Chap. 1 corporate governance in international businessPresentation Transcript
Chapter 1 - Corporate Governance in InternationalBusiness:Concepts and MechanismsCorporate Governance = (OECD) is the system by which businesscorporations are directed and control. = specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholder: spells out the rules and procedures for making decisions on corporate affairs. = requires developing internal processes and structures within a firm to minimize agency costs between shareholders. = structures serve to motivate managers to maximize firm value instead of pursuing personal objectives and to ensure thatminority shareholders receive reliable information about the value of the firm and the company’s managers and large shareholdersdo not cheat them out of the value of their investment.
• Effective corporate governance is also important to social welfare. A good corporate governance however goes beyond company standards and effort.• In modern corporations like United States and in United Kingdom a primary objective of corporate governance is to ensure that the interest of top level managers are aligned with the interest of the shareholders.
Agency Theory = implies that entrepreneurs, shareholders, and managers should always find ways to minimize the loss value that arises from the separation of ownership = is directed at the ubiquitous agency relationship, in which one party (the principal) delegates work to another (the agent), who performs that work.
Two Main Problems that are Concerns by the Agency Theory1. The first is the agency problem that arises when: a. The desires or goals of the principal and agent conflict b. It is difficult or expensive for the principal to verify that the agent has behave appropriately2. Risk-sharing problem that arises when the principal and agent have different attitudes toward risk
Corporate Governance in Publicly TradedMNCs generally contains related Tiers: 1. Parent-level corporate governance - how the parent company’s rights, power and responsibilities are divided and monitored. 2. Subsidiary-level corporate governance – how foreign subsidiaries that have their own board of directors deal with their shareholders and other local stakeholders while simultaneously answering to and integrating with the parent firm.
• Subsidiaries with their own board of directors are either independently listed and traded on foreign stock exchanges or they are not listed on exchanges but meet either a host country’s legal requirements or a parent firm’s strategic consideration for establishing such boards.• Subsidiaries with their own board of directors are generally not wholly owned by the parent MNC.
First–tier governance influences the second-tier through ownership holding, operational coordination, corporate support and performance monitoring.Second-tier governance in turn channels back to the first-tier through advice provision, governance sharing, and information reporting and directorate expansion.
First tier governance Parent level•Ownership •Advisingholding agents•Operational •Governancecoordination sharing• Corporate •Informationsupport reporting•Performance •Directoratemonitoring expansion Second tier governance: Subsidiary level
Corporate governance is notsynonymous with organizationalgovernance; it is just part of it.Organizational governance comprises bothmanagerial governance and corporategovernance. Corporate governance involvesgovernance and control of affairs whilemanagerial governance emphasizes thoseinternal processes and structures that regulateoperational decisions and business activitiesundertaken by an MNCs various subunits.
Managerial governance includes thesystem that bring about internal adherence withinthe corporation to a set of strategic goalsdesigned by top management through usingcorporate power or authority. It is a more directintervention involving output monitoring,bureaucratic monitoring and cultural monitoring. Corporate governance that often usesownership concentration, board composition,board leadership, and executive compensation.
Main Distinctions between MNCs and DomesticFirms with Respect to Corporate Governance 1. MNCs must deal with more demanding and more diverse global shareholders and stakeholders 2. MNCs have more complex governance structures that are subject to more institutional and strategic constraints 3. MNCs have multi-tier or multi level governance systems which jointly constitute their overall corporate governance framework
4. MNCs must establish and execute a largernumber of governance mechanisms andinstruments to cope with globalizing needs andcross-country differences in governance norms5. MNCs must configure corporate governancewith a multitude of much more complicatedstrategies, strategies and environments6. MNCs face heterogeneous corporategovernance standards institutionalized bydifferent countries in which they invest andoperate
Mechanisms of Corporate Governance 1. Market-based governance mechanisms includes a. Ownership Concentration = defined by the number of large-block shareholders as well as by the proportion of share they own. Continued cross-border investment means that international institutional investors become increasingly influential or powerful in shaping board and shareholder meetings.
b. Board Composition = proportion of “inside”directors (executive directors) vs. “outside”directors (non-executive directors), also hasstrong implications on corporate because theboard is essentially the “guardian” of theprincipal’s interest. Inside directors participatein the decision processes and are able to accessinside information and can easily influenced bythe CEO in the decision making process. Outsidedirectors can be more effective boards andprofound evaluations of strategic decisions andmanagement behavior than inside directors.
