MGMT 485W Test 2 essay
Describe how an acquisition program can result in managerial time and energy absorption.
Typically, a considerable amount of managerial time and energy is required for acquisition strategies to be used successfully. Activities with which managers become involved include: searching for viable acquisition candidates, completing effective due-diligence processes, preparing for negotiations, and managing the integration process after completing the acquisition. Company experiences show that participating in and overseeing the activities required for making acquisitions can divert managerial attention from other matters that are necessary for long-term competitive success, such as identifying and taking advantage of other opportunities and interacting with important external stakeholders.
There are several unique reasons firms choose to use an acquisition strategy.
1. Increased market power. Market power exists when a firm is able to sell its goods or services above competitive levels or when the costs of its primary or support activities are lower than those of its competitors. Market power usually is derived from the size of the firm, the quality of the resources it uses to compete, and its share of the market(s) in which it competes. Firms use horizontal, vertical, and related types of acquisitions to increase their market power. 2. Overcoming entry barriers. Firms can gain immediate access to a market by purchasing a firm with an established product that has consumer loyalty. Acquiring firms can also overcome economies of scale entry barriers through buying a firm that has already successfully achieved economies of scale. In addition, acquisitions can often overcome barriers to entry into international markets. 3. Cost of new product development and increasing speed to market. Developing new products and ventures internally can be very costly and time consuming without any guarantee of success. Acquiring firms with products new to the acquiring firm avoids the risk and cost of internal innovation. In addition, acquisitions provide more predictable returns on investments than internal new product development. Acquisitions are a much quicker path than internal development to enter a new market, and they are a means of gaining new capabilities for the acquiring firm. 4. Lower risk compared to developing new products. Acquisitions are a means to avoid internal ventures (and R&D investments), which many managers perceive to be highly risky. However, substituting acquisitions for innovation may leave the acquiring firm without the skills to innovate internally. 5. Increased diversification. Firms can diversify their portfolio of business through acquiring other firms. It is easier and quicker to buy firms with different product lines than to develop new product lines independently. 6. Reshaping the firm's competitive scope. Firms can move more easily into new markets as a way to decrease their dependence on a market or product line that has high levels of competition. 7. Learning and developing new capabilities. By gaining access to new knowledge, acquisitions can help companies gain capabilities and technologies they do not possess. Acquisitions can reduce inertia and help a firm remain agile.
Acquisition strategies present many potential problems.
1. Integration difficulties. It may be difficult to effectively integrate the acquiring and acquired firms due to differences in corporate culture, financial and control systems, management styles, and status of executives in the combined firms. Turnover of key personnel from the acquired firm is particularly negative. 2. Inadequate evaluation of target. Due diligence assesses where, when, and how management can drive real performance gains through an acquisition. Acquirers that fail to perform effective due diligence are likely to pay too much for the target firm. 3. Large or extraordinary debt. Acquiring firms frequently incur high debt to finance the acquisition. High debt may prevent the investment in activities such as research and development, training of employees, and marketing that are required for long-term success. High debt also increases the risk of bankruptcy and can lead to downgrading of the firm's credit rating. 4. Inability to achieve synergy. Private synergy occurs when the acquiring and target firms' assets are complementary in unique ways, making this synergy difficult for rivals to understand and imitate. Private synergy is difficult to create. Transaction costs are incurred when firms seek private synergy through acquisitions. Direct transaction costs include legal fees and investment banker charges. Indirect transaction costs include managerial time to evaluate target firms, time to complete negotiations, and the loss of key managers and employees following an acquisition. Firms often underestimate the indirect transaction costs of an acquisition. 5. Too much diversification. A high level of diversification can have a negative effect on the firm's long-term performance. For example, the scope created by additional amounts of diversification often causes managers to rely on financial controls rather than strategic controls to evaluate business units' performance. The focus on financial controls creates a short-term outlook among managers and they forego long-term investments. Additionally, acquisitions can become a substitute for innovation, which can be negative in the long run. 6. Managers overly focused on acquisitions. Firms that become heavily involved in acquisition activity often create an internal environment in which managers devote increasing amounts of their time and energy to analyzing and completing additional acquisitions. This detracts from other important activities, such as identifying and taking advantage of other opportunities and interacting with importance external stakeholders. Moreover, during an acquisition, the managers of the target firm are hesitant to make decisions with long-term consequences until the negotiations are completed. 7. Too large. Acquisitions may lead to a combined firm that is too large, requiring extensive use of bureaucratic controls. This leads to rigidity and lack of innovation and can negatively affect performance. Very large size may exceed the efficiencies gained from economies of scale and the benefits of the additional market power that comes with size.
