1. Chapter 12
Corporate Governance and Business Ethics

3. Chapter Outline 12.1 The Shared Value Framework
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. HP’s Boardroom Soap Opera Continues
ChapterCase 12
©ChinaFotoPress via Getty Images
HP’s Boardroom Soap Opera Continues
$120 billion in sales
“The HP Way” – an admired corporate culture (1938)
Mark Hurd became CEO in 2005.
Good financial results – lower costs & higher sales
18-month period, HP’s market value dropped 80%
$105 billion (April ‘10) to $23 billion (November ‘12)
Leo Apotheker became CEO in Fall 2010.
Meg Whitman became CEO in Fall 2011.

5. HP’s Boardroom Soap Opera Continues
ChapterCase 12
HP’s Boardroom Soap Opera Continues
2006 First Stage – HP-initiated unethical surveillance to uncover a suspected leak.
2010 (summer) Second Stage – Jodie Fisher, a former adult-movie actress, filed a lawsuit against CEO Mark Hurd.
2010 (fall) Third Stage – (new) CEO Leo Apotheker overpaid for British software company Autonomy ($11B).
HP took nearly $9 billion write-down for this within a year!

6. Strategy Smart Videos Governance Gone Wrong – The Case of Tyco
4:29 Minutes
Dennis Kozlowski on 60 Minutes
Instructors:
“Strategy Smart” videos or exercises are additional material provided here to instructors to help you customize the course.
In this video of Dr. Michael Porter of Harvard Business School, he discusses some misconceptions about strategy. This lecture is from the Leaders in London Summit in 2008

7. 12.1 The Shared Value Framework
Guidance to managers on competitive advantage, balancing Agency & Stakeholder perspectives
Economic imperative
Corporate social responsibility
introduced in Ch. 1
Creates a larger pie
Benefits shareholders and other stakeholders

8. Public Stock Companies and Shareholder Capitalism
Public stock companies are vital in free market economies.
Four attractive characteristics of public firms:
Limited liability for investors
Transferability of investor interest
Legal personality
Separation of ownership and control

9. MILTON FRIEDMAN VS. MICHAEL PORTER/ARCHIE CARROLL
Traditional View: (Friedman)
Shareholder capitalism: shareholders – the providers of the necessary risk capital and the legal owners of public companies – have the most legitimate claim on profits. Argues that managers are obligated to maximize returns to stockholders as the legitimate owners of the firm.
Shared Value View: (Porter/Carroll)
Corporate social responsibility (CSR): obligations extend beyond the economic responsibility to stockholders and include legal, ethical, and philanthropic obligations to other stakeholder groups and society as a whole.

10. CSR of Business

11. 12.2 Corporate Governance AGENCY THEORY BOARD OF DIRECTORS
A theory that views the firm as a nexus of legal contracts
BOARD OF DIRECTORS
The centerpiece of corporate governance, composed of inside and outside directors who are elected by the shareholders
OTHER GOVERANCE MECHANISMS
Executive compensation
The market for corporate control
Financial statement auditors, government regulators, and industry analysis

12. Exhibit 12.5 Principal-Agent Problem

13. Corporate Governance (cont’d)
Agency Theory
Views a firm as a nexus of legal contracts
Relationships among shareholders, managers, and hierarchies.
Front-line employees have an advantage over management.
Firms need to design work tasks.
Adverse Selection
Misrepresentation of a job
Beyond his/her ability to do things
Moral Hazard
Difficulty to ascertain whether the agent gives his/her best (shirking)

14. The Board of Directors Centerpiece of corporate governance
Primary responsibility to “monitor & control” actions of CEO & TMT – Legal obligation
Different shareholder goals
Institutional investors
Individual short-term investors
Inside directors
Generally part of the company’s senior management team
Outside directors – (interlocking directorates)
Not employees of the firm, but not always “outsiders”
Senior executives from other firms or full-time professionals

15. GE’s Board of Directors
Strategy Highlight 12.1
GE’s Board of Directors
16/17 members are independent outside directors
Comprised of business, academia, & government
CEO Duality – Jeffrey Immelt, the one inside director, is both the CEO and chairperson of the board (CEO Duality), a declining practice due to the potential conflict of interest
GE’s board has 5 committees.
Boardroom diversity (28% for GE) in backgrounds and expertise is considered an asset: More diverse boards are less likely to fall victim to groupthink.

16. EXECUTIVE COMPENSATION
Interest aligned through “monitoring & control” and/or compensation (Stewardship Theory)
Salary, bonus, perks, and stock issuance/options (long-term incentives)
CEO pay - two issues:
CEO pay compared to average employee pay
U.S. ratio 2014: 373 to 1, 1980: 40 to 1
Average CEO pay – S&P 500 (2014): $13.5 million
Firm performance and CEO pay
McKesson high salary but also high performance
Home Depot, HP….NOT
Why do CEOs make so much?

17. Other Governance Mechanisms
The market for corporate control
External governance mechanism
Hostile takeover (golden parachutes/poison pill)
Corporate raiders and hedge funds
2013−Dell’s LBO was a target of Carl Icahn.
Auditors, government regulators, and industry analysts
SEC−GAAP as reported publicly via EDGAR
The Wall Street Journal, Bloomberg Businessweek, Forbes…
GovernanceMetrics International (GMI Ratings)

18. 12.3 Strategy and Business Ethics
Agreed-upon explicit code of conduct in business
Legal conduct vs. Ethical conduct
Legal (min acceptable standard), but may not be ethical
Mortgage brokers selling “option ARMs”
Ethical, but may not be legal
Pharmaceutical firms discussing pricing to increase affordability
When facing an ethical dilemma:
Do the actions fall into acceptable norms of professional behavior?
Does it feel comfortable explaining and defending the decision in public?

19. Did Goldman Sachs and the “Fabulous Fab” Commit Securities Fraud?
Strategy Highlight 12.2
Did Goldman Sachs and the “Fabulous Fab” Commit Securities Fraud?
The SEC alleged that Goldman violated its fiduciary responsibility and defrauded its clients.
Collateralized Debt Obligation (CDO) such as Abacus
Roll-up of risky investments into a AAA-rated CDO
Rating agencies falsely viewed these as safe investments!
Goldman Sachs settled by paying a $550 million
Did not admit any wrongdoing
Mr. Tourre convicted of securities fraud in Aug. 2013

20. 12.4 Implications for the Strategist
Effective corporate governance and business ethics
Critical to gaining and sustaining competitive advantage
Strategic leaders need to take actions with integrity.
IBM emphasizes its values across the globe.
Example of an employee falling ill at a training session
An expectation among IBMers- a “lived” value
Glaring ethical lapses in the last 10 years call for:
Consistent International ethical values & code of conduct
Professionalization of management

21. ChapterCase 12 Consider This…
©ChinaFotoPress via Getty Images
Consider This…
HP featured in the bestseller Built to Last (1994)
Much has changed since Mr. Hewlett’s death in 2001.
HP board’s decisions destroyed $82 billion in shareholder value.
groupthink in rallying around Mr. Apotheker as CEO
Full board never met him before hiring him.
flawed due diligence process in the Autonomy acquisition
Lack of an open search to appoint Meg Whitman as CEO