1. Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. Strategic Control and Corporate Governance chapter 9

2. Learning Objectives 9-2 After reading this chapter, you should have a good understanding of: LO9.1 The value of effective strategic control systems in strategy implementation. LO9.2 The key difference between “traditional” and “contemporary” control systems. LO9.3 The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general environments.

3. Learning Objectives LO9.4 The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries. LO9.5 The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of directors. LO9.6 The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of shareholders from both the United States and international perspectives. 9-3

4. Strategic Control Consider… Once strategy is formulated, it must be implemented, and part of implementation is establishing a mechanism for monitoring and correcting organizational performance. This control mechanism must be consistent with the strategy the firm is following. How does a firm make sure all key stakeholders are moving in the right direction? 9-4

5. Strategic Control- at HP 1.Not hiring the best person as CEO 2.Leaking damaging information about senior executives that caused turnover 3.Frequent turnover among senior 4.Limited sharing of information among top executives 5.Inability for the board and top management to make the best decisions since relevant information may not have been shared 6.Difficulty in moving the firm forward since the warring factions are unwilling to work together to implement strategic change efforts HP’s performance would likely have been much better if firm governance were more effective. 9-5

6. Strategic Control This chapter focuses on how management can develop and use effective strategic control. The first two sections address:  informational control (the ability to respond effectively to change), and,  behavioral control (the appropriate balance and alignment among an organization’s culture, reward, and boundaries). 9-6

7. Strategic Control  Strategic control = the process of monitoring and correcting a firm’s strategy and performance.  An organization does a strategic analysis of the external environmental conditions, evaluates its internal capabilities for responding to those conditions, formulates a strategy for sustaining a competitive advantage, and then implements this strategy. 9-7

8. Strategic Control  Once implemented, this strategy must be monitored and adjusted as needed.  Effective strategic control systems allow for corrective action to be taken Via effective systems: Informational control systems Behavioral control systems Corporate governance 9-8

9. Strategic Control: Traditional Approach  The traditional approach to strategic control is sequential Strategies are formulated, goals are set Strategies are implemented Performance is measured against goals Exhibit 9.1 Traditional Approach to Strategic Control 9-9

10. Strategic Control: Traditional Approach  Control = feedback loop from performance measurement to strategy formulation  Involves lengthy time lags, “single-loop” learning  Most appropriate when Environment is stable and relatively simple Objectives can be measured with certainty Little need for complex measures of performance 9-10

11.  This traditional approach does not work well for firms competing in highly unpredictable competitive environments.  An inflexible commitment to predetermined goals and milestones can prevent the very adaptability that is required of a good strategy. Examples of control systems that rely on feedback controls include sales quotas, operating budgets, and production schedules. #-11 Strategic Control: Traditional Approach

12. Strategic Control: Contemporary Approach  The contemporary approach to strategic controls allows managers to adapt to and anticipate changes in both the internal and external environment. Relationships between strategy formulation, implementation, & control are highly interactive, utilizing Informational control Behavioral control 9-12

13. Strategic Control: Contemporary Approach  Notice in EXHIBIT 9.2 that both informational and behavioral controls are needed for the contemporary approach.  Informational control is primarily concerned with whether or not the organization is obtaining the best fit between its goals and strategies and the external strategic environment – is the organization “doing the right things”, given the external situation and the internal capabilities of the organization.  Behavioral control, on the other hand, is a mechanism for making sure the employees of the firm are doing things correctly while implementing strategy – are the employees “doing things right”. Both the informational and behavioral components of strategic control are necessary, but not sufficient, conditions for success. 9-13

14. Informational Control  Informational control = is part of an ongoing process of organizational learning that continuously updates and challenges the assumptions that underlie the organization’s strategy.  In such “double-loop” learning, the organization’s assumptions, premises, goals, and strategies are continuously monitored, tested, and reviewed  It deals with both the internal & external environment  Do the organization’s goals and strategies still “fit” within the context of the current strategic environment? 9-14

15. Informational Control  Two key issues: Scan & monitor the external environment, both the general environment and the industry environment Continuously monitor the internal environment (Changing internal conditions can include the resignation of key executives or delays in the completion of major production facilities.) 9-15

16. Informational Control  The benefits of continuous monitoring are evident  Time lags are dramatically shortened,  Changes in the competitive environment are detected earlier,  And the organization’s ability to respond with speed and flexibility is enhanced. Example: Google interactive control process. 9-16