Differentiate between corporate- and business-level strategies and give examples of each.
A business-level strategy determines how a firm will compete in a single industry or product market. When a firm diversifies beyond a single industry, it uses a corporate-level strategy. A diversified company has two levels of strategy: business-level and corporate-level. Each business unit has a business-level strategy. The corporate strategy is concerned with: (1) what businesses the firm should be in and (2) how the corporate office should manage the group of businesses. The top management of diversified companies views the firm's businesses as a portfolio of core competencies that will generate above-average returns by creating value. An example of a business-level strategy would be whether the firm targets the mass market and competes on price, or whether it competes on the basis of uniqueness. An example of a corporate-level strategy would be whether the firm should sell off a poorly performing subsidiary.
Identify the competitive risks associated with cooperative strategies.
Cooperative strategies are not risk-free strategy choices; as many as 50 percent fail. If a contract is not developed appropriately and fails to avert opportunistic behavior, or if a potential partner firm misrepresents its competencies or fails to make available promised complementary resources, failure is likely. Furthermore, a firm may make investments that are specific to the alliance while the partner does not. This puts the investing firm at a disadvantage in terms of return on investment. The core of many failures is the lack of trustworthiness of the partner(s) who act opportunistically.
Why are cooperative strategies often used when firms pursue international strategies? What are the advantages and disadvantages of international cooperative strategies?
A cross-border strategic alliance is a strategy in which firms with headquarters in different countries decide to combine some of their resources to create a competitive advantage. The typical reasons follow: (1) In general, multinational firms outperform firms operating only on a domestic basis. Firms may be able to leverage core competencies developed domestically in other countries. (2) Limited domestic growth opportunities push firms into international expansion. (3) Some governments require local ownership in order for foreign firms to invest in businesses in their countries, which requires foreign firms to ally with local firms. (4) Local partners often have significantly more information about factors contributing to competitive success such as local markets, sources of capital, legal procedures, and politics, which makes an alliance useful for a foreign firm. (5) Cross-border alliances can help firms transform themselves or better use their competitive advantages surfacing in the global economy. On the negative side, cross-border alliances are more complex and risky than domestic strategic alliances.
Identify the three types of corporate-level cooperative strategies.
A diversifying strategic alliance is a strategy in which firms share some of their resources to engage in product and/or geographic diversification. A synergistic strategic alliance is a strategy in which firms share some of their resources to create economies of scope. These alliances create synergy across multiple functions or multiple businesses between partner firms. Franchising is a strategy in which the franchisor uses a contractual relationship to describe and control the sharing of its resources with franchisees. A franchise is a contract between two independent organizations whereby the franchisor grants the right to the franchisee to sell the franchisor's product or do business under its trademarks in a given location for a specified period of time.
Identify and define the two different types of network cooperative strategies.
A network cooperative strategy is a strategy where several firms agree to form multiple partnerships to achieve shared objectives. Stable alliance networks (primarily found in mature industries) usually involve exploitation of economies of scale or scope. In this type of network, the firms try to extend their competitive advantages to other settings while continuing to profit from operations in their core industries. Dynamic alliance networks (witnessed mainly in rapidly changing industries) are used to help a firm keep up when technologies shift rapidly by stimulating product innovation and successful market entries. Dynamic alliance networks explore new ideas and typically generate frequent product innovations with short product life cycles.
What are the managerial motives to diversify, even if that diversification is value-reducing?
A top-level manager may be motivated to pursue diversification because diversification leads to greater job security for executives. In general, greater amounts of diversification reduce managerial risk because if a particular business fails, the top executive remains employed by the corporation. In addition, diversification increases firm size, and firm size has a direct effect on executive compensation. Moreover, managing a highly diversified firm is more difficult; thus, managerial compensation is generally higher in such a firm. Consequently, executives may have selfish motives to diversify the company in ways that may actually reduce corporate competitiveness
What are the attributes of a successful acquisition program?
