STRATEGIC MANAGEMENT


 Corporate Governance

• Corporate governance is
– a relationship among stakeholders that is used to
determine and control the strategic direction
and performance of organizations
–
– concerned with identifying ways to ensure that
strategic decisions are made effectively
–
– used in corporations to establish order between
the firm’s owners and its top-level managers

2
 Separation of Ownership and
Managerial Control
• Basis of the modern corporation
– shareholders purchase stock, entitles them to
income from the firm’s operations after paying
the expenses
–
– shareholders reduce risk by holding diversified
portfolios
–
– professional managers are contracted to provide
decision-making
–
– Modern public corporation form leads to efficient
specialization of tasks 3
Agency Relationship: Owners and
Managers

Shareholders
(Principals)
• Firm owners

Managers
• Decision makers (Agents)

•Risk bearing specialist (principal)

pays compensation to a An Agency
managerial decision-making Relationship
specialist (agent)
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 Managerial Opportunism
• The seeking of self-interest with guile (cunning or
deceit)
•
• Managerial opportunism is:
– An attitude (inclination)
– A set of behaviors (specific acts of self-interest)


• Managerial opportunism prevents the maximization of

shareholder wealth (the primary goal of
owner/principals).
 Response to Managerial
Opportunism
• Principals do not know beforehand which
agents will or will not act opportunistically.
•
• Thus, principals establish governance and
control mechanisms to prevent managerial
opportunism.
 Agency Relationship Problems
• Principal and agent have divergent interests and goals.
•
• Shareholders lack direct control of large, publicly traded
corporations.
•
• Agent makes decisions that result in the pursuit of
goals that conflict with those of the principal.
•
• It is difficult or expensive for the principal to verify that
the agent has behaved appropriately.
 Examples of the Agency
Problem
• The Problem of Product Diversification
– Increased size, and the relationship of size to
managerial compensation
– Reduction of managerial employment risk
–
• Use of Free Cash Flows
– Managers prefer to invest these funds in
additional product diversification (see above).
– Shareholders prefer the funds as dividends so
they control how the funds are invested.
Manager and Shareholder Risk
and Diversification
Shareholder Managerial
(business) (employment)
S risk profile risk profile M
Risk

A B
Dominant Related Related Unrelated
Business Constrained Linked Businesses
Diversification
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 Agency Costs and Governance
Mechanisms
• Agency Costs
– The sum of incentive costs, monitoring costs,
enforcement costs, and individual financial
losses incurred by principals, because
governance mechanisms cannot guarantee total
compliance by the agent.
–
• Principals may engage in monitoring behavior
to assess the activities and decisions of
managers.
– However, dispersed shareholding makes it difficult
and inefficient to monitor management’s
behavior.
 Corporate Governance Mechanisms
Internal Governance Mechanisms
Ownership Concentration
 Relative amounts of stock owned by individual
shareholders and institutional investors
Board of Directors
 Individuals responsible for representing the firm’s
owners by monitoring top-level managers’ strategic
decisions
Executive Compensation
 Use of salary, bonuses, and long-term incentives to align
managers’ interests with shareholders’ interests

External Governance Mechanism

Market for Corporate Control
 The purchase of a company that is underperforming
relative to industry rivals in order to improve the
firm’s strategic competitiveness
 OWNERSHIP CONCENTRATION
 O w n e rsh ip C o n ce n tra tio n is d e fin e d a s b o th th e n u m b e r o f
la rg e b lo ck sh a re h o ld e rs a n d th e to ta lp e rce n ta g e o f sh a re s
th a t th e y o w n .
 It h a s re ce ive d co n sid e ra b le in te re st a s a g o ve rn a n ce
m e ch a n ism b e ca u se la rg e b lo ck sh a re h o ld e rs a re
in cre a sin g ly a ctive in th e ir d e m a n d s th a t co rp o ra tio n s a d o p t
e ffe ctive g o ve rn a n ce m e ch a n ism s to co n tro lm a n a g e ria l
d e cisio n s.

D iffu se O w n e rsh ip
 A la rg e n u m b e r o f sh a re h o ld e rs w ith sm a llh o ld in g s a n d fe w ,
if a n y , la rg e – b lo ck sh a re h o ld e rs.
 Pro d u ce s w e a k m o n ito rin g o f m a n a g e rs d e cisio n s.
 It m a ke s d ifficu lt fo r o w n e rs to e ffe ctive ly co o rd in a te th e ir
a ctio n s.


