Chapter 2

Corporate Governance

Concepts in Strategic
Management and
Business Policy
15th Edition
Wheelen, Hunger, Hoffman and
Bamford

Dr. Malkah Noor Kiani

Ch 3 -1
Content

• Role and Responsibilities of board of directors

• Composition of board of directors
• Impact of Sarbanes Oxley Act on Corporate Governance
• Recent trends in corporate governance
• Role of leadership in strategic management

Ch 3 -2
1. Introduction
• A corporation is a mechanism established to allow different
parties to contribute capital, expertise, and labor for their mutual
benefit.
• The investor/shareholder participates in the profits (in the form of
dividends and stock price increases) of the enterprise without
taking responsibility for the operations.
• Management runs the company without being responsible for
personally providing the funds.
• To make this possible, laws have been passed that give
shareholders limited liability and, correspondingly, limited
involvement in a corporation’s activities. That involvement does
include, however, the right to elect directors who have a legal
duty to represent the shareholders and protect their interests.
• As representatives of the shareholders, directors have both the
authority and the responsibility to establish basic corporate
policies and to ensure that they are followed.
Ch 3 -3
1. Introduction
• The board of directors, therefore, has an obligation to approve all
decisions that might affect the long-term performance of the
corporation.

• This means that the corporation is fundamentally governed by

the board of directors overseeing top management, with the
concurrence of the shareholder.

• The term corporate governance refers to the relationship among

these three groups in determining the direction and performance
of the corporation

Ch 3 -4
1. Introduction – Responsibilities of Board
• Laws and standards defining the responsibilities of boards of
directors vary from country to country.
• An article by Spencer Stuart written by an international team of
contributors suggested the following five board of director
responsibilities:
– Effective board leadership including the processes, makeup, and output of
the board
– Strategy of the organization
– Risk vs. initiative and the overall risk profile of the organization
– Succession planning for the board and top management team
– Sustainability

Ch 3 -5
1. Introduction – Responsibilities of Board
• How does a board of directors fulfill their many responsibilities?
The role of the board of directors in strategic management is to
carry out three basic tasks:
– Monitor: By acting through its committees, a board can keep
abreast of developments inside and outside the corporation, bringing
to management’s attention developments it might have overlooked.
A board should, at the minimum, carry out this task.
– Evaluate and influence: A board can examine management’s
proposals, decisions, and actions; agree or disagree with them; give
advice and offer suggestions; and outline alternatives. More active
boards perform this task in addition to monitoring.
– Initiate and determine: A board can delineate a corporation’s
mission and specify strategic options to its management. Only the
most active boards take on this task in addition to the two previous
ones

Ch 3 -6
1. Introduction – Responsibilities of Board

Ch 3 -7
2. Board of Directors Composition
• The boards of most publicly owned corporations are composed
of both inside and outside directors.
– Inside directors (sometimes called management directors) are typically
officers or executives employed by the corporation.
– Outside directors (sometimes called non-management directors) may be
executives of other firms but are not employees of the board’s corporation.
• People who favor a high proportion of outsiders state that
outside directors are less biased and more likely to evaluate
management’s performance objectively than are inside directors.
• This view is in agreement with agency theory, which states that
problems arise in corporations because the agents (top
management) are not willing to bear responsibility for their
decisions unless they own a substantial amount of stock in the
corporation. The theory suggests that a majority of a board
needs to be from outside the firm so that top management is
prevented from acting selfishly to the detriment of the
shareholders.
Ch 3 -8
2. Board of Directors Composition
• This view is supported by research revealing that manager-
controlled firms (with weak boards) are more likely to go into
debt to diversify into unrelated markets (thus quickly boosting
sales and assets to justify higher salaries for themselves).

• These actions result in poorer long-term performance than would

be seen with owner-controlled firms.

• Boards with a larger proportion of outside directors tend to favor

growth through international expansion and innovative venturing
activities than do boards with a smaller proportion of outsiders.

• Outsiders tend to be more objective and critical of corporate

activities.

