1. Chapter 12 Corporate Governance and Business Ethics
Be sure to see the NEW integrated Instructor’s Manual located in the Connect Library under Instructor’s Resources.
Chapter 12 Corporate Governance and Business Ethics

2. The AFI Strategy Framework
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3. Chapter 12 Outline 12.1 The Shared Value Creation Framework
Public Stock Companies and Shareholder Capitalism
Creating Shared Value
12.2 Corporate Governance
Agency Theory
The Board of Directors
Other Governance Mechanisms
12.3 Strategy and Business Ethics
12.4 Implications for the Strategist

4. Learning Objectives
LO 12-1 Describe the shared value creation framework and its relationship to competitive advantage. LO 12-2 Explain the role of corporate governance. LO 12-3 Apply agency theory to explain why and how companies use governance mechanisms to align interests of principals and agents. LO 12-4 Evaluate the board of directors as the central governance mechanism for public stock companies. LO 12-5 Evaluate other governance mechanisms. LO 12-6 Explain the relationship between strategy and business ethics.

5. The Shared Value Creation Framework

6. The Public Stock Company: Four Benefits
Limited liability for investors
Transferability of investor ownership
Through the trading of shares of stock on exchanges
Legal personality
Has legal rights and obligations
Separation of legal ownership and management control

7. Exhibit 12.1 The Public Stock Company: Hierarchy of Authority
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8. Milton Friedman’s Philosophy
“The social responsibility of business is to increase its profits.”
A survey asked the top 25 percent of income earners holding a university degree in each country surveyed whether they agree with Milton Friedman’s philosophy.
The results…

9. Jump to Appendix 3 long image description
Exhibit 12.2 Percent of “Informed Public” Who “Strongly/Somewhat Agree” with Milton Friedman
SOURCE: Author’s depiction of data from Edelman’s (2011) Trust Barometer as included in “Milton Friedman goes on tour,” The Economist, January 27, 2011.
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10. Creating Shared Value
Porter argues that executives should not concentrate exclusively on increasing firm profits.
Rather, the strategist should focus on creating shared value, a concept that involves:
Creating economic value for shareholders
Creating social value by addressing society’s needs and challenges
Instructors:
The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on creating value and sustainability. (LO 12-1).

11. The Shared Value Creation Framework
A model proposing that managers have a dual focus on:
Shareholder value creation
Value creation for society
Example: GE’s ecomagination initiative
To provide cleaner and more efficient sources of energy
To provide abundant sources of clean water anywhere in the world
To reduce emissions

12. Expand the customer base
Michael Porter’s Recommendations to Reconnect Economic & Societal Needs
Expand the customer base
Bring in nonconsumers such as those at the bottom of the pyramid (large / poor socioeconomic group).
Expand traditional internal firm value chains.
Include more nontraditional partners such as nongovernmental organizations (NGOs).
Focus on creating new regional clusters:
Such as Silicon Valley in the United States
Electronic City in Bangalore, India
Chilecon Valley in Santiago, Chile
Porter argues that these strategic actions will lead to a larger pie of revenues and profits that can be distributed among a company’s stakeholders.

13. Corporate Governance

14. The Role of Corporate Governance
To provide mechanisms to:
Direct and control an enterprise
Ensure that it pursues strategic goals successfully and legally
To offer checks and balances
To ask the tough questions when needed
Attempts to address the principal-agent problem
Instructors:
The digital companion to this book McGraw-Hill Connect has an interactive exercise on this section of the textbook. It builds student confidence on corporate governance and its misuse….creating ethical issues for firms and stakeholders. (LO 12-2 & 12-3).

