Ch 12: Corporate Governance, Business Ethics, and Business Models
Information Asymmetry, Insider Trading, and on-the-job consumption pt.2 (12-1)
on-the-job consumption: - can be like golf outings, resort retreats, sporting events, or elegant dinners and other entertainments, and other forms are more extreme - Dennis Kozllowski, form CEO of Tyco, used firm funds to furnish his $30M NYC apartment and threw a $2M birthday party for his spouse - During global financial crisis (2008), John Thain, former CEO of Merrill Lynch, spent $1.2M of firm funds on redecorating his office while demanding cost cutting and frugality on his staff
Corporate Governance (12-1)
systems of mechanisms to DIRECT and CONTROL an enterprise that pursues it strat. goals successfully and legally - "checks and balance" - account scandals of early 2000s and global financial crisis of 2008 Ex; Theranos and Elizabeth Holmes - In public trades companies, shareholders own the BUSINESS, but hire managers to run business creating a principal-agent-problem which can occur anytime - Separation of CONTROL and OWNERSHIP is major advantage for stock companies - Conflicts? When agents pursue theory own personal interests - Principals want MAX total returns for their shareholders, but agents may want more like total comp, benefits, job security, status, and power
Apples Service Ecosystem
- After introduction of iPod(2001) and iTunes(2003), Apple was able to extends its CA more than a decade - BM innovation to embed products into services allowed Apple to link music producers to consumers and benefit from those transactions
Bad apples vs bad Barrels (12-5)
- Agency theory, "bad agents" who act opportunistically, principals need to be on guard against bad actors - bad apples and also entire org. can create climate of UNETHICAL + ILLEGAL BEHAVIOR - Researchers found that people work in place where they expect and value ethicaly behavior, they are most likely to do so - Opposite is true as well -Ex; Enron - Sometimes, the bad barrel can spoil the apples! Ex; VW. Some engineers installs on 11M cars, w/o top mgmt. approval. If managers didn't know what was going on, they SHOULD HAVE KNOWN
12.1 Corporate Governance
- Agent Theory - The BOD - Other Govt Mechanisms
Board of Directors (BOD) (12-3) pt.2
- All directors, have a fiduciary responsibility- a legal duty to act soley in another party's interests, toward shareholders because of trust being place in them - BOD meets several times a year to review and evaluate the firms performance and assess its future strat. plans as well as opportunities and threats
Dell's LBO, Transformation, and Re-Listing as Public Company
- An example of LBO - after years of poor performance, they became a takeover target of famed corp. raider Carl Icahn (2013) - Carl decided to buy when Dell was announcing to a LBO - struggle with transition from PC to mobile devices and services - for 4 years, its market capped dropped 80% from $76B to $14B - Dell SH agreed to approve the founders $25B offer to make company private, and avoid a HOSTILE TAKEOVER - Later on Dell acquired EMC, a CC for $60B (2016) - Dell performed a reverse takeover with Dells and VMare swapped to equity shares - With this acquisition, it allowed Dell to re-list his form to public stock exchange 2018 - $36B in summer 2022
3. Disruption
- Apple who used the agency model - Amazon disrupted the wholesale model by offering books (e-books0 well below cost of other retailers - Publishers disliked amazon - Amazon not only devalued printed books but lost money on every book sold - used this to increased users for kindle
1. executive compensation (12-4)
- BOD determines this - grants stock options - is share prices rises, the EXECUTIVE stands to reap significant gains 2 issues for Exec. Compensation: 1. The absolute size of CEO pay package compared with the pay of the avg. employee - ratio of CEO to avg. employee pay in US is about 350 to 1 - Median compensation of CEOS in the S&P 500 was $15M - CEOs with highest compensation are in tech, media, and financial firms 2. The relationship between CEO pay and firm's performance - Survey results show that 2/3 of CEO pay is linked to firms performance - can be positive, the link is weak at best - Some recent experiments in behavioral economics caution that incentives that are too high (ex; outsized bonuses) = may have negative effect on job performance - Loses focus because too much attention to big bonuses - This can increase job stress and negative impact on job performance - Outside bonuses can lead to short-termism- exclusive focus by the CEO just on short term projects and objectives for immediate stock appreciation, at expense of long-term performance Ex; addressing climate change = long-term thinking
Board of Directors (BOD) (12-3) pt.3
- BOD makes sures shareholders interest are pursued - If not pursued, could lead to loss in reputation or be removed from board CEO: - different than BOD - BOD oversees, but CEO reports to BOD and a liaison between company and BOD - CEO is public face of firm/organization - Takes hit or pat on back if company fails or succeeds Role split arguments: - CEO has invaluable information that can help in the board effectively - Benefit to combine CEO + BOD is unity that streamlines speeds the decision-making process and strat. implementation
