HI6006

Competitive Strategy

Lecture 10: Corporate Governance and

Structure
Corporate Governance and Structure
C G KNOWLEDGE OBJECTIVES 1-3

Define corporate governance and explain why it is

used to monitor and control top-level managers’
decisions.

Explain why ownership is largely separated from

managerial control in organisations.

Define an agency relationship and managerial

opportunism and describe their strategic implications.
C G KNOWLEDGE OBJECTIVES 4-6

Discuss the types of compensation top-level

managers receive and their effects on managerial
decisions.

Describe how the external corporate governance

mechanism – the market for corporate control –
restrains top-level managers’ decisions.

Describe how corporate governance fosters the

making of ethical decisions by a firm’s top-level
managers.
 CORPORATE GOVERANCE

 Corporate governance can destroy or create

value for a firm.
 It is concerned with:
1. Strengthening the effectiveness of a
company’s board of directors
2. Verifying the transparency of a firm’s
operations
3. Enhancing accountability to shareholders
4. Incentivising executives
5. Maximising value-creation for stakeholders
and shareholders.
 C G: WHAT IS ALL THE FUSS ABOUT?

Corporate governance fundamentals

 Corporate directors should:
– Focus on creating long-term value for
shareholders
– Use performance-related pay to attract and
retain senior management
– Exercise sound business judgement to
evaluate opportunities and manage risk

– Communicate with key shareholders.

 What is CORPORATE GOVERNANCE
Corporate governance is the set of mechanisms used
to manage the relationships (and conflicting interests)
among stakeholders and to determine and control the
strategic direction and performance of organisations.

 Identifying ways to ensure that decisions are effective,

and facilitate the achievement of strategic
competitiveness

 Ensuring that top-level managers interests are aligned

with shareholders and other stakeholders interests
 Corporate Governance In-Class Activity

Consider what types of ‘conflict’ could exist between the

following stakeholders:

Customers and Regulators (eg. Opening and closing hours)

Suppliers and Traffic Authorities (eg. Delivery of good)

Directors and Shareholders (eg. Dividend vs reinvestment of profits)

Employees and Management (eg. Rates of pay)

Management and Environmentalists (eg. Sustainability and Corporate

Social Responsibility issues)

Brainstorm Any Other Conflicting Interests ???

 Corporate Governance Guiding Principles

3 Main Areas

P1. Separate Managerial Control from Ownership – known as

‘Agency’

P2. Executive Compensation – must understand the ‘executive

recruitment market’ and be able to attract and retain the best
talent

P3. Ethical Conduct – the firm and its agents must behave in
ways that are morally acceptable, socially responsible, and
sustainable
 P1 - SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL

• Shareholders own shares in the firm and are

entitled to a corresponding share of the profits.

SHAREHOLDERS • Shareholders bear the risk of a firm losing

value, through unsatisfactory profits OR lack of
investor confidence, leading to a reduction of
share value.

• Professional managers are contracted to

MANAGERS develop strategies and implement decisions
that steer the company.
 P1 - SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL

• Small firms’ usually have less separation between

ownership and management control.

• Family-owned businesses face two critical issues.

– As they grow, they may not have access to all
needed skills to manage the growing firm and
maximise its returns. Therefore, they need to hire
professional managers.
– To finance growth, they may seek capital investment,
thereby having to give up some ownership control.

Activity: For a growing family business, what are

the pros and cons of financing growth through loan
capital vs. (non-family) share capital ?
P1 - SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL

How an Agency Relationship

comes about
P1 - SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL

The ‘Agency Dilemma’

[when owners and ‘agents’ have opposing goals]

Diversification
Growth in firm increases top
size leads to executives’
higher executive employment and
compensation remuneration
prospects

So, hired professional managers tend to

pursue Growth and Diversification
P1 - SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL

Owners are more likely to prefer strategy A; Professional managers B

 P2 – Executive Compensation - BOARD OF DIRECTORS

The board of directors is a group

of shareholder-elected individuals
Board of directors whose primary responsibility is to
act in the shareholders’interests by
formally monitoring and controlling
the corporation’s top-level
executive managers.

As stewards of an organisation’s resources, an effective board of directors

influences the performance of a firm by:
• Monitoring and controlling executive managers to ensure the company is
operated in ways that maximise shareholder wealth
• Directing the organisation’s affairs
• Ensure managers are appropriately rewarded
• Custodianship of shareholders’ rights and interests
• Safe-guarding owners from managerial opportunism (agency dilemmas)
 P2 – Executive Compensation - BOARD OF DIRECTORS

Director classifications:
1. Executive Directors
Insiders – the firm’s CEO and other
Board of directors top-level managers, OR
Related outsiders – individuals
uninvolved with day-to-day
operations, but who have a
relationship with the firm
2. Non-Executive Directors
Outsiders – individuals who are
independent of the firm’s day-to-day
operations and other relationships
 P2 – Executive Compensation - BOARD OF DIRECTORS

Criticisms of boards of directors

include that they:
• too readily approve managers’
self-serving initiatives
Board of directors • are exploited by managers with
personal ties to board members
• are not vigilant enough in hiring
and monitoring CEO behaviour
• lack agreement about the number
of and most appropriate role of
outside directors.
 P2 – Executive Compensation – how it works

Executive compensation is:

• a governance mechanism that

seeks to align the interests of top
managers and owners through
Executive salaries, bonuses and long-term
compensation incentive compensation, such as
share options (sometimes referred
to as ‘stock options)

• Attracts criticism of the firm when

thought to be excessive and out of
line with performance.
 P2 – Executive Compensation – how it works

Factors complicating executive

compensation
• Strategic decisions by top-level
managers are complex, non-routine
and affect the firm over an extended
period, making it difficult to assess the
current decision effectiveness.

