1. Strategic Management: Concepts and Cases
Part III: Strategic Actions: Strategy Implementation
Chapter 10 and 11: Corporate Governance &
Organizational Structure and Controls 1

2. The Strategic Management Process2

3. CG and Its Effect on the Lives of CEOs
In 2006 record number of CEOs lost jobs
Dismissal
Retirement
Recruitment to another firm
Partly due to increasing scrutiny by
Boards
Governance activists
Increased pressure from the market for corporate control
Media
Trend: decrease in average tenure (current: mo.)
Result: CEOs looking at short-term vs. long-term 3

4. Introduction Corporate Governance (CG)
Set of mechanisms used to manage the relationships (and conflicting interests) among stakeholders, and to determine and control the strategic direction and performance of organizations (aligning strategic decisions with company values)
Effective CG interest to nations as it reflects societal standards
Firms’ shareholders are treated as key stakeholders as they are the company’s legal owners 4

5. Separation of Ownership and Managerial Control
Introduction
Historically, firms managed by founder-owners & descendants
Separation of ownership and managerial control allow shareholders to purchase stock, entitling them to income (residual returns) – implies ‘risk’ for this group who manage their investment risk
Shareholder value reflected in price of stock 5

6. Separation of Ownership and Managerial Control
Introduction
Small firms’ managers are high percentage owners, which implies less separation between ownership and management control
Usually implies family-owned businesses
This group faces 2 critical issues
1. As they grow, they may not have access to all needed skills to manage the growing firm and maximize its returns, so may need outsiders to improve management
2. May need to seek outside capital (whereby they give up some ownership control) 6

7. Separation of Ownership and Managerial Control (Cont’d)
Agency relationships
Relationships between business owners (principals) and decision-making specialists (agents) hired to manage principals' operations and maximize returns on investment (and focus of this chapter)
Other agency relationship examples: Consultants/clients; insured/insurer; manager/employee 7

8. Separation of Ownership and Managerial Control
Agency relationships (Cont’d)
Managerial Opportunism: Seeking self-interest with guile (i.e., cunning or deceit)
Opportunism: an attitude and set of behaviors
Managers don’t know which agents will enact managerial opportunism
Principals establish governance and control mechanisms to prevent agents from acting opportunistically 8

9. An Agency Relationship9

10. Separation of Ownership and Managerial Control
Agency problems: Product diversification
Can result in 2 manager benefits shareholders “don’t enjoy”
1. Increase in firm size
2. Firm portfolio diversification which can reduce top executives’ employment risk (i.e., job loss, loss of compensation and loss of managerial reputation)
Diversification reduces these risks because a firm and its managers are less vulnerable to the reduction in demand associated with a single or limited number of product lines or businesses 10

11. Separation of Ownership and Managerial Control
Agency problems: Firm’s free cash flow
Resources remaining after the firm has invested in all projects that have positive net present values within its current businesses
Available cash flows
Managerial inclination to overdiversify can be acted upon
Shareholders may prefer distribution as dividends, so they can control how the cash is invested
Curve S depicts shareholders’ optimal level of diversification where Point A is preferred by shareholders and Point B by top executives 11

12. Manager and Shareholder Risk and Diversification12

13. Separation of Ownership and Managerial Control (Cont’d)
Agency costs and governance mechanisms
Sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals, because governance mechanisms cannot guarantee total compliance by the agent
Costs associated with agency relationships, and effective governance mechanisms should be employed to improve managerial decision making and strategic effectiveness
Transaction Costs 13

14. Ownership Concentration
Introduction: Key concepts
Ownership Concentration: Governance mechanism defined by both the number of large-block shareholders and the total percentage of shares they own
Large Block Shareholders: Shareholders owning a concentration of at least 5 percent of a corporation’s issued shares
Institutional Owners: Financial institutions such as stock mutual funds and pension funds that control large-block shareholder positions 14

15. The Board of Directors (BOD)
Introduction
Group of shareholder-elected individuals (usually called ‘directors’) whose primary responsibility is to act in the owners’ interests by formally monitoring and controlling the corporation’s top-level executives 15

16. The Board of Directors (BOD)
As stewards of an organization's resources, an effective and well-structured board of directors can influence the performance of a firm
Oversee managers to ensure the company is operated in ways to maximize shareholder wealth
Direct the affairs of the organization
Punish and reward managers
Protect shareholders’ rights and interests
Protect owners from managerial opportunism
3 types: Insider, related outsider and outsider 16