17. Behavioral Control  Behavioral control =” is a mechanism for making sure the employees of the firm are doing things correctly while implementing strategy – are the employees “doing things right”.  Behavioral control is an approach to implementing strategy that relies on three behavioral forces or “levers” culture rewards and incentives and boundaries  The aim is to use these levers to evoke appropriate actions in the workforce and also to maintain a proper balance between these three factors. Depending on the type of organization and the business environment, the way these forces are manipulated may vary in order to achieve goals with the greatest degree of efficiency. 9-17

18. Behavioral Control  EXHIBIT 9.3 illustrates the three behavioral controls. Exhibit 9.3 Essential Elements of Behavioral Control 9-18

19. Attaining Behavioral Control: Balancing Culture, Rewards, and Boundaries  There are two reasons why behavioral controls are important for strategic managers today. 1.Increasingly complex and unpredictable environments make it important that all workers respond quickly. Reward systems and culture provide an implicit type of coordination mechanism. 2.Today’s work force includes younger managers who see themselves as free agents. Traditional controls such as rules and regulations typically will not motivate such employees. Effective behavioral controls are needed to build loyalty and commitment. 9-19

20. Behavioral Control: Culture  Organizational culture = a system of shared values and beliefs that shape the company’s people, organizational structures, and control systems to produce behavioral norms.  Culture has a powerful influence on what goes on within organizations and how they perform.  Effective leaders understand culture’s importance and strive to shape and use it as one of their important levers of strategic control. 9-20

21. Behavioral Control: Culture  Culture can play an important role by focusing on those values that sustain the organization’s primary source of competitive advantage.  Organizational culture sets implicit boundaries regarding: unwritten standards of acceptable behavior, dress, ethical matters and the organization conducts its business  A strong culture Leads to greater employee engagement Provides a common purpose and identity By creating a framework of shared values, culture encourages individual identification with the organization and its objectives. Culture acts as a means of reducing monitoring costs. 9-21

22. Behavioral Control: Sustaining an Effective Culture  Companies use many different techniques to foster a positive culture and create an environment that is fun and motivating.  Southwest Airlines, known for its culture of enthusiasm and openness, has a culture committee to perpetuate its strong culture.  Organizational cultures can be maintained and sustained by Storytelling is one way effective cultures are maintained. Rallies or pep talks by top executives also serve to reinforce a firm’s culture. Examples of cultures standing as sources of competitive advantage are: FedEx and Southwest Airlines (customer service), Lexus and Hewlett Packard (product quality), Apple and 3M (innovation), and Toyota and Emerson Electric (with operational efficiency). 3M video 9-22

23. Example: Wal-Mart  A lot of Wal-Mart's success was attributed to the strong and pervasive culture at the company, which was developed and nurtured by founder Sam Walton.  In over four decades of operation, Wal-Mart managed to retain most of the elements of culture it had when it first started out, as well as the entrepreneurial spirit which often drives startup companies to success.  Wal-Mart's culture was characterized by an orientation towards customer service and providing the best value at the lowest prices.  https://www.youtube.com/watch?v=C6-eoiHvSfc https://www.youtube.com/watch?v=C6-eoiHvSfc 9-23

24. Behavioral Control: Rewards Reward systems & incentive programs:  Reward systems specify who gets rewarded and why.  They can have a powerful influence on individual performance and overall firm outcomes.  Reward systems need to be closely linked to culture since they “put the money where the mouth is” of the organization. Example: Symantec’s new CEO changed the firm’s compensation scheme to recognize different individuals’ distinctive importance. 9-24

25. Behavioral Control: Rewards  Potential downside:  If rewards don’t match up to the espoused values and beliefs, reward systems can also be a powerful de-motivator.  Different business units have differing rewards systems. Conflicts can also arise across divisions when divisional profits become a key compensation criterion.  Behavior reinforced within subcultures may reflect value differences in opposition to the dominant culture  Reward systems may lead to information hoarding, working at cross purposes 9-25

26. Behavioral Control: Incentives Creating Incentive Programs One of the challenges for strategic managers is to design and implement reward systems in which what is best for the “rational” individual is also best for the organization. EXHIBIT 9.4 presents the qualities and characteristics of a good reward system: 1. Objectives are clear, well understood, and broadly accepted. 2.Rewards are clearly linked to performance and desired behaviors. 3.Performance measures are clear and highly visible. 4.Feedback is prompt, clear, and unambiguous. 5.The compensation “system” is perceived as fair and equitable. 6.The structure is flexible — it can adapt to changing circumstances. 9-26

