Corporate governance

Prof. RJ Brual, MBA, COBIT 5MBA106
Corporate Governance
Chapter 3
~Corporate governance is not a matter or right or wrong - 'it is more
nuanced than that~

Topics
• Role of the Board of Directors
• The Role of Top Management
• Trends In Corporate Governance

Role of the Board of Directors
A corporation is a mechanism established to allow different parties
to contribute capital, expertise, and labor for their mutual benefit. The
investor/shareholder participates in the profits of the enterprise without
taking responsibility for the operations. Management runs the company
without being responsible for personally providing the funds.
This means that the corporation is fundamentally governed by the
board of directors overseeing top management, with the concurrence of
the shareholder. The term corporate governance refers to the relationship
among these three groups in determining the direction and performance
of the corporation.

RESPONSIBILITIES OF THE BOARD
Laws and standards defining the responsibilities of boards of
directors vary from country to country. For example, board members in
Ontario, Canada, face more than 100 provincial and federal laws
governing director liability.
The United States, however, has no clear national standards or federal
laws. Specific requirements of directors vary, depending on the state in
which the corporate charter is issued. There is, nevertheless, a developing
worldwide consensus concerning the major responsibilities of a board.
Interviews with 200 directors from eight countries (Canada, France,
Germany, Finland, Switzerland, the Netherlands, the United Kingdom, and
Venezuela) revealed strong agreement.

The following five board of director
responsibilities, listed in order of importance:
• Setting corporate strategy , overall direction, mission, or vision
• Hiring and firing the CEO and top management  
• Controlling, monitoring, or supervising top management  
• Reviewing and approving the use of resources  
• Caring for share holder interests

Role of the Board in Strategic Management
How does a board of directors fulfill these many responsibilities? The role of the board of
directors in strategic management is to carry out three basic tasks:  
• Monitor: By acting through its committees, a board can keep abreast of developments
inside and outside the corporation, bringing to management’s attention
developments it might have overlooked. A board should at the minimum carry out this
task.  
• Evaluate and influence: A board can examine management’s proposals, decisions, and
actions; agree or disagree with them; give advice and offer suggestions; and outline
alternatives. More active boardsperform this task in addition to monitoring.  
• Initiate and determine: A board can delineate a corporation’s mission and specify
strategic options to its management. Only the most active boards take on this task in
addition to the two previousones.

Members of Board of Directors
The boards of most publicly owned corporationsare composed of both inside
and outside directors. Inside directors (sometimes called management directors) are
typically officers or executives employed by the corporation. Outside directors
(sometimes called non-management directors) may be executives of other firms but are
not employees of the board’s corporation. Al- though there is yet no clear evidence
indicating that a high proportion of outsiders on a board results in improved financial
performance, there is a trend in the United States to increase the number of outsiders on
boards and to reduce the total size of the board.
This view is in agreement with agency theory, which states that problems arise in
corporationsbecause the agents (top management) are not willing to bear responsibility
for their decisions unless they own a substantial amount of stock in the corporation.

Those who question the value of having more outside board
members point out that the term outsider is too simplistic because some
outsiders are not truly objective and should be considered more as
insiders than as outsiders. For example, there can be:
• Affiliated directors, who, though not really employed by the corporation,
handle the legal or insurance work for the company or are important
suppliers (thus dependent on the current management for a key part of
their business). These outsiders face a conflict of interest and are not likely
to be objective.  
• Retired executive directors, who used to work for the company, such as the
past CEO who is partly responsible for much of the corporation’s current
strategy and who probably groomed the current CEO as his or her
replacement. In the recent past, many boards of large firms kept the firm’s
recently retired CEO on the board for a year or two after retirement as
Managers of large, modern publicly held corporations are typically not the
owners.