17. The Board of Directors (BOD) (Cont’d)
Historically, BOD dominated by inside managers
Managers suspected of using their power to select and compensate directors
NYSE implemented an audit committee rule requiring outside directors to head audit committee (a response to SEC’s proposal requiring audit committees be made up of outside directors)
Sarbanes-Oxley Act passed leading to BOD changes
CG becoming more intense through BOD mechanism
BOD scandals led to trend of separating roles of CEO and Chairperson 17

18. The Board of Directors (BOD) (Cont’d)
Outside directors
Improve weak managerial monitoring and control that corresponds to inside directors
Tend to emphasize financial controls, to the detriment of risk-related decisions by managers, as they do not have access to daily operations and a high level of information about managers and strategy 18

19. The Board of Directors (BOD) (Cont’d)
Outside directors (Cont’d)
Large number of outsiders can create problems
Limited contact with the firm’s day-to-day operations and incomplete information about managers
results in ineffective assessments of managerial decisions and initiatives.
emphasizes financial, as opposed to strategic, controls to gather performance information to evaluate performance of managers & business units, which could reduce R&D investments, increase diversification, and pursue higher compensation to offset their employment risk 19

20. The Board of Directors (BOD) (Cont’d)
Enhancing BOD effectiveness (5 changes)
Increased diversity in board members’ backgrounds
Establishment and consistent use of formal processes to evaluate the board’s performance
Creation of a “lead director” role that has strong agenda-setting and oversight powers
Modified compensation of directors
Requires that directors own significant stakes in the company in order to keep focused on shareholder interests 20

21. Executive Compensation (EC)
Defined: Governance mechanism that seeks to align the interests of top managers and owners through salaries, bonuses, and long-term incentive compensation, such as stock awards and stock options
Thought to be excessive and out of line with performance
Alignment of pay and performance: complicated board responsibility
The effectiveness of pay plans as a governance mechanism is suspect 21

22. Executive Compensation (EC) (Contd’)
The effectiveness of executive compensation
Complicated, especially long-term incentive comp
The quality of complex and nonroutine strategic decisions that top-level managers make is difficult to evaluate
Decisions affect financial outcomes over an extended period, making it difficult to assess the effect of current decisions on corporation performance
External factors affect a firm’s performance in addition to top-level management decisions and behavior 22

23. Executive Compensation (EC) (Contd’)
The effectiveness of executive compensation (Cont’d)
Performance-based compensation used to motivate decisions that best serve shareholder interest are imperfect in their ability to monitor and control managers
Incentive-based compensation plans intended to increase firm value, in line with shareholder expectations, subject to managerial manipulation to maximize managerial interests
Many plans seemingly designed to maximize manager wealth rather than guarantee a high stock price that aligns the interests of managers and shareholders 23

24. Market for Corporate Control
Definition: external governance mechanism consisting of a set of potential owners seeking to acquire undervalued firms and earn above-average returns on their investments
Becomes active when a firm’s internal controls fail
Need (for external mechanisms) exists to
address weak internal corporate governance
correct suboptimal performance relative to competitors, and
discipline ineffective or opportunistic managers.
External mechanisms are less precise than internal governance mechanisms 24

25. International Corporate Governance
Corporate Governance in Germany
Concentration of ownership is strong
Banks exercise significant power as a source of financing for firms
Two-tiered board structures, required for larger employers, place responsibility for monitoring and controlling managerial decisions and actions with separate groups
Power sharing includes representation from the community as well as unions 25

26. International Corporate Governance (Cont’d)
Corporate Governance in Japan
Cultural concepts of obligation, family, and consensus affect attitudes toward governance
Close relationships between stakeholders and a company are manifested in cross-shareholding, and can negatively impact efficiencies
Banks play an important role in financing and monitoring large public firms
Despite the counter-cultural nature of corporate takeovers, changes in corporate governance have introduced this practice 26

27. International Corporate Governance (Cont’d)
Global Corporate Governance
Relatively uniform governance structures are evolving
These structures are moving closer to the U.S. corporate governance model
Although implementation is slower, merging with U.S. practices is occurring even in transitional economies 27

28. Chapter 11: Organizational Structure (and Controls)
Components of internal strategic fit
Role of organizational structure in strategy implementation
Basic forms of organizational structure;
advantages/disadvantages of each
- simple
- functional
- multi-divisional (M-Form)
- - 3 types
11–28

29. Chapter 11: Organizational Structure (and Controls)
Strategic control; financial control
Strategy-structure “fit”
Contemporary forms of organizational structure
- matrix structure
- strategic alliances, networks, virtual
organizations (Chapter 9)
- creative/experimental forms
11–29

