Chapter 12: Corporate Governance and Business Ethics

shareholder capitalism

Shareholders—the providers of the necessary risk capital and the legal owners of public companies—have the most legitimate claim on profits.

global survey of attitudes toward business responsibility

US ranks in the middle

what is a public company?

a company that has issued securities through an IPO and is traded on at least one stock exchange or in the over the counter market

codes of conduct

allow an org to overcome moral hazards and adverse selections as they attempt to resonate with employees' deeper values of justice, fairness, honesty, integrity, and reciprocity

outside directors

board members who are not employees of the firm, but who are frequently senior executives from other firms or full-time professionals

To foster ethical behavior in employees,

boards must be clear in their ethical expectations, and top management must create an organizational structure, culture, and control system that values and encourages desired behavior

A company's formal and informal cultures

must be aligned, and executive behavior must be in sync with the formally stated vision and values -employees will quickly see through any duplicity. Actions by executives speak louder than words in vision statements

agent

performs work, provides time and talent to principal -info asymmetry b/t

board of directors

the centerpiece of corporate governance, composed of inside and outside directors who are elected by the shareholders

Executive Compensation

the topic of executive compensation -- and CEO pay, in particular -- has attracted significant attention in recent years. Two issues: 1. the absolute size of the CEO pay package compared with the pay of the average employee 2. the relationship b/t CEO pay and firm performance

inside directors

-Members who are generally part of the company's senior management team, such as the chief financial officer (CFO) and the chief operating officer (COO). -They are appointed by shareholders to provide the board with necessary information pertaining to the company's internal workings and performance.

Board of Directors Responsibilities

-Strategic Goals and Initiatives -General Strategic Oversight and Guidance -Overall Resource Allocation -Remuneration Review -CEO Selection and Succession -Evaluate Performance -Overall Risk Mitigation

Auditors, Regulators, Analysts (2)

-as part of its disclosure policy, the SEC makes all financial reports filed by public companies available electronically via the EDGAR database -this database contains more than 7 million financial statements, going back several years -industry analysts scrutinize these reports in great detail, trying to identify any financial irregularities and asses firm performance -given recent high-profile oversights in accounting scandals and fraud cases, the SEC has come under pressure to step up its monitoring and enforcement

Auditors, Regulators, Analysts (1)

-auditors, government regulators, and industry analysts serve as additional external-governance mechanisms -all public companies listed on the US stock exchanges must file a number of financial statements with the SEC, a fed regulatory agency whose task it is to oversee stock trading and enforce fed securities laws -to avoid misinterpretation of financial results, all public financial statements must follow generally accepted accounting principles (GAAP) and be audited by certified public accountants

market for corporate control

-consists of activist investors who seek to gain control of an underperforming corporation by buying shares of its stock in the open market. -corporate managers strive to protect shareholder value by delivering strong share-price performance or putting in place poison pills to avoid this

while the board of directors is the central governance piece for a public stock company, several other corporate mechanisms are also used to align incentives b/t principals and agents, including:

-executive compensation -the market for corporate control -financial statement auditors, government regulators, and industry analysts

the manager should imagine whether he or she would feel comfortable explaining and defending the decision in public

-how would the media report the business decision if it were to become public? -how would the company's stakeholders feel about it?

market for corporate control cont.

-if a company is poorly managed, its performance suffers and its stock price falls as more and more investors sell their shares -once shares fall to a low enough level, the firm may become the target of a hostile takeover (as discussed in chp 9)

Auditors, Regulators, Analysts (3)

-industry analysts often buy, hold, or sell recommendations on financial statements filed with the SEC and business news published in the WSJ, Bloomberg Businessweek, Fortune, Forbes, and other business media such as CNBC -researchers have questions the independence of industry analysts and credit-rating agencies that evaluate companies (such as Fitch, Moody's and Standard & Poor's)

market for corporate control cont. again

-last resort bc it comes with sig transaction costs -to succeed in its hostile takeover bid, buyers generally pay a sig premium over the given share price -this often leads to overpaying for the acquisition and subsequent shareholder value destruction -- the so-called winner's curse

