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Managerial Economics and Organizational Architecture, 5e
Managerial Economics and Organizational Architecture, 5e
Chapter 18: Corporate Governance
McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Managerial Economics and Organizational Architecture, 5e
Corporate Governance• Describes the organizational structure at
the top of the firm
• Includes– Top-level incentives– Partitioning of decision rights– Board of directors– Top management– Outside monitors
18-2
Managerial Economics and Organizational Architecture, 5e
Corporate Structure• Corporations have the legal standing of an
individual• Shareholders elect a board of directors
with primary decision control rights• Shareholder-owners have limited liability• Corporations may establish governance
procedures within legal boundaries
18-3
Managerial Economics and Organizational Architecture, 5e
Corporate Ownership
• Stock in closely-held corporations is not freely traded
• Stock of publicly-traded corporations may be freely bought and sold– Widely held corporation
• No one owner controls more than 10 percent of the shares
18-4
Managerial Economics and Organizational Architecture, 5e
Corporate Governance Objectives• Maximizing value
• Protecting assets
• Production of proper financial statements that meet legal requirements
18-5
Managerial Economics and Organizational Architecture, 5e
Separation of Ownership and Control
• Incentive issues• Are executive interests aligned with those of
stockholders?
• Survival of corporations• Despite governance concerns, the corporate
form seems both productive and resilient
• Benefit of publicly-traded corporations• Ability to raise large amounts of capital
18-6
Managerial Economics and Organizational Architecture, 5e
Top-level ArchitectureUS corporations
• Decision rights divided among selected stakeholders• Shareholders• Governing board• Top management• External monitors
18-7
Managerial Economics and Organizational Architecture, 5e
Government Impacts on Decision Rights
• State regulations affect firms incorporated within those states
• Federal laws and regulations further stipulate decision rights
• Courts have impact through interpretations of laws
18-8
Managerial Economics and Organizational Architecture, 5e
Shareholders
• Ultimate owners
• Limited participation in management– Elect board– Board oversees management– Some ratification rights
18-9
Managerial Economics and Organizational Architecture, 5e
Shareholder Incentives• Small shareholders (individuals) have
incentive to free ride rather than be actively involved
• Institutional investors (e.g. pension funds) differ in incentives to challenge management
• Blockholders internalize more of the benefits of active involvement
18-10
Managerial Economics and Organizational Architecture, 5e
Board of Directors• Delegates legal authority to professional
managers• Primary function is top-level decision
control• Other responsibilities
– Hire, monitor, fire CEO– Authorize strategic directions– Approve large capital outlays
18-11
Managerial Economics and Organizational Architecture, 5e
Board of Directors
• Fiduciary responsibilities– Represent the interests of the corporation and
shareholders– Good faith efforts– Loyalty
• Legal protection through business judgment rule
18-12
Managerial Economics and Organizational Architecture, 5e
Board Composition and Work
• Size can vary from 4 to 33+• Over half are outside directors• CEO usually sits on board
– Frequently chairs the board
• Much work done in committees– Audit– Compensation– Nominating
18-13
Managerial Economics and Organizational Architecture, 5e
Board Member Incentives
• Some stock ownership aligns financial interests with other shareholders
• High-profile board members have reputational concerns
• Are members independent of top management?– Incentives to back management for self-
interested reasons
18-14
Managerial Economics and Organizational Architecture, 5e
Top Management• CEO’s decision authority flows from the
board• More decision rights are delegated as
firm size and complexity increase• Senior management retains important
decision rights– Shape strategic direction– Establish overall architecture– Recruiting and retaining key personnel
18-15
Managerial Economics and Organizational Architecture, 5e
Top Management
• CEO often deals with investor relations, media, and customers
• COO manages internal operations
• CFO supervises senior financial managers
18-16
Managerial Economics and Organizational Architecture, 5e
Top Management Incentives
• Straight salary
• Performance-based compensation– Bonuses– Stock options– Stock ownership
18-17
Managerial Economics and Organizational Architecture, 5e
External Monitors
• Public accounting firms– Annual independent audits increase
shareholder confidence
• Stock market analysts– May have incentives to promote stocks that
use their firm’s banking services
• Commercial banks• Credit-rating agencies• Regulatory authorities
18-18
Managerial Economics and Organizational Architecture, 5e
International Corporate Governance
• Historical emphasis on broader set of stakeholders– Employees– Lenders– Affiliated companies– Broader public
• Gradual shift toward US architecture
18-19
Managerial Economics and Organizational Architecture, 5e
Monitoring Effect of Market Forces
• Management failure opens door to hostile takeover
• Management failure closes door to further professional opportunities
• Inefficiency places firm’s products at competitive disadvantage
18-20
Managerial Economics and Organizational Architecture, 5e
Sarbanes-Oxley Act of 2002
• Establishes Public Companies Accounting Oversight Board
• Prohibits certain transactions between companies and managers
• Holds CEOs and CFOs accountable for financial statements
• Establishes civil and criminal penalties for violations
18-21
Managerial Economics and Organizational Architecture, 5e
Chapter 18 Appendix
Legal Forms of Organization
Managerial Economics and Organizational Architecture, 5e
Organizational Form
• For profit• Residual claimants
• Nonprofit• Nondistribution constraint
18-23
Managerial Economics and Organizational Architecture, 5e
For-profit Organizations
• Individual proprietorships
• General partnerships
• Limited liability partnerships
• Limited partnerships
• S corporations
• C corporations
18-24
Managerial Economics and Organizational Architecture, 5e
Individual Proprietorships
• Resolve owner-top management conflict
• Limited ability to raise capital
• Income passes through to owner’s tax return
18-25
Managerial Economics and Organizational Architecture, 5e
General Partnership
• Income passes through to partners’ individual tax returns
• Partners exposed individually and jointly to unlimited liability• fosters mutual monitoring
• Take advantage of teamwork opportunities
18-26
Managerial Economics and Organizational Architecture, 5e
S Corporation
• Attractive choice for some small companies
• Same tax treatment as proprietorships and partnerships
• Limited liability
• Entails incorporation fees
• Lenders still require personal guarantees
18-27
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