CHAPTER 2 Corporate Governance STRATEGIC MANAGEMENT & BUSINESS POLICY 10TH EDITION THOMAS L. WHEELEN J. DAVID HUNGER Prentice Hall, Inc. © 2006 Prentice Hall 2006

Corporate Governance Prentice Hall, Inc. © 2006 Prentice Hall 2006

Corporate Governance The relationship among the board of directors, top management, and shareholders – determining the direction and performance of the corporation Prentice Hall, Inc. © 2006 Prentice Hall 2006

Corporate Governance Elect Appoint Hire Common Shareholders Board of Directors Corporate Officers Employees of the Company Individuals Companies Non-profits Pensions Mutual Funds Dividends Corporate Affairs Strategic Plans Select Officers Finances Chief Executive Chief Financial Chief Operations Operations Finance Marketing Personnel Engineering The term corporate governance can be used in a broad sense to describe all the policies, procedures, relationships, and systems in place to oversee the successful and legal operation of the enterprise; media coverage tends to define governance in a more narrow sense: as the responsibilities and performance of the board of directors specifically. Shareholders of a corporation can be individuals, other companies, nonprofit organizations, pension funds, and mutual funds. All shareholders who own voting shares are invited to an annual meeting to choose directors, select an independent accountant to audit the company’s financial statements, and attend to other business. Representing the shareholders, the board of directors is responsible for declaring dividends, guiding corporate affairs, reviewing long-term strategic plans, selecting corporate officers, and overseeing financial performance. Corporate governance has come under close scrutiny in recent years, with critics and regulators claiming that a number of corporate officials in companies such as Enron and WorldCom have failed to uphold their obligations to shareholders. The center of power in a corporation often lies with the chief executive officer, or CEO. Together with the chief financial officer (CFO) and the chief operating officer (COO), the CEO is responsible for establishing company policies, managing corporate direction, and making the big decisions that will affect the company’s growth and competitive position. Employees occupy positions is various departments: for example, operations, finance, marketing, personnel, and engineering. Prentice Hall, Inc. © 2006 Prentice Hall 2006

Evaluate and influence Initiate and determine Corporate Governance Role of Board Monitor Evaluate and influence Initiate and determine by ; Setting strategic direction Capital allocation Succession planning Prentice Hall, Inc. © 2006 Prentice Hall 2006

Board of Directors Continuum Research suggests that active board involvement in strategic management is positively related to a corporation’s financial performance Prentice Hall, Inc. © 2006 Prentice Hall 2006

Members -- Insiders Outsiders Inside directors Outside directors Board of Directors Members -- Inside directors “management directors” Officers or execs employed by the firm Outside directors “non-management directors” Execs of other firms not employed by the board’s corporation Insiders Outsiders US 2 9 UK 5 5 F 3 8 J 12 2 Prentice Hall, Inc. © 2006 Prentice Hall 2006

Agency Theory – Stewardship Theory Objectives of owners & agents in conflict Difficult for owners to verify agent performance Owners & agents risk assessment in conflict Stewardship Theory – Executives more motivated to act in best interest of the corporation than their own self-interests. Theory that over time, senior executives tend to view corporation as extension of selves Prentice Hall, Inc. © 2006 Prentice Hall 2006

When Outsiders can be considered Insiders Board of Directors When Outsiders can be considered Insiders Affiliated Directors Retired Directors Family Directors Prentice Hall, Inc. © 2006 Prentice Hall 2006

Board of Directors Codetermination The inclusion of a corporation’s employees on its board of directors Prentice Hall, Inc. © 2006 Prentice Hall 2006

Interlocking Directorates Board of Directors Interlocking Directorates Direct Interlocking Indirect Interlocking (keiretsu) Although there is a risk of collusion, well-interlocked corporations are better able to survive in a highly competitive environment Prentice Hall, Inc. © 2006 Prentice Hall 2006

Nominations & Elections of the members of the board Board of Directors Nominations & Elections of the members of the board Traditional Approach CEO invitation to membership Shareholders approval in annual proxy statement All nominees usually elected (What if CEO select only the members who do not disturb her/his policies) Prentice Hall, Inc. © 2006 Prentice Hall 2006

Nominations & Elections Board of Directors Nominations & Elections Staggered Board Approach Term limits Age limits Nominating committees Prentice Hall, Inc. © 2006 Prentice Hall 2006

Organization of the Board Board of Directors Organization of the Board Size Charter(yetkiler) & Bylaws(tüzükler) Determination Size: US 11 Japan 14 Asia 9 Germany 16 UK 10 France 11 Prentice Hall, Inc. © 2006 Prentice Hall 2006

Chairman – CEO . Combined or separate Organization of the Board Board of Directors Organization of the Board Chairman – CEO . Combined or separate Lead directors Committees Prentice Hall, Inc. © 2006 Prentice Hall 2006

Sarbanes-Oxley Code of Ethics Board of Directors Sarbanes-Oxley Code of Ethics Audit, Nominating, and Compensation Committees all outside directors No loans to corporate officers Protection for “whistle-blowers” Increasing number of boards are evaluating not only the performance of the CEO but also the performance of the board in total and that of individual directors Prentice Hall, Inc. © 2006 Prentice Hall 2006

Avoiding Governance Improvements Board of Directors Avoiding Governance Improvements Multiple classes of stocks (super stocks) Controlled company Prentice Hall, Inc. © 2006 Prentice Hall 2006

Trends in Corporate Governance Board of Directors Trends in Corporate Governance Review & shaping of strategy Pressure for corporate performance Demand for executive stock ownership Outside directors increasing Impact of Sarbanes-Oxley Social pressures on environmental issues Prentice Hall, Inc. © 2006 Prentice Hall 2006

Board of Directors CEO: Getting things done through and with others in order to meet the corporate objectives 1.Provide executive leadership and strategic vision 2.Manage the strategic planning process Successful CEO’s Strategic vision Passion for the company Strong communication charisma Prentice Hall, Inc. © 2006 Prentice Hall 2006

Board of Directors Executive Leadership Articulates a strategic vision for the corporation Presents a role for others to identify with and to follow Communicates high performance standards Shows confidence in the follower’s abilities to meet these standards (Transformational Leadership) Prentice Hall, Inc. © 2006 Prentice Hall 2006

Strategic Planning Staff Strategic Management Process Strategic Planning Staff Supports top management & business units in the strategic planning process Identify & analyze company-wide strategic issues Generate strategic alternatives Facilitate business units in coordinating activities related to strategic planning process Prentice Hall, Inc. © 2006 Prentice Hall 2006