Gladys C.

Canteros
BSA41

1. Define corporate governance and explain why it is used to monitor and control
managers’strategic decisions.
Corporate governance is the set of mechanisms used to manage the relationship among
stakeholders that is used to determine and control the strategic direction and performance of
organizations. At its core, corporate governance is concerned with identifying ways to ensure that
strategic decisions are made effectively. Corporate governance has been emphasized in recent
years because, as the Opening Case illustrates, corporate governance mechanisms increasingly
affect all stakeholders and the firm's future. Effective corporate governance is also of interest to
nations. Governments want firms operating within their countries to grow and provide
employment, wealth, and satisfaction. This raises standards of living and enhances social cohesion.
Three internal governance mechanisms examined here are (1) ownership concentration, as
represented by types of shareholders and their different incentives to monitor managers, (2) the
board of directors, and (3) executive compensation. The external governance mechanism is the
market for corporate control.

2. Explain why ownership has been largely separated from managerial control in the
modern corporation.
Historically, U.S. firms were managed by the founders/owners and their descendants. In these
cases, corporate ownership and control resided in the same person(s). As firms grew larger,
ownership and control were separated in most large corporations so that control of the firm shifted
to professional managers while ownership was dispersed among unorganized stockholders who
were removed from day-to-day management. These changes created the modern public
corporation, which is based on the efficient separation of ownership and managerial control.
Supporting the separation is a basic legal premise suggesting that the primary objective of a firm’s
activities is to increase the corporation’s profit and thereby the financial gains of the owners (or
shareholders). However, this right also requires that they accept the financial risk of the firm and
its operation.
As shareholders diversify their investments over a number of corporations, their risk declines
(the poor performance or failure of any one firm in which they invest has less overall effect).
Shareholders thus specialize in managing their investment risk while managers focus on decision
making. Without management specialization in decision making and owner specialization in risk
bearing, a firm probably would be limited by the abilities of its owners to manage and make
effective strategic decisions. Therefore, in concept, the separation and specialization of ownership
(risk bearing) and managerial control (decision making) should produce the highest returns.

3. Define an agency relationship and managerial opportunism and describe their strategic
implications.
The separation of owners and managers creates an agency relationship. An agency relationship
exists when a principal hires an agent as a decision-making specialist to perform a service. Some
problems that result from the agency relationship between owners and managers include the
potential for a divergence of interests and a lack of direct control of the firm by shareholders.
Managerial opportunism is the seeking of self-interest with guile. It is both an attitude and a set of
behaviors, which cannot be perfectly predicted from the agent's reputation. Top executives may
make strategic decisions that maximize their personal welfare and minimize their personal risk,
such as excessive product diversification. Decisions such as these prevent the maximization of
shareholder wealth, which is supposed to be the top executives' priority. Although shareholders
implement corporate governance mechanisms to protect themselves from managerial opportunism,
these mechanisms are imperfect. Agency costs include the costs of managerial incentives,
monitoring costs, enforcement costs, and the individual financial losses incurred by principals
(owners of the firm) because governance mechanisms cannot guarantee total compliance by the
agents (managers).