Acquisitions can contribute to a firm's competitiveness if they have the following attributes: 1. The acquired firm has assets or resources that are complementary to the acquiring firm's core business. 2. The acquisition is friendly. 3. The acquiring firm conducts effective due diligence to select target firms and evaluate the target firm's health (financial, cultural, and human resources). 4. The acquiring firm has financial slack (cash or a favorable debt position). 5. The merged firm maintains low to moderate debt position. 6. The acquiring firm has a sustained and consistent emphasis on R&D and innovation. 7. The acquiring firm manages change well and is flexible and adaptable.
What is corporate governance, and how is it used to monitor and control managers' decisions?
Corporate governance is the relationship among stakeholders that is used to determine and control the firm's strategic direction and its performance. Effective governance that aligns top-level managers' interests with shareholders' interests can produce a competitive advantage for the firm. Corporate governance includes oversight in areas where there are conflicts of interest among major stakeholders, including the election of directors, supervision of CEO pay, and the organization's overall structure and strategic direction. Three internal governance mechanisms (ownership concentration, the board of directors, and executive compensation) and an external mechanism (the market for corporate control) are used in U.S. corporations. Unfortunately, corporate governance mechanisms are not always successful
Briefly compare and contrast corporate governance in the United States, Germany, Japan, and China.
Corporate governance structures used in Germany and Japan differ from each other and from the ones used in the United States. Historically, the U.S. governance structure has focused on maximizing shareholder value. Banks have been at the center of the German corporate governance structure, because as lenders, banks become major shareholders in the firms. Shareholders usually allow the banks to vote their ownership positions, so banks have majority positions in many German firms. The German system has other unique features. For example, German firms with more than 2,000 employees are required to have a two-tier board structure, separating the board's management supervision function from other duties that it would normally perform in the United States (e.g., nominating new board members). Historically, German executives have not been dedicated to the maximization of shareholder value, because private shareholders rarely have major ownership in German firms, nor do larger institutional investors play a significant role. Attitudes toward corporate governance in Japan are affected by the concepts of obligation, family, and consensus. Japan continues to follow a bank-based financial and corporate governance structure compared to the market-based financial and corporate governance structure in the United States. In addition, Japanese firms belong to keiretsu, groups of firms tied together by cross-shareholding. In many cases, the main-bank relationship of the firm is part of a keiretsu. However, the influence of banks in monitoring and controlling managerial behavior and firm outcomes is beginning to lessen and a minor market for corporate control is emerging. Chinese corporate governance has become stronger in recent years. There has been a decline in equity held in state-owned enterprises, but the state still dominates the strategies employed by most firms. Firms with higher state ownership tend to have lower market value and more volatility in those values over time. In a broad sense, the Chinese governance system has been moving toward the Western model in recent years. For example, YCT International recently announced that it was strengthening its corporate governance with the establishment of an audit committee within its board of directors and appointing three new independent directors. In addition, recent research shows that the compensation of top executives in Chinese companies is closely related to prior and current financial performance of the firm.
What are the differences between downscoping and downsizing, and why is each used?
Downsizing is a reduction in the number of a firm's employees. It may or may not change the composition of businesses in the company's portfolio. In contrast, the goal of downscoping is to reduce the firm's level of diversification. Downsizing is often used when the acquiring form paid too high a premium to acquire the target firm or where the acquisition created a situation in which the newly formed firm had duplicate organizational functions such as sales or manufacturing. Downscoping is accomplished by divesting unrelated businesses. Downscoping is used to make the firm less diversified and allow its top-level managers to focus on a few core businesses. A firm that downscopes often also downsizes at the same time.
What are the results of the three forms of restructuring?
Downsizing usually does not lead to higher firm performance. The stock markets tend to evaluate downsizing negatively, as investors assume downsizing is a result of problems within the firm. In addition, the laid-off employees represent a significant loss of knowledge to the firm, making it less competitive. The main positive outcome of downsizing is accidental, since many laid-off employees become entrepreneurs, starting up new businesses. In contrast, downscoping generally improves firm performance through reducing debt costs and concentrating on the firm's core businesses. LBOs have mixed outcomes. The resulting large debt increases the financial risk and may end in bankruptcy. The managers of the bought-out firm often have a short-term and risk-averse focus because the acquiring firm intends to sell it within five to eight years. This prevents investment in R&D and other actions that would improve the firm's core competence. But, if the firms have an entrepreneurial mindset, buyouts can lead to greater innovation if the debt load is not too large.
