CHAPTER 2 Corporate Governance STRATEGIC MANAGEMENT BUSINESS POLICY

Corporate Governance Prentice Hall, Inc. © 2006 2 -2

Corporate Governance Corporation A mechanism established to allow different parties to contribute expertise and labor for their mutual benefit Corporate Governance The relationship among the board of directors, top management, and shareholders – determining the direction and performance of the corporation Prentice Hall, Inc. © 2006 2 -3

Corporate Governance Tyco International Ltd. – Operates in 100 countries, Revenues of $36 B – Dennis Kozlowski (1975 – 2002) • CEO 1995 – Credited with rapid worldwide expansion • Compensation – 1996 $8. 8 MM – 1999 $136. 1 MM – Company Loans for $$MM • Treated Company as his own – – Wife B-Day Party Shower Curtain Dog Umbrella Stand Apartment $2. 1 MM $6 K $15 K $16. 8 MM – Board of Directors • • Members granted large loans Many conflicts of interest Many former company executives Regularly bypassed in the decision process Prentice Hall, Inc. © 2006 2 -4

Corporate Governance BOD Responsibilities (200 Directors from 8 countries) – – – Setting strategy and overall direction, mission or vision Hiring firing CEO and top management Controlling, monitoring or supervising top management Reviewing and approving use of resources Caring for Shareholder interests (CEO’s surveyed) – – Corporate performance CEO Succession Strategic planning Corporate governance Prentice Hall, Inc. © 2006 2 -5

Corporate Governance Role of Board in Strategic Management –Monitor –Evaluate and influence –Initiate and

Board of Directors Continuum Small Entrepreneur Prentice Hall, Inc. © 2006 Large Public 2

Board of Directors Members -–Inside directors • “management directors” • Officers or execs employed by the firm –Outside directors • “non-management directors” • Execs of other firms not employed by the board’s corporation • 80% of members in large publicly held firms • 19% in privately held firms Prentice Hall, Inc. © 2006 2 -8

Agency Theory Agency Problem – –Objectives of owners & agents in conflict –Difficult for owners to verify agent performance Risk Sharing Problem – –Owners & agents risk assessment in conflict Prentice Hall, Inc. © 2006 2 -9

Stewardship Theory Executives more motivated to act in best interest of the corporation than their own self-interests. Theory that over time, senior executives tend to view corporation as extension of selves. Prentice Hall, Inc. © 2006 2 -10

Agency Theory versus Stewardship Theory Esteem Stewardship Self Actualization Agency Theory Socialization Safety Physiological

Board of Directors When Outsiders can be considered Insiders –Affiliated Directors Conflict of interests –Retired Directors Former CEO’s- Objectivity? –Family Directors Descendents with significant blocks of stock Prentice Hall, Inc. © 2006 2 -12

Board of Directors Codetermination –The inclusion of a corporation’s employees on its board of

Board of Directors Interlocking Directorates –Direct Interlocking Shared director or exchanged seats –Indirect Interlocking Two corporations have directors that serve on the board of a 3 rd firm Prentice Hall, Inc. © 2006 2 -14

Board of Directors Nominations & Elections –Traditional Approach • CEO invitation to membership • Shareholders approval in annual proxy statement • All nominees usually elected –Staggered Board Approach • Staggered terms of service/election –Annual Elections • Opportunity for hostile takeover • Increased shareholder control Prentice Hall, Inc. © 2006 2 -15

Board of Directors Criteria for a good Director – – – – – Willing to challenge management Has special expertise Available outside of meetings Expertise on global business issues Understands key firm’s technologies Brings valuable external contacts Knowledge of firm’s industry High visibility in their field Accomplished in representing the firm to stakeholders Prentice Hall, Inc. © 2006 2 -16

Board of Directors Sarbanes-Oxley –Key elements –All audit committee members must be outside directors and receive no additional fee –Board no longer grants loans to officers –Formal procedures for “whistle blowers” –CEO and CFO must certify all financial info. –Internal and external auditors may not be from the same firm –Must identify if there is a member of the audit committee with financial expertise –Code of Ethics for CEO and CFO must be disclosed –Members of the Audit, Nominating, and Compensation Committees must all be outside directors Prentice Hall, Inc. © 2006 2 -17

Board of Directors Organization of the Board –Size • Charter & Bylaws Determination • States may set minimums • Large Publicly held – 11 • SME Privately held – 7 or 8 • Family owned - 4 Prentice Hall, Inc. © 2006 2 -18

Board of Directors Corporate Governance Trends –Review & shaping of strategy – active participation –Pressure for corporate performance from shareholders and institutional investors –Demand for executive/director stock ownership with performance based incentives –Outside directors increasing –Impact of Sarbanes-Oxley –Smaller boards –Separate CEO/COB and/or Lead Director –Members with Int’l experience –Shareholder nominations –Social responsibility on the rise Prentice Hall, Inc. © 2006 2 -19

Board of Directors CEO Responsibilities – Provide executive leadership and effective strategic management –

Board of Directors Transformational leaders –Articulate a strategic vision –Presents a role for others to identify with and to follow –Communicates high standards of performance and confidence in followers ability Prentice Hall, Inc. © 2006 2 -21

Strategic Management Process Strategic Planning Staff –Supports top management & business units in the strategic planning process –Identify & analyze company-wide strategic issues –Generate strategic alternatives –Facilitate business units in coordinating activities related to strategic planning process Prentice Hall, Inc. © 2006 2 -22

Strategic Management Process Board of Directors Role in Succession Planning • Set criteria for selection based on strategic needs of the company • Executive type • Dynamic industry expert - growth • Analytical portfolio manager - diversification • Cautions profit planner - stability • Turnaround specialist – weak company/active market • Professional liquidator – company can’t be saved • Set realistic performance expectations • Develop a deep understanding of the organization and conduct thoughtful annual reviews of the CEO Prentice Hall, Inc. © 2006 2 -23

Board of Directors Criteria for a good Director – – – – – Willing to challenge management Has special expertise Available outside of meetings Expertise on global business issues Understands key firm’s technologies Brings valuable external contacts Knowledge of firm’s industry High visibility in their field Accomplished in representing the firm to stakeholders Prentice Hall, Inc. © 2006 2 -25

Corporate Governance BOD Responsibilities (200 Directors from 8 countries) – – – Setting strategy and overall direction, mission or vision Hiring firing CEO and top management Controlling, monitoring or supervising top management Reviewing and approving use of resources Caring for Shareholder interests (CEO’s surveyed) – – Corporate performance CEO Succession Strategic planning Corporate governance Prentice Hall, Inc. © 2006 2 -26