4. Explain how three internal governance mechanisms— ownership concentration, the

board of directors, and executive compensation—are used to monitor and control
managerial decisions.
The three internal corporate governance mechanisms are: ownership concentration, the board
of directors, and executive compensation.
Ownership concentration is based on the number of large-block shareholders and the
percentage of shares they own. With significant ownership percentage, institutional investors, such
as mutual funds and pension funds, are often able to influence top executives' strategic decisions
and actions. Thus, unlike diffuse ownership, which tends to result in relatively weak monitoring
and control of managerial decisions, concentrated ownership produces more active and effective
monitoring of top executives. An increasingly powerful force in corporate America, institutional
owners are actively using their positions of concentrated ownership in individual companies to
force managers and boards of directors to make decisions that maximize a firm's value. These
owners (e.g., CalPERS) have caused poorly performing CEOs to be ousted from the firm.
The board of directors, elected by shareholders, is composed of insiders, related outsiders, and
outsiders. The board of directors is a governance mechanism shareholders expect to run the firm
in such a ways as to maximize shareholder wealth. Outside directors are expected to be more
independent of a firm's top executives than are those who hold top management positions within
the firm. A board with a significant percentage of insiders tends to be weak in monitoring and
controlling management decisions. Boards of directors have been criticized for being ineffective,
and there is a movement to more formally evaluate the performance of boards and their individual
members.
Executive compensation is a highly visible and often criticized governance mechanism. Salary,
bonuses, and long-term incentives such as stock options are intended to reward top executives for
aligning their goals with the interests of shareholders. A firm's board of directors has the
responsibility of determining the degree to which executive compensation succeeds in controlling
managerial behavior. But, it is difficult to evaluate top executives' performance, and so executive
compensation tends to be linked to financial measures which do not necessarily reflect the
effectiveness of the executive's decision on long-term shareholder outcomes. In addition, many
external factors affect the performance of a firm. Moreover, performance incentive plans can be
subject to management manipulation. Consequently, executive compensation is a far-from-perfect
governance mechanism.

5. Discuss the types of compensation executives receive and their effects on strategic
decisions.
 Compensations executives receive are in the form of salary, bonuses, long-term performance
incentives, stock awards, and stock options. Executive compensation, especially long-term
incentive compensation, is complicated.
First, the strategic decisions made by top-level managers are typically complex and nonroutine;
as such, direct supervision of executives is inappropriate for judging the quality of their decisions.
Because of this, there is a tendency to link the compensation of top-level managers to measurable
outcomes such as financial performance.
Second, an executive's decision often affects a firm's financial outcomes over an extended
period of time, making it difficult to assess the effect of current decisions on the corporation's
performance. In fact, strategic decisions are more likely to have long-term, rather than short-term,
effects on a company's strategic outcomes.
Third, a number of other factors affect firm performance. Unpredictable economic, social, or
legal changes make it difficult to discern the effects of strategic decisions. Thus, although
performance-based compensation may provide incentives to managers to make decisions that best
serve shareholders' interests, such compensation plans alone are imperfect in their ability to
monitor and control managers. Although incentive compensation plans may increase firm value in
line with shareholder expectations, they are subject to managerial manipulation. For instance,
annual bonuses may provide incentives to pursue short-run objectives at the expense of the firm's
long-term interests. Supporting this conclusion, some research has found that bonuses based on
annual performance were negatively related to investments in R&D, which may affect the firm's
long-term strategic competitiveness. Although long-term performance-based incentives may
reduce the temptation to underinvest in the short run, they increase executive exposure to risks
associated with uncontrollable events, such as market fluctuations and industry decline. Long-term
incentives may not be highly valued by a manager: thus, firms may have to overcompensate
managers when they use long-term incentives.

6. Describe how the external corporate governance mechanism—the market for corporate
control—acts as a restraint on top-level managers’strategic decisions.
The market for corporate control is an external governance mechanism that becomes active
when a firm’s internal controls fails. The market for corporate control is composed of individuals
and firms that buy ownership positions in (or take over) potentially undervalued corporations so
they can form new divisions in established diversified companies or merge two previously separate
firms. Because they are assumed to be the party responsible for formulating and implementing the
strategy that led to poor performance, the top management team of the acquired company is usually
replaced. Thus, the market for corporate control disciplines managers that are ineffective or act
opportunistically. A firm’s poor performance is an indication that internal governance mechanisms
have failed (that is, their use did not result in managerial decisions that maximized shareholder
value), opening the door to the involvement of the market for corporate control. Indeed, hostile
takeovers are the major activity in the market for corporate control.

7. Discuss the use of corporate governance in international settings, in particular in

Germany and Japan.
Corporate governance structures used in Germany and Japan differ from each other and from
the ones used in the United States. Historically, the U.S. governance structure has focused on
maximizing shareholder value. Banks have been at the center of the German corporate governance
structure, because as lenders, banks become major shareholders in the firms. Shareholders usually
allow the banks to vote their ownership positions, so banks have majority positions in many
German firms. The German system has other unique features. For example, German firms with
more than 2,000 employees are required to have a two-tier board structure, separating the board's
management supervision function from other duties that it would normally perform in the United
States (e.g., nominating new board members). Historically, German executives have not been
dedicated to the maximization of shareholder value, because private shareholders rarely have
major ownership in German firms, nor do larger institutional investors play a significant role.

