11 CHARLES W. L. HILL / GARETH R. JONES Strategic Management An Integrated Approach 10th ed. Corporate Performance, Governance, and Business Ethics Chapter 11 Student Version © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Prepared by C. Douglas Cloud , Professor Emeritus of Accounting, Pepperdine University

STAKEHOLDERS AND CORPORATE PERFORMANCE Learning Objective: After reading this chapter, you should be able to understand the relationship between stakeholder management and corporate performance. STAKEHOLDERS AND CORPORATE PERFORMANCE Stakeholders are individuals or groups with an interest, claim, or stake in the company, in what it does, and how well it performs. Internal stakeholders are stockholders and employees and board members. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STAKEHOLDERS AND CORPORATE PERFORMANCE External stakeholders are all other individuals and groups that have some claim on the company. Stockholders provide the enterprise with risk capital and in exchange expect management to attempt to maximize the return on their investment. Creditors also provide the company with capital in the form of debt to be repaid with interest. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STAKEHOLDERS AND CORPORATE PERFORMANCE Employees provide labor and skills primarily in exchange for commensurate income. Customers provide revenue in exchange for high-quality, reliable products or services. Suppliers provide a company with inputs in exchange for revenues. Governments provide a company with rules and regulations that govern business practice and maintain fair competition. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STAKEHOLDERS AND CORPORATE PERFORMANCE Shareholder Impact Analysis Typically, stakeholders impact analysis follow these steps: Identify stakeholders. Identify stakeholders’ interest and concerns. As a result, identify what claims stakeholders are likely to make on the organization. Identify the stakeholders who are most important from the organization’s perspective. Identify the resulting strategic challenges. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

STAKEHOLDERS AND CORPORATE PERFORMANCE The Unique Role of Stockholders Stockholders are legal owners and the providers of real capital. Maximizing returns to stockholders has taken on significant importance as an increasing number of employees have become stockholders. By making employees stockholders, employee stock option plans tend to increase the already strong emphasis on maximizing returns to stockholders. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

PROFITABILITY, PROFIT GROWTH, AND STOCKHOLDER CLAIMS Learning Objective: After reading this chapter, you should be able to explain why maximizing returns to stockholders is often viewed as the preeminent goal in many corporations. PROFITABILITY, PROFIT GROWTH, AND STOCKHOLDER CLAIMS Return on invested capital (ROIC) is an excellent measure of the profitability of a company. The relationship between profitability and profit growth is a complex one. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

PROFITABILITY, PROFIT GROWTH, AND STOCKHOLDER CLAIMS When a company is profitable and its profits are continuing to grow, it can pay higher salaries and give more benefits to productive employees. Neither suppliers nor customers want the company to maximize its profitability at their expense. While profitability is a way to satisfy the claims of several key stakeholder groups, a company must do so within the limits set by the law and in a manner consistent with societal expectations. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Unfortunately, not all agents are worthy of trust. AGENCY THEORY Information asymmetry between principals and agents is not necessarily a bad thing. However, it could make it difficult for principals to measure how well an agent is performing. Without this measurement, it is difficult to hold the agent accountable for how well he or she is using the entrusted resources. Unfortunately, not all agents are worthy of trust. A minority will mislead principals for personal gain, sometimes behaving unethically or illegally. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

AGENCY THEORY Some authors have argued that senior managers are motivated by desire for status, power, job security, and income. By virtue of their position within the company, certain managers can use their authority and control over corporate funds to satisfy these desires at the cost of return to stockholders. CEOs might invest corporate funds in various perks that enhance their status. Economists have termed such behavior on-the-job consumption. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

AGENCY THEORY A further concern is that in trying to satisfy a desire for status, security, power, and income, a CEO might engage in empire building. Empire building involves a CEO buying many new businesses in an attempt to increase the size of the company through diversification. Instead of trying to maximize stockholders’ returns by seeking the right balance between profitability and profit growth, some senior managers trade long-term profitability for greater company growth via new purchases. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

GOVERNANCE MECHANISMS Learning Objective: After reading this chapter, you should be able to describe the various governance mechanisms that are used to align the interest of stockholders and managers. GOVERNANCE MECHANISMS Governance mechanisms are mechanisms that principals put in place to align incentives between principals and agents and to monitor and control agents. The board of directors is elected by stock-holders, and under corporate law, represents the stockholders’ interests in the company. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

GOVERNANCE MECHANISMS Confronted with agency problems, the challenge for principals includes: Shaping the behavior of agents so that they act in accordance with the goals set by principals. Reducing the information asymmetry between agents and principals. Developing mechanisms for removing agents who do not act in accordance with the goals of principals and mislead them. Principals try to deal with these challenges through a series of governance mechanisms. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