12.3 Business Model: Strategy in Action
- Business Models Framework - Popular Business Model - Dynamic Nature of Business Models - Business Model Innovation
Theranos: Bad Blood
- Founded by Elizabeth Holmes at age 19 - Founded in 2003 as a medical diagnostic company - Her big invention was a miniturez lab that could run 200 tests from a single drop of blood that's painless unlike drawing vials from veins - Her strat. intent was to focus on consumer-friendly blood tests, more reliable, and more convenient - Take bloods tests at local pharmacy or at home - Believes repeated testing over short intervals would allow detection and prevention of diseases - She was challenging incumbent companies like Quest Dignostics and LabCorp, which uses decades old tech and charges hundreds of dollars on blood tests - Govt have had issues with those comapneis and even filed lawsuit
A management Oath
- Many org. have accepted CoC, but mgmt doesn't - Some believe they should - Like how lawyers and medical doctors can lose right t practice their professions for misconduct Harvard MBA Oath: - role of business in society and responsibilities beyond shareholders - managers 'create value responsibly and ethically' see chart
3. WHO are the main stakeholders performing these activities?
- Microsoft focuses on both individual end consumers and more profit business clients Ex; Azure - Walmart with many employees and revenues, using Azure than AWS. Becuz Amazon is a major competitor to Walmart - Home Depot as well
4. HOW offerings are to the customers designed?
- Microsoft shifts most of resources, like R&D and customer support to CC
8. Bundling
- Sell products/services when demand is NEGATIVE CORERLATED for discount - When customers value one product more than other Ex; Use Word more than Excel - instead selling $120 each, bundle for like $150 - Before bundling, Microsoft was facing competition from Word Perfect, Lotus 1-2-3, and Harvard Graphics
2. Evolution
- The freemium BM can vary with the razor blade BM - Ex; Video game, like MMO, and app-based games, follow this with basic access to game, but charge power-ups, customizations, specialties, and other to enhance gaming experience
5. Legal Conflicts
- The rapid development of BM, leads to producers to breach commerce laws - publishers prompted a ANTITRUST investigation - DOJ found Apple guilty with other major book publishers to fix prices on e-books, which then they change agency model
Business Ethics (12-5) pt.2
- To go above and beyond the acceptable standard, many organizations have explicit CODES OF CONDUCT - Explains how employees to behave and to represent the company in business dealings - CoC overcomes moral hazards and adverse selections Other ways to improve mangers decision making: - When facing ethical dilemma, a Manager can ask if the intended course of actions falls with acceptable norms of professionalism as outline in their CoC organizations - The manager should imagine whether they would feel comfortable explaining and defending the decision to the public Ex; How would media report it and how would other Stakeholders feel
Bad apples vs bad Barrels (12-5) pt/2
- employees takes cues on how to act - so ethical leaders is critical and strat. leaders set the tone for this ethical environment in the business - One reasons HP BOD, removed CEO-Mark Hurd (2010) even w/o proof of illegal behavior or violation of sexual harassment - To avoid ethical behaviors, BOD, must be clear in ethical expectations, and top mgmt. must create a business culture, structure, and control systems that values and encourages desired behavior
Hostile Takeovers and Poison Pills
- if HT is successful, its likely the new owner to replace old mgmt and BOD to create more values for SH - to avoid being takeover, they use poison pill - Ex; allow SH to buy additional shares at a cheap discount. Which makes takeover more expensive for those corp. raiders - its rare to use this, because they hinder the effective function of equity - Ex; battle to control Dell Inc., HT of Cadbury by Kraft, and Elon Musk bought twitter - But corp. control is LAST RESORT because costly like overpaying for acquisitions leading to a WINNER'S CURSE
Applying the BM for Microsoft
- implement this framework through structures, processes, cultures, and procedures (almost like org. design and structure.) - the BMF, guides the strat leaders through process of formulating and implementing the business model by asking questions like WHY, WHAT, WHO, and HOW
Information Asymmetry, Insider Trading, and on-the-job consumption