Law and Ethics

-law and ethics, however, are not synonymous -this distinction is important and not always understood by the general public -staying within the law is a minimum acceptable standard -a manager's actions can be completely legal, but ethically questionable

business ethics uniformity

-the principles, norms, and standards of business practice differ to some degree in different cultures around the globe -research studies have found that some notions -- such as fairness, honesty, and reciprocity -- are universal norms -as such, many of these values have been codified into law

Absolute Size of Pay Package

-the ratio of CEO to average employee pay in the US is about 300 to 1, up from roughly 40 to 1 in 1980 -based on a 2014 survey of CEOs among 300 large companies with revenues of at least $9 billion, the average salary for a CEO was $14 million

four advantages of public companies

1. Limited liability for investors 2. Transferability of investor ownership 3. Legal personality 4. Separation of legal ownership and management control

The Public Stock Company: Hierarchy of Authority

1. State Charter 2. Shareholders 3. Board of Directors 4. Management 5. Employees

shared value creation framework steps

1. expand the customer base to bring in nonconsumers such as those at the bottom of the pyramid -- the largest but poorest socioeconomic group of the world's population 2. expand traditional internal firm value chains to include more non traditional partners such as nongovernmental orgs (NGOs) 3. focus on creating new regional clusters such as silicon valley in the US, electronic city in bangalore, india, and chilecon valley in santiago, Chile

Leveraged Buyout (LBO)

A single investor or group of investors buys, with the help of borrowed money (leveraged against the company's assets), the outstanding shares of a publicly traded company in order to take it private.

Agency Theory: Moral Hazard

A situation in which information asymmetry increases the incentive of one party to take undue risks or shirk other responsibilities because the costs incur to the other party.

Employee Stock Options

An incentive mechanism to align the interests of shareholders and managers, by giving the recipient the right (but not the obligation) to buy a company's stock at a predetermined price sometime in the future.

Jeffrey Immelt

CEO of GE -"green is green"

Corporate Governance Mechanisms

Play an important part in aligning the interests of principals and agents. They enable closer monitoring and controlling, as well as provide incentives to align interests of principals and agents. -perhaps even more important are the "most internal control mechanisms": business ethics -- a topic we discuss next

Porter argues that executives should not concentrate exclusively on increasing firm profits.

Rather, the strategist should focus on creating shared value, a concept that involves creating economic value for shareholders while also creating social value by addressing society's needs and challenges

When facing an ethical dilemma

a manager can ask whether the intended course of action falls within the acceptable norms of professional behavior as outlined in the org's code of conduct and defined by the profession at large

shared value creation framework

a model proposing that managers have a dual focus on shareholder value creation and value creation for society

Agency Theory: Adverse Selection

a situation that occurs when information asymmetry increases the likelihood of selecting inferior alternatives

Corporate Governance

a system of mechanisms to direct and control an enterprise in order to ensure that it pursues its strategic goals successfully and legally

Agency Theory

a theory that views the firm as a nexus of legal contracts

Pay and Performance

about 2/3 of CEO pay is linked to firm performance -the relationship b/t pay and performance is positive, but the link is weak at best -agency theory would predict a positive link b/t pay and performance (this aligns incentives) -some recent experiments in behavioral economics caution that incentives that are too high-powered (outsized bonuses) may have a negative effect

Business Ethics

business ethics lay the foundation and provide training for "behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society"

poision pill

defensive provisions to deter hostile takeovers by making the target firm less attractive

in 2010, the SEC sued the goldman Sachs and an employee, named Fabrice Tourre, for fraud.

did the bank knowingly mislead investors? -bank argued that it is up to clients to assess risk involved in investments. Public pressure mounted -bank ended up paying 550M to settle the lawsuit, but did not admit wrongdoing -Tourre was convicted of fraud

Principal

hires, monitors and compensates the agent -info asymmetry b/t

ethical pursuit of competitive advantage

lays the foundation for long-term superior performance

to go beyond the minimum acceptable standard codified in law,

many orgs have explicit codes of conduct -these codes go above and beyond the law in detailing how the org expects an employee to behave and to represent the company in business dealings

shared value creation framework

provides guidance to managers about how to reconcile the economic imperative of gaining and sustaining competitive advantage with corporate social responsibility