15. Exhibit 12.3 The Principal-Agent Problem
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16. Agency Theory
A theory that views the firm as a nexus of legal contracts
So conflicts that arise should be resolve legally.
Therefore, the firm needs to design work tasks, incentives, and employment contracts
To minimize opportunism by agents
Governance mechanisms should be put in place to overcome two agency problems:
Adverse selection
Moral hazard

17. Adverse Selection and Moral Hazard
Both caused by information asymmetry
Adverse Selection
Increases the likelihood of selecting inferior alternatives
Moral Hazard
Increases the incentive of one party to take undue risks or shirk other responsibilities
The costs incur to the another party

18. The Board of Directors The centerpiece of corporate governance
Helps overcome the principal-agent problem
Usually consist of inside and outside directors
Inside directors: usually consist of: CEO, COO, CFO
Outside directors: senior execs from other firms
Elected by the shareholders
Shareholder votes determine who is elected to the board

19. Responsibilities of the Board of Directors
General strategic oversight and guidance
Selecting, evaluating, and compensating the CEO
The board may fire him or her.
Overseeing the company’s CEO succession plan
Providing guidance for executive compensation
Reviewing, monitoring, evaluating, and approving strategic initiatives
Such as large acquisitions
Risk assessment & mitigation

20. GE’s Board of Directors
Strategy Highlight 12.1
GE’s Board of Directors
GE’s board consists of:
Members of companies, academia, and government
16 members, 5 different committees
They meet about 12 times annually
25% of the board are women (more than usual)
Generally, the larger the company, the greater its gender diversity.
Diverse boards are less likely to fall victim to groupthink.
Generally, the larger the company, the greater its gender diversity, as demonstrated in recent years by tracking different levels of the Fortune For example, in 2014 boards of the Fortune 100 companies averaged 22 percent gender diversity; of Fortune 500 (as noted), 19 percent; and of the bottom half of the Fortune 1000, 16. Percent. GE as of this writing ranks number eight in the Fortune 1000 rankings in terms of gender diversity.

21. Corporate Mechanisms to Align Incentives Between Principals & Agents
Executive compensation
The market for corporate control
Financial statement auditors, government regulators, and industry analysts
…we’ll review each of these

22. Executive Compensation
Stock options are often part of compensation.
The average ratio of CEO to employee pay is 300:1.
About 2/3 of CEO pay is linked to firm performance.
But this link is weak
Can further increase job stress
Can negatively impact job performance

23. The Market for Corporate Control
An external corporate-governance mechanism
Consists of activist investors who:
Seek to gain control of an underperforming corporation
Buy shares of its stock in the open market
Often pursued when a company is underperforming

24. Auditors, Government Regulators, And Industry Analysts
Serve as additional external-governance mechanisms
To avoid misrepresentation of financial results:
Public financial statements must follow GAAP:
Generally accepted accounting principles
Financial statements must be audited
By certified public accountants
Industry analysts often base their buy, hold, or sell recommendations on:
Financial statements filed with the SEC
Business news (WSJ, Forbes, CNBC, etc.)

25. Strategy and Business Ethics

26. Business Ethics
An agreed-upon code of conduct in business, based on societal norms
Lay the foundation and provide training for:
“behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society”
Can differ in various cultures around the globe
Universal norms include:
Fairness
Honesty
Reciprocity
Instructors:
The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on leadership providing ethical guidance. It also brings in a global perspective using an example from a firm in South Africa that reflects back on Apartheid. (LO 12-6).

27. When Facing an Ethical Dilemma
Ask whether the intended course of action falls within the acceptable norms of professional behavior.
As outlined in the organization’s code of conduct
As defined by the profession at large
Would you feel comfortable explaining and defending the decision in public?
How would the media report the business decision if it were to become public?
How would the company’s stakeholders feel about it?

28. Did Goldman Sachs and the “Fabulous Fab” Commit Securities Fraud?
Strategy Highlight 12.2
Did Goldman Sachs and the “Fabulous Fab” Commit Securities Fraud?
In 2010, the SEC sued the company and an employee, named Fabrice Tourre, for fraud
Did the bank knowingly mislead investors?
Goldman Sachs argued that it is up to clients to assess risk involved in investments.
Public pressure mounted.
Goldman Sachs ended up paying $550M to settle the lawsuit, but did not admit wrongdoing.
Tourre was convicted of fraud.

