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Strategic management


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Strategic management

  1. 1. STRATEGIC MANAGEMENT UNIT I NOTES STRATEGY AND PROCESSINTRODUCTION Strategy word derives from the greek word stratçgos, which derives from twowords: stratos (army) and ago (ancient greek for leading). Stratçgos referred to a ‘militarycommander’ during the age of Athenian Democracy. Strategy - originally a military term, in a business planning context strategy/strategicmeans/pertains to why and how the plan will work, in relation to all factors of influenceupon the business entity and activity, particularly including competitors (thus the use of amilitary combative term), customers and demographics, technology and communicationsLEARNING OBJECTIVESAfter learning this unit you must be able to: • Understand the concepts of strategic management • Analyze the strategic formation process • Explain the strategic planning process • Describe the role of corporate governance • Know the corporate governance responsibilities for society1.1 CONCEPTUAL FRAMEWORK FOR STRATEGIC MANAGEMENTDefinition of strategyJohnson and Scholes (Exploring Corporate Strategy) define strategy as follows: “Strategy is the direction and scope of an organization over the long-term: whichachieves advantage for the organization through its configuration of resources within a 1 ANNA UNIVERSITY CHENNAI
  2. 2. DBA 1703 challenging environment, to meet the needs of markets and to fullfil stakeholder NOTES expectations”. In other words, strategy is about: ∗ Where is the business trying to get to in the long-term (direction) ∗ Which markets should a business compete in and what kind of activities is involved in such markets? (markets; scope) ∗ How can the business perform better than the competition in those markets? (Advantage)? ∗ What resources (skills, assets, finance, relationships, technical competence, and facilities) are required in order to be able to compete? (Resources)? ∗ What external, environmental factors affect the businesses’ ability to compete? (Environment)? ∗ What are the values and expectations of those who have power in and around the business? (stakeholders) 1.2 THE CONCEPT OF STRATEGIC MANAGEMENT Strategic management is the art and science of formulating, implementing and evaluating cross-functional decisions that will enable an organization to achieve its objectives. It is the process of specifying the organization’s objectives, developing policies and plans to achieve these objectives, and allocating resources to implement the policies and plans to achieve the organization’s objectives. Strategic management, therefore, combines the activities of the various functional areas of a business to achieve organizational objectives. It is the highest level of managerial activity, usually formulated by the Board of Directors and performed by the organization’s Chief Executive Officer (CEO) and executive team. Strategic management provides overall direction to the enterprise and is closely related to the field of organization Studies. “Strategic management is an ongoing process that assesses the business and the industries in which the company is involved; assesses its competitors and sets goals and strategies to meet all existing and potential competitors; and then reassesses each strategy annually or quarterly [i.e. regularly] to determine how it has been implemented and whether it has succeeded or needs replacement by a new strategy to meet changed circumstances, 2 ANNA UNIVERSITY CHENNAI
  3. 3. STRATEGIC MANAGEMENTnew technology, new competitors, a new economic environment., or a new social, financial,or political environment.” (Lamb, 1984:ix) NOTES1.3 BIRTH OF STRATEGIC MANAGEMENT Strategic management as a discipline originated in the 1950s and 60s. Althoughthere were numerous early contributors to the literature, the most influential pioneers wereAlfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and Peter Drucker. Alfred Chandler recognized the importance of coordinating the various aspectsof management under one all-encompassing strategy. Prior to this time the various functionsof management were separate with little overall coordination or strategy. Interactionsbetween functions or between departments were typically handled by a boundary position,that is, there were one or two managers that relayed information back and forth betweentwo departments. Chandler also stressed the importance of taking a long term perspectivewhen looking to the future. In his 1962 groundbreaking work Strategy and Structure,Chandler showed that a long-term coordinated strategy was necessary to give a companystructure, direction, and focus. He says it concisely, “structure follows strategy.” In 1957, Philip Selznick introduced the idea of matching the organization’s internalfactors with external environmental circumstances. This core idea was developed intowhat we now call SWOT anlysis by Learned, Andrews, and others at the Harvard BusinessSchool General Management Group. Strengths and weaknesses of the firm are assessedin light of the opportunities and threats from the business environment. Igor Ansoff built on Chandler’s work by adding a range of strategic concepts andinventing a whole new vocabulary. He developed a strategy grid that compared marketpenetration strategies, product development strategies, market development strategies andhorizontal and vertical integration and diversification strategies. He felt that managementcould use these strategies to systematically prepare for future opportunities and challenges.In his 1965 classic Corporate Strategy, he developed the gap analysis still used today inwhich we must understand the gap between where we are currently and where we wouldlike to be, then develop what he called “gap reducing actions”. Peter Drucker was a prolific strategy theorist, author of dozens of managementbooks, with a career spanning five decades. His contributions to strategic management 3 ANNA UNIVERSITY CHENNAI