- insider-training cases provide examples of exploited information asymmetry - Ex; hedge fun, Galleon Group was engulfed of insider scandal that had private data about Goldman, Google, IBM, Intel and P&G - The founder, Raj Rajaratnam was behind this complex information and was sentenced to 11 years in prison and fined more than $150M Ex1: Galleon bought Intel Stock before information went public knowing that demand for Intel processors would be higher than analysts expected Ex2: Rajaratnam got more insider tips from a former chief in Goldmans boards from Gupta. Bought their shares after BOD meeting with injection money from Buffet well before he announced the Invesment Ex3: From Gupta call again, known about bank missing earnings estimates. So Rajaratnam sold its forms holds of Goldman before announcement which saved him a multimillion dollar loss
Theranos: Bad Blood pt.2
- inspired by Steve jobs and wore black like he did, hired former Apple employees, hire same advertising firm, and schedule same day of meetings like he did which was Wednesdays - had great eye contact and didn't blink much - trained herself to have deeper voice to be more confident - convince people like Channing Robertson, senior associate dean in Stanford's School of engineering, to help her startup her company - endorsed by famous venture capitals Tim Draper, who made investments like Tesla, Skype, and Baidu(Chinas google) - Holmes become famous and started to attracted other venture capitalists to invest - 2014, Theranos was valued at $10B - The Edison or mini-labs weren't FDA approved, but still worked around Walgreens - Lab results failed and inaccurate - Later, Holmes realized she needed more blood than jsut a finger prick - she cut corners, leading to unethical behaviors like defrauding patients, healthcare providers, and investors
Waymo, Uber, and The Principal-Agent Problem
- lawsuit between Uber and Waymo - issues of principal-agent problem in employment relationships - Anthony Levandwoski, was accused of setting up his autonomous vehicle company, Otto, while still working at Waymo as the duties to siphon trade secrets and propriety tech from his employer - Uber acquired his startup company, Otto, for about $700M - in 2018, 2 companies settled the lawsuit, when Uber gave Waymo $245M worth of equity as promise that Uber would use Waymo's autonomous vehicle tech - 2019, federal authorities charged Levandwoski, for trade secret - Levandwoski pleaded guitly and sencted to prison for 18months and requires to pay close to $800M to Waymo - Judge commented and said this was the biggest trade secret crime they seen - However, Levandwoski is a groundbreaking engineer that country needs (immigrant from Belgium) and claimed we need people like him so Levandwoski received a FULL PRESIDENTIAL PARDON
2. Subscription
- models used traditionally by zines and newspapers - Pay to access - Microsoft uses this model for Office 365 - Other industries like cable tv, cell service, satellite radio, internet, and health clubs - Netflix is an example
The Long Tail and BMI (12-7)
- pareto principle - long-tail
1. Combination
- phone companies like AT&T and Verizon combine the razor-blade model + subscription model - require customers sign up for lengthy long term - goal to keep churn rate- subscribers who leave, before end of contract- as LOW AS POSSIBLE
7. Agency
- producer relies on agents or retailer to sell its products with % commission - producer sometimes control price - used by entertainment industry when placing artists or artistic properties and take their commission - Apples apps
4. Freemium
- provides basic features free of charge, but charges users for PREM. SERVICES like advance and add-on features - examples like trials to try - The New York Times and WSJ used this model - Free or discounted by placing ads (Facebook, Google Search, and Netflix)
4. Response to Disruption
- publishers responded and worked with Apple as an agency to set prices and received 70% of rev while Apple gets 30% - like other Apple apps - use of agency model gives Publishers to leverage to raise e-book prices for retailers - TO work with Amazon, Publishers withheld new releasees from them, which forced Amazon to sell e-books to $14.95
5. Ultra-low Cost
- similar to freemium - goal is to DRIVE DOWN COSTS - Ex: Spirit Airlines, Ryanair, and AirAsia that have min. flight services but allow customer to pay for add. services and upgrade a la carte, often a premium
2. The market for corporate control (12-4)
- the BOD + executive comp. = INTENRAL corp. govt mechanisms, while the market for corp. control = EXTERNAL - To avoid this, corp. managers protect SH value by using STRONG SHARE-PRICE performance or putting POISON PILLS How market corp. control works: - If a company is poorly managed, its performance suffers and its stock prices falls as more and more investors sell their shares - Hostile takeover: shares fall to a low enough level, that new bidders believe they can fix the internal problems that causing the poor performance - Can be bought like corp. raiders (Carl Icahn and Daniel Loeb) or private-equity firms and hedge funds (The Blackstone Group and Pershing Square Capital Mgmt)
1. Razor-Razor blades
- the product is often sold at a LOSS or GIVEN AWAT to drive demands for the complementary goods - Firm makes money on REPLACEMENT PARTS - invented by Gillette - Used by other firms like HP printers that are cheap, but cartridges are EXPENSIVE