Attitudes toward corporate governance in Japan are affected by the concepts of

obligation, family, and consensus. Japan continues to follow a bank-based financial and corporate
governance structure compared to the market-based financial and corporate governance structure
in the United States. In addition, Japanese firms belong to keiretsu, groups of firms tied together
by cross-shareholding. In many cases, the main-bank relationship of the firm is part of a keiretsu.
However, the influence of banks in monitoring and controlling managerial behavior and firm
outcomes is beginning to lessen and a minor market for corporate control is emerging.

8. Describe how corporate governance fosters ethical strategic decisions and the importance
of such behaviors on the part of top-level executives.
Governance mechanisms focus on the control of managerial decisions to ensure that the interest
of shareholders, the most important stakeholder, will be served. But shareholders are just one
stakeholder along with product market stakeholders (e.g., customers, suppliers, and host
communities) and organizational stakeholders (e.g., managerial and nonmanagerial employees).
These stakeholders are important as well. Therefore, at least the minimal interests or needs of all
stakeholders must be satisfied through the firm's actions. Otherwise, dissatisfied stakeholders will
withdraw their support from one firm and provide it to another (e.g., employees will exit and seek
another employer, customers seek other vendors, etc.). Some believe that ethically responsible
companies design and use governance mechanisms to ensure that the interests of all stakeholders
are served.
Top-level executives are monitored by the board of directors. All corporate
stakeholders are vulnerable to unethical behaviors by the firm. If the image of the firm is tarnished,
the image of customers, suppliers, shareholders, and board members is also tarnished. Top-level
managers, as the agents who have been hired to make decisions that are in shareholders' best
interests, are ultimately responsible for the development and support of an organizational culture
that allows unethical decisions and behaviors. The board of directors has the power and
responsibility to enforce this expectation. The decisions and actions of a corporation's board of
directors can be an effective deterrent to unethical behaviors. The board has the power to hold top
managers accountable for unethical actions as they can hire and fire these managers. Thus, the
board of directors, which holds a position above the firm's highest-level managers, holds
considerable power over top-level executives and can set and enforce standards for ethical
behaviors within the organization.

9. Define organizational structure and controls and discuss the difference between strategic
and financial controls.
Organizational structure specifies the firm’s formal reporting relationships, procedures,
controls, and authority and decision-making processes. Organizational controls are an important
aspect of structure. Organizational controls guide the use of strategy, indicate how to compare
actual results with expected results, and suggest corrective actions to take when the difference
between actual and expected results is unacceptable. The fewer the differences between actual and
expected outcomes, the more effective are the organization’s controls. It is hard for the company
to successfully exploit its competitive advantages without effective organizational controls.
Properly designed organizational controls provide clear insights regarding behaviors that enhance
firm performance. Firms rely on strategic controls and financial controls as part of their structures
to support use of their strategies.
Strategic controls are largely subjective criteria intended to verify that the firm is using
appropriate strategies for the conditions in the external environment and the company’s
competitive advantages. Thus, strategic controls are concerned with examining the fit between
what the firm might do and what it can do.
Financial controls are largely objective criteria used to measure the firm’s performance against
previously established quantitative standards. Accounting-based measures, such as return on
investment and return on assets, and market-based measures, such as economic value added, are
examples of financial controls.

10. Describe the relationship between strategy and structure. 3. Discuss the functional
structures used to implement business-level strategies.
Strategy and structure have a reciprocal relationship. This relationship highlights the
interconnectedness between strategy formulation and strategy implementation. In general, this
reciprocal relationship finds structure flowing from or following the selection of the firm’s
strategy. Once in place, structure can influence current strategic actions as well as choices about
future strategies. The general nature of the strategy/structure relationship means that changes to
the firm’s strategy create the need to change how the organization completes its work. In the
“structure influences strategy” direction, firms must be vigilant in their efforts to verify that how
their structure calls for work to be completed remains consistent with the implementation
requirements of chosen strategies. Research shows, however, that “strategy has a much more
important influence on structure than the reverse.

