1. McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. STRATEGIC MANAGEMENT Chapter 9 Strategic Control and Corporate Governance Strategic Management: creating competitive advantages Gregory G. Dess G. T. Lumpkin Marilyn L. Taylor Part 3: Strategic Implementation Part 3: Strategic Implementation

2. 9-2 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives After reading this chapter, you should have a good understanding of: The value of effective strategic control systems in strategy implementation. The key difference between “traditional” and “contemporary” control systems. The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general environments.

3. 9-3 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives After reading this chapter, you should have a good understanding of: The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries. Why there is no “one best way” to design strategic control systems and the important contingent roles of business- and corporate- level strategies.

4. 9-4 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Learning Objectives After reading this chapter, you should have a good understanding of: The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of directors. The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of shareholders.

5. 9-5 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Ensuring Informational Control Traditional control system Based largely on the feedback approach Little or no action taken to revise strategies, goals and objectives until the end of the time period Contemporary control system Continually monitoring the environments (internal and external) Identifying trends and events that signal the need to revise strategies, goals and objectives

6. 9-6 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Traditional Approach to Strategic Control Traditional approach is sequential Strategies are formulated and top management sets goals Strategies are implemented Performance is measured against the predetermined goal set Control is based on a feedback loop from performance measurement to strategy formulation Adapted from Exhibit 9.1 Traditional Approach to Strategic Control

7. 9-7 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Traditional Approach to Strategic Control Process typically involves lengthy time lags, often tied to the annual planning cycle This “single-loop” learning control system simply compares actual performance to a predetermined goal Most appropriate when Environment is stable and relatively simple Goals and objectives can be measured with certainty Little need for complex measures of performance

8. 9-8 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Informational control Behavioral control Contemporary Approach to Strategic Control Relationships between strategy formulation, implementation and control are highly interactive Two different types of control Informational control Behavioral control Adapted from Exhibit 9.2 Contemporary Approach to Strategic Control

9. 9-9 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Contemporary Approach to Strategic Control 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 conditions for success

10. 9-10 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Informational Control Deals with internal environment and external strategic context Key question “Do the organization’s goals and strategies still ‘fit’ within the context of the current strategic environment?” Two key issues Scan and’ monitor external environment (general and industry) Continuously monitor the internal environment

11. 9-11 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Informational Control Traditional approach Understanding of the assumption base is an initial step in the process of strategy formulation Contemporary approach Information control is part of an ongoing process of organizational learning that updates and challenges the assumptions underlying the firm’s strategy

12. 9-12 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Informational Control StrategiesAssumptionsPremisesGoals The Firm’s Continuously Monitor Test Review Contemporary Control System Update and challenge the assumptions

13. 9-13 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Behavioral Control Behavioral control is focused on implementation—doing things right Three key control “levers” Culture Rewards Boundaries

14. 9-14 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Behavioral Control: Balancing Culture, Rewards, and Boundaries Traditional approach Emphasizes comparing outcomes to predetermined strategies and fixed rules Contemporary approach A balance between Culture Rewards boundaries Adapted from Exhibit 9.3 Essential Elements of Strategic Control

15. 9-15 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Characteristics of Effective Contemporary Control Systems Control system must focus on Constantly changing information Information identified by managers as having potential strategic importance Changing information

16. 9-16 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Characteristics of Effective Contemporary Control Systems Information Important enough to demand frequent and regular attention from operating managers at all levels of the organization Changing information Important information

17. 9-17 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Characteristics of Effective Contemporary Control Systems Data and information generated by the control system Interpreted and discussed in face- to-face meetings Superiors Subordinates Peers Changing information Important information Interpretation and discussion of information

18. 9-18 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Characteristics of Effective Contemporary Control Systems Control system is a key catalyst for ongoing debate Underlying data Assumptions Action plans Changing information Important information Interpretation and discussion of information Centrality of control system

19. 9-19 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Building a Strong and Effective 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)

20. 9-20 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Building a Strong and Effective Culture Culture sets implicit boundaries (unwritten standards of acceptable behavior) Dress Ethical matters The way an organization conducts its business Culture acts as a means of reducing monitoring costs The role of culture

21. 9-21 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Building a Strong and Effective Culture Effective culture must be Cultivated Encouraged Fertilized Maintaining an effective culture Storytelling Rallies or pep talks by top executives The role of culture Sustaining an effective culture

22. 9-22 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Motivating with Rewards and Incentives Rewards and incentive systems Powerful means of influencing an organization’s culture Focuses efforts on high-priority tasks Motivates individual and collective task performance Can be an effective motivator and control mechanism

23. 9-23 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Motivating with Rewards and Incentives Potential downside Subcultures may arise in different business units with multiple reward systems May reflect differences among functional areas, products, services and divisions Shared values may emerge in subculture in opposition to patterns of the dominant culture Reward systems may lead to information hoarding, working at cross purposes

24. 9-24 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Motivating with Rewards and Incentives Creating effective reward and incentive programs Objectives are clear, well understood and broadly accepted Rewards are clearly linked to performance and desired behaviors Performance measures are clear and highly visible Feedback is prompt, clear, and unambiguous Compensation “system” is perceived as fair and equitable Structure is flexible; it can adapt to changing circumstances

25. 9-25 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Setting Boundaries and Constraints Focus efforts on strategic priorities Short-term objectives Specific and measurable Specific time horizon for attainment Achievable, but challenging Provide proper direction, but be flexible when faced with need to change Short-term action plans Specific Can be implemented Individual managers held accountable for implementation of action plans