  4. 4. DBA 1703 were many but two are most important. Firstly, he stressed the importance of objectives. NOTES An organization without clear objectives is like a ship without a rudder. As early as 1954 he was developing a theory of management based on objectives. This evolved into his theory of management by objectives (MBO). According to Drucker, the procedure of setting objectives and monitoring your progress towards them should permeate the entire organization, top to bottom. His other seminal contribution was in predicting the importance of what today we would call intellectual capital. He predicted the rise of what he called the “knowledge worker” and explained the consequences of this for management. He said that knowledge work is non-hierarchical. Work would be carried out in teams with the person most knowledgeable in the task at hand being the temporary leader. In1985, Ellen-Earle Chaffee summarized what she thought were the main elements of strategic management theory by the 1970s: • Strategic management involves. adapting the organization to its business environment. • Strategic management is fluid and complex Change creates novel combinations of circumstances requiring unstructured non-repetitive responses. • Strategic management affects the entire organization by providing direction. • Strategic management involves both strategy formation (she called it content) and also strategy implementation (she called it process). • Strategic management is partially planned and partially unplanned. • Strategic management is done at several levels: overall corporate strategy, and individual business strategies. • Strategic management involves both conceptual and analytical thought processes. 1.4 STRATEGIC ANALYSIS This is all about the analyzing the strength of businesses’ position and understanding the important external factors that may influence that position. The process of Strategic Analysis can be assisted by a number of tools, including: 4 ANNA UNIVERSITY CHENNAI
  5. 5. STRATEGIC MANAGEMENT NOTESPEST Analysis - a technique for understanding the “environment” in which a businessoperatesScenario Planning - a technique that builds various plausible views of possible futuresfor a businessFive Forces Analysis - a technique for identifying the forces which affect the level ofcompetition in an industryMarket Segmentation - a technique which seeks to identify similarities and differencesbetween groups of customers or usersDirectional Policy Matrix - a technique which summarizes the competitive strength of abusinesses operations in specific marketsCompetitor Analysis - a wide range of techniques and analysis that seeks to summariesa businesses’ overall competitive positionCritical Success Factor Analysis - a technique to identify those areas in which a businessmust outperform the competition in order to succeedSWOT Analysis - a useful summary technique for summarizing the key issues arising froman assessment of a businesses “internal” position and “external” environmental influences. 5 ANNA UNIVERSITY CHENNAI
  6. 6. DBA 1703 1.5 BENEFITS OF STRATEGIC MANAGEMENT NOTES Studies have revealed that organizations following strategic management have out performed those that do not. Strategic planning ensures a rational allocation of resources and improves co-ordination between various divisions of the organization. It helps managers to think ahead and anticipate problems before they occur. The main benefit of the planning process is a continuous dialogue about the organisation’s future between the hierarchical levels in the organization. In short, the most highly rated benefits of strategic management are: • Clarity of strategic vision for the organization • Focus on what is strategically important to the organization • Better understanding of the rapidly changing business environment. Strategic management need not always be a formal process. It can begin with answering a few simple questions: 1. Where are we now? 2. In no changes are made, where will we be in the next one year? Next two years? Next three years? Next five years? Are the answers acceptable, if the answers are not acceptable, what actions should the top management take with what results and payoffs. Today, as you know that business is becoming more complex due to rapid changes in environment. It is becoming increasingly difficult to predict the environment accurately. The internal and external environments of organizations are now driven by multitudes of forces that were hitherto nonexistent. Earlier the changes in technology were not so rapid but today the information from all over the globe is pouring in through the computers. The world in fact has shrunk. This has created fierce competition as the customers and stakeholders have become more aware of their rights. Think of yourself as a consumer who has got several alternatives to choose from you as a customer look for real value for your money. You have become aware of quality and cost ratios and then diligently select the products. You are now more demanding for better service in the least possible time. This has brought in new rules of business that companies all over the world are evolving through their experience. The obsolence has become so rapid that the time when you are in the process of buying a computer it might 6 ANNA UNIVERSITY CHENNAI
  7. 7. STRATEGIC MANAGEMENThave already become obsolete in some part of the globe. The number of events that affectdomestic and world market are now far too many and too often. NOTES Over reliance on experience in such situations may really work out to be verycostly for companies. (e.g) Reliance has shifted to more creativity, innovation and newways of looking at business and doing it in novel ways. The earlier concept of having highlyfunctionalized departments and developing specialization of labour is losing its credibility.Organizations are becoming more responsive, flexible, and adaptable to changing businesssituations. In such environments that are charged with high level of competition, developingcompetitive edge for survival and growth has become imperative for companies. What doyou think will business strategy concepts and techniques benefit foreign businesses asmuch as domestic firms? Fig1.1 The role of core values, purpose and visionary goals in astrategy formation process The need is now to distinguish between long-range planning and strategic planning.The importance of strategic management in setting the directions for growth of organizationsis being increasingly realized these days. The evolution of objectives after setting directionsfor growth of organisations has become necessary. The technique of strategic managementis used as a major vehicle for planning and implementing major changes in organisation.The implementation of the strategic plans needs good teamwork and understanding of theconcept at grass root Have a look at the difference between the two: 7 ANNA UNIVERSITY CHENNAI