30. Components of Internal Strategic Fit (Froelich Model)
Environment
Strategy
Structure
Systems
Resources/Capabilities
Organizational Culture
11–30

31. Organizational Structure
Organizational structure specifies:
The firm’s formal reporting relationships, procedures, controls, and authority and
decision-making processes
It is critical to match organizational structure to the firm’s strategy
11–31

32. Relationships between Strategy and Structure
Strategy and structure have a reciprocal relationship:
Structure flows from or follows the selection of the firm’s strategy but …
Once in place, structure can influence current strategic actions as well as choices about future strategies
11–32

33. Strategy and Structure Growth Pattern
Efficient implementation of formulated strategy
As firms grow larger and become more complex, structural challenges emerge
Firms’ larger sizes dictate the need for more sophisticated workflows and integrating mechanisms
Simple
Functional
Multidivisional
Efficient implementation of formulated strategy
11–33
Figure 11.1

34. Strategy and Structure: Simple Structure
Owner-manager
Makes all major decisions directly
Monitors all activities
Staff
An extension of manager’s supervisor authority
Matched with focus (or niche) strategies and small single business strategies
Commonly compete by offering a single product line in a single geographic market
11–34

35. Strategy and Structure: Functional Structure
Chief Executive Officer (CEO)
Limited corporate staff
Functional line managers in needed organizational areas, possibly:
Manufacturing ➢Marketing ➢Engineering
Accounting ➢R&D ➢HRM
Supports use of business-level strategies and some corporate-level strategies
(larger) Single or dominant business with low levels of diversification
Facilitates centralization/company-wide coordination
11–35

36. Functional Structure for a Differentiation Strategy
Notes: • Marketing is the main function for keeping track of new product ideas • New product R&D is emphasized
• Most functions are decentralized, but R&D and marketing may have centralized staffs that work closely with each other
• Formalization is limited so that new product ideas can emerge easily and change is more readily accomplished
• Overall structure is organic; job roles are less structured
11–36
Figure 11.3

37. Functional Structure under a Differentiation Strategy
Marketing is the main function for tracking new product ideas
New product R&D is emphasized
Most functions are decentralized
Formalization is limited to foster change and promote new ideas
Overall structure is organic
Job roles are less structured
11–37

38. Functional Structure for Cost Leadership Strategy
Notes: • Operations is the main function • Process engineering is emphasized rather than new product R&D • Relatively large centralized staff coordinates functions • Formalized procedures allow for emergence of a low-cost culture • Overall structure is mechanical; job roles are highly structured
11–38
Figure 11.2

39. Functional Structure under a Cost Leadership Strategy
Operations is typically the main function
Process engineering is emphasized over research and development
Large centralized staff oversees activities
Formalized procedures guide actions
Structure is mechanical
Job roles are highly structured
11–39

40. Implementing an Integrated Cost Leadership/Differentiation Strategy
The integrated form of the functional structure must have:
Decision-making patterns that are partially centralized and partially decentralized
Semi-specialized jobs
Rules and procedures that allow both formal and informal job behaviors
A hybrid form; no wonder it is hard to implement!
Copyright © 2004 South-Western. All rights reserved.
11–40

41. Functional Structure
Differences in orientation among organizational functions can:
Impede communication and coordination
Cause functional-area managers to focus on local versus overall company strategic issues
Increase the need for CEO to integrate decisions and actions of business functions
Facilitate career paths and professional development in specialized functional areas
Copyright © 2004 South-Western. All rights reserved.
11–41

42. Evolutionary Growth of the Firm leading to increased diversification
A firm’s continuing success that leads to:
Product diversification, or
Market diversification, or
Both product and market diversification
Increasing diversification creates information processing and coordination problems that the functional structure can’t handle
11–42

43. Strategy and Structure: Multidivisional Structure
Top corporate officer delegates responsibilities to division managers
For day-to-day operations
For business-unit strategy
Appropriate as a firm grows through diversification
11–43

44. Multidivisional Structure (cont’d)
Major Benefits
Corporate officers are more detached as they monitor and compare performance of divisions, facilitating resource allocation decisions
Stimulates divisional managers to optimize performance of their units
Provides for faster reaction to change and a stronger customer focus at division level
Development of “general management” expertise within the firm
11–44

45. Multidivisional Structure (con’t)
Major Disadvantages
Increased complexity of the firm overall
Difficulties coordinating and sharing expertise across divisions
Duplication of resources
Tendency to rely on financial controls rather than strategic controls
11–45