In general, outside directors should becompetent, committed and have character.* Competence includes experience and expertise in both business and management.* Commitment is the availability to fulfill important duties such as learning about the business and company, preparing for meetings and serving on committees.* Character involves possessing a good personality, vision, enthusiasm, moral integrity, and interpersonal skills.
c. Market Discipline = it is an externalmechanisms, namely an open market forcorporate control, which becomes active whena firms internal control fail, its performance ispoor, and /or its management is ineffective.For example, poor market performance as wellas weak corporate governance of Peoples ofled to Oracles $9.2 billion hostile takeover bidin 2004. a more globalized company is likelyto be watched by more companies around theworld.
Put alternatively, there will be morepotential buyers interested in taking over thispoor performing firm. Despite its poorfinancial performance for years somepowerful companies from other countriesmay initiate a hostile takeover to acquire thecompany in trouble. Such takeover could be amore cost effective way for foreigncompanies to acquire some strategic assets ofother company in a target host country.
d. Board Chairmanship = involves whether or not a firm’s CEO is also the board of directors chairperson. The central role of the chairperson is to monitor top management behavior, this sort of CEO “duality” is likely to seriously hinder management accountability and may inhibit the board’s ability to function properly as an independent body. Agency theory advocates the separation of these two positions to protect shareholder.
Implications of Chairmanship inInternational Expansion:• As an MNC globalizes, a board chairperson’s international experience becomes more important• As an MNC’s global operations become significantly complex, there will be a greater pressure the MNC’s CEO from board chairmanship
e. Board Size = Drawbacks when boards are either too small or too large. Too small implies a higher agency cost since CEO is better able to influence board meetings and decisions; the board also suffers from a shortage of services and expertise. When a board is too large, despite having a bigger and more diversified pool of expertise and resources, it is also more likely to have factions that increase group conflict.
f. Management Remuneration = can beeither behavior-based or outcome-based.Behavior-based performance is agovernance mechanism that seeks to align theinterests of managers and owners throughsalaries, bonuses, and long-term incentivecompensations such as stock awards andoption. Outcome-based compensation plansthat reward the agent’s performance instead ofaction are preferred.
Agreed Compensation Standards Across Countries: • Executive remuneration should reflect executive responsibilities • Remuneration should be reasonable and comparable with market standards • Incentives schemes should be clearly linked to performance benchmarks
Culture-based governance• Market-based governance mechanisms are necessary but instilling the right culture to support corporate governance is essential. Culture-based governance which comprises (i)governance culture (ii) corporate integrity, sets the moral tone for governance and accountability.• Governance culture refers to the statements, visions, slogans, values, role models and social rituals that are unique to, and used by, an MNC board members and key executive.
• Vision and commitment from key executive and board members also play a significant role in improving governance and accountability.• Ethical leadership sets moral standards for the organization.• Role models sets a positive ethical climate because humans as social beings are influence by the other humans and generally strive to ‘fit in’.
• Governance and accountability also necessitate corporate integrity which is concerned with the disposition and behavior directed at realizing the wholeness of the organization. Apart from a formal structure to educate, detect and rectify illicit behaviors, an organization may also established committees to improved governance and transparency; these committees can draft codes of conduct and educate and train on compliance procedures. Lastly, transparency throughout an entire organization reduces the opportunity for employees to engage in illicit behaviors.
Discipline based governanceIt comprises the following:(i) executive penalty(ii) internal auditing(iii) conduct code(iv) ethics program first, executive compensation is not enough to monitor and control agents action, it also requires an executive penalty scheme. Financial or non financial penalties for non performance can be alternatives or supplements to incentive schemes.
•Penalties may include base salaryreduction or freeze, bonus elimination,fine payment, power downsizing andmost harshly total dismissal. With suchpenalties in place, agents are less likelyto gamble with the firms assets. Thus,penalties can help better align theinterest of shareholders and management
• Independent auditing of corporate affairs isa prerequisite for discipline-basedgovernance: internal and externalindependent auditing can identify misconductthat can be penalized. External auditorsshould be appointed not by the managementbut by shareholders in their general meeting.The auditing committee should monitor theintegrity of the financial statements, reviewsignificant financial reporting judgments andattempt to identify any misconduct beyondfinancial statements.
• Conduct codes make expectations aboutlegal and ethical behavior clear, increase thelikelihood of detection, assure thepunishments of transgressions, reward desirebehaviors and discipline those who engage inillegal behavior.• Codes may contain general precepts,mandate specific practices, provide clearlystated provisions to address legalities, dealwith ethical concerns and stipulate methodsof investigation.
• Lastly, ethics program are organizationalcontrol systems that encourage shared ethicalgoals and rule compliance. It is important not todelegate too much discretionary authorityoffshore executive in case they are prone toengaging in misconduct. For a reportingmechanism to be effective it should beaccompanied by adequate policies onconfidentially and non realization in order tofoster open communication when ordinarychannels fail.