How difficult is it for merger and acquisition strategies to create value, and which firms benefit the most from M&A activity?
Evidence suggests that using merger and acquisition strategies to create value is challenging. This is particularly true for acquiring firms in that some research results indicate that shareholders of acquired firms often earn above-average returns from acquisitions, while shareholders of the acquiring firms typically earn returns that are close to zero. In addition, in approximately two-thirds of all acquisitions, the acquiring firm's stock price falls immediately after the intended transaction is announced. This negative response reflects investors' skepticism about the likelihood that the acquirer will be able to achieve the synergies required to justify the premium to purchase the target firm.
Explain why executive compensation is or is not effective as an internal governance mechanism.
Executive compensation, especially long-term incentive compensation, is complicated. First, the strategic decisions made by top-level managers are typically complex and nonroutine; as such, direct supervision of executives is inappropriate for judging the quality of their decisions. Because of this, there is a tendency to link the compensation of top-level managers to measurable outcomes such as financial performance. Second, an executive's decision often affects a firm's financial outcomes over an extended period of time, making it difficult to assess the effect of current decisions on the corporation's performance. In fact, strategic decisions are more likely to have long-term, rather than short-term, effects on a company's strategic outcomes. Third, a number of other factors affect a firm's performance. Unpredictable economic, social, or legal changes make it difficult to discern the effects of strategic decisions. Thus, although performance-based compensation may provide incentives to managers to make decisions that best serve shareholders' interests, such compensation plans alone are imperfect in their ability to monitor and control managers. Although incentive compensation plans may increase firm value in line with shareholder expectations, they are subject to managerial manipulation. For instance, annual bonuses may provide incentives to pursue short-run objectives at the expense of the firm's long-term interests. Supporting this conclusion, some research has found that bonuses based on annual performance were negatively related to investments in R&D, which may affect the firm's long-term strategic competitiveness. Although longterm performance-based incentives may reduce the temptation to underinvest in the short run, they increase executive exposure to risks associated with uncontrollable events, such as market fluctuations and industry decline. Long-term incentives may not be highly valued by a manager; thus, firms may have to overcompensate managers when they use long-term incentives.
Describe the primary reasons a firm pursues increased diversification
Firms typically diversify to increase their value by improving their overall performance. Value is created either through related diversification or through unrelated diversification when the strategy allows a company's businesses to increase revenues or reduce costs while implementing their business-level strategies. Alternatively, a firm may diversify to gain market power over competitors. Value-neutral diversification may occur in response to governmental policies, firm performance problems, or uncertainties about future cash flows. Finally, managers may have selfish motives to diversify, such as increased compensation or personal reduced employment risk. These selfish motivations may actually erode the firm's competitiveness and can be value-reducing diversifications.
How does corporate governance foster ethical strategic decisions, and how important is this to top-level executives?
Governance mechanisms focus on the control of managerial decisions to ensure that the interest of shareholders, the most important stakeholder, will be served. But shareholders are just one stakeholder along with product market stakeholders (e.g., customers, suppliers, and host communities) and organizational stakeholders (e.g., managerial and nonmanagerial employees). These stakeholders are important as well. Therefore, at least the minimal interests or needs of all stakeholders must be satisfied through the firm's actions. Otherwise, dissatisfied stakeholders will withdraw their support from one firm and provide it to another (e.g., employees will exit and seek another employer, customers seek other vendors, etc.). Some believe that ethically responsible companies design and use governance mechanisms to ensure that the interests of all stakeholders are served. Top-level executives are monitored by the board of directors. All corporate stakeholders are vulnerable to unethical behaviors by the firm. If the image of the firm is tarnished, the image of customers, suppliers, shareholders, and board members is also tarnished. Top-level managers, as the agents who have been hired to make decisions that are in shareholders' best interests, are ultimately responsible for the development and support of an organizational culture that allows unethical decisions and behaviors. The board of directors has the power and responsibility to enforce this expectation. The decisions and actions of a corporation's board of directors can be an effective deterrent to unethical behaviors. The board has the power to hold top managers accountable for unethical actions as they can hire and fire these managers. Thus, the board of directors, which holds a position above the firm's highest-level managers, holds considerable power over top-level executives and can set and enforce standards for ethical behaviors within the organization.