Executive • Other intervening variables affect the

compensation firm’s performance over time.
- alignment of pay and performance is
complicated.
- effectiveness of pay plans as a
governance mechanism is suspect.
 P2 – Executive Compensation – how it works

Making executive compensation

effective:
• Performance-based compensation is
used to motivate decisions that best
serve shareholder interest [but they are
imperfect in their ability to monitor and
control managers].

Executive
compensation • Incentive-based compensation plans
aim to increase firm value in line with
shareholder expectations [but can be
subject to managerial manipulation to
maximise managerial interests].
 In-Class Activity

If you were the owner of a family business, how much of your

annual profits would you be willing to pay to a professional
executive management team and/or a board of directors ?

What exactly would you expect the board of directors to do ?

How would you ensure that they do it all, effectively ?

What exactly would you expect the professional

managemnent team to do ?

How would you ensure that they do it all, effectively ?

 Tutorial Case

Consider the Case of IKEA in the light

of what we have learnt about
Corporate Governance

1. Are there any observable ‘Agency Issues’ -

What does IKEA do to separate managerial
control from ownership?

2. Are there any Executive Compensation issues

(include Board of Directors)?

3. What evidence is there to support that IKEA

conducts its business activities in ways that are
morally acceptable, socially responsible, and
sustainable?
FIGURE 1.1

THE
STRATEGIC
MANAGEME
NT
PROCESS
KNOWLEDGE OBJECTIVES

Define organisational structure and controls

and discuss the difference between strategic
and financial controls.

Describe the relationship between

strategy and structure.

Explain the use of structure to implement

diversification strategies.
 ORGANISATIONAL STRUCTURE

• The firm’s formal reporting relationships,

procedures, controls, and authority and decision-
making processes

• Specifies the work to be done and how to do it,

given the firm’s strategy or strategies

• Is the pivotal component of effective strategy

implementation.
It is critical to create an organisational
structure that is matched to strategy.
 ORGANISATIONAL STRUCTURE

There are two considerations regarding the structure

and its alignment with strategy:

Structural Stability : Structural Flexibility:

The capacity a firm The opportunity to adapt
requires to consistently the structure in order to
and predictably manage explore competitive
its daily work routines (to strategies (to be
be efficient now) successful in the future)
 ORGANISATIONAL CONTROLS
• Controls guide the use of strategy, indicate how
to compare actual results with expected
results and suggest corrective actions to take
when the difference is unacceptable.

Strategic Controls:
intended to verify that the firm
is using appropriate Financial Controls:
strategies to maximise
used to measure the firm’s
advantage from the
performance based on profit
conditions in the external
goals and cost management
environment and the
company’s core
competencies
 STRATEGY AND STRUCTURE are synergistic

• Strategy and structure form a reciprocal

relationship, i.e. a change in one causes a
change in the other (there is often a time-lag though)

STRATEGY STRUCTURE

The matching of strategy and structure is complex

STRATEGY AND STRUCTURE

Simple Functional Multidivisional

Structure Structure Structure
The owner-manager makes all
major decisions and monitors all
activities. Each operating division
represents a separate
CEO and a limited corporate
staff make all decisions.
business or profit centre

Staff acts as extension of

manager’s supervisory authority.
Top corporate officers
delegate responsibilities for
day-to-day operations and
Firms use matched focus business-unit strategies to
strategies and business-level Functional line managers are in
strategies, meaning that these dominant organisational areas:
division managers.
firms offer single product lines in production, marketing,
single geographic markets. engineering, R&D, Accounting,
HRM Each division represents a
separate business or profit
centre with its own functional
There are few rules, limited task hierarchy, and is responsible
specialisation and basic for daily operations.
technology systems.
Functional specialization results
in active knowledge sharing
With size comes complexity and within each area, but can
managerial and structural impede communication and Business-unit strategy is
challenges; firms tend to move coordination among different delegated to the division
from a simple to a functional functional areas
structure.
A Typical [Functional] Organisational Structure
A Typical [Multi-Divisional] Organisational Structure
An Illustration of the concept of a Multi-National Organisational Structure
 A Modern View of a Business Organisation

Competitor Key
with alliance technology
agreement supplier

Main
strategic Key raw
centre of material
supplier
the firm
[HUB]
Research
team at local Top legal
university firm in
intellectual
property

Activity: Consider how organisational structures are changing and

what may be driving these changes in the modern day
 Tutorial Case

Consider the Case of IKEA in the light

of what we have learnt about
Organisation Structure

1. What type of organisation structure does IKEA

make use of

2. How well does this organisation structure

serve IKEA’s strategy

3. What firms can you think of where their

organisation structure has undergone significant
changes? Why was that?