RP ORATE
CO NANCE
GOV ER GROUP 8
CORPORATE GOVERNANCE
set of mechanisms used to manage the
relationships among stakeholders and to
determine and control the strategic direction
and performance of organizations. This is by
means to achieve strategic competitiveness.
GOVERNANCE
means to establish and maintain harmony
between parties which may have conflicting
interests.
SEPARATION OF OWNERSHIP AND
MANAGERIAL CONTROL
US Firms managed by Separation at large
founder-owners and companies
descendants
CREATION OF MODERN
PUBLIC CORPORATION
Based on the efficient
separation of ownership and
managerial control.
PRO'S CONS
iNCREASED IMBALANCE REVENUE
CORPORATION PROFIT AND EXPENSES
ALLOW PURCHASE OF INVESTMENT
SHARES RISK
AGENCY RELATIONSHIP
exists when one or more people hire another
person as decision-making specialist to
perform a service. Thus an exchange for
compensation is their quality performance with
regards to responsible tasks.
PRINCIPALS AGENTS
AGENCY RELATIONSHIP
MANAGERIAL
OPPORTUNISM
SEEKING OF SELF-INTEREST WITH GUILE
AN ATTITUDE AND A SET OF BEHAVIORS
PRODUCT
DIVERSIFICATION AS AN
EXAMPLE OF AN AGENCY
PROBLEM
IT IS BELIEVED THAT CORPORATE-LEVEL
STRATEGIES PREFER TO DIVERSIFY THEIR LINE OF
PRODUCTS TO ENHANCE STRATEGIC
COMPETITIVENESS AND INCREASE RETURNS.
BENEFIT: TOP-LEVEL MANAGERS > STAKEHOLDERS
1ST BENEFIT OF DIVERSIFICATION: PAY AND
COMPENSATION
2ND BENEFIT OF DIVERSIFICATION: REDUCE TOP-
LEVEL MANAGER’S EMPLOYMENT RISK
OWNERSHIP
CONCENTRATION AND
BOARD OF DIRECTORS
OWNERSHIP CONCENTRATION
It refers to the degree to which a small number of
shareholders hold large portions of a company's shares.
Large-block shareholders, defined as those who own at least
5% of a firm’s issued shares, are particularly significant.
This concentration is a key governance mechanism, as these
shareholders can exert strong influence over managerial
decisions. In contrast, diffuse ownership, where shares are
spread across many small holders, often results in weak
monitoring and reduced accountability for managers.
IMPORTANCE
Ownership concentration is important because it
strengthens oversight of management. Large
shareholders can push for better governance to
protect their interests, while dispersed ownership
makes coordination difficult. Concentrated
ownership helps prevent poor decisions and aligns
actions with shareholder value.
TRENDS IN OWNERSHIP
Over recent decades, there has been a notable shift in ownership
patterns. The number of individual large-block shareholders has declined,
and they have been largely replaced by institutional investors. These
institutions, such as mutual funds and pension funds, now play a dominant
role in corporate governance. In the U.S., institutional owners hold an
estimated 60% to 75% of equity in firms, making them key players in
shaping corporate strategies and accountability.
INSTITUTIONAL OWNERS AS
GOVERNANCE MECHANISM
They are becoming increasingly influential as governance agents due
to the large equity stakes they hold. Their roles as large-block
shareholders allow them to exert considerable pressure on management
to prioritize shareholder interests. Moreover, institutions like pension
funds are viewed as stable and long-term sources of capital, which
contributes to broader economic growth and corporate stability.
BOARD OF DIRECTORS
The board of directors is composed of individuals elected
by shareholders to monitor and control the actions of top-
level managers. Their primary responsibility is to act in the
best interests of the owners, making sure the company is
managed effectively. They have the authority to reward or
discipline executives based on performance. The board plays
a crucial oversight role, helping ensure that corporate
actions align with stakeholder and shareholder
expectations.