29. Ethical Leadership Is Critical
Strategic leaders set the tone for the ethical climate within an organization.
Employees take cues from their environment on how to act.
CEOs of Fortune 500 companies are under constant public scrutiny.
Ought to adhere to the highest ethical standards
Unethical behavior can destroy the CEO’s reputation.
Ethical expectations must be clear.
Management must provide.

30. The MBA Oath Developed by Harvard Business School students
Helps anchor future managers to professional values
Helps management achieve a professional status
Has been taken by:
6,000 MBA students
Students in over 300 institutions around the world

31. The MBA Oath – Part 1
As a business leader I recognize my role in society.
My purpose is to lead people and manage resources to create value that no single individual can create alone.
My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.
Therefore, I promise that:
I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.
I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise.
I will refrain from corruption, unfair competition, or business practices harmful to society.

32. The MBA Oath – Part 2
I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation.
I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.
I will report the performance and risks of my enterprise accurately and honestly.
I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.
In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards.
This oath I make freely, and upon my honor.

33. Implications for the Strategist

34. Corporate Governance Mechanisms
Can be effective in addressing the principal–agent problem
Tend to focus on monitoring, controlling, and providing incentives
Must be complemented by:
A strong code of conduct
Strategic leaders who act with integrity

35. Corporate Governance and Business Ethics
Are critical to gaining and sustaining competitive advantage
Are closely intertwined with:
Setting the right organizational core values
Ensuring compliance
Glaring ethical lapses in the last 10 years call for:
Ethical values and code of conduct
Professionalization of management

36. The Strategist Must Help employees to “walk the talk”
Lead by an ethical example
Live organizational core values by example
Fairness and transparency is critical
Needs to apply a stakeholder perspective
To ensure long-term survival and success of the firm

37. Chapter 12 Summary

38. Take Away Concepts (1 of 6)
LO 12-1 Describe the shared value creation framework and its relationship to competitive advantage.
By focusing on financial performance, many companies have defined value creation too narrowly.
Companies should instead focus on creating shared value, a concept that includes value creation for both shareholders and society.
The shared value creation framework seeks to identify connections between economic and social needs, and then leverage them into competitive advantage.

39. Take Away Concepts (2 of 6)
LO 12-2 Explain the role of corporate governance.
Corporate governance involves mechanisms used to direct and control an enterprise in order to ensure that it pursues its strategic goals successfully and legally.
Corporate governance attempts to address the principal–agent problem, which describes any situation in which an agent performs activities on behalf of a principal.

40. Take Away Concepts (3 of 6)
LO 12-3 Apply agency theory to explain why and how companies use governance mechanisms to align interests of principals and agents.
Agency theory views the firm as a nexus of legal contracts.
The principal–agent problem concerns the relationship between owners (shareholders) and managers and also cascades down the organizational hierarchy.
The risk of opportunism on behalf of agents is exacerbated by information asymmetry: Agents are generally better informed than the principals.
Governance mechanisms are used to align incentives between principals and agents.
Governance mechanisms need to be designed in such a fashion as to overcome two specific agency problems: adverse selection and moral hazard.

41. Take Away Concepts (4 of 6)
LO 12-4 Evaluate the board of directors as the central governance mechanism for public stock companies.
The shareholders are the legal owners of a publicly traded company and appoint a board of directors to represent their interests.
The day-to-day business operations of a publicly traded stock company are conducted by its managers and employees, under the direction of the chief executive officer (CEO) and the oversight of the board of directors. The board of directors is composed of inside and outside directors, who are elected by the shareholders.
Inside directors are generally part of the company’s senior management team, such as the chief financial officer (CFO) and the chief operating officer (COO).
Outside directors are not employees of the firm. They frequently are senior executives from other firms or full-time professionals who are appointed to a board and who serve on several boards simultaneously.

