Chapter 9

Corporate Governance and

Strategic Management

CA
 Key Definitions

Managerial Employment Risk

is the risk of job loss, loss of compensation, or loss of
managerial reputation.
Free Cash Flows
are resources generated after investment in all projects
that have positive net present values within the firm’s
current product lines.
Ownership Concentration
is both the number of large block owners (usually holding
five percent of shares) as well as the total percentage
held by these large block owners.

Chapter 9 2
 Key Definitions

Institutional Owners
are large block shareholder positions controlled by financial
institutions such as stock mutual funds and pension funds.
Executive Compensation
is a governance mechanism used to align managers’ and
owners interest through salary, bonus and long-term incentive
compensation such as stock options.
Golden Parachutes
are contingency contracts that pay managers significant extra
compensation (but only if the firm is taken over) and which
can have a positive effect on shareholder returns.
Chapter 9 3
Chief Executive Compensation in
the 1980s and Early 1990s

… rose faster than

profits and inflation
and resulted in
protest being
published in the
media.

Chapter 9 4
By Separating Managers and
Shareholders, Managers can
Specialize in …

… Strategy Development and Decision Making.

Chapter 9 5
By Separating Managers and
Shareholders, Stockholders can
Specialize in …

… Risk Bearing through the Diversification

of their Portfolio of Stocks.

Chapter 9 6
Separation of Ownership and
Managerial Control in Modern
Corporations…

1
 Permits managers to specialize in decision
making and owners to specialize in
diversifiable risk-bearing.

2
 Firms are not limited to the abilities of their
owners to manage.

3
 Therefore, the separation and specialization
of ownership (risk bearing) and managerial
control is economically efficient.
Chapter 9 7
Managers and Shareholder Risk and
Diversification

Shareholder Management
Risk

(business) (employment)
risk profile risk profile

Dominant A Related Related- B Unrelated-

business business linked business

Diversification
Chapter 9 8
Ownership Concentration

As more shareholders own fewer shares of stock, their

incentive to monitor managerial decision in one firm
declines

They all bear the cost of the monitoring, but they benefit
from monitoring in proportion to share ownership
Chapter 9 9
Board of
Directors

Primary Role
is to monitor and ratify major
managerial decisions to protects
the interest of owners.
Secondary Role
is to protect the contractual relationship between the firm and
its managers, including, hiring, disciplining and setting pay
policies for top executives officers.
Outside Directors
safeguard the shareholders’ investment in the firm against
potential managerial opportunism or ineffectiveness.
Chapter 9 10
The Multidivisional (M-form) Structure

EXPENSE
REPORT $
1
Serves as a governance mechanism through the
corporate office.

2
The corporate office, in addition to the board of
directors, monitors the strategy and performance of
division managers.
Chapter 9 11
The Market for Corporate Control

is composed of individuals and

firms that buy ownership
positions in (or takeover)
potentially undervalued firms…

1. To form a new division in an established diversified

firm.
2. Merge two previously separate firms, and
3. Usually displace the target firm’s management team to
revamp the strategy that caused low firm performance.

Chapter 9 12
U.S. Versus Japanese Corporate Governance

The Role of the U.S. Board The Role of Banks in Japanese

Keiretsu

1. Shareholders in the 1. Bank can be both lenders

external capital markets and investors.
provide much of the
2. Banks can have seats on
financing
their borrower’s board.
2. Often focuses on short-
3. Bank have incentive to
term results
monitor borrowers which
tends to decrease their
innovation.
Chapter 9 13
It’s time to break

Have a nice …

Chapter 9 14