27. Behavioral Control: Setting Boundaries and Constraints  Rules and regulations, as well as aspiration levels and goals, can provide effective forms of organizational control. Culture and reward systems often need to be supplemented or reinforced by boundaries and constraints.  Used properly they can: 1. Focus individual efforts on organizational priorities. 2. Provide short-term objectives and action plans that channel efforts. 3. Improve efficiency and effectiveness. 4. Minimize improper and unethical conduct.  Boundaries and constraints must be used sparingly in order to be effective. Excessive regulations or rules that are enforced with poor judgment can be counterproductive. 9-27

28. Behavioral Control: Focusing Efforts on Strategic Priorities  Vision, mission, and strategic objectives are a type of boundary that was introduced in Chapter 1.  These types of goals can take several forms.  For example, former GE Chairman Jack Welch set a goal of having all of the business in GE’s portfolio ranked first or second in their industry.  http://www.lilly.com/Pages/Home.aspx has reduced its research efforts to only five broad areas of disease down from nine. IBM sold the PC business and so did Pfizer sold the infant formula business to concentrate on the pharmaceutical products. Steve Jobs also had set priorities for Apple products. http://www.lilly.com/Pages/Home.aspx  This type of goal gives all organization members a boundary in the sense of a goal line to shoot for.  The concentration of effort and resources provides the firm with greater strategic focus and the potential for stronger competitive advantage in the remaining areas. 9-28

29. Behavioral Control: Providing Short-Term Objectives and Action Plans  Strategic objectives and actions plans may have a more direct impact on the behavior of an organization’s employees. The attributes of short-term objectives that need to be present for them to be effective. They must: 1. be specific and measurable. 2. include a specific time horizon for their attainment. 3. be achievable yet challenging enough to motivate managers who must strive to accomplish them.  Short-term objectives must provide proper direction but also be flexible enough to keep pace with changing conditions and unexpected circumstances. 9-29

30. Behavioral Control: Providing Short-Term Objectives and Action Plans  Action plans are another type of boundary or constraint because they provide specific, measurable frameworks for how a strategy is to be implemented.  Once managers understand the outcome that is to be achieved, developing an action plan gives them a sense of ownership of the company’s goals.  They also feel a degree of autonomy since they can often select (or modify) the specific means for accomplishing the implementation. STRATEGY SPOTLIGHT 9.2 illustrates how Marks and Spencer's puts its sustainability mission into action by creating clear, measurable goals. 9-30

31. Behavioral Control: Providing Short-Term Objectives and Action Plans 9-31

32. Behavioral Control:Improving Operational Efficiency and Effectiveness  Rules-based controls are most appropriate in organizations where: 1. Environments are stable and predictable. 2. Employees are largely unskilled and interchangeable. 3. Consistency in product and service is critical. 4. The risk of malfeasance is extremely high (as in banking or casino operations), and controls must be implemented to guard against improper conduct. McDonald’s, policy manuals, the Ritz Carlton and spending limits, and Computer Associates and its restrictions of usage of emails during peak times, are typical examples. 9-32

33. Behavioral Control: Minimizing Improper and Unethical Conduct  Rules and guidelines are often used to control commercial practices such as bribes, kickbacks, and other forms of payment that may be illegal. (Cadbury Sweppes and book keeping) Singapore Airlines has a 17-page policy outlining its anticorruption and antibribery polices.  These guidelines, (For example the Sarbanes-Oxley Act provides for stiffer penalties for financial reporting misdeeds) are used in many arenas including maintaining customer confidentiality and developing sourcing strategies for dealing with suppliers. 9-33

34. Behavioral Control in Organizations: Situational Factors  Sometimes we have take a contingency approach to behavioral control. That is, the effective use of rewards/incentives, culture, and boundaries are dependent on a variety of internal and external factors.  Culture is most associated with professional organizations, where high autonomy and norms are the basis for behavior; rules/boundaries are best where there are standardized output, repetitive tasks, and a minimal need for creativity; and rewards are most appropriate when performance evaluation is quite straightforward.  EXHIBIT 9.5 provides a summary of alternative approaches to behavioral control. Ask: 9-34

35. Behavioral Control Systems Exhibit 9.5 Organizational Control: Alternative Approaches 9-35

36. Behavioral Control Systems  Rewards and incentives, plus a strong culture, reduce the need for external controls, IF organizations 1. Hire the right people, those who identify with the company’s dominant values. 2. Use training and indoctrination to build a strong identity and sense of the company culture. 3. Encourage managers to set examples for the whole company with their behaviors. 4. Align company reward systems with organizational goals and objectives. 9-36