26. 9-26 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Setting Boundaries and Constraints Rule-based controls most appropriate in firms with the following characteristics Stable and predictable environments Largely unskilled and interchangeable employees Consistency in product and service is critical Risk of malfeasance is extremely high Guidelines Can set spending limits and range of discretion Can specify proper relationships with customers and suppliers

27. 9-27 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Organizational Control: Alternative Approaches Culture: a system of unwritten rules that forms an internalized influence over behavior. ApproachSome Situational Factors Adapted from Exhibit 9.5 Organizational Control: Alternative Approaches Often found in professional organizations Associated with high autonomy Norms are the basis for behavior Rules: Written and explicit guidelines that provide external constraints on behavior. Associated with standardized output Tasks are generally repetitive and routine Little need for innovation or creative activity

28. 9-28 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Organizational Control: Alternative Approaches Rewards: The use of performance-based incentive systems to motivate. ApproachSome Situational Factors Measurement of output and performance is rather straightforward Most appropriate in organizations pursuing unrelated diversification strategies Rewards may be used to reinforce other means of control Adapted from Exhibit 9.5 Organizational Control: Alternative Approaches

29. 9-29 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Evolving from Boundaries to Rewards and Culture Organizations should strive to have boundaries internalized System of rewards and incentives coupled with a strong culture Hire the right people (already identify with the firm’s dominant values) Train people in the dominant cultural values Have managerial role models Reward systems clearly aligned with organizational goals and objectives

30. 9-30 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Business-Level Strategy and Strategic Control: Firms competing on the basis of cost must implement Tight cost controls Frequent and comprehensive reports to monitor costs associated with outputs Highly structured tasks and responsibilities Incentives based on explicit financial targets, rather than innovation and creativity Overall Cost Leadership

31. 9-31 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Business-Level Strategy and Strategic Control: Firms competing on the basis of differentiation must implement Employ experts who can identify crucial elements of intricate, creative designs and marketing decisions Support for collaboration and cooperation among specialists and functional managers Behavioral performance measures and intangible incentives and rewards Differentiation

32. 9-32 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Corporate-Level Strategy and Strategic Control Key issue is the need for independence versus interdependence Cost strategies and unrelated diversification Less need for interdependence Reward and control systems focus more on financial indicators Differentiation or related diversification Intense need for tight interdependencies among functional areas and business units Sharing of resources is critical Synergies are more important than cost leadership Heavy use of behavioral performance indicators

33. 9-33 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Relationships Between Control and Business- Level and Corporate-Level Strategies Business-levelOverall cost leadershipLowFinancial Business-levelDifferentiationHighBehavioral Corporate-levelRelated diversificationHighBehavioral Corporate-levelUnrelated diversificationLowFinancial Primary Type Level of Types of Need forof Rewards StrategyStrategyInterdependenceand Controls Adapted from Exhibit 9.6 Summary of Relationships between Control and Business-Level and Corporate-Level Strategies

34. 9-34 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Management (led by CEO) Role of Corporate Governance Corporate governance Relationship among The shareholders The management (led by the Chief Executive Officer) The board of directors Management (led by CEO) Issue is How corporation s can succeed (or fail) in aligning managerial motives with the interests of the shareholders The interests of the board of directors Shareholders Board of Directors

35. 9-35 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Separation of Owners (Shareholders) and Management Shareholders (investors) Limited liability Participate in the profits of the enterprise Limited involvement in the company’s affairs Management (led by CEO) Shareholders Management Run the company Does not personally have to provide the funds

36. 9-36 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Separation of Owners (Shareholders) and Management Board of directors Elected by shareholders Fiduciary obligation to protect shareholder interests Management (led by CEO) Shareholders Board of Directors

37. 9-37 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Agency Theory: Two Problems Goals of principals and agents may conflict Difficulty or expensive for the principal to verify what the agent is actually doing Hard for board of directors to confirm that managers are actually acting in shareholders interests Managers may opportunistically pursue their own interests Principal and agent may have different attitudes and preferences toward risk

38. 9-38 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Governance Mechanisms: Aligning the Interests of Owners and Managers Two primary means of monitoring behavior of managers Committed and involved board of directors Active, critical participants in setting strategies Evaluate managers against high performance standards Take control of succession process Director independence Shareholder activism Right to sell stock Right to vote the proxy Right to sue for damages if directors or managers fail to meet their obligations Right to information from the company Residual rights following company’s liquidation

39. 9-39 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Governance Mechanisms: Aligning the Interests of Owners and Managers Managerial incentives (contract-based outcomes) Reward and compensation agreements (from TIAA- CREF) Align rewards of all employees (including rank and file as well as executives) to the long-term performance of the corporation Allow creation of executive wealth that is reasonable in view of the creation of shareholder wealth Measurable and predictable outcomes that are directly linked to the company’s performance Market oriented Easy to understand by investors and employees Fully disclosed to investing public and approved by shareholders

40. 9-40 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. External Governance Control Mechanisms Market for corporate control Auditors Banks and analysts Regulatory bodies (Sarbanes-Oxley Act in 2002) Media and public activists

41. 9-41 Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved. Major Provisions of Sarbanes-Oxley Act Auditors Barred from certain types of nonaudit work Not allowed to destroy records for five years Lead partners auditing a firm should be changed at least every five years CEOs and CFOs Must fully reveal off-balance sheet finances Vouch for the accuracy of information revealed Executives Must promptly reveal the sale of shares in firms they manage Are not allowed to sell shares when other employees cannot