Ch 3 -9
2. Board of Directors Composition
• Research on family businesses has found that boards with a
larger number of outsiders on the board tended to have better
corporate governance and better performance than did boards
with fewer outsiders

• Stewardship theory proposes that, because of their long tenure

with the corporation, insiders (senior executives) tend to identify
with the corporation and its success. Rather than use the firm for
their own ends, these executives are thus most interested in
guaranteeing the continued life and success of the corporation

Ch 3 -10
3. Sarbanes Oxley Act
• In response to the many corporate scandals uncovered since
2000, the U.S. Congress passed the Sarbanes–Oxley Act in
June 2002. This act was designed to protect shareholders from
the excesses and failed oversight that characterized criminal
activities at Enron.
• Several key elements of Sarbanes–Oxley were designed to
formalize greater board independence and oversight.
• For example, the act requires that all directors serving on the
audit committee be independent of the firm and receive no fees
other than for services of the director.
• In addition, boards may no longer grant loans to corporate
officers.
• The act has also established formal procedures for individuals
(known as “whistleblowers”) to report incidents of questionable
accounting or auditing.

Ch 3 -11
3. Sarbanes Oxley Act
• Firms are prohibited from retaliating against anyone reporting
wrongdoing.
• Both the CEO and CFO must certify the corporation’s financial
information.
• The act bans auditors from providing both external and internal
audit services to the same company.
• It also requires that a firm identify whether it has a “financial
expert” serving on the audit committee who is independent from
management

Ch 3 -12
4. Trends in Corporate Governance
Some of today’s trends in governance that are likely to continue
include the following:
•Boards are getting more involved not only in reviewing and evaluating
company strategy but also in shaping it.
•Institutional investors, such as pension funds, mutual funds, and insurance
companies, are becoming active on boards and are putting increasing
pressure on top management to improve corporate performance.
•Non-affiliated outside (non-management) directors are increasing their
numbers and power in publicly held corporations as CEOs loosen their grip
on boards. Outside members are taking charge of annual CEO evaluations.
•Women and minorities are being increasingly represented on boards.
•Boards are establishing mandatory retirement ages for board members—
typically around age 70.

Ch 3 -13
4. Trends in Corporate Governance
Some of today’s trends in governance that are likely to continue
include the following:
•Boards are evaluating not only their own overall performance, but also that
of individual directors.
•Boards are getting smaller—partially because of the reduction in the
number of insiders but also because boards desire new directors to have
specialized knowledge and expertise instead of general experience.
•Boards continue to take more control of board functions by either splitting
the combined Chair/CEO into two separate positions or establishing a lead
outside director position.
•As corporations become more global, they are increasingly looking for
board members with international experience.
•Instead of merely being able to vote for or against directors nominated by
the board’s nominating committee, shareholders may eventually be allowed
to nominate board members

Ch 3 -14
5. Role of Top Management in CG
• Top management responsibilities, especially those of the CEO, involve
getting things accomplished through and with others in order to meet the
corporate objectives.
• Top management’s job is thus multidimensional and is oriented toward
the welfare of the total organization.
• Specific top management tasks vary from firm to firm and are developed
from an analysis of the mission, objectives, strategies, and key activities
of the corporation.
• Tasks are typically divided among the members of the top management
team. A diversity of skills can thus be very important.
• Research indicates that top management teams with a diversity of
functional backgrounds, experiences, and length of time with the
company tend to be significantly related to improvements in corporate
market share and profitability.
• In addition, highly diverse teams with some international experience
tend to emphasize international growth strategies and strategic
innovation, especially in uncertain environments, as a means to boost
financial performance.
Ch 3 -15
5. Role of Top Management in CG
• The CEO, with the support of the rest of the top management team, has
two primary responsibilities when it comes to strategic management.
– The first is to provide executive leadership and a vision for the firm.
– The second is to manage a strategic planning process.

• Executive leadership is the directing of activities toward the

accomplishment of corporate objectives. Executive leadership is
important because it sets the tone for the entire corporation. A strategic
vision is a description of what the company is capable of becoming.

• These transformational leaders have been able to command respect

and execute effective strategy formulation and implementation because
they have exhibited three key characteristics:
– The CEO articulates a strategic vision for the corporation:
– The CEO presents a role for others to identify with and to follow
– The CEO communicates high-performance standards and also shows confidence in the
followers’ abilities to meet these standards.

Ch 3 -16