Agency Theory
As suggested in the classic study by Berle and Means, top
managers are, in effect, “hired hands” who may very likely be more
interested in their personal welfare than that of the shareholders. For
example, management might emphasize strategies, such as acquisitions,
that increase the size of the firm (to become more powerful and to
demand increased pay and benefits) or that diversify the firm into
unrelated businesses (to reduce short-term risk and to allow them to put
less effort into a core product line that may be facing difficulty) but that
result in a reduction of dividends and/or stock price.

Stewardship Theory
In contrast, stewardship theory suggests that executives tend to be
more motivated to act in the best interests of the corporation than in their
own self-interests. Whereas agency theory focuses on extrinsic rewards
that serve the lower-level needs, such as pay and security, stewardship
theory focuses on the higher-order needs, such as achievement and self-
actualization. Stewardship theory argues that senior executives over time
tend to view the corporation as an extension of themselves. Rather than
use the firm for their own ends, these executives are most interested in
guaranteeing the continued life and success of the corporation.

Family Directors
Who are descendants of the founder and own significant
blocks of stock (with personal agendas based on a family
relationship with the current CEO). The Schlitz Brewing
Company, for example, was unable to complete its turnaround
strategy with a non-family CEO because family members
serving on the board wanted their money out of the company,
forcing it to be sold

Nomination and Election of Board Members
Traditionally the CEO of a corporation decided whom to
invite to board membership and merely asked the shareholders
for approval in the annual proxy statement. All nominees were
usually elected. There are some dangers, however, in allowing
the CEO free rein in nominating directors. The CEO might select
only board members who, in the CEO’s opinion, will not disturb
the company’s policies and functioning.

Evaluating Governance
To help investors evaluate a firm’s corporate governance, a number of independent
rating services, such as Standard & Poor’s (S&P), Moody’s, Morningstar, The Corporate
Library, Institutional Shareholder Services (ISS), and Governance Metrics International (GMI),
have established criteria for good governance.
The Corporate Library use a wide mix of research data and criteria to evaluate
companies, ISS and GMI have been criticized because they primarily use public records to
score firms, using simple checklists. In contrast, the S&P Corporate Governance Scoring
System researches four major issues:
• Ownership Structure and Influence
• Financial Stakeholder Rights and Relations
• Financial Transparency and Information Disclosure
• Board Structure and Processes

The Role of Top Management
The top management function is usually conducted by the
CEO of the corporation in coordination with the COO (Chief
Operating Officer) or president, executive vice president, and
vice presidents of divisions and functional areas. Even though
strategic management involves everyone in the organization,
the board of directors holds top management primarily
responsible for the strategic management of a firm.

Responsibilities of Top Management
Top management responsibilities, especially those of the
CEO, involve getting things accomplished through and with
others in order to meet the corporate objectives. Top
management’s job is thus multidimensional and is oriented
toward the welfare.

Executive Leadership and Strategic Vision
Executive leadership is the directing of activities toward
the accomplishment of corporate objectives. Executive
leadership is important because it sets the tone for the entire
corporation. A strategic vision is a description of what the
company is capable of becoming. It is often communicated in
the company’s mission and vision statements (as described in
Chapter 1 -2). People in an organization want to have a sense of
mission, but only top management is in the position to specify
and communicate this strategic vision to the general workforce.

They have many of the characteristics of transformational
leaders that is, leaders who provide change and movement in
an organization by providing a vision for that change. For
instance, the positive attitude characterizing many well known
industrial leaders such as Bill Gates at Microsoft, Anita Roddick
at the Body Shop, Richard Branson at Virgin, Steve Jobs at
Apple Computer, Phil Knight at Nike, Bob Lutz at General
Motors, and Louis Gerstner at IBM has energized their
respective corporations. These transformational leaders have
been able to command respect and to influence strategy
formulation and implementation because they tend to have
three key characteristics:

1. The CEO articulates a strategic vision for the corporation:
The CEO envisions the company not as it currently is but as it can
become. The new perspective that the CEO’s vision brings to activities and
conflicts gives renewed meaning to everyone’s work and enables
employees to see beyond the details of their own jobs to the functioning of
the total corporation.
Louis Gerstner proposed a new vision for IBM when he proposed that the
company change its business model from computer hardware to services:
“If customers were going to look to an integrator to help them envision,
design, and build end- to-end solutions, then the companies playing that
role would exert tremendous influence over the full range of technology
decisions from architecture and applications to hardware and software
choices.”

