managerial economics and organizational architecture, 5e managerial economics and organizational...

Managerial Economics and Organizational Architecture, 5e


Chapter 18: Corporate Governance

McGraw-Hill/IrwinCopyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.


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

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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

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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

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Corporate Governance Objectives• Maximizing value

• Protecting assets

• Production of proper financial statements that meet legal requirements

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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

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Top-level ArchitectureUS corporations

• Decision rights divided among selected stakeholders• Shareholders• Governing board• Top management• External monitors

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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

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Shareholders

• Ultimate owners

• Limited participation in management– Elect board– Board oversees management– Some ratification rights

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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

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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

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Board of Directors

• Fiduciary responsibilities– Represent the interests of the corporation and

shareholders– Good faith efforts– Loyalty

• Legal protection through business judgment rule

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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

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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

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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

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Top Management

• CEO often deals with investor relations, media, and customers

• COO manages internal operations

• CFO supervises senior financial managers

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Top Management Incentives

• Straight salary

• Performance-based compensation– Bonuses– Stock options– Stock ownership

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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

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International Corporate Governance

• Historical emphasis on broader set of stakeholders– Employees– Lenders– Affiliated companies– Broader public

• Gradual shift toward US architecture

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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

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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

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Chapter 18 Appendix

Legal Forms of Organization


Organizational Form

• For profit• Residual claimants

• Nonprofit• Nondistribution constraint

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For-profit Organizations

• Individual proprietorships

• General partnerships

• Limited liability partnerships

• Limited partnerships

• S corporations

• C corporations

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Individual Proprietorships

• Resolve owner-top management conflict

• Limited ability to raise capital

• Income passes through to owner’s tax return

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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

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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

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C Corporations

• Attractive for large companies

• Easier to raise capital

• Shareholders subject to “double taxation”

• Limited liability for shareholders

• Small risk-bearing costs• shareholders have diversified portfolios

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managerial economics and organizational architecture, 5e managerial economics and organizational...

Documents

organizational architecture

e managerial economics

organizational structure

e chapter

e corporate ownership

e separation of ownership

management elect board

e government impacts