BOARD COMPOSITION
CEO DUALITY
DEFINITION EXAMPLE
CEO duality refers to the situation in the case of Jamie Dimon
where one individual holds both the at JPMorgan Chase—is
CEO and the chairperson roles on the often difficult and
board. This structure can weaken controversial.
board independence, as it centralizes
too much power in one person’s hands
VALUE OF EXPERIENCED BOARDS
Even with an independent board, it’s important that
members know what they’re doing.When board
members have experience in the industry, they can give
better advice, spot problems earlier, and help make
smarter decisions. So, the best boards are not only
independent—but also experienced and
knowledgeable. That combination helps companies
grow and avoid risky or poor strategies.
ENHANCING THE
EFFECTIVENESS OF
OF THE BOARD OF
DIRECTORS
Because of the importance of boards of directors in
corporate governance and as a result of increased scrutiny
from shareholders in particular, large institutional investors
the performances of individual board members and of entire
boards are being evaluated more formally and with greater
intensity. The demand for greater accountability and
improved performance is stimulating many boards to
voluntarily make changes. Among these changes are:
1. Increases in the diversity of the backgrounds of board
members (e.g., a greater number of directors from public
service, academic, and scientific settings; a greater
percentage of ethnic minorities and women; and members
from different countries on boards of U.S. firms);
2. the strengthening of internal management and accounting
control systems;
3. establishing and consistently using formal processes to
evaluate board member's performance;
4. modifying the compensation of directors, especially
reducing or eliminating stock options as a part of their
package; and
5. creating the "leader director" role that has strong powers
with regard to the board agenda and oversight of non-
management board member activities.
An increase in the board's involvement with a firm's strategic
decision-making processes creates the need for effective
collaboration between board members and top-level managers.
Some argue that improving the processes used by boards to
make decisions and monitor managers and firm outcomes is
important for board effectiveness. Moreover, because of the
increased pressure from owners and the potential conflict
among board members, procedures are necessary to help
boards function effectively while seeking to discharge their
responsibilities.
EXECUTIVE
COMPENSATION
The compensation of top-level managers, especially CEOs,
has been a topic of debate. Some people believe that these
executives deserve high pay because they hold major
responsibilities and significantly influence a firm’s performance.
Others argue that CEOs are overcompensated and that their pay
does not accurately reflect the company’s success. To address
this issue, executive compensation serves as one of the three
internal governance mechanisms. It aims to align the interests
of managers and shareholders by offering a mix of salaries,
bonuses, and long-term incentives such as stock awards and
options.
Long-term incentive plans, in particular, have become a significant
part of executive pay, especially in U.S. firms. These plans are
intended to reduce agency problems by tying managerial rewards to
shareholder wealth. Well-structured compensation packages can
discourage large shareholders from demanding changes in
leadership, as they expect the incentives to guide managers toward
decisions that benefit shareholders. However, concerns remain.
Research shows that stock-based compensation can sometimes
encourage unethical practices like earnings manipulation. This
underscores the need for boards of directors to actively monitor
executive compensation to ensure it truly supports the firm's goals
and values.
MARKET FOR
CORPORATE
CONTROL
DEFINITION
The market for corporate control is an external governance
mechanism that is active when a firm’s internal governance mechanisms
fail. 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.
MANAGEMENT ACCOUNTABILITY
Because the top-level managers are assumed to be
responsible for the undervalued firm’s poor performance, they
are usually replaced. An effective market for corporate
control ensures that ineffective and/or opportunistic top-
level managers are disciplined.
SENSITIVITY TO TAKEOVERS
Commonly, target firm managers and board
members are sensitive about takeover bids
emanating from the market for corporate control,
since being a target suggests that they have been
ineffective in fulfilling their responsibilities.
For top-level managers, a board’s decision to
accept an acquiring firm’s offer typically finds
them losing their jobs because the acquirer
usually wants different people to lead the firm.
At the same time, rejection of an offer also
increases the risk of job loss for top-level managers
because the pressure from the board and
shareholders for them to improve the firm’s
performance becomes substantial.
MANAGERIAL DEFENSE TACTICS
HOSTILE TAKEOVERS AND
CORPORATE CONTROL
Hostile takeovers are the principal way the market for
corporate control is activated. A hostile takeover is an
acquisition of a target company not by agreement with
management but by going directly to the shareholders or
replacing management to get approval.
MANAGERIAL DEFENSE TACTICS
Firms may use multiple defense tactics to fend off hostile
takeovers. These tactics have become more sophisticated
due to increased takeover activity. Because hostile takeovers
increase risk for managers, managerial pay may be
augmented indirectly, such as through golden parachutes,
where a CEO can receive up to three years’ salary if taken
over. These and other tactics are controversial.
