Understanding Strategic

Management
Corporate Governance
Definitions

1. The way in which organizations are directed and
controlled Cadbury (1992)

2. The process by which corporations are made
responsive to the rights and wishes of stakeholders
Demb and Neubauer (1992)
The Growth of Modern Corporations

Limited liability of investors

Free transferability of investor interest

Legal personality

Centralised management
Corporate Governance
The Purpose of Corporations

Maximize Shareholder Value

In a free enterprise, private property system, a corporate executive
is an employee of the owners of the business. He has direct
responsibility to his employers. That responsibility is to conduct the
business in accordance with their desires, which generally will be to
make as much money as possible
(Friedman, 1970, p.1)
Corporate Governance
The Agency Problem

The agency problem arises because of the separation between
ownership of an organization and its control

It is inherent in the relationship between the providers of capital, referred
to as the principal, and those who employ that capital, referred to as the
agent.

The directors of such companies however being the managers rather of
other peoples money than of their own, it cannot well be expected that they
should watch over it with the same anxious vigilance which the partners in
private copartnery frequently watch over their ownNegligence and
profusion, therefore, must always prevail.
(Adam Smith, The Wealth of Nations)
Corporate Governance
The Agency Problem

This agency relationship, however, can give rise to a number of
agency problems

These occur because no contract, however precisely drawn, can
possible take account of every conceivable action that an agent
may engage in

How do you ensure that the agent will always act in the best
interest of the principal?

Agency costs occur where there is a divergence between these
interests
Jensen and Meckling (1976)
Corporate Governance
The Purpose of Corporations

To Meet the Needs of Stakeholders

Stakeholders are those individuals or groups that affect or are affected by
the achievement of an organizations objectives. Freeman, R.E. (1984)

Customers

Suppliers

Employees

Government

The local community

Shareholders
Corporate Governance

Corporate Governance
Corporate Governance Codes (UK)

Cadbury Report (1992)

Greenbury Report (1995)

Hampel Report (1998)

Higgs Report (2003)

Specialist reviews such as (DTI, 1996, HMT, 2001)
into institutional investment

Company Law Review (DTI, 2001)
Corporate Governance
Corporate Governance Codes (USA)

The Sarbanes-Oxley Act (2002)

Recommendations include:

Chief executives now have to attest personally for the accuracy of
company accounts

A higher standard for board members who sit on the audit committee

The prevention of loans to executives

Further criminal and civil penalties for securities violations
Corporate Governance
Excessive Executive Pay

The issue is not one of high salaries per se but the difference
between fair and excessive compensation

Institutional investors are more vocal about compensation for
poor performance and the setting of easy bonus targets

In 2003, shareholders voted against the pay package of Jean-
Pierre Garnier, boss of GlaxoSmithKline because it would
reward him handsomely even if he were to fail

Corporate Governance
Excessive Executive Pay

In 2006, the board of the US retailer Home Depot launched a
review of its executive compensation package following criticisms
of the pay awarded to its CEO, Bob Nardelli

He received over $124 million in less than six years

Over the same period Home Depots share price fell 15 percent

The board of Home Depot were content to award these sums
because they said the CEO met the targets set for him
Corporate Governance
Corporate Governance Reform

In evaluating different corporate governance models Kakabadse and
Kakabadse (2001) argue that the pursuit of shareholders interests leads
to ever widening social inequalities.

They suggest instead that:

the governance debate needs to be pursued more at the
societal/political level, rather than the enterprise level, as burning
issues surrounding governance are ones of social inequality and not of
transparency in reporting economic performance for the purpose of
greater enterprise economic gain.

(Kakabadse and Kakabadse, 2001, p.xiv)

They argue that building and promoting positive community values in
conjunction with the creation of wealth is the prime governance challenge
in an age of globalization.
Corporate Governance