Ch 9: Strategic Control and Corporate Governance Analysis – Formation – Implementation I.Informational Control Traditional / Contemporary II.Behavioral Control Culture / Rewards / Boundaries III.Role of Corporate Governance A.Aligning managerial & shareholder interests B.External Control Mechanisms

Strategic Control Strategic control -- the process of monitoring and correcting a firm’s strategy and performance Informational control Behavioral control 9-2

Informational Control Traditional control system 1.strategies are formulated and top management sets goals 2.strategies are implemented 3.performance is measured against the predetermined goal set 9-3

Traditional Approach to Strategic Control 9-4 Process typically involves lengthy time lags, often tied to the annual planning cycle This “single-loop” learning control system simply compares actual performance to a predetermined goal

Traditional Approach to Strategic Control Most appropriate when  Environment is stable and relatively simple  Goals and objectives can be measured with certainty  Little need for complex measures of performance 9-5

Contemporary Approach to Strategic Control Contemporary control system  Continually monitoring the environments (internal and external)  Identifying trends and events that signal the need to revise strategies, goals and objectives  “Double-loop” learning 9-6

Contemporary Approach to Strategic Control 9-7

Contemporary Approach to Strategic Control Informational control the ability to respond effectively to environmental change Are we “doing the right things?” Outcomes Behavioral control the appropriate balance and alignment among a firm’s culture, rewards, and boundaries Are we “doing things right” in the implementation of our strategy/ strategies? Process 9-8

I. Informational Control Deals with internal environment and external strategic context Key question  “Do the organization’s goals and strategies still ‘fit’ within the context of the current strategic environment?” 9-9

Informational Control Two key issues  Scan and monitor external environment (general and industry)  Continuously monitor the internal environment 9-10

Informational Control - Outcomes Common measures and controls: o Sales o Revenue, Increased revenue o Profit o Customer service o Low Cost / Differentiation / Focus o Cost o Quality o Uniqueness 9-11

Evaluating Firm Performance (Ch 3) Financial ratio analysis  Balance sheet  Income statement  Historical comparison  Comparison with industry norms  Comparison with key competitors Stakeholder perspective  Employees  Customers  Owners

Financial Ratio Analysis (Ch 3) Five types of financial ratios  Short-term solvency or liquidity  Long-term solvency measures  Asset management (or turnover)  Profitability  Market value Balanced Scorecard, Triple bottom line

II. Behavioral Control Behavioral control is focused on implementation—doing things right Three key control “levers”  Culture  Rewards  Boundaries 9-14

Reasons for an increased emphasis on culture and rewards 1.The competitive environment is increasingly complex and unpredictable, demanding both flexibility and quick response to its challenges. 2.The implicit long-term contract between the organization and its key employees has been eroded. 9-15

Building a Strong and Effective Culture Organizational culture  a system of shared values and beliefs that shape a company’s people, organizational structures, and control systems to produce behavioral norms. Culture acts as a means of reducing monitoring costs 9-16

Building a Strong and Effective Culture Culture sets implicit boundaries (unwritten standards of acceptable behavior)  Dress  Ethical matters  The way an organization conducts its business  How you interact with customers, suppliers 9-17

Sustaining an Effective Culture Effective culture must be  Cultivated  Encouraged  Fertilized Maintaining an effective culture  Storytelling  Rallies or pep talks by top executives  Layout / location 9-18

Motivating with Rewards and Incentives Rewards and incentive systems  Powerful means of influencing an organization’s culture  Focuses efforts on high-priority tasks  Motivates individual and collective task performance  Can be an effective motivator and control mechanism 9-19

Motivating with Rewards and Incentives Potential downside  Subcultures may arise in different business units with multiple reward systems  May reflect differences among functional areas, products, services and divisions Individual rationality does not guarantee organizational rationality 9-20

Characteristics of Effective Reward and Evaluation Systems 9-21

Setting Boundaries and Constraints Focus efforts on strategic priorities Providing short-term objectives and action plans  Specific and measurable  Specific time horizon for attainment  Achievable, but challenging Improve operational efficiency and effectiveness Minimizing improper and unethical conduct 9-22

Question Effective boundaries and constraints: A.Tend to inhibit efficiency and effectiveness B.Distract employees who are trying to focus on organizational priorities C.Minimize improper and unethical conduct D.Tend to limit organizational growth 9-23

Setting Boundaries and Constraints Rule-based controls are most appropriate in organizations with the following characteristics:  Environments are stable and predictable.  Employees are largely unskilled and interchangeable.  Consistency in product and service is critical.  The risk of malfeasance is extremely high 9-24

Organizational Control: Alternative Approaches 9-25

Organizational Control: Alternative Approaches – Culture 9-26

Organizational Control: Alternative Approaches – Rules

Organizational Control: Alternative Approaches – Rewards

Evolving from Boundaries (Rules) to Rewards and Culture System of rewards and incentives coupled with a strong culture  Hire the right people  Training plays a key role  Managerial role models are vital  Reward systems clearly aligned with organizational goals and objectives 9-29

Think whole System Efficiency Not just piece/part efficiency A Note on Efficiency 30

III. Role of Corporate Governance Corporation  A mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. Corporate governance  the relationship among various participants in determining the direction and performance of corporations.  primary participants are the shareholders, the management, and the board of directors.” 9-31

Agency Theory Deals with the relationship between  Principals – who are owners of the firm (stockholders), and the  Agents – who are the people paid by principals to perform a job on their behalf (management) 9-32

Agency Theory: Two Problems 1.The conflicting goals of principals and agents, along with the difficulty of principals to monitor the agents, and 2.The different attitudes and preferences towards risk of principals and agents. 9-33

Governance Mechanisms Board of directors  a group that has a fiduciary duty to ensure that the company is run consistently with the long-term interests of the owners, or shareholders, of a corporation and that acts as an intermediary between the shareholders and management. 9-34

Duties of the Board 1. Select, regularly evaluate, and, if necessary, replace the CEO. Determine management compensation. Review succession planning. 2. Review and, where appropriate, approve the financial objectives, major strategies, and plans of the corporation. 3. Provide advice and counsel to top management. 4. Select / recommend (to shareholders for election) an appropriate slate of candidates for the BOD; evaluate board processes / performance. 5. Review the adequacy of the systems to comply with all applicable laws/regulations. 9-35

The New Rules for Directors 9-36

Governance Mechanisms Shareholder activism  actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization. 9-37

TIAA-CREF’s Principles on the Role of Stock in Executive Compensation 9-38

External Governance Control Mechanisms External governance control mechanisms  methods that ensure that managerial actions lead to shareholder value maximization and do not harm other stakeholder groups and that are outside the control of the corporate governance system. 9-39

External Governance Control Mechanisms Market for corporate control  Stock value Auditors Banks and analysts Regulatory bodies  governments Media and public activists 9-40

Sarbanes-Oxley Act Auditors  Barred from certain types of non-audit work  Not allowed to destroy records for five years  Lead partners auditing a firm should be changed at least every five years 9-41

Sarbanes-Oxley Act CEOs and CFOs  Must fully reveal off-balance sheet finances  Vouch for the accuracy of information revealed Executives  Must promptly reveal the sale of shares in firms they manage  Are not allowed to sell shares when other employees cannot 9-42

International Different rules  Legal issues Different governance structures  Ownership structures/rules 9-43