37. Example: Building a Strong, Rewarding Culture  Zappos hires only one out of 100 applicants - a hiring process that is weighted 50% on job skills & 50% on the potential to mesh with Zappos’ culture.  Call center reps are measured based on how much time they spend with customers, not how many calls they take  Rewards include Zollars (Zappos dollars) given by peers to peers for deserving behaviors  Because Zappos has a strong culture they can… Run primarily using recognition with few “incentive” programs Eschew traditional programs – use what works for them http://www.zapposinsights.com/ 9-37

38. Corporate Governance  Corporation = a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. There is a separation of owners (shareholders) & management in a modern corporation Shareholders (investors) have limited liability & can participate in the profits without taking direct responsibility for operations Management can run the company without personally providing any funds The Board of Directors are elected by shareholders & have a fiduciary obligation to protect shareholder interests 9-38

39. Corporate Governance  Corporate governance :the relationship among various participants in determining the direction and performance of corporations. Primary participants are: The shareholders The management (led by the Chief Executive Officer - CEO) The Board of Directors  The strategic control mechanism known as corporate governance focuses on the need for both shareholders (the owners of the corporation) and their elected representatives, the Board of Directors, to actively ensure that management fulfills its overriding purpose of increasing long-term shareholder value.  Sound governance practices often lead to superior financial performance. 9-39

40. Corporate Governance 9-40

41. Corporate Governance Mechanisms  According to the Business Roundtable, the largest US corporation's, duties of the Board of Directors are The Board of Directors acts as a fulcrum between the owners and controllers of a Corporation. Regularly evaluate, and, if necessary, replace the CEO; determine management compensation; review succession planning. Review & approve financial objectives, major strategies, and plans of the Corporation. Provide advice and counsel to top management. Select & recommend candidates for the Board of Directors; evaluate board processes. Review the adequacy of all compliance systems. 9-41

42. Corporate Governance Mechanisms  Business Roundtable views that an effective Board of Directors should: Become active, critical participants Ensure that strategic plans undergo rigorous scrutiny Evaluate managers against high performance standards Take control of the succession process Practice director independence. That means a minimum of “insiders” (past or present members of the management team) should serve on the board, and that directors and their firms should be barred from doing consulting, legal, or other work for the company. Insist that directors own significant stock in the company, this will best guarantee that directors act in the best interest of shareholders 9-42

43. Corporate Governance Mechanisms Shareholder activism refers to actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization.  Individual shareholders have rights: To sell stock, vote the proxy, bring suit for damages, get information, receive residual rights following the company’s liquidation  Collectively, shareholders have power: To direct the course of corporations, file shareholder action suits, demand key issues be brought up for proxy votes  Institutional investors can be aggressive: By reviewing performance, requesting changes in the firm’s governance structure, filing court action, becoming major shareholders 9-43

44. Corporate Governance Mechanisms  Incentive systems must be designed to help the company achieve its goals. One of the most critical roles of the Board of Directors is to create incentives that align the interests of the CEO and top executives with the interests of owners of the corporation, and long-term shareholder returns.  Boards can require that CEOs become substantial owners of company stock Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and penalties for poor performance Dismissal for poor performance should be a realistic threat. See Exhibit 9.7 for suggestions on how to build effective compensation packages for executives. 9-44

45. Corporate Governance Mechanisms 9-45

46. Example: Corporate Governance & Stakeholder Groups  During the 2008 financial crisis, AIG had to pay out, and would have gone bankrupt if the US government had not provided an $85 billion loan. Yet AIG (American International Group) paid $218 million in bonuses to its financial services division employees AFTER receiving an $85 billion bailout from the U.S. government  The U.S. House of representatives complained. AIG leadership caved in  Many AIG financial services managers were AIG shareholders  Was corporate governance effective? Were external governance control mechanisms inappropriate?  External governance control mechanisms should ensure that managerial actions put in place to safeguard shareholders do not harm other stakeholder groups. Many stakeholders, including current and future employees, customers, creditors, and investors, had to wonder if AIG could be trusted to handle their business in the future. In this case, external governance controls might not be as effective as controls put in place by the company itself. 9-46

47. External Governance Control Mechanisms  Thus far, our discussion has been on internal governance mechanisms. However, internal controls do not always ensure good governance.  External governance control mechanisms = methods that ensure that management actions lead to shareholder value maximization and do not harm other stakeholder groups that are outside the control of the corporate governance system. #-47

48. External control mechanisms  1.The Market for Corporate Control  2.Auditors  3.Banks and Analysts  4.Regulatory Bodies  5.Media and Public Activists #-48