2. WHAT activities to be performed to create and deliver offerings to customers?
- to pivot mobile and cloud business model, Microsoft made huge investments - Redmond, Washing-based firm, rewrite of its software to be functional in cloud - open office suit to competing OS - Microsoft Azure
6. Wholesale
- traditional model for retail - Ex; book publishing - book publishers sell books usually 50% below retailer - But retailer can set prices on any book and profit from difference that they bought from wholesaler
1. WHY does business model (BM) create value?
- under CEO Nadella, Microsoft pivoted Windows desktop to mobile, cloud business model - doesn't sell software licenses - Instead uses CC to provide the SAAS which users would subscribe - Users can access and collaborate and not need to worry to upgrade - Microsoft enjoys steady revenues over time, reducing piracy and balance of cost for ongoing support
3. Pay as you go (like utilities)
- uses per for only the services they CONSUME - widely used by power and water, and cell phone service plans - but now rental cars and CC
pareto principle
80-20 rule. 80% of effects are from 20% of causes - appeal to large sement of mass market
poison pill
Defensive provisions to deter HT by making firm less attractive
Business Model Innovation
Novel and useful way to deliver value to customers - Products/services and BM, are NOT STATIC - BMI, complements product/service innovation and raises barriers to imitation, which in turn allows firms to extend their CA - Ex; Airbnb, Amazon, Apple, Dell, Netflix, Tesla, Iber and others used this ti gain and sustain CA - 54% of Senior Exec. use this than product/process innovation - Becuze product/process innovation are COSTLY, HIGHER RISKS, ad LONGER to implement
Microsoft BM pivot: results?
Revenues: - Before, Microsoft had rev spikes on sales only but nothing after match - They make more money on subscription than software license Security: - Customer before worried about data security - Now, users have latest software, access anywhere, and collaborate online with others - security patches as well Software Piracy: - Before, Microsoft had suffered losses through this - Piracy affects customer too, as cost of piracy by paring for large degree - Now, CC software, because now Micrsoft can monitor how many users (based on IP) - Once suspected piracy, they disable the accounts, becuz against TOS and illegal
CEO/chairperson duality
Situation where the CEO of the public traded company, is also the chairman of the BOD - among the largest 500 public companies in US, 70% have dual CEO-Chair in 2005. Dropped to 50% post global financial crisis Ex; Mary Barra (GM), Arvind Krishna (IBM), Satya Nadella (Microsoft), Peter Zaffino (AIG), and Mark Zuckerberg (Meta).
