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CHAPTER

12

Corporate Governance, Business Ethics, and Strategic Leadership

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Part 3 Strategy Implementation

LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader.

ChapterCase 12
Mark Hurd

HPs CEO Mark Hurd Resigns amid Ethics Scandal

CEO of HP after Carly Fiorina

Low profile, no-nonsense, strategy execution forte

Highly successful Increasing market shares for computers and printers Stock rose 110% (well above that of NASDAQ)

2010 sexual harassment scandal


Forced to resign
With $45 million severance package Hired by Oracle

Strategic Management and the Role of Business in Society


The public stock company is the backbone of our economy. Four characteristics of public firms:
Limited liability for investors
Transferability of investor interest Legal personality

Separation of ownership and control

EXHIBIT 12.1

The Public Stock Company: Hierarchy of Authority

Strategic Management and the Role of Business in Society


21st century already two financial crises
Accounting scandals: Enron, WorldCom, Tyco Global financial crisis: real estate bubble burst

Lessons
Managerial actions affect economy

Ethical business produces wealth but unethical practices destroy it

Stakeholder management is needed

EXHIBIT 12.2

Honesty and Ethics Ranking of Different Professions

How would you rate the honesty and ethical standards of people in different fields?

EXHIBIT 12.3

Stakeholder Impact Analysis

EXHIBIT 12.4

The Pyramid of Corporate Social Responsibility

LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader.

Corporate Social Responsibility


Milton Friedman circa 1962:
the only social responsibility of business is

to increase profits so long as it stays within the rules of the game

Todays businesses tend to do more than just make profits


But does CSR help build competitive advantage?

The answer might depend on where you do

business
UAE,

Japan, and India are less interested in CSR Brazil, and Germany are more interested in CSR

China,

EXHIBIT 12.5

Global Survey of Attitudes toward Business

At least somewhat agree that the social responsibility of business is increasing profits

Corporate Social Responsibility Shared value-creation framework


Expand customer base and bring in non-consumers Expand internal firm value chains by including more

non-traditional partners such as NGOs Focus on creating new regional clusters

GE recognizes a convergence between shareholders and stakeholders Empirical evidence supports that firms can do well ($) by doing good (CSR)

Corporate Governance
Corporate governance represents the relationship among stakeholders that is used to determine and control the strategic direction and performance of organizations.

Agency costs are the sum of incentive costs, monitoring costs, enforcement costs, and individual financial losses incurred by principals because it is impossible to use governance mechanisms to guarantee total compliance by the agent.

Corporate Governance
Corporate governance
Mechanisms to direct and control a firm Ensure the pursuit of strategic goal

Address the principalagent problem

When corporate governance failed


Accounting scandal
Global financial crisis Bernard Madoff Ponzi scheme

Information asymmetry
Insider information ImClone and Galleon Group

Corporate Governance
Agency theory
Views a firm as a nexus of legal contracts
Relationships among shareholders, managers, and hierarchies Firms need to design work tasks

Adverse selection
Misrepresentation of a job

Beyond his/her ability to do things

Moral hazard
Difficulty to ascertain whether the

agent gives his/her best

Agency Problems
Berle and Means in The Modern Corporation inquired whether we have any justification assuming that those in control of a modern corporation will also choose to operate it in the interests of the stockholders? (1932: p. 121) for

What are the institutions of capitalism which lessen the problem of the separation of (shareholder) ownership (the risk-bearing principals) from control (managerial decision-making agents)?

Agency Problems
What are the institutions of capitalism that lessen the problem of the separation of ownership from control?
1. 2. 3. 4. 5.

Takeovers (the market for corporate control); Recruitment of executives from outside the firm; Monitoring by boards of directors; Compensation heavily weighted toward stock options; Monitoring by institutional investors; 6. Debt (minimize free cash flow; e.g., LBOs); 7. Separate Chairperson and CEO; and 8. Internal control of Multidivisional --- miniature capital market

Board of Directors
Centerpiece of corporate governance
Inside and outside directors General strategic oversight and guidance

Selecting, evaluating, and compensating the CEO


Overseeing CEO succession plan Recently problematic at both HP and Apple

Providing guidance on executives and their compensation


Reviewing, monitoring, and approving strategic initiatives Conducting a risk assessment and mitigation

Ensuring a firms audited financial statements


Ensuring a firms compliance with laws and regulations

STRATEGY HIGHLIGHT 12.1

GEs Board of Directors

Diversity of GEs board of directors (17 members) Business, academia, politicians 4 women, 2 ethnic minorities 15 board members are independent outside directors

Less likely to fall victim to groupthink


Organized into committees to function The separation of CEO/Board Chair duality Due to recent global financial crisis
121

Other Governance Mechanisms


Executive compensation
Stock options
Performance-oriented compensation in recent years

The market for corporate control


External governance mechanism
Hostile takeover Corporate raiders and hedge funds

Auditors, government regulators, and industry analysts


Wall Street Journal, Bloomberg Businessweek, Forbes Credit rating agencies

CEO Compensation Dan Ariely Video

Corporate Governance Around the World


Difference in national institutions and culture Free market economies?
State-directed capitalism (less freedom). Ex: China
Free market capitalism (more freedom). Ex: U.S.