 Higher levels of monitoring could encourage managers to avoid
 2. Board of Directors
 Board of directors
– Group of elected individuals that acts in the
owners’ interests to formally monitor and
control the firm’s top-level executives
 Board has the power to:
– Direct the affairs of the organization
– Punish and reward managers
– Protect owners from managerial
opportunism



 Board of Directors (Contd)
 Composition of Boards:
– Insiders: the firm’s CEO and other top-level
managers
– Related Outsiders: individuals uninvolved with
day-to-day operations, but who have a
relationship with the firm
– Outsiders: individuals who are independent of
the firm’s day-to-day operations and other
relationships
–
 Enhancing the effectiveness of boards and
directors:
– More diversity in the backgrounds of board
members
 3. Executive Compensation
 Forms of compensation:
– Salaries, bonuses, long-term performance
incentives, stock awards, stock options


 Factors complicating executive compensation:

– Strategic decisions by top-level managers are
complex & non-routine
– Executive’s decision often affects firm’s financial
outcomes over an extended period
– Other variables affecting the firm’s performance
over time.



 4. Market for Corporate Control
• Individuals and firms buy or take over
undervalued corporations.
– Ineffective managers are usually replaced in such
takeovers.
• Threat of takeover may lead firm to operate
more efficiently.
• Changes in regulations have made hostile
takeovers difficult.
• Managerial defense tactics increase the costs of
mounting a takeover
• Defense tactics may require:
– Asset restructuring
– Changes in the financial structure of the firm
– Shareholder approval
 Managerial Defense Tactics
• Poison Pill – preferred stock in the merged firm
offered to shareholders at a highly attractive rate of
exchange
•
• Corporate charted ammendment- an
ammendment to stagger the elections of members to
the BOD of the attacked firm so that all are not
elected during the same year ,which prevents a
bidder from installing a completely new board in the
same year.
•
• Golden Parachute- Lump-sum payments of cash that
are distributed to a select group of senior executives.
•
• Litigation- Lawsuits that help a target company stall
 Managerial Defense Tactics
(Contd)
• Greenmail – The repurchase of shares of stock by the
aggressor at a premium in exchange for an
agreement that an aggressor will no longer target the
company for takeover.
•
• Standstill agreement – Contract between the parties
in which the pursuer agrees not to acquire any more
stock of the target firm for a specified period of time
in exchange for the firm paying the pursuer a fee.
•
• Capital structure change – Dilution of stock, making
it more costly for a bidder to acquire , ESOPs,
recapitalization, new depth, stock selling and share
 International Corporate
Governance
• Understanding the international corporate
governance is required for assessing the
multinational firm in today’s economy.
• The stability associated with the German &
Japanese governance structures has been viewed
as an asset.
• The main aim is to develop a more global
governance system.

 Corporate Governance in
Germany
 The owner & manager may still be the same individual.

 Concentration of ownership is an important means of

corporate governance.
 Banks occupied the centre of German corporate
governance structure.
 Firms with more than 2000 employees required to have
a two-tiered board structure.
 Corporate governance in Germany is changing due to
globalization of business.

 Corporate governance in Japan
• Attitudes in Japan are affected by the concepts of obligation,
family & consensus.


• Obligation: to return a service for one rendered or derived

from a more general relationship.
•
• Family: company family, individuals are members of a unit.
•
• Consensus: energy used to win the hearts and minds of
people whenever possible.
•
• Japan has a bank-based financial & corporate governance
structure.
•
• Foreign shareholders accounts for 28% of the overall
Governance Mechanisms and
Ethical Behavior

It is im p o rta n t to se rve th e in te re sts o f th e firm ’ s

m u ltip le sta ke h o ld e r g ro u p s!

Capital Market •S h a re h o ld e rs ( in th e ca p ita lm a rke t

Stakeholders sta ke h o ld e r g ro u p ) a re vie w e d a s
th e m o st im p o rta n t sta ke h o ld e r
Product Market g ro u p .
Stakeholders •T h e fo cu s o f g o ve rn a n ce
m e ch a n ism s is o n th e co n tro lo f
Organizational m a n a g e ria ld e cisio n s to a ssu re
Stakeholders sh a re h o ld e r in te re sts.
•In te re sts o f sh a re h o ld e rs is se rve d
b y th e B o a rd o f D ire cto rs.