Strategic Control and Corporate Governance Chapter Nine McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives After reading this chapter, you should have a good understanding of: LO1 The value of effective strategic control systems in strategy implementation. LO2 The key difference between “traditional” and “contemporary” control systems. LO3 The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general environments. 9-2

Learning Objectives (cont.) LO4 The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries. LO5 The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of directors. LO6 The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of shareholders from both the United States and international perspectives. 9-3

Strategic Control Strategic control the process of monitoring and correcting a firm’s strategy and performance Informational, behavioral two central aspects of strategic control: 2 (1) informational control, which is the ability to respond effectively to environmental change, and (2) behavioral control, which is the appropriate balance and alignment among a firm’s culture, rewards, and boundaries. 9-4

Ensuring Informational Control Traditional control system strategies are formulated and top management sets goals strategies are implemented performance is measured against the predetermined goal set 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 9-5

Traditional Approach to Strategic Control 9-6

Traditional Approach to Strategic Control Most appropriate when Environment is stable and relatively simple Goals and objectives can be measured with certainty Little need for complex measures of performance 9-7

Contemporary Approach to Strategic Control Contemporary control system Continually monitoring the environments (internal and external) Identifying trends and events that signal the need to revise strategies, goals and objectives 9-8

Contemporary Approach to Strategic Control 9-9

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 9-10

Question Top managers at USA Today meet every Friday to review daily operational reports and year-to-date data. This is an example of  A. Behavioral control B. Informational control C. Strategy formulation D. Strategy implementation Answer: B. Informational control 9-11

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?” 9-12

Informational Control Two key issues Scan and monitor external environment (general and industry) Continuously monitor the internal environment 9-13

Effectiveness of Contemporary Control Systems Focus on constantly changing information that has potential strategic importance. The information is important enough to demand frequent and regular attention from all levels of the organization. The data and information generated are best interpreted and discussed in face-to-face meetings. The control system is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans. 9-14

Behavioral Control Behavioral control is focused on implementation—doing things right Three key control “levers” Culture Rewards Boundaries 9-15

Reasons for an increased emphasis on culture and rewards The competitive environment is increasingly complex and unpredictable, demanding both flexibility and quick response to its challenges. The implicit long-term contract between the organization and its key employees has been eroded. 9-16

Building a Strong and Effective Culture Organizational culture a system of shared values and beliefs that shape a company’s people, organizational structures, and control systems to produce behavioral norms. 9-17

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 9-18

Example: Wal-Mart A lot of Wal-Mart's success was attributed to the strong and pervasive culture at the company, which was developed and nurtured by founder Sam Walton. In over four decades of operation, Wal-Mart managed to retain most of the elements of culture it had when it first started out, as well as the entrepreneurial spirit which often drives startup companies to success. A lot of Wal-Mart's success was attributed to the strong and pervasive culture at the company, which was developed and nurtured by founder Sam Walton. In over four decades of operation, Wal-Mart managed to retain most of the elements of culture it had when it first started out, as well as the entrepreneurial spirit which often drives startup companies to success. The fact that the company's growth rate was often in double digits bears this out. Wal-Mart's culture was characterized by an orientation towards customer service and providing the best value at the lowest prices. http://www.icmrindia.org/casestudies/catalogue/Human%20Resource%20and%20Organization%20Behavior/HROB037.htm 9-19

Sustaining an Effective Culture Effective culture must be Cultivated Encouraged Fertilized Maintaining an effective culture Storytelling Rallies or pep talks by top executives 9-20

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 9-21

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 9-22

Characteristics of Effective Reward and Evaluation Systems 9-23

Setting Boundaries and Constraints Focus efforts on strategic priorities Providing short-term objectives and action plans Specific and measurable Specific time horizon for attainment Achievable, but challenging 9-24

Setting Boundaries and Constraints Improve operational efficiency and effectiveness Minimizing improper and unethical conduct Rule-based controls are most appropriate in organizations with the following characteristics: • Environments are stable and predictable. • Employees are largely unskilled and interchangeable. • Consistency in product and service is critical. • The risk of malfeasance is extremely high 9-25

Question Effective boundaries and constraints:   A. Tend to inhibit efficiency and effectiveness B. Distract employees who are trying to focus on organizational priorities C. Minimize improper and unethical conduct D. Tend to limit organizational growth Answer: C. Minimize improper and unethical conduct 9-26

Organizational Control: Alternative Approaches 9-27

Evolving from Boundaries to Rewards and Culture System of rewards and incentives coupled with a strong culture Hire the right people Training plays a key role Managerial role models are vital Reward systems clearly aligned with organizational goals and objectives 9-28

Role of Corporate Governance the relationship among various participants in determining the direction and performance of corporations. primary participants are the shareholders, the management, and the board of directors.” 9-29

The Modern Corporation A mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. Shareholders (investors) Limited liability Participate in the profits of the enterprise Limited involvement in the company’s affairs Management Run the company Does not personally have to provide the funds Board of directors Elected by shareholders Fiduciary obligation to protect shareholder interests 9-30

Agency Theory Deals with the relationship between Principals – who are owners of the firm (stockholders), and the Agents – who are the people paid by principals to perform a job on their behalf (management) 9-31

Agency Theory: Two Problems The conflicting goals of principals and agents, along with the difficulty of principals to monitor the agents, and The different attitudes and preferences towards risk of principals and agents. 9-32

Governance Mechanisms Board of directors a group that has a fiduciary duty to ensure that the company is run consistently with the long-term interests of the owners, or shareholders, of a corporation and that acts as an intermediary between the shareholders and management. The Business Roundtable, representing the largest U.S. corporations, describes the duties of the board as follows: 1. Select, regularly evaluate, and, if necessary, replace the CEO. Determine management compensation. Review succession planning. 2. Review and, where appropriate, approve the financial objectives, major strategies, and plans of the corporation. 3. Provide advice and counsel to top management. 4. Select and recommend to shareholders for election an appropriate slate of candidates for the board of directors; evaluate board processes and performance. 5. Review the adequacy of the systems to comply with all applicable laws/regulations. 9-33

The New Rules for Directors 9-34

Governance Mechanisms Shareholder activism actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization. 9-35

TIAA-CREF’s Principles on the Role of Stock in Executive Compensation 9-36

External Governance Control Mechanisms methods that ensure that managerial actions lead to shareholder value maximization and do not harm other stakeholder groups and that are outside the control of the corporate governance system. 9-37

External Governance Control Mechanisms Market for corporate control Auditors Banks and analysts Regulatory bodies Media and public activists 9-38

Sarbanes-Oxley Act Auditors Barred from certain types of non-audit work Not allowed to destroy records for five years Lead partners auditing a firm should be changed at least every five years 9-39

Sarbanes-Oxley Act CEOs and CFOs Executives 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 9-40