Business Model (12-6)
Start into action be detailing firms tactics and initiatives to delivers value to their customers + make money. It identifies the firms target market, customer needs, and how firms prod/services meet their needs
Board of Directors (BOD) (12-3)
The centerpiece of corp. governance, composed of inside and outside directors, selected by shareholders - Challenge; shareholders interests MAY NOT BE UNIFORM - Shareholders goals = enterprises long-term viability and profitable growth - Long term viability and growth should allow consistent of dividends and stock appreciation over time - In contrast, hedge funds, want a short-term of stock prices - The BOD consist of Inside and Outside Directors
reverse takeover
an acquisition of a larger private firm bought by a smaller- public firm
stock options
An incentive mechanism to align the interests of SH and managers, by giving a reciept of the rights to buy (not obligated), to buy firms stock at PREDETERMINE PRICE sometime in future
long-tail
BMI when firms obtain a large part of profits by selling smaller units from their unlimited choices - a small number of units from among a very large selection of items - low sales vol per unit - obtain more revenues from LONG TAIL than short head - Why? smaller dollar amount on unlimited selection adds up Ex; Amazon, Netflix, and Spotify
Outside Directors
BOD members who ARE NOT EMPLOYEES of firm, but are senior execs. from other firms or full-time professions - Since interdependence, they are more likely to watch out for shareholders interests
12.2 Strategy and Business Ethics
Bad Apples vs Bad Barrels
Inside Directors
Board members are part of company's senior mgmt team; all appointed by shareholders to provide the board the necessary information pertaining the company's internal workings and performance - part of team like CFO and COO - Need this to MONITOR firm - But with SENIOR EXEC., inside BOD interests aligns with MGMT and the CEO, but not shareholders
Popular business models
1. Razor-Razorblades 2. Subscription 3. Pay as you go 4. Freemium 5. Ultra-low Cost 6. Wholesale 7. Agency 8. Bundling
Additional functions of BOD (7)
1. Select, evaluate, and compensate the CEO. CEO then reports to board. If lose confidence in CEO, the BOD can fire them 2. Oversees firms CEO plan 3. Provide guidance to CEO in the selection, evaluation, and compensation of other senior executives 4. Review, monitor, evaluate, and approve any significant strat. initiatives and corp. actions, like acquisitions 5. Conduct a thorough risk assessment and proposes options to mitigate risk 6. Ensure that firm audited FS are true and accurate 7. Ensure the firms compliance with laws and regulations
Govt mechanisms to overcome agency problems
1. Adverse Selection 2. Moral Hazard
Dynamic (changing) nature of Business Models (5)
1. Combination 2. Evolution 3. Disruption 4. Response to Disruption 5. Legal Conflicts
Other govt. mechanisms to align incentives between principal and agents (12-4)
1. Executive compensation 2. The market for corporate control 3. FS auditors, govt regulators, and industry analysts
Business Ethics (12-5)
Agree code of conduct in business, based on society norms - "behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society." - they business practices differ in different cultures around the world - research found that universal norms can be like FAIRNESS, HONESTY, and RECIPROCITY - LAWS + ETHICS are not synonymous - Obeying the law is only MIN. ACCEPTABLE STANDARD - Loan officer who is incentivize with commissions, persuades consumers to sign up for EXOTIC MORTAGES like ARMS - Legal but unethical
Leverage Buyout (LBO) (part of The market for corporate control)
A single investor or group of investors that BUYS, with the help of borrowed money (leverage against firms assets), the outstanding shares of public trade company in order to take it PRIVATE - Expectations is that private owners will reconstruct the firm and take it public again through IPO - aka private equity - Private companies enjoy benefits like not required to share FS, receive less scrutiny from analysts and have more focuses on LONG-TERM GOAL
Adverse Selection
A situation that happens when information asymmetry increases the likelihood of selecting an INFERIOR ALT. - Ex; is when agents mispresent their ability to perform their job - mostly common during recruiting - This can lead to other employees take advt. of others efforts (Free-rider)
Moral Hazard
A situation when information asymmetry increases the incentive of 1 party to take undue risk or shrink other responsibilities because the costs incur to other party - One example is like an agent knows more information than principal. Which they can risk more or not do responbtilties ask of principal - Other examples; bailing out mortgage obligations or baling out banks - Cost of default = rolled over to society - Or when a biotech employee could decide to work on own project, hoping to start own firm, or work on a project assigned - Addit. the biotech employee maybe using company's laboratory and technicians during company time - However, it can be complex to pinpoint what an employee is actually working on
Agency Theory (12-2)
A theory that views the firms as legal contracts Ex; Employee Contracts - Employees who perform the operational labor are agents on behalf of their managers - They may tell their managers they took longer to complete a project or serve a customer than they actually did - Some employees may be tempted to use information adv. for own self-interests like spend time on TikTok and IG during work hours, watching YouTube for their personal business