GOVERNANCE MECHANISMS Inside directors are senior employees of the company who have valuable information about the company’s activities. Outside directors are not full-time employees of the company. According to agency theory, one of the best ways to reduce the scope of the agency problem is for principals to establish incentives for agents to behave in the company’s best interest. Giving managers stock options has been the most common pay-for-performance system. (continued) © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

GOVERNANCE MECHANISMS Academic studies suggest that stock-based compensation schemes for executives, such as stock options and stock grants, can align management and stockholders’ interest. In an attempt to make sure that managers do not misrepresent financial statements, the SEC requires that the accounts be audited by an independent and accredited accounting firm. Unfortunately, this system has not always worked as intended in the U.S. (Enron, Computer Associates). © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

GOVERNANCE MECHANISMS If enough stockholders sell in large numbers, the price of the company’s stock will decline. At this point, the company may become an attractive acquisition target and run the risk of being purchased by another company. This risk is known as the takeover constraint, which limits the extent to which managers can pursue actions to put their own interests above those of stockholders. If a takeover fails, raiders can still experience greenmail by being bought out by the defending company at a hefty premium. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Governance Mechanisms Inside a Company Strategic control systems are the primary governance mechanisms designed to reduce the scope of the agency problem. The purpose of strategic control systems is to: Establish standards and targets against which performance can be measured. Create systems for measuring and monitoring performance on a regular basis. Compare actual performance against a target. Evaluate results and take corrective action if necessary. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Governance Mechanisms Inside a Company One version of the balanced scorecard approach is to develop specific performance measures that assess how well the four building blocks of competitive advantage are being achieved: Efficiency Quality Innovation Responsiveness to customers © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective: After reading this chapter, you should be able to identify the main ethical issues that arise in business and the causes of unethical behavior. ETHICS AND STRATEGY Ethics refers to accepted principles of right or wrong that govern the conduct of an entity. Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople. When none of the available alternatives seem ethically acceptable, we have an ethical dilemma. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Ethical Issues in Strategy Most ethical issues are due to potential conflict between the goals of the enterprise, or the goals of the individual managers, and the fundamental rights of important stakeholders. The most common examples of unethical behavior involve self-dealing when managers find a way to feather their own nests with corporate monies. Information manipulation occurs when managers use their control over corporate data to hide information for their own benefit or the competitive position of the firm. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Ethical Issues in Strategy Anticompetitive behavior covers a range of behaviors aimed at harming actual or potential competitors, most often by using monopoly power. When the managers of a firm seek to unilaterally rewrite the terms of a contract with those with which it deals in a way that is more favorable to the firm by using their power to force a revision, this is referred to as opportunistic exploitation. To reduce production cost, managers may under-invest in working conditions, underpay workers, engage in environmental degradation, and corruption. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Ethical Issues in Strategy Environmental degradation occurs when a company’s actions result in pollution or other forms of environmental harm. Corruption occurs when managers pay bribes to gain access to lucrative business contracts. It is important to recognize that business ethics are not divorced from personal ethics. Many studies of unethical behavior have come to the conclusion that businesspeople sometimes do not recognize that they are behaving unethically. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Learning Objective: After reading this chapter, you should be able to identify what managers can do to improve the ethical climate of their organization, and to make sure that business decisions do not violate good ethical principles. BEHAVING ETHICALLY Hiring and Promotion Businesses should strive to hire people who have a strong sense of personal ethics. Firms should ask for letters of reference from prior employers and talk to people who worked with the prospective employee. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Organization Culture and Leadership BEHAVING ETHICALLY Organization Culture and Leadership Three actions are important to foster ethical behavior among its employees. A business must explicitly articulate values that place a strong emphasis on ethical behavior by having a code of ethics. The leaders in the business must give life and meaning to the code of ethics by repeatedly emphasizing them and then acting on them. A business must place a high value on ethical behavior by offering incentives and rewards for people who engage in ethical behavior. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Decision-Making Processes BEHAVING ETHICALLY Decision-Making Processes Rawl’s theory of justice helps to provide a moral compass. A decision is ethically acceptable if a businessperson can answer “yes” to the following: Does my decision fall within the acceptable values or standards that typically apply in the organizational environment? Am I willing to see the decision communicated to all stakeholders affected by it? Would the people with whom I have a significant relationship with approve of the decision? © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

BEHAVING ETHICALLY There are four more things that managers can do to ensure that basic ethical principals are adhered to which are not cover in detail in this slide show: Make sure that leaders within the business not only articulate the rhetoric of ethical behavior but also act in a manner that is consistent with that rhetoric. Use ethical officers to make sure a business behaves in an ethical manner. Put strong governance processes in place to ensure that senior managers do not engage in self-dealing or information manipulation. Don’t punish employees who act with moral courage. © 2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.