What is the effect of a firm's low performance on the pursuit of diversification?
High corporate performance eliminates the need for diversification. Some research shows that low returns are related to greater levels of diversification. Firms plagued by poor performance often diversify in an effort to become more profitable. But, continued poor performance following diversification may slow the pace of diversification and may lead to divestitures and a focus on the core business. In addition, firms that are more broadly diversified compared to their competitors may have lower overall performance. The related constrained diversification strategy is the highest performing strategy. So poor performing firms that intend to diversify should look at purchasing businesses that would be suitable for this strategy rather than moving into unrelated diversification or retaining a dominant-business strategy.
Explain which type of cooperative strategy a firm might want to use based upon the type of basic market situations (i.e., slow, standard, and fast cycles) in which it operates.
In slow-cycle markets (markets that are near-monopolies), firms cooperate with others to gain entry into restricted markets or to establish franchises in new markets. Slow-cycle markets are rare and diminishing. Cooperative strategies can help firms in (presently) slow-cycle markets make the transition from this relatively sheltered existence to a more competitive environment. In standard-cycle markets (which are often large and oriented toward economies of scale), firms try to gain access to partners with complementary resources and capabilities. Through the alliance, the firms try to increase economies of scale and market power. In fast-cycle markets (characterized by instability, unpredictability, and complexity), sustained competitive advantages are rare, so firms must constantly seek new sources of competitive advantage. In fast-cycle markets, alliances between firms with excess resources and capabilities and firms with promising capabilities who lack resources help both firms to rapidly enter new markets.
What is an LBO, and what have been the results of such activities?
Leveraged buyouts (LBOs) are a restructuring strategy. Through a leveraged buyout, a (publicly traded) firm is purchased so that it can be taken private. In this manner, the company's stock is no longer publicly traded. LBOs usually are financed largely through debt, and the new owners usually sell off a number of assets. There are three types of LBOs: management buyouts (MBOs), employee buyouts (EBOs), and whole-firm buyouts. Because they provide managerial incentives, MBOs have been the most successful of the three leveraged buyout types. MBOs tend to result in downscoping, an increased strategic focus, and improved performance.
Discuss the effect of the separation of ownership and control in the modern corporation
Ownership is typically separated from control in large U.S. corporations. Owners (principals) hire managers (agents) to make decisions that maximize the value of their firm. As risk specialists, owners diversify their risk by investing in an array of corporations. As decision-making specialists, top executives are expected by owners to make decisions that will result in earning above-average returns for which they are compensated. Thus, the typical corporation is characterized by an agency relationship that is created when one party (the firm's owners) hires and pays another party (top executives) to use decision-making skills. Since owners may not possess the specialized skill to run a large company, delegating these tasks to managers should produce higher returns for owners.
What is restructuring, and what are its common forms?
Restructuring refers to changes in a firm's portfolio of businesses and/or financial structure. There are three general forms of restructuring: (1) Downsizing involves reducing the number of employees, which may include decreasing the number of operating units. (2) Downscoping entails divesting, spinning off, or eliminating businesses that are not related to the core business. It allows the firm to focus on its core business. (3) A leveraged buyout occurs when a party (managers, employees, or an external party) buys all the assets of a (publicly traded) business, takes it private, and finances the buyout with debt. Once the transaction is complete, the company's stock is no longer publicly traded.
Identify and define the different types of strategic alliances.
Strategic alliances are cooperative strategies in which firms combine some of their resources to create a competitive advantage. All strategic alliances require firms to exchange and share resources and capabilities to co-develop or distribute goods or services. The three basic types of strategic alliances are: (1) joint ventures, where a legally independent company is created by at least two other firms, with each firm usually owning an equal percentage of the new company; (2) equity strategic alliances, whereby partners own different percentages of equity in the new company they have formed; and (3) nonequity strategic alliances, which are contractual relationships between firms to share some of their resources and capabilities. The firms do not establish a separate organization, nor do they take an equity position. Because of this, nonequity strategic alliances are less formal and demand fewer partner commitments than joint ventures and equity strategic alliances. Typical forms are licensing agreements, distribution agreements, and supply contracts.