42. Take Away Concepts (5 of 6)
LO 12-5 Evaluate other governance mechanisms.
Other important corporate mechanisms are executive compensation, the market for corporate control, and financial statement auditors, government regulators, and industry analysts.
Executive compensation has attracted significant attention in recent years. Two issues are at the forefront: (1) the absolute size of the CEO pay package compared with the pay of the average employee and (2) the relationship between firm performance and CEO pay.
The board of directors and executive compensation are internal corporate-governance mechanisms. The market for corporate control is an important external corporate-governance mechanism. It consists of activist investors who seek to gain control of an underperforming corporation by buying shares of its stock in the open market.
All public companies listed on the U.S. stock exchanges must file a number of financial statements with the Securities and Exchange Commission (SEC), a federal regulatory agency whose task it is to oversee stock trading and enforce federal securities laws. Auditors and industry analysts study these public financial statements carefully for clues of a firm’s future valuations, financial irregularities, and strategy.

43. Take Away Concepts (6 of 6)
LO 12-6 Explain the relationship between strategy and business ethics.
The ethical pursuit of competitive advantage lays the foundation for long- term superior performance.
Law and ethics are not synonymous; obeying the law is the minimum that society expects of a corporation and its managers.
A manager’s actions can be completely legal, but ethically questionable.
Some argue that management needs an accepted code of conduct that holds members to a high professional standard and imposes consequences for misconduct.

44. Key Terms Adverse selection Agency theory Board of directors
Business ethics
CEO/chairperson duality
Corporate governance
Inside directors
Leveraged buyout (LBO)
Moral hazard
Outside directors
Poison pill
Shared value creation framework
Shareholder capitalism
Stock options

45. Chapter 12 Cases & Exercises

46. Chapter Case 12: Consider This… (1 of 2)
Uber has
Happy drivers (set their own hours)
Happy customers (rides are convenient and cheap)
It is disrupting the transportation industry:
It has a fleet of vehicles offering cheap rides.
It incorporates eventual use of autonomous vehicles.
People may not need to own cars in the future.
Uber might expand in the future to offer delivery services.

47. Chapter Case 12: Consider This… (2 of 2)
Have you used a ride service like Uber? If so, how was your experience?
What is Uber’s business model / strategic intent?
Is Uber “the most ethically challenged company in Silicon Valley”?
Should drivers be reimbursed for gas and car maintenance? Are they “employees”?

48. My Strategy Exercise: Gen Y Workforce
This generation:
Has received more individual attention (small classes)
Grew up through an explosion of technology
May expect higher pay, flexible schedules, promotions
Seeks frequent feedback & accomodation
Questions to answer:
Will this hold a new set of business ethics?
Does the MBA oath reflect a new approach Gen Y will take to the business environment?

49. Small Group Exercise #1 Research competitors of Uber:
Lyft: targets college students headed home
Sidecar: offers carpooling & delivery
Questions to answer:
What similarities and differences do you find in the way these firms have implemented sometimes similar ideas?
Why are traditional taxi companies attempting to prohibit these services vs. implementing their own app-calling systems?

50. Small Group Exercise #2 Many corporate boards lack women & minorities
In the U.S. women hold 19% of board seats
This trend has been flat for 10 years.
In Norway, females make up 40% of boards.
Went from 9% - 40% in two years
The government made it mandatory.
Group discussion:
Is it a problem that women are underrepresented?
Why has the trend in the U.S. been flat for 10 years?
Is a regulatory quota a good solution?
What other methods could be used?

