Strategic Control and Corporate Governance

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Education.

Strategic Control and Corporate

Governance

chapter 9

Learning Objectives9-2

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.

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.

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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?

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Strategic Control

Strategic control involves monitoring performance toward strategic goals and taking corrective action when needed via effective systems: Informational control systems Behavioral control systems Corporate governance

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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

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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

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Strategic Control: Contemporary Approach

Relationships between strategy formulation, implementation, & control are highly interactive, utilizing Informational control Behavioral control

Exhibit 9.2 Contemporary Approach to Strategic Control

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Strategic Control: Contemporary Approach

Informational control = concerned with whether or not the organization is “doing the right things”

Behavioral control = concerned with whether or not the organization is “doing things right” in the implementation of its strategy

Both types of control are necessary, but not sufficient, conditions for success

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Question?

Top managers at ABC Company meet every Friday to review daily operational reports and year-to-date data. This is an example ofA. behavioral control.B. informational control.C. strategy formulation.D. strategy implementation.

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Informational Control

Informational control deals with both the internal & external environment

Do the organization’s goals and strategies still “fit” within the context of the current strategic environment?

Two key issues: Scan & monitor the external environment Continuously monitor the internal

environment

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Informational Control

Informational control = ongoing process of organizational learning

Focus on constantly changing information - continuous monitoring, testing, review

Updates & challenges assumptions, so Time lags are shortened Changes are detected earlier Speed & flexibility of response is

enhanced

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Question?

Which of the following is not one of the characteristics of a contemporary control system?A. It is a key catalyst for an ongoing debate about

underlying data, assumptions, and action plans.B. It must focus on constantly changing information

that is strategically important.C. It circumvents the need for face-to-face meetings

among superiors, subordinates, and peers.D. It generates information that is important enough

to demand regular and frequent attention.

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Behavioral Control

Behavioral control = focused on implementation – “doing things right”

Influences the actions of employees via: Culture Rewards Boundaries

Exhibit 9.3 Essential Elements of Behavioral Control

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Behavioral Control: Culture

Organizational culture is a system of Shared values (what is important) Beliefs (how things work)

Organizational culture shapes a firm’s People Organizational structures Control systems

Organizational culture produces Behavioral norms (the way we do things

around here)

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Behavioral Control: Culture

Organizational culture sets implicit boundaries regarding: Dress Ethical matters The way an organization conducts its

business A strong culture

Leads to greater employee engagement Provides a common purpose and identity Reduces monitoring costs

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Behavioral Control: Culture

Effective organizational cultures must be Cultivated Encouraged Fertilized

Organizational cultures can be maintained by Storytelling Rallies or pep talks by top executives

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Behavioral Control: Rewards

Reward systems & incentive programs: Powerful means of influencing an

organization’s culture Focus efforts on high-priority tasks Motivate individual & collective task

performance Can be an effective motivator & control

mechanism

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Behavioral Control: Rewards

Potential downside: Individual actions are not related to

compensation; employees are rewarded for the wrong things

Different business units have differing rewards systems

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

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Behavioral Control: Rewards

Exhibit 9.4 Characteristics of Effective Reward and Evaluation Systems

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Behavioral Control: Boundaries

Boundaries and constraints can be useful Focusing individual efforts on strategic

priorities Providing short-term objectives and action

plans to channel efforts Specific, measurable, including a specific time

horizon for attainment Achievable, yet challenging enough to motivate Individual managers held accountable for

implementation

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Question?

Rules and regulations, rather than culture or rewards, would probably be used for strategic control at what type of company?A. Software developerB. Stock brokerage firmC. Manufacturer of mass-produced productsD. High-tech research facility

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Behavioral Control: Boundaries

Boundaries and constraints can also Improve efficiency and effectiveness through

rule-based controls, appropriate when Environments are stable and predictable Employees are largely unskilled and

interchangeable Consistency in product and services is critical The risk of malfeasance is extremely high

Minimize improper and unethical conduct via Anti-bribery policies Regulations and sanctions – i.e. Sarbanes-Oxley

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Behavioral Control Systems

Exhibit 9.5 Organizational Control: Alternative Approaches

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Behavioral Control Systems

Rewards and incentives, plus a strong culture, reduce the need for external controls, IF organizations Hire the right people Train people in the dominant cultural

values Have managerial role models Have reward systems clearly aligned with

organizational goals and objectives

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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

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Corporate Governance

Corporate governance controls focus on relationships between The shareholders The management (led by the Chief

Executive Officer - CEO) The Board of Directors

How can corporations succeed (or fail) in aligning managerial motives with The interests of the shareholders The interests of the board of directors

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Corporate Governance

The 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

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Corporate Governance: Agency Theory

Agency theory deals with the relationship between principals & agents

What to do when the goals of the principals and agents conflict?

What to do when it is difficult or expensive for the principal to verify what the agent is actually doing?

What happens when the principal and the agent have different attitudes and preferences toward risk?

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Corporate Governance Mechanisms

Corporate governance mechanisms: aligning the interests of owners and managers through A committed and involved Board of

Directors Shareholder activism Managerial rewards and incentives

Contract-based outcomes CEO duality – should the CEO also be chairman

of the board of directors?

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Corporate Governance Mechanisms

Duties of the Board of Directors 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.

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Corporate Governance Mechanisms

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

No interlocking directorships Insist that directors own significant stock in

the company

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Corporate Governance Mechanisms

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

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Corporate Governance Mechanisms

Boards are responsible for managerial rewards and incentives 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

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Corporate Governance Mechanisms: CEO Duality?

Provides clear focus Eliminates confusion

and conflict Enhances a firm’s

responsiveness Enables quick

decisions based on first-hand knowledge

Safeguards against corruption or incompetence

Removes conflict of interest, especially regarding CEO succession

Improves perceptions of legitimacy

Unity of Command:

(in favor of) Duality

Agency Theory:

(in favor of) Separation

OR?

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Corporate Governance Mechanisms

External governance control mechanisms The market for corporate control

The takeover constraint Auditors

Enron, WorldCom? Banks and analysts

Lehman Brothers, Countrywide? Regulatory bodies

Securities and Exchange Commission (SEC) The Sarbanes-Oxley Act

Media and public activists Bloomberg Businessweek, Ralph Nader

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Example: Corporate Governance & Stakeholder

Groups 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 AIG financial services managers were

left without an income Many AIG financial services managers were AIG

shareholders Was corporate governance effective? Were external

governance control mechanisms inappropriate?

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International Corporate Governance

Principal – principal conflicts (vs principal – agent conflicts) involve Concentrated ownership, or family ownership

Motivation to engage in expropriation of minority shareholders for personal gain

Business groups who can take coordinated action Japanese keiretsus, Korean chaebols

Few external regulatory constraints

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International Corporate Governance

Exhibit 9.9 Principal-Agent Conflicts and Principal-Principal Conflicts: A DiagramSource: Young, M.N., Peng, M.W., Ahlstrom, D., Bruton, G.D., & Jiang, 2008. Principal-Principal Conflicts in Corporate Governance. Journal of Management Studies 45(1):196-220; and Peng, M.V. 2006. Global Strategy. Cincinnati: Thomson South-Western. We are very appreciative of the helpful comments of Mike Young of Hong Kong Baptist University and Mike Peng of the University of Texas at Dallas.

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