1. MKT 450 Strategic Management Mishari Alnahedh

2. LECTURE 4: CORPORATE GOVERNANCE

3. Organization Structure and Management Systems
Mishari Alnahedh
Learning Objectives
Define corporate governance and explain why it is used to monitor and control managers’ strategic decisions.
Explain how ownership came to be separated from managerial control in the modern corporation.

4. Corporate Governance Agency Problems Agency Problems
Mishari Alnahedh
Corporate Governance
Corporate governance represents the relationship among stakeholders that is used to determine and control the strategic direction and performance of organizations.
Agency Problems
An agency relationship exists when one or more persons (the principal or principals) hire another person or persons (the agent or agents) as decision-making specialists to perform a service.
Examples: - Shareholders (P) and CEO (A) - Manager (P) and subordinates (A)

5. Agency Problems
Mishari Alnahedh
“A very widespread economic situation is that of the relation between principal and agent. Even in ordinary and legal discourse, the principal-agent relation would be significant in scope and economic magnitude. But economic theory in recent years has recognized that analogous interactions are almost universal in the economy, at least as one significant component of almost all transactions” (Kenneth Arrow)

6. Risk Bearing Specialist Managerial Decision-Making Specialist
Agency Theory
Mishari Alnahedh
An agency relationship exists when:
Agency Relationship
Risk Bearing Specialist
(Principal)
Managerial Decision-Making Specialist
(Agent)
Shareholders
(Principals)
Firm Owners
Hire
Managers
(Agents)
Decision
Makers
which creates

7. Agency Costs Applications Agency Problems
Mishari Alnahedh
Agency Costs
Agency costs are the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals, because it is impossible to use governance mechanisms to guarantee total compliance by the agent.
Applications
Executive compensation
Incentives in organizations
Contracts with service providers

8. What is the problem of the separation of ownership from control?
Separation of Ownership from Management Control
Mishari Alnahedh
What is the problem of the separation of ownership from control?
How did ownership come to be separated from managerial control in the modern corporation?
Do we have any justification for assuming that those in control of a modern corporation will also choose to operate it in the interests of the stockholders?

9. The Basic Tasks of Organization
Mishari Alnahedh
Achieving high levels of productivity requires SPECIALIZATION
Specialization by individuals necessitates COORDINATION
For coordination to be effective requires COOPERATION
But goals of employees = goals of owners
THE AGENCY PROBLEM
ORGANIZATIONAL CHALLENGE: design structure & systems that:
Permit specialization
Facilitate coordination by grouping individuals & link groups with systems of communication, decision making, & control
Deploy incentives to align individual & firm goals

10. Agency Theory Overview – Eisenhardt (1989)
Mishari Alnahedh
Key idea
Principal-agent relationships should reflect efficient organization of information and risk-bearing costs
Unit of analysis
Contract between principal and agent
Human assumptions
Self-interest
Bounded rationality
Risk aversion
Organizational assumptions
Partial goal conflict among participants
Efficiency as the effectiveness criterion
Information asymmetry between principal
and agent
Information assumption
Information as a purchasable commodity
Contracting problems
Agency (moral hazard and adverse selection)
Risk sharing
Problem domain
Relationships in which the principal and agent have partly differing goals and risk preferences (e.g., compensation, regulation, leadership, impression management, whistle-blowing, vertical integration, transfer pricing)

11. Institutions of Capitalism
Mishari Alnahedh
What are the “institutions of capitalism” which lessen the problem of the separation of ownership from control?
Takeovers (the market for corporate control)
Recruitment of executives from outside the firm
Monitoring by boards of directors
Executive compensation heavily weighted toward stock options
Monitoring by institutional investors
Debt (minimize free cash flow) e.g., LBOs
Separate chairperson and CEO
Internal control of multidivisional as a “miniature capital market”