Identify the two strategic management approaches to managing alliances and explain the advantages of each.
The ability to effectively manage competitive strategies can be one of a firm's core competencies. There are two basic approaches to managing competitive alliances. Cost minimization leads firms to develop protective formal contracts and effective monitoring systems to manage alliances. Its focus is to prevent opportunistic behavior by the partner(s). Opportunity maximization is intended to maximize value creation opportunities. It is less formal and places fewer constraints on partner behaviors. But, identifying trustworthy partners is the key to this second approach. If (well-founded) trust is present, monitoring costs are lowered and opportunities will be maximized. Trust is more difficult to establish between international partners. Ironically, the cost-minimization approach is more expensive to implement and to use than the opportunity-maximization approach.
What are the five categories of businesses based on level of diversification? How are they defined?
The five categories of businesses determined by level of diversification are as follows: 1. Single business (95 percent or more of revenue comes from a single business) 2. Dominant business (between 70 percent and 95 percent of revenue comes from a single business) 3. Related constrained (a diversified organization earning less than 70 percent of revenue from the dominant business, and all businesses share product, technological, and distribution linkages) 4. Related linked (a diversified organization earning less than 70 percent of revenue from the dominant business with only limited links between businesses) 5. Unrelated (a diversified organization earning less than 70 percent of revenue from the dominant business with no common links between businesses)
What are the two ways that an unrelated diversification strategy can create value?
Unrelated diversification can create value through two types of financial economies (cost savings): 1. Unrelated diversified firms can more efficiently allocate capital among the component businesses than can the external financial market. This is possible because the corporate-level management has more complete information about the performance of the component businesses and it can also discipline underperforming management teams. 2. Unrelated diversified firms can also create value by purchasing other businesses at low prices, restructuring them, and reselling them at a higher price. This practice is most successful with mature, low-technology businesses, rather than high-technology or service businesses, which are more dependent on employees who may leave.
Describe the market for corporate control and its implications for organizations.
The market for corporate control is composed of individuals and firms that buy ownership positions in or purchase all of potentially undervalued corporations typically for the purpose of forming new divisions in established companies or merging two previously separate firms. The target firm's top management team is usually replaced because it is assumed to be partly responsible for formulating and implementing the strategy that led to poor firm performance. The market for corporate control is (supposedly) triggered by low corporate performance by a firm relative to competitors in its industry. Thus, the market for corporate control should act as a control mechanism for corporate governance that leads to the replacement of underperforming executives. But, the market for corporate control is not an efficient governance mechanism because in reality many of the firms taken over have above-average performance. Hostile takeovers, on the other hand, are typically triggered by poor performance. Some managers have sought to buffer themselves from the effect of the market for corporate control (hostile takeovers) by instituting golden parachutes that will pay the managers significant extra compensation if the firm is taken over. Those and other takeover defenses are intended to increase the costs of mounting a takeover and reducing the managers' risk of losing their jobs. Examples of takeover defenses include asset restructuring, changes in the financial structure of the firm, reincorporation in another state, and greenmail. These defense tactics are controversial and the research on their effectiveness is inconclusive. Most institutional investors oppose them.
Define the agency relationship and managerial opportunism and explain their strategic implications
The separation between owners and managers creates an agency relationship. An agency relationship exists when a principal hires an agent as a decision-making specialist to perform a service. Some problems that result from the agency relationship between owners and managers include the potential for a divergence of interests and a lack of direct control of the firm by shareholders. Managerial opportunism is the seeking of self-interest with guile. It is both an attitude and a set of behaviors, which cannot be perfectly predicted from the agent's reputation. Top executives may make strategic decisions that maximize their personal welfare and minimize their personal risk, such as excessive product diversification. Decisions such as these prevent the maximization of shareholder wealth, which is supposed to be the top executives' priority. Although shareholders implement corporate governance mechanisms to protect themselves from managerial opportunism, these mechanisms are imperfect. Agency costs include the costs of managerial incentives, monitoring costs, enforcement costs, and the individual financial losses incurred by principals (owners of the firm) because governance mechanisms cannot guarantee total compliance by the agents (managers).
Define the three internal corporate governance mechanisms and explain how each one can be used to control and monitor managerial decisions.