46. Organizational Controls
Strategic
Controls
Organizational
Controls
“Subjective” (strategically relevant) Criteria
Philosophy of the “balanced scorecard”
Evaluate the degree to which the firm accomplishes key tasks related to success of the particular strategy being implemented
Examples = market share, innovation lead time, image, location advantages, product mix
requires in-depth knowledge/insight in market
11–46

47. Organizational Controls
Strategic
Controls
Organizational
Controls
Financial
Controls
“Objective” financial criteria
Enables comparisons of differing divisions using “standardized financial measures, such as:
Requires less strategic understanding
Use with caution - do not tell the whole story!
11–47

48. Matching Control to Strategy
Relative use of controls varies by type of strategy
Large diversified firms using a cost leadership strategy tend to emphasize financial controls
Companies and business units using a differentiation strategy typically emphasize strategic controls
Diversification strategy requires firm to change from functional structure to a multidivisional structure
Different levels of diversification create the need for implementation of a unique form of the multidivisional structure
11–48

49. Variations of the Multidivisional Structure
11–49
Figure 11.4

50. Multidivisional Structure: Cooperative Form
Development of integrating mechanisms to bring about cooperation among divisions
Goals = activity sharing/skill transfer
HQ involved in centralized strategic planning, HRM, marketing, and possibly other functions with synergistic potential
R&D is likely centralized
Greater use of strategic control measures
A more cooperative culture is nurtured
A more complex management task compared to the competitive M-Form
11–50
Related-Constrained Strategy

51. Multidivisional Structure: Competitive Form
A structure in which there is independence among the firm’s divisions
Divisions do not share common strengths, so integrating mechanisms are not employed
Corporate HQ has a small staff; strategy is delegated to divisions, but resource allocation among divisions is centralized
Financial controls predominate
Prominent functions are finance, auditing; plus legal is acquisitions/divestitures are frequent
Culture of competition rather than cooperation between divisions
11–51
Unrelated Strategy

52. Cooperative Form of Multidivisional Structure: Related-Constrained Strategy
Notes • Structural integration devices create tight links among all divisions
• Corporate office emphasizes centralized strategic planning, human resources, and marketing to foster cooperation between divisions
• R&D is likely to be centralized•
• Rewards are subjective and tend to emphasize overall corporate performance in addition to divisional performance
• Culture emphasizes cooperative sharing
11–52
Figure 11.5

53. Competitive Form of Multidivisional Structure:Unrelated Strategy
Notes • Corporate headquarters has a small staff
• Finance and auditing are the most prominent functions in the headquarters office to manage cash flow and assure the accuracy of performance data coming from divisions
• The legal affairs function becomes important when the firm acquires or divests assets
• Divisions are independent and separate for financial evaluation purposes
• Divisions retain strategic control, but cash is managed by the corporate office
• Divisions compete for corporate resources
11–53
Figure 11.7

54. Matrix Organizational Form
Simultaneous use of functional departments and project teams
To facilitate and speed strategies relying on innovation
Seldom used for structuring an entire organization; rather, used in particular areas of the organization as needed
11–54

55. Creative/Experimental Structural Forms
“Organizational ecosystem” concept of overlapping teams - to facilitate innovation and high employee commitment
Bottom-up structures - to emphasize importance of customers and staff
Non-hierarchical structures - to focus on organizational mission/shared values
11–55

56. Even More Structures !!! Structures for international strategies
(Network) structures for cooperative strategies
Matrix structures to facilitate innovation
Creative and experimental structures
11–56

57. Worldwide Geographic Area Structure: Multi-domestic Strategy
Notes: • The perimeter circles indicate decentralization of operations • Emphasis is on differentiation by local demand to fit an area or country culture • Corporate headquarters coordinates financial resources among independent subsidiaries • The organization is like a decentralized federation
11–57
Figure 11.8

58. Worldwide Product Divisional Structure: Global Strategy
Notes • The headquarters’ circle indicates centralization to coordinate information flow among worldwide products
• Corporate headquarters uses many intercoordination devices to facilitate global economies of scale and scope
• Corporate headquarters also allocates financial resources in a cooperative way • The organization is like a centralized federation
11–58
Figure 11.9

59. Strategic Center Firm
Is the foundation for the strategic network’s structure
Manages the complex, cooperative interactions among network partners
Is more obvious in stable and vertically arranged networks, but less obvious in horizontally arranged and dynamic networks
11–59

60. A Strategic Network - for elaborate cooperative strategies (Chapter 9)
Center
Firm
Adapted from Figure 11.10
11–60