2. The CEO presents a role for others to identify with and to follow:
The leader empathizes with followers and sets an example in terms of
behavior, dress, and actions. The CEO’s attitudes and values concerning
the corporation’s purpose and activities are clear cut and constantly
communicated in words and deeds.
For example, when design engineers at General Motors had problems with
monitor resolution using the Windows operating system, Steve Ballmer,
CEO of Microsoft, personally crawled under conference room tables to
plug in PC monitors and diagnose the problem.

3. The CEO communicates high performance standards and
also shows confidence in the followers’ abilities to meet these
standards:
The leader empowers followers by raising their beliefs in their
own capabilities. No leader ever improved performance by
setting easily attainable goals that provided no challenge.
Communicating high expectations to others can often lead to
high performance.

Managing the Strategic Planning Process
As business corporations adopt more of the
characteristics of the learning organization, strategic planning
initiatives can come from any part of an organization. A survey
of 156 large corporations throughout the world revealed that, in
two-thirds of the firms, strategies were first proposed in the
business units and sent to headquarters for approval.

This staff may prepare the background materials used in senior
management’s off-site strategy workshop. This planning staff
typically consists of fewer than ten people, headed by a senior
executive with the title of Director of Corporate Development or
Chief Strategy Officer.
The staff’s major responsibilities are to:
• Identify and analyze company wide strategic issues, and
suggest corporate strategic alternatives to top management.  
• Work as facilitators with business units to guide them through
the strategic planning process.

Trends in Corporate Governance
The role of the board of directors in the strategic management of a
corporation is likely to be more active in the future. Although neither the
composition of boards nor the board leadership structure has been
consistently linked to firm financial performance, better governance does
lead to higher credit ratings and stock prices. A McKinsey survey reveals
that investors are willing to pay 16% more for a corporation’s stock if it is
known to have good corporate governance.
The investors explained that they would pay more because, in their
opinion (1) good governance leads to better performance over time, (2)
good governance reduces the risk of the company getting into trouble, and
(3) governance is a major strategic issue.

Some of today’s trends in governance (particularly
prevalent in the United States and the United Kingdom)
that are likely to continue include the following:
• Boards are getting more involved not only in reviewing and evaluating company
strategy but also in shaping it.
• Institutional investors, such as pension funds, mutual funds, and insurance companies,
are becoming active on boardsand are putting increasing pressure on top
management to improve corporate performance.
• Shareholders are demanding that directors and top managers own more than token
amounts of stock in the corporation.

Continuation.
• Non-affiliated outside (non-management) directors are increasing their numbers and
power in publicly held corporationsas CEOs loosen their grip on boards.
• Women and minorities are being increasingly represented on boards.  
• Boards are establishing mandatory retirement ages for board members typically
around  age of 70.
• Boards are evaluating not only their own overall performance, but also that of
individual directors.
• Boards are getting smaller—partially because of the reduction in the number of
insiders but also because boards desire new directors to have specialized knowledge
and expertise instead of general experience.

Continuation.
• Boards continue to take more control of board functions by either splitting the combined
Chair/CEO into two separate positions or establishing a lead outside director position.
• Boards are eliminating 1970s anti-takeover defenses that served to entrench current
management.
• As corporations become more global, they are increasingly looking for board members with
international experience.
• Instead of merely being able to vote for or against directors nominated by the board’s
nominating committee, shareholders may eventually be allowed to nominate board
members.
• Society, in the form of special interest groups, increasingly expects boards of directors to
balance the economic goal of profitability with the social needs of society. Issues dealing
with workforce diversity and environmental sustainability are now reaching the board level.

Corporate governance

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