Different forms of the functional organizational structure are used to support implementation
of the cost leadership, differentiation, and integrated cost leadership/differentiation strategies. The
differences in these forms are accounted for primarily by different uses of three important
structural characteristics or dimensions—specialization (the type and number of jobs required to
complete work), centralization (the degree to which decision-making authority is retained at higher
managerial levels), and formalization (the degree to which formal rules and procedures govern
work).

11. Explain the use of three versions of the multidivisional (M-form) structure to implement
different diversification strategies.
The firm’s level of diversification is a function of decisions about the number and type of
businesses in which it will compete, as well as how it will manage the businesses. Geared to
managing individual organizational functions, increasing diversification eventually creates
information processing, coordination, and control problems that the functional structure can’t
handle. This requires a shift from a functional structure to a complex multidivisional structure.
The demands created by different levels of diversification require that each strategy be
implemented through a unique organizational structure.
 The three variations of the multidivisional structure that will be discussed from the
perspective of how each is best suited to specific diversification strategies are the: Cooperative
form, Strategic Business Unit (SBU) form, and Competitive form.
The cooperative form structure uses horizontal integration to bring about interdivisional
cooperation. The divisions in the firm using the related-constrained diversification strategy
commonly are formed around products, markets, or both.
The strategic business unit (SBU) structure is most appropriate for the related-linked (mixed
related and unrelated) strategy. A strategic business unit (SBU) structure consists of at least three
levels, with a corporate headquarters at the top, SBU groups at the second level, and divisions
grouped by relatedness within each SBU at the third level.
Unrelated diversified firms should adopt the third variant of the multidivisional structure, the
competitive form of the multidivisional structure, where controls emphasize competition between
separate (usually unrelated) divisions for corporate capital allocations.

12. Discuss the organizational structures used to implement three international strategies.
Forming proper matches between international strategies and organizational structures
intended to support their use facilitates the firm’s efforts to effectively coordinate and control its
global operations.
Although centralization of decision-making authority has been recognized as a means of
achieving coordination (and control) in organizations, some strategies require that local business
units (or divisions) have the flexibility that will enable them to adapt to local market preferences.
This may mean that a decentralized structure will be needed to provide this flexibility.
The multidomestic strategy is a strategy in which strategic and operating decisions are
decentralized to business units in each country to facilitate tailoring of products to each country.
The structure used to implement the multidomestic strategy is the worldwide geographic area
structure, an organizational form in which national interests dominate and that facilitates
managers’ efforts to satisfy local or cultural differences.

13. Define strategic networks and discuss how strategic center firms implement such
networks at the business, corporate and international levels.
A strategic network is a grouping of organizations that has been formed to create value by
participating in an array of cooperative arrangements. It is often a loose federation of partners who
participate in the network’s operations on a flexible basis. A strategic center firm is the one around
which the network’s cooperative relationships revolve.
As coordinator or manager of activities carried out by partners in the strategic network, the
strategic center firm—and other network partners—should note four critical aspects of the strategic
center firm’s functions:
 Strategic Outsourcing
 Development of Competencies
 Technology Management
 Race to Learn (or Managing Learning Processes)

Strategic Outsourcing is one of the strategic center firm’s key functions. In addition to
outsourcing more than other members of the strategic network, the center firm also encourages
member firms to go beyond contracting to solve problems and to initiate competitive actions that
the network can pursue.
 The Competence-related role of the center firm is to build or develop the core competencies of
other network member firms and encourage them to share these with other network partners.

Technology aspects of the center firm’s role include managing the development and sharing
of technology-based ideas among network partners.

Emphasizing the Race to Learn implies that the strategic center firm must encourage positive
rivalry among partner firms that will strengthen each partner’s (as well as the network’s) value
chain. The effectiveness of the center firm is related to how well it learns to manage learning
processes among network partners.