  8. 8. DBA 1703 1.6 VARIOUS APPROACHES OF STRATEGIC MANAGEMENT NOTES In general terms, there are two main approaches, which are opposite but complement each other in some ways, to strategic management: Major approach of strategic management I-The Industrial Organizational Approach Based on economic theory — deals with issues like competitive rivalry, resource allocation, economies of scale Assumptions — rationality, self discipline behaviour, profit maximization II-The Sociological Approach Deals primarily with human interactions Assumptions — bounded rationality, satisfying behaviour, profit sub-optimality. An example of a company that currently operates this way is Google. Strategic management techniques can be viewed as bottom-up, top-down, or collaborative processes. In the bottom-up approach, employees submit proposals to their managers who, in turn, funnel the best ideas further up the organization. This is often accomplished by a capital budgeting process. Proposals are assessed using financial criteria such as return on investment or cost benefit analysis. The proposals that are approved form the substance of a new strategy, all of which is done without a grand strategic design or a strategic architect. The top-down approach is the most common by far. In it, the CEO (such as Don Sheelen, Jeff Bezos and Samuel J. Palmisano) possibly with the assistance of a strategic planning team, decides on the overall direction the company should take. Some organizations are starting to experiment with collaborative strategic planning techniques that recognize the emergent nature of strategic decisions. 8 ANNA UNIVERSITY CHENNAI
  9. 9. STRATEGIC MANAGEMENT1.7 STRATEGY AND STRATEGY FORMATION PROCESS NOTES1.7.1 Strategic Management Processes The strategic management formulation and implementation methods vary withproduct profile, Company profile, environment within and outside the Organization andvarious other factors. Large organizations which use sophisticated planning use detailedstrategic management Models whereas smaller organizations where formality is low usesimpler models. Small businesses concentrate on planning steps compared to largercompanies in the same industry. Large firms have diverse products, operations, markets,and technologies and hence they have to essentially use complex systems. In spite of thefact that companies have different structures, systems, product profiles, etc, variouscomponents of models used for analysis of strategic management are quite similar. Youmust have observed that different thinkers have defined business strategy differently, yetthere are some common elements in the way it is defined and understood. The strategicmanagement consists of different phases, which are sequential in nature. There are four essential phases of strategic management, they are process. Indifferent companies these phases may have different, nomenclatures and the phases mayhave a different sequences,however, the basic content remains same. The four phases can be listed as below. 1. Defining the vision, business mission, purpose, and broad objectives. 2. Formulation of strategies. 3. Implementation of strategies. 4. Evaluation of strategies.These phases are linked to each other in a sequence as shown in It may not be possible to draw a clear line of difference between each phase, andthe change over from one phase to another is gradual. The next phase in the sequence maygradually evolve and merge into the following phase. An important linkage between thephases is established through a feedback mechanism or corrective action. The feedbackmechanism results in a course of action for revising, reformulating, and redefining the pastphase. The process is highly dynamic and compartmentalization of the process is difficult. 9 ANNA UNIVERSITY CHENNAI
  10. 10. DBA 1703 The change over is not clear and boundaries of phases overlap. My purpose to depict this NOTES diagram is to assist you in remembering and recalling it with ease Exhibit Phases of Strategic Management Process Strategic management process that could be followed in a typical organization is presented in .The process takes place in the following stages: 1. The Strategic Planner has to define what is intended to be accomplished (not just desired). This will help in defining the objectives, strategies and policies. 2. In the light of stage I, the results of the current performance of the organization are documented. 10 ANNA UNIVERSITY CHENNAI
  11. 11. STRATEGIC MANAGEMENT 3. The Board of Directors and the top management will have to review the current performance of the documented. NOTES 4. In view of the review, the organization will have to scan the internal environment for strengths and weaknesses and the external environment for opportunities and threats. 5. The internal and external scan helps in selecting the strategic factors. 6. These have to be reviewed and redefined in relation to the Mission and Objectives. 7. At this stage a set of strategic alternatives and generated. 8. The best strategic alternative is selected and implemented through programmed budgets and procedures. 9. Monitoring, evaluation and review of the strategic alternative chosen is undertaken in this mode. This can provide a feedback on the changes in the implementation if required. As can be seen, this provides a rational approach to strategic decision making and it can be successfully practiced by Indian organizations, which now have to operate in a competitive environment.1.7.2 Top Management Decisions On Strategic Issues To establish the vision of the firm, stating of corporate objectives, and strategicthrust areas, defining a comprehensive corporate philosophy and values, identifying thedomains in which an organization would operate, learning and recognizing worldwidebusiness trends, and allocation of resources in line with corporate priorities, are some ofthe key areas wherein top management of organisations take decisions. Let us now look atthe domain of top management? Strategic Issues for Sharing of Concern and Resources tomeet certain specific needs of certain customers, use of common upgraded technologiesby certain business units, deployment of people, physical assets or money from internal orexternal sources and to achieve economics of scale in deployment, certain decisions maybe taken by the management.1.7.3 Strategic Issues Likely To Have Long Term Impact Strategic decisions for implementing a course of action have broad implicationsand long term ramifications and the people of an organisation have to commit themselvesto the decisions and plans for a long period of time. Once a firm takes strategic decisionsand implements the action programs, the impact is seen slowly on its competitive imageand the advantage tied to the particular strategy start pouring in. The companies become 11 ANNA UNIVERSITY CHENNAI
