Chapter 10 Corporate Governance Hitt Ireland and Hoskisson

Chapter 10 Corporate Governance Hitt, Ireland, and Hoskisson

Definition of corporate governance n Corporate governance – the set of mechanisms used q q q to manage the relationship among stakeholders and to determine strategic direction and control the performance of organizations. Copyright © 2008 Cengage

Internal governance mechanisms n Three internal governance mechanisms q q q n ownership concentration the board of directors executive compensation. The market for corporate control is the single external governance mechanism influencing managers’ decisions and the outcomes resulting from them. Copyright © 2008 Cengage

Ownership separation n Modern corporations are characterized by an agency relationship that is created when one party (the firm’s owners) hires and pays another party (top-level managers) to use its decision-making skills. Copyright © 2008 Cengage

Separation of ownership and control n n Separation of ownership and control creates an agency problem when an agent pursues goals that conflict with principals’ goals. Principals establish and use governance mechanisms to control this problem. Copyright © 2008 Cengage

Ownership concentration n n Ownership concentration is based on the number of large block shareholders and the percentage of shares they own. Institutional investors are an increasingly powerful force in corporate America and actively use their positions of concentrated ownership to force managers and boards of directors to make decisions that maximize a firm’s value. Copyright © 2008 Cengage

Boards of directors n n In the U. S. and the U. K. , a firm’s board of directors (composed of insiders, related outsiders, and outsiders) is a governance mechanism expected to represent shareholders’ collective interests. The percentage of outside directors on many boards now exceeds the percentage of inside directors. The SOX Act requires outsiders to be more independent of a firm’s top-level managers compared with directors selected from inside the firm. Copyright © 2008 Cengage

Executive compensation n n Executive compensation – including salary, bonuses, and long-term incentives - is a highly visible and often criticized governance mechanism. The firm’s board of directors determines the effectiveness of the firm’s executive compensation system. Copyright © 2008 Cengage

Corporate control n n While shareholders and boards of directors may have become more vigilant in their control of managerial decisions, they are insufficient to govern managerial behavior in many large companies. Therefore, the market for corporate control is an important governance mechanism. q Although corporate control is also imperfect, it has been effective in causing corporations to combat inefficient diversification and to implement more effective strategic decisions. Copyright © 2008 Cengage

Corporate governances differ globally n Corporate governance structures differ in Germany, Japan, and U. S. q q q U. S. historically focused on maximizing shareholder value. Employees in Germany took a prominent role as stakeholders. Japanese shareholders played virtually no role until recently n n Now Japanese firms are being challenged by “activist” shareholders. Internationally, systems in various countries are becoming increasingly similar. Copyright © 2008 Cengage

Effective governance mechanisms n n Effective governance mechanisms ensure that the interests of all stakeholders are served. Long-term strategic success results when firms are governed in ways that permit satisfaction of q q q n capital market stakeholders (such as shareholders) product market stakeholders (such as customers and suppliers) and organizational stakeholders (managerial and nonmanagerial employees). Effective governance produces ethical behavior in forming and implementing strategies. Copyright © 2008 Cengage