POISON PILL STRATEGY
The “poison pill” allows shareholders (other than the
acquirer) to convert rights into a large number of
common shares if someone acquires more than 10 to 20
percent of stock. This dilutes the acquirer’s stake, forcing
them to buy additional shares at premium prices,
increasing their costs.
STAGGERED ELECTIONS
Some firms amend their corporate charter so board
member elections are staggered, with only one-third up
for reelection each year. This reduces the firm’s
vulnerability to hostile takeovers by creating managerial
entrenchment.
HOSTILE TAKEOVER DEFENSE STRATEGIES
INTERNATIONAL
CORPORATE
GOVERNANCE
CORPORATE GOVERNANCE
Corporate governance is an increasingly important issue
in economies around the world, including emerging
economies. Globalization in trade, investments, and equity
markets increases the potential value of firms throughout the
world using similar mechanisms to govern corporate
activities.
Moreover, because of globalization, major companies
want to attract foreign investment. For this to happen, foreign
investors must be confident that adequate corporate
governance mechanisms are in place to protect their
investments. Recognizing and understanding differences in
various countries governance systems, as well as changes
taking place within those systems, improves the likelihood a
firm will be able to compete successfully in the international
markets it chooses to enter.
COPORATE GOVERNANCE IN
GERMANY AND JAPAN
GERMANY
In many private German companies, the owner and manager are often the same person,
so there is no agency problem.
Even in public companies, ownership is usually concentrated, with a dominant
shareholder.
Banks play a central role in German corporate governance.
German firms with more than 2,000 employees are required to have a two-tier board
structure: the Vorstand (management board) and the Aufsichtsrat (supervisory board).
German executives have not focused solely on maximizing shareholder value
COPORATE GOVERNANCE IN
GERMANY AND JAPAN
JAPAN
Japanese corporate governance is influenced by concepts of obligation, family, and consensus.
The keiretsu system is central, with companies holding shares in each other and a main
bankproviding financial support and oversight.
Decision-making is consensus-based, which promotes harmony but can be slow
Japanese banks, especially the main bank in a keiretsu, are important in monitoring and advising
companies, but their influence has decreased as Japan’s economy globalizes and regulations change
Japanese companies invest more in long-term R&D compared to U.S. firms, but poor performance
and scandals have pushed for more reforms and transparency.
COPORATE GOVERNANCE IN
CHINA
CHINA
China has a unique and large, socialist mixed with a market-oriented economy.
Over time, the government has improved the corporate governance of listed
companies.
Corporate governance practices in China have been changing with increasing
privatization of businesses and the development of equity markets.
The stock markets in China remain young and are continuing to develop. In
their early years, these markets were weak because of significant insider
trading, but with stronger governance these markets have improved.
GOVERNANCE MECHANISMS
AND ETHICAL BEHAVIOR
In the United States, shareholders are recognized as a company's most
significant stakeholder. Thus, governance mechanisms focus on the
control of managerial decisions to ensure that shareholders' interests will
be served, but product market stakeholders (e.g., customers, suppliers,
and host communities) and organizational stakeholders (e.g., managerial
and nonmanagerial employees) are important as well.
GOVERNANCE MECHANISMS
AND ETHICAL BEHAVIOR
All corporate owners are vulnerable to unethical behaviors by their employees,
including top-level managers-the agents who have been hired to make decisions
that are in shareholders' best interests. The decisions and actions of a corporation's
board of directors can be an effective deterrent to these behaviors. In fact, some
believe that the most effective boards participate actively to set boundaries for their
firms' business ethics and values. Once formulated, the board's expectations related
to ethical decisions and actions of all of the firm's stakeholders must be clearly
communicated to its top-level managers.
GOVERNANCE MECHANISMS
AND ETHICAL BEHAVIOR
Only when the proper corporate governance is exercised can
strategies be formulated and implemented that will help the firm
achieve strategic competitiveness and earn above-average returns.
As the discussion in this chapter suggests, corporate governance
mechanisms are a vital, yet imperfect, part of firms' efforts to select
and successfully use strategies.
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