  12. 12. DBA 1703 known in certain markets, products, or technologies or the decisions may adversely affect NOTES the previous progress. In today’s business world, where changes are by leaps and bounds, some organisations may decide for radical changes through reengineering of their business processes to gain strategically better position Strategic Directions are Futuristic Strategies are essentially for the future. Strategic decisions are taken based o forecasts that are in turn based on available data on trends. The managers involved in strategic planning concentrate on developing projections that would take the company to better strategic position. The companies thus become proactive rather than being reactive to business situations. Strategies have Multi Functional and Multi Business Effects Every company has several business units. Strategic decisions are coordinative in nature among all the business units of the company. Many strategic decisions on product mix, competitive edge, organisational structure etc. affect various departments and functions that may be classified as strategic business units (SBUs). Each of these units get affected by the decision taken at the top level, regarding allocation of resources and deployment of personnel etc. So, Business Strategy as a discipline focuses at the organization as one single unit. Strategies are Defined Based on Study of Environment The organisation culture internal to the organisation and also the external environment must be thoroughly scanned and studied to decide on strategies. The interaction between the organisations and the external environment affects both of them. The organisation tends to change the environment and the same environment makes an impact on the organisation. The firms have to define their strategic position with regard to the environment and decide strategies that will take it to the desired position. The firms are part of the system, where customers, stake holders, competitors etc. exist and the firm cannot remain insulated from these determinants of the external environment 1.8 STRATEGY PLANNING PROCESS 1.8.1 Strategic Planning Model Elements In Strategic Management Process Each phase of strategic management process can be viewed to be consisting of a number of elements, which can be clearly defined with input and output relationships. 12 ANNA UNIVERSITY CHENNAI
  13. 13. STRATEGIC MANAGEMENT The steps have logical connectivity and hence these are sequential. These stepscan be illustrated with the help of a flow diagram. The following discrete twelve steps can NOTESbe considered as comprehensive. 1. Defining the vision of the company 2. Defining the mission of the company 3. Determining the purposes or goals 4. Defining the objectives 5. Environment scanning 6. Carrying out corporate appraisal 7. Developing strategic alternatives 8. Selecting a strategy 9. Formulating detailed strategy 10. Preparing a plan 11. Implementing a strategy 12. Evaluating a strategy Figure 1.2 The Strategic Planning Process 13 ANNA UNIVERSITY CHENNAI
  14. 14. DBA 1703 1.8.2 Strategic Management Models NOTES Firstly have a look at the various models which has got relevance to the strategic process. Now think of a firm which in your opinion has been successful over the past 15 years and list down the things you think have attributed to its success: Some of the strategic management models are shown. Now, I will discuss each of the elements of strategic management model. Exhibit Strategic Management Model: • Company vision statement • Company mission statement • Company profile • External environment and internal environment • Evolution strategic choices and selection • Long term objectives • Grand strategy • Annual objective • Functional strategy • Operating policies • Institutionalizing Strategy • Control and evaluation 1.8.3 Working Model Of Strategic Management After looking at the above given fig 1.2, we will now discuss each phase in detail. Vision Let us, now discuss in details the model of strategic management Vision of The Company Vision of a company is rather a permanent statement articulated by the CEO of the company who may be Managing Director, President, Chairman, etc. 14 ANNA UNIVERSITY CHENNAI
  15. 15. STRATEGIC MANAGEMENTThe purpose of a vision statement is to: NOTES 1. Communicate with the people of the organisation and to those who are in some way connected or concerned with the organisation about its very existence in terms of corporate purpose, business scope, and the competitive leadership. 2. Cast a framework that would lead to development of interrelationships between firm and stakeholders viz. employees, shareholders, suppliers, customers, and various communities that may be directly or indirectly involved with the firm. 3. Define broad objective regarding performance of the firm and its growth in various fields vital to the firm. So, lets talk about our own Rai University, find out what is the vision statement and list down various purposes of our vision statement. Vision is a theme which gives a focused view of a company. It is a unifying statementand a vital challenge to all different units of an organisation that may be busy pursuing theirindependent objectives. It consists of a sense of achievable ideals and is a fountain ofinspiration for performing the daily activities. It motivates people of an organisation tobehave in a way which would be congruent with the corporate ethics and values. Manyfirms do not have clear vision statements. An indirect method of knowing whether a firmhas reached the stage of corporate strategic management is emergence of a vision