership and

control Shift from entrepreneurs to managers?

Broadly, the separation can be as such:

a) Separation and specialisation of ownership (risk bearing)

b) Managerial control (decision making)

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Corporate Governance & Strategic Management:

Agency Relationships:

Shareholders (Principals)
Firm Owners
Hire

Managers (Agents)
Decision Makers
And Create

Agency Relationship
Risk-bearing (Principal)
Decision-maker (Agent)
Principal paying compensation
to decision maker
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Corporate Governance & Strategic Management:

An agency relationship is created because of separation between owners and

managers From Strategic Management perspective, this relationship is crucial
because success or failure of strategies depends upon this relationship

Such relationships can exist between different entities like managers and their
employees

Managerial Opportunism Opportunism exhibited by managers Strategy

formulation and execution then depends upon managerial opportunism

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Corporate Governance & Strategic Management:

The role of strategists becomes challenging:

Do they develop strategies that are in the interests of a group of

shareholders?

OR

Do they develop strategies to meet the aspirations of managers?

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Corporate Governance & Strategic Management:

Misalignment of interest Decisions taken are not in the best interests

The most important factor responsible for majority of corporate
scandals

A famous one is the Enron scandal Corporate governance reforms in the US

created the Sarbanes-Oxley Act (SOX) in 2002

This tightened accounting standards and auditor independence from

management was increased

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Corporate Governance & Strategic Management:

Agency Problem Product Diversification

How managers seek benefits via product diversification strategy?

1. Diversification increases the size of a firm Size is positively related to

executive compensation

Increased complexity because of product diversification can hence be a deliberate

strategy of managers

2. Product diversification can reduce employment risk of top-level managers

With increased product lines, top-level managers can safeguard their employment
risk

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Corporate Governance & Strategic Management:

Agency Problem Product Diversification

Free Cash Flow and Opportunistic Behaviour of Managers

By overdiversifying a company, the top-level managers use free cash flow

In contrast, the shareholders might prefer to use the available cash as dividends
for their share in the company

Issues of corporate governance then arise as both the entities have conflicting
motives of using available cash

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Corporate Governance & Strategic Management:

Agency Problem Product Diversification

Product diversification can therefore increase agency costs because of

monitoring

What are agency costs?

sum of incentive costs, monitoring costs, enforcement costs, and individual
financial losses incurred by principals.

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Corporate Governance & Strategic Management:

Board of Directors:

A group of elected members

Board of Directors in a way work as an intermediary between the shareholders and

the top-level managers

Shareholders monitor the actions and decisions of managers via Board of Directors

A strong board of directors is expected to have the following features:

1. Well informed about companys performance

2. Guides and judges the CEO and other top executives

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Corporate Governance & Strategic Management:

A strong board of directors is expected to have the following features:

3. Has courage to curb inappropriate management actions

4. Certifies to shareholders that the CEO is doing what the board expects

5. Is intensely involved in debating the pros and cons of key decisions and
actions

6. Provides insight and advice to management

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