51. End of Chapter 12

52. Strategy Smart Videos

53. Strategy Smart Videos (1 of 6)
INSEAD
Turning around Tyco: How Corporate Governance Saved the Day
Part 1 Link:
10:05 Minutes

54. Strategy Smart Videos (2 of 6)
INSEAD
Corporate Governance Comes of Age
Link:
7:14 Minutes

55. Strategy Smart Videos (3 of 6)
Milton Friedman – Greed
An excerpt from an interview with Phil Donahue in 1979
Link:
2:24 Minutes

56. Strategy Smart Videos (4 of 6)
Patagonia Founder Yvon Chouinard
Can Wal-Mart Be Sustainable?
Link:
2:02 Minutes

57. Strategy Smart Videos (5 of 6)
[one percent] of the story – 1% for the Planet film
Network of companies that give 1% of sales to environmental causes
Link:
15:04 Minutes

58. Strategy Smart Videos (6 of 6)
Michael Porter
Why business can be good at solving social problems
Link:
can_be_good_at_solving_social_problems.html
16:28 Minutes

59. Chapter Case 12

60. Chapter Case 12: Uber (1 of 2)
The most valuable private start-up ever
Offers cab-hailing service via an app
Uber’s beginning
Started by two tech entrepreneurs
Frustrated by the inconvenience of hailing a cab
Record breaking growth:
Successfully expanded both in the United States and globally to more than 300 cities
Revenue growth:
$400 million in 2014 to $2 billion in 2015

61. Chapter Case 12: Uber (2 of 2)
Ethically challenged?
Uber is pushing the envelope of what is acceptable, ethical, and even legal with all its stakeholders.
Regulators, government, drivers, journalists, competitors
Primary claims, among others:
Dynamic pricing: supply & demand vs. price gouging?
Competitive tactics: ordering rides from competitors, then canceling them?
Death of a child: distracted driver using the app
Disregard for rules: inadequate licensing
Poisoning source of funding

62. Appendix 1 The AFI Strategy Framework
The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with five different circles on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The five outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4) Formulation, Corporate Strategy, and (5) Implementation. Each of these outer five circles have a brief description beside them to explain what the circle means: Under the first outer circle titled "Getting Started", it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic Leadership: Managing the Strategy Process (Chapter 2)". Under the second outer circle titled "External and Internal Analysis", it says: Part 1, Strategy Analysis, "External Analysis: Industry Structure, Competitive Forces and Strategic Groups (Chapter 3)", "Internal Analysis: Resources, Capabilities and Core Competencies (Chapter 4)", and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)". Under the third outer circle titled "Formulation: Business Strategy", it says: Part 2, Strategy Formulation, "Business Strategy: Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter 7)". Under the fourth outer circle titled "Formulation: Corporate Strategy", it says: Part 2, Strategy Formulation, "Corporate Strategy: Vertical Integration and Diversification (Chapter 8)", "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter 9)", and "Global Strategy: Competing Around the World (Chapter 10)". Under the fifth outer circle titled "Implementation", it says: Part 3, Strategy Implementation, "Organizational Design: Structure, Culture and Control (Chapter 11)", and "Corporate Governance and Business Ethics (Chapter 12)".
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63. Appendix 2 Exhibit 12.1 The Public Stock Company: Hierarchy of Authority
Starting at the top: State Charter, then Shareholders, then Board of Directors, then Management, then Employees. The state or society grants a charter of incorporation to the company’s shareholders—its owners, who legally own stock in the company. The shareholders appoint a board of directors to govern and oversee the firm’s management. The managers hire, supervise, and coordinate employees to manufacture products and provide services.
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64. Appendix 3 Exhibit 12.2 Percent of “Informed Public” Who “Strongly/Somewhat Agree” with Milton Friedman
The survey asked the top 25 percent of income earners holding a university degree in each country surveyed whether they agree with Milton Friedman’s philosophy that “the social responsibility of business is to increase its profits.” The results, as displayed in this graph, revealed some intriguing national differences.
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65. Appendix 4 Exhibit 12.3 The Principal-Agent Problem
This image shows two circles titled Principal and Agent with arrows pointing to each other. The arrow pointing from Principal to Agent says "hires, monitors and compensates", and the arrow pointing from agent to principal says "performs work, provides time and talents." In the middle of these circles are the words "information asymmetry."
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