statement.Vision of a firm cannot be high jacked from a company; however, a firm may definitely getinspired by the vision statement of another firm. It has to be evolved after a lot ofdeliberations, brain storming, and thinking. It is pertinent that you as an individual workingin a firm should become an active participant and collaborator in accomplishing corporateobjectives. You must understand and share the vision of the firm because you would haveto contribute in transformation of vision into a reality through his or her actions. Totalbehaviour of people of an organization should get conditioned by the basic framework ofvision. Personal objectives of individuals are very important to them and only to fulfill theseobjectives people join organisations. Vision of a company when translated into action programme must be able to meetpersonal needs of people. This includes the need of achievement also. Vision of a firm thusencompasses personal objectives of people which they try to achieve.Step 1: Name of the companyStep 2: Practices that have made the company successful 15 ANNA UNIVERSITY CHENNAI
  16. 16. DBA 1703 The primary purpose of the strategic management process is to enable companies NOTES to achieve strategic competitiveness and earn above average returns. Researches have indicated that companies that engage in strategic management generally out perform those that do not. The attainment of an appropriate match or fit between a company’s environment and its strategy, structure, and processes has positive effects on the company’s performance. Bruce Henderson, founder of the Boston Consulting Group, pointed out that a company cannot afford to follow intuitive strategies once it becomes large, has layers of management, or its environment changes substantially. As the world’s environment becomes increasingly complex and changing, today’s companies, as one way to make the environment more manageable, use strategic management. Strategic competitiveness is achieved when a company successfully formulates and implements a value creating strategy. By implementing a value creating strategy that current and potential competitors are not simultaneously implementing and that competitors are unable to duplicate, a company achieves a sustained or sustainable competitive advantage. So long as a company can sustain (or maintain) a competitive advantage, investors will earn above average returns. Above average returns represent returns that exceed returns that investors expect to earn from other investments with similar levels of risk (investor uncertainty about the economic gains or losses that will result from a particular investment). In other words, above average returns exceed investors’ expected levels of return for given levels of risk. In the long run, companies must earn at least average returns and provide investors with average returns if they are to survive. If a company earns below average returns and provides investors with below average returns, investors will withdraw their funds and place them in investments that earn at least average returns. Internationally these types of companies are prime take over targets, a concept that is picking up in India. A framework that can assist companies in their quest for strategic competitiveness is the strategic management process, the full set of commitments, decisions and actions required for a company to systematically achieve strategic competitiveness and earn above average. Mission An organization’s mission is the purpose or reason for the organizations existence. A well convinced mission statement defines the fundamental, unique purpose that sets a company apart other firms of its and identifies the scope of the company’s operations in terms of products offered and market served. 16 ANNA UNIVERSITY CHENNAI
  17. 17. STRATEGIC MANAGEMENTObjectives NOTES It is the end results of planned activity. The corporate objectives achievementshould result in the fulfillment of a corporation’s mission.Some of the areas in which corporations might establish its goals and objectives are: • Profitability • Efficiency • Growth • Shareholder wealth • Utilization of resources • Reputation • Contribution to employees • Contribution to society through taxes paid etc.., • Market leadership • Technological leadership • SurvivalStrategyStrategy at Different Levels of a Business Strategies exist at several levels in any organization - ranging from the overallbusiness (or group of businesses) through to individuals working in it. • Corporate Strategy - is concerned with the overall purpose and scope of the business to meet stakeholder expectations. This is a crucial level since it is heavily influenced by investors in the business and acts to guide strategic decision-making throughout the business. Corporate strategy is often stated explicitly in a “mission statement”. • Business Unit Strategy - is concerned more with how a business competes successfully in a particular market. It concerns strategic decisions about choice of products, meeting needs of customers, gaining advantage over competitors, exploiting or creating new opportunities etc. 17 ANNA UNIVERSITY CHENNAI
  18. 18. DBA 1703 • Operational Strategy - is concerned with how each part of the business is NOTES organized to deliver the corporate and business-unit level strategic direction. Operational strategy therefore focuses on issues of resources, processes, people etc. Policies A Policy is a broad guideline for decision making that links the formulation of strategy with its implementation Programs A program is a statement of the activities or steps needed to accomplish a single use plan. It makes the strategy action oriented. Budgets A Budget is a statement of a corporation’s programs in term of dollars/money Used in planning and control, a budget lists the detailed cost of each program. Procedures It is a system of sequential steps or techniques that describe in detail how a particular task or job is to be done. 1.9 MINTZBERG’S MODES OF STRATEGIC DECISION MAKING • Entrepreneurial Mode • Adaptive Mode • Planning Mode • Logical Incrementalism 1.10 CORPORATE GOVERNANCE & SOCIAL RESPONSIBILITY Corporate governance is the set of processes, customs, policies, laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate 18 ANNA UNIVERSITY CHENNAI
  19. 19. STRATEGIC MANAGEMENTgovernance also includes the relationship stakeholders among the many players involved(the stakeholders) and the goals for which the corporation is governed. The principal NOTESplayers are the shareholders, management and the board of directors. Other stakeholdersinclude employees, suppliers, customers, banks and other lenders, regulators, theenvironment and the community at large. Corporate governance is a multi-faceted subject. An important theme of corporategovernance is to ensure the accountability of the impact of a corporate governance systemin economic efficiency, with a strong emphasis on shareholders welfare. There are yetother aspects to the corporate governance subject, such as the stake holder view andcertain individuals in an organization through mechanisms that try to reduce or eliminate theprincipal –agent problem. A related but separate thread of discussions focus on the corporategovernance models around the world.1.10.1 Definition Of Corporate Governance In A Board Culture of Corporate Governance business author GabrielleO’Donovan defines corporate governance as ‘an internal system encompassing policies,processes and people, which serves the needs of shareholders and other stakeholders, bydirecting and controlling management activities with good business savvy, objectivity andintegrity. Sound corporate governance is reliant on external marketplace commitment andlegislation, plus a healthy board culture which safeguards policies and processes’. O’Donovan goes on to say that ‘the perceived quality of a company’s corporategovernance can influence its share price as well as the cost of raising capital. Quality isdetermined by the financial markets, legislation and other external market forces plus theinternational organisational environment; how policies and processes are implemented andhow people are led. External forces are, to a large extent, outside the circle of control ofany board. The internal environment is quite a different matter, and offers companies theopportunity to differentiate from competitors through their board culture. To date, toomuch of corporate governance debate has centred on legislative policy, to deter fraudulentactivities and transparency policy which misleads executives to treat the symptoms and notthe cause. Corporate Governance is a system of structuring, operating and controlling acompany with a view to achieve long term strategic goals to satisfy shareholders, creditors, 19 ANNA UNIVERSITY CHENNAI
  20. 20. DBA 1703 employees, customers and suppliers, and complying with the legal and regulatory NOTES requirements, apart from meeting environmental and local community needs. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.” The definition is drawn from Gandhian principle of Trusteeship and Directive Principle of constitution. Corporate Governance is viewed as ethics and a moral duty. 1.10.2 History Of Corporate Governance In the 19th century, state corporation law enhanced the rights of corporate boards to govern without unanimous consent of shareholders in exchange for statutory benefits like appraisal rights, to make corporate governance more efficient. Since that time, and because most large publicly traded corporations in the US are incorporated under corporate administration friendly Delaware law, and because the US’s wealth has been increasingly securitized into various corporate entities and institutions, the rights of individual owners and shareholders have become increasingly derivative and dissipated. The concerns of shareholders over administration pay and stock losses periodically has led to more frequent calls for corporate governance reforms. In the 20th century in the immediate aftermath of the Wall Street Crash of 1929 legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means pondered on the changing role of the modern corporation in society. Berle and Means’ monograph “The Modern Corporation and Private Property” (1932, Macmillan) continues to have a profound influence on the conception of corporate governance in scholarly debates today. From the Chicago school of economics, Ronald Coase’s “Nature of the Firm” (1937) introduced the notion of transaction costs into the understanding of why firms are founded and how they continue to behave. Fifty years later, Eugene Fama and Michael Jensen’s “The Separation of Ownership and Control” (1983, Journal of Law and Economics) firmly established agency theory as a way of understanding corporate 20 ANNA UNIVERSITY CHENNAI
  21. 21. STRATEGIC MANAGEMENTgovernance: the firm is seen as a series of contracts. Agency theory’s dominance washighlighted in a 1989 article by Kathleen Eisenhardt (Academy of Management Review). NOTES US expansion after World War II through the emergence of multinationalcorporations saw the establishment of the managerial class. Accordingly, the followingHarvard Business School Management professors published influential monographs studyingtheir prominence: Myles Mace (entrepreneurship), Alfred D Chandler, Jr (business history),Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior).According to Lorsch and MacIver “many large corporations have dominant control overbusiness affairs without sufficient accountability or monitoring by their board of directors.” Since the late 1970’s, corporate governance has been the subject of significantdebate in the U.S. and around the globe. Bold, broad efforts to reform corporate governancehave been driven, in part, by the needs and desires of shareowners to exercise their rightsof corporate ownership and to increase the value of their shares and, therefore, wealth.Over the past three decades, corporate directors’ duties have expanded greatly beyondtheir traditional legal responsibility of duty of loyalty to the corporation and its shareowners. In the first half of the 1990s, the issue of corporate governance in the U.S. receivedconsiderable press attention due to the wave of CEO dismissals (e.g.: IBM, Kodak, Honeywell) by their boards. CALERS led a wave of institutional shareholder activism (somethingonly very rarely seen before), as a way of ensuring that corporate value would not bedestroyed by the now traditionally cozy relationships between the CEO and the board ofdirectors (e.g., by the unrestrained issuance of stock options, not infrequently back dated). In 1997, the East Asian Financial Crisis saw the economies of Thailand, Indonesia,South Korea, Malaysia and The Philippines severely affected by the exit of foreign capitalafter property assets collapsed. The lack of corporate governance mechanisms in thesecountries highlighted the weaknesses of the institutions in their economies. In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enronand Worldcom, as well as lesser corporate debacles, such as AldelphiaCommunications,AOL, Arthur Andersen, Global Crossing Tyco, and, more recently, FannieMae and Freddie Mac, led to increased shareholder and governmental interest in corporategovernance. This culminated in the passage of the Sarbanes-Oxley Act of 2002. But, sincethen, the stock market has greatly recovered, and shareholder zeal has waned accordingly. 21 ANNA UNIVERSITY CHENNAI
  22. 22. DBA 1703 1.10.3 Impact Of Corporate Governance NOTES Positive effect of good corporate governance on different stakeholders ultimately results into strong economy and hence good corporate governance is tool for socio- economic development. After East Asia economy collapse in late 20th century, World Bank president warned those countries, that for sustainable development, corporate governance is must to be good. Economic health of a nation depends substantially how sound and ethical businesses are. Enlightened Corporate Governance Corporate governance, the unwieldy name given to the systems that guide the control and management of corporations, is a relatively recent term that came into being in the 1970s. Because corporate governance structures and processes specify the various roles and duties of corporate directors, senior executives, shareholders, and other stakeholders in the corporation, they play a large role in determining how responsible and accountable a corporation’s leaders will be in exercising their authority. When properly designed, governance processes guide companies toward useful objectives and help them monitor and measure their progress in achieving those objectives; when poorly designed, these processes permit companies to drift toward painful losses for shareholders and everyone else with a stake in the company. A company’s corporate governance—whether good or bad—is established by its board of directors. Ideally, these directors will be energetic, experienced people deeply concerned about the company’s welfare. Because the board’s most pivotal responsibilities are to hire and supervise the company’s chief executive officer (CEO), these directors should not be company employees who work under the CEO’s direction; instead, they should be independent of the company’s management. When independent directors know how to work effectively with the company’s senior management team, they are likely to produce a corporate climate that accelerates the growth of long-term shareholder value. Role of Institutional Investors Many years ago, worldwide, buyers and sellers of corporation stocks were individual investors, such as wealthy businessmen or families, who often had a vested, personal and emotional interest in the corporations whose shares they owned. Over time, 22 ANNA UNIVERSITY CHENNAI
  23. 23. STRATEGIC MANAGEMENTmarkets have become largely institutionalized: buyers and sellers are largely institutions(e.g., pension funds, insurance companies, mutual funds, hedge funds, investor groups, NOTESand banks). The rise of the institutional investor has brought with it some increase of professionaldiligence which has tended to improve regulation of the stock market (but not necessarilyin the interest of the small investor or even of the naïve institutions, of which there aremany). Note that this process occurred simultaneously with the direct growth of individualsinvesting indirectly in the market (for example individuals have twice as much money inmutual funds as they do in bank accounts). However this growth occurred primarily byway of individuals turning over their funds to ‘professionals’ to manage, such as in mutualfunds. In this way, the majority of investment now is described as “institutional investment”even though the vast majority of the funds are for the benefit of individual investors. Program trading, the hallmark of institutional trading, is averaging over 60% a dayin 2007. Unfortunately, there has been a concurrent lapse in the oversight of largecorporations, which are now almost all owned by large institutions. The Board of Directorsof large corporations used to be chosen by the principal shareholders, who usually had anemotional as well as monetary investment in the company (think Ford), and the Boarddiligently kept an eye on the company and its principal executives (they usually hired andfired the President, or Chief Executive Officer— CEO). Nowadays, if the owning institutions don’t like what the President/CEO is doingand they feel that firing them will likely be costly (think “golden handshake”) and/or timeconsuming, they will simply sell out their interest. The Board is now mostly chosen by thePresident/CEO, and may be made up primarily of their friends and associates, such asofficers of the corporation or business colleagues. Since the (institutional) shareholdersrarely object, the President/CEO generally takes the Chair of the Board position for his/herself (which makes it much more difficult for the institutional owners to “fire” him/her).Occasionally, but rarely, institutional investors support shareholder resolutions on suchmatters as executive pay and anti-takeover measures. Finally, the largest pools of invested money (such as the mutual fund ‘Vanguard500’, or the largest investment management firm for corporations, State Street Corp) aredesigned simply to invest in a very large number of different companies with sufficientliquidity, based on the idea that this strategy will largely eliminate individual company financial 23 ANNA UNIVERSITY CHENNAI
  24. 24. DBA 1703 or other risk and, therefore, these investors have even less interest in a particular company’s NOTES governance. Since the marked rise in the use of Internet transactions from the 1990’s, both individual and professional stock investors around the world have emerged as a potential new kind of major (short term) force in the direct or indirect ownership of corporations and in the markets: the casual participant. Even as the purchase of individual shares in any one corporation by individual investors diminishes, the sale of derivatives (e.g., exchange traded funds (ETFs), Stock market index options, etc.) has soared. So, the interests of most investors are now increasingly rarely tied to the fortunes of individual corporations. But, the ownership of stocks in markets around the world varies; for example, the majority of the shares in the Japanese market are held by financial companies and industrial corporations (there is a large and deliberate amount of cross-holding among Japanese keirestu corporations and within S. Korean chaebol ‘groups’), whereas stock in the USA or the UK and Europe are much more broadly owned, often still by large individual investors. 1.10.4 Parties To Corporate Governance Parties involved in corporate governance include the regulatory body (e.g. the Chief Executive Officer, the board of directors, management and shareholders). Other stakeholders who take part include suppliers, employees, creditors, customers and the community at large. In corporations, the shareholder delegates decision rights to the manager to act in the principal’s best interests. This separation of ownership from control implies a loss of effective control by shareholders over managerial decisions. Partly as a result of this separation between the two parties, a system of corporate governance controls is implemented to assist in aligning the incentives of managers with those of shareholders. With the significant increase in equity holdings of investors, there has been an opportunity for a reversal of the separation of ownership and control problems because ownership is not so diffuse. A board of directors often plays a key role in corporate governance. It is their responsibility to endorse the organisation’s strategy, develop directional policy, appoint, 24 ANNA UNIVERSITY CHENNAI
  25. 25. STRATEGIC MANAGEMENTsupervise and remunerate senior executives and to ensure accountability of the organisationto its owners and authorities. NOTES The Company Secretary, known as a Corporate Secretary in the US and oftenreferred to as a Chartered Secretary if qualified by the Institute of Charted Secretaries andAdministrators (ICSA), is a high ranking professional who is trained to uphold the higheststandards of corporate governance, effective operations, compliance and administration. All parties to corporate governance have an interest, whether direct or indirect, inthe effective performance of the organisation. Directors, workers and management receivesalaries, benefits and reputation, while shareholders receive capital return. Customers receivegoods and services; suppliers receive compensation for their goods or services. In returnthese individuals provide value in the form of natural, human, social and other forms ofcapital. A key factor in an individual’s decision to participate in an organisation e.g. throughproviding financial capital and trust that they will receive a fair share of the organisationalreturns. If some parties are receiving more than their fair return then participants maychoose to not continue participating leading to organizational collapse.1.10.5 Principles Of Corporate Governance Key elements of good corporate governance principles include honesty, trust andintegrity, openness, performance orientation, responsibility and accountability, mutualrespect, and commitment to the organization. Of importance is how directors and management develop a model of governancethat aligns the values of the corporate participants and then evaluate this model periodicallyfor its effectiveness. In particular, senior executives should conduct themselves honestlyand ethically, especially concerning actual or apparent conflicts of interests, and disclosurein financial reports.Commonly accepted principles of corporate governance include: • Rights and equitable treatment of shareholders: Organizations should respect the rights of shareholders and help shareholders to exercise those rights. They can 25 ANNA UNIVERSITY CHENNAI
  26. 26. DBA 1703 help shareholders exercise their rights by effectively communicating information NOTES that is understandable and accessible and encouraging shareholders to participate in general meetings. • Interests of other stakeholders: Organizations should recognize that they have legal and other obligations to all legitimate stakeholders. • Role and responsibilities of the board: The board needs a range of skills and understanding to be able to deal with various business issues and have the ability to review and challenge management performance. It needs to be of sufficient size and have an appropriate level of commitment to fulfill its responsibilities and duties. There are issues about the appropriate mix of executive and non-executive directors. The key roles of Chairperson and CEO should not be held by the same person. • Integrity and ethical behaviour: Organizations should develop a code of conduct for their directors and executives that promotes ethical and responsible decision making. It is important to understand, though, that systemic reliance on integrity and ethics is bound to eventual failure. Because of this, many organizations establish Compliance and Ethics Programs to minimize the risk that the firm steps outside of ethical and legal boundaries. • Disclosure and transparency: Organizations should clarify and make publicly known the roles and responsibilities of board and management to provide shareholders with a level of accountability. They should also implement procedures to independently verify and safeguard the integrity of the company’s financial reporting. Disclosure of material matters concerning the organization should be timely and balanced to ensure that all investors have access to clear, factual information. Issues involving corporate governance principles include: • oversight of the preparation of the entity’s financial statements • internal controls and the independence of the entity’s auditors • review of the compensation arrangements for the chief executive officer and other senior executives • the way in which individuals are nominated for positions on the board • the resources made available to directors in carrying out their duties • oversight and management of risk • dividend policy 26 ANNA UNIVERSITY CHENNAI
  27. 27. STRATEGIC MANAGEMENT1.10.6 Mechanisms And Controls NOTES Corporate governance mechanisms and controls are designed to