Germany
Stakeholder capitalism Kurzarbeit

France
Stakeholder capitalism

China
State-owned enterprises

LO 12-1 Describe and evaluate the relationship between strategic management and the role of business in society. LO 12-2 Conduct a stakeholder impact analysis. LO 12-3 Critically evaluate the relationship between corporate social performance (CSR) and competitive advantage. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. LO 12-5 Describe and evaluate the relationship between business strategy and ethics. LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader.

EXHIBIT 12.7

Roles that Strategic Leaders Play

EXHIBIT 12.8 Strategic Leaders: The Level 5 Pyramid

Take-Away Concepts
LO 12-1 Describe and critically evaluate the relationship between strategic management and the role of business in society. The public stock company is the institutional backbone of any modern free-market economy. Four characteristics of the public stock company make it an attractive corporate form: limited liability for investors, transferability of investor interests (the trading of stocks), legal personality, and separation of ownership and control.

In the first decade of the 21st century, accounting scandals and the global financial crises eroded the publics trust in business as an institution and free-market capitalism as an economic system.
Effective stakeholder management is necessary to ensure the continued survival of the firm and to sustain any competitive advantage .

Take-Away Concepts
LO 12-2 Conduct a stakeholder impact analysis.

Stakeholder impact analysis considers the needs of different stakeholders, which enables the firm to perform optimally and to live up to good citizenship.
In a stakeholder impact analysis, managers pay particular attention to three important stakeholder attributes: power, legitimacy, and urgency. Stakeholder impact analysis is a five-step process that answers the following questions: 1. Who are our stakeholders? 2. What are our stakeholders interests and claims? 3. What opportunities and threats do our stakeholders present? 4. What economic, legal, and ethical responsibilities do we have to our stakeholders? 5. What should we do to effectively address the stakeholder concerns?

Take-Away Concepts
LO 12-3 Critically evaluate the relationship between corporate social responsibility (CSR) and competitive advantage. A majority of empirical research studies support the notion that firms can do well (financially) by doing good (through CSR).

Some studies, however, found that the relationship is reversed: Superior financial performance allows firms to engage in CSR ( to buy good will).
Although there seems to be a positive relationship between CSR and firm financial performance, it is not entirely clear what causes what. LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms.

Corporate governance is about checks and balances, about asking the tough questions at the right time.
Corporate governance attempts to address the principalagent problem, which describes any situation in which an agent performs activities on behalf of a principal.

Take-Away Concepts
LO 12-4 Describe the role of corporate governance and evaluate different governance mechanisms. The principalagent problem is a core tenet in agency theory, which views the firm as a nexus of legal contracts.

The principalagent problem concerns not only the relationship between owners (shareholders) and managers, but also cascades down the organizational hierarchy.
The risk of opportunism on behalf of agents is exacerbated by information asymmetry: Agents are generally better informed than the principals. The board of directors is the centerpiece of corporate governance. Other important corporate mechanisms are: executive compensation, the market for corporate control, and financial statement auditors, government regulators, and industry analysis.

Take-Away Concepts
LO 12-5 Describe and evaluate the relationship between business strategy and ethics. The ethical pursuit of competitive advantage lays the foundation for long-term superior performance.

Law and ethics are not synonymous; obeying the law is the minimum that society expects of a corporation and its managers.
A managers actions can be completely legal, but ethically questionable.

The following questions can help managers make sound ethical decisions. 1. Does the intended course of action fall within the acceptable norms of professional behavior? 2. Would the manager feel comfortable explaining and defending the decision in public? 3. How would the media report the particular business decision if it became public? 4. How would the companys stakeholders feel about it?

Take-Away Concepts
LO 12-6 Describe the different roles that strategic leaders play and how to become a strategic leader. Strategic leaders play three different roles: interpersonal, informational, and decisional. To become an effective strategic leader, a manager needs to develop a set of skills to move sequentially through five different leadership levels. At Level 5, the executive is able to build enduring greatness for the company through a combination of will power and humility. At that level, ambition is primarily for the organization, rather than for the self.