The three internal corporate governance mechanisms are ownership concentration, the board of directors, and executive compensation. Ownership concentration is based on the number of large-block shareholders and the total percentage of the firm's shares they own. With significant ownership percentage, institutional owners, such as mutual funds and pension funds, are often able to influence top executives' strategic decisions and actions. Thus, unlike diffuse ownership, which tends to result in relatively weak monitoring and control of managerial decisions, concentrated ownership produces more active and effective monitoring of top executives. An increasingly powerful force in corporate America, institutional owners are actively using their positions of concentrated ownership in individual companies to force managers and boards of directors to make decisions that maximize a firm's value. These owners have caused poorly performing CEOs to be ousted from the firm. The board of directors, elected by shareholders, is composed of insiders, related outsiders, and outsiders. The board of directors is a governance mechanism shareholders expect to run the firm in such a way as to maximize shareholder wealth. Outside directors are expected to be more independent of a firm's top executives than are those who hold top management positions within the firm. A board with a significant percentage of insiders tends to be weak in monitoring and controlling management decisions. Boards of directors have been criticized for being ineffective, and there is a movement to more formally evaluate the performance of boards and their individual members. Executive compensation is a highly visible and often criticized governance mechanism. Salary, bonuses, and long-term incentives such as stock options are intended to reward top executives for aligning their goals with the interests of shareholders. A firm's board of directors has the responsibility of determining the degree to which executive compensation succeeds in controlling managerial behavior. But, it is difficult to evaluate top executives' performance, and so executive compensation tends to be linked to financial measures that do not necessarily reflect the effectiveness of the executive's decision on long-term shareholder outcomes. In addition, many external factors affect the performance of a firm. Moreover, performance incentive plans can be subject to management manipulation. Consequently, executive compensation is a far-from-perfect governance mechanism.
Identify the four types of business-level cooperative strategies and the advantages and disadvantages of each.
Through vertical and horizontal complementary alliances, companies combine their resources and capabilities in ways that create value. Vertical complementary strategic alliances result when firms creating value in different parts of the value chain combine their assets to create a competitive advantage. Vertical complementary strategies have the greatest probability of being successful compared with other types of cooperative strategies. But firms using this type of alliance need to be wise in how much technology they share with their partners. Vertical complementary alliances rely heavily on trust between partners to succeed. Horizontal complementary strategic alliances are developed when firms in the same stage of the value chain combine their assets to create additional value. Usually, they are formed to improve long-term product development and distribution opportunities. Horizontal complementary strategies can be unstable because they often join highly rivalrous competitors. In addition, even though partners may make similar investments, they rarely benefit equally from the alliance. The competition response strategy involves alliances formed to react to competitors' actions. Usually, they respond to strategic, rather than tactical, actions because the alliances are difficult to reverse and expensive to operate. The uncertainty-reducing strategy is used to hedge against risk and uncertainty, such as when entering new product markets or in emerging economies. Both of these strategies are less effective in the long run than the complementary alliances that are focused on creating value. Competition-reducing (collusive) strategies are often illegal. There are two types of collusive competition-reducing strategies: explicit collusion and tacit collusion. Explicit collusion exists when two or more firms negotiate directly to jointly agree about the amount to produce as well as the prices for what is produced. Explicit collusion strategies are illegal in the United States and most developed economies. Tacit collusion exists when several firms in an industry indirectly coordinate their production and pricing decisions by observing each other's competitive actions and responses. Both types of collusion result in lower production levels and higher prices for consumers.
Describe how diversified firms can use activity sharing and transfer of core competencies to create value.
n related diversification, a firm seeks to exploit economies of scope between its business units. Economies of scope are cost savings a firm creates by successfully sharing resources and capabilities or transferring one or more corporate-level core competencies that were developed in one of its businesses to another of its businesses. Firms create value through economies of scope two ways: sharing activities (operational relatedness) and transferring corporate-level core competencies (corporate relatedness). Both primary and support activities may be shared, including marketing and production. This activity sharing can result in cost reductions and improve financial returns. The sharing of core competencies allows the firm to create value two ways: (1) it eliminates the need for the second unit to allocate resources to develop the competence, and (2) transferring intangible resources internally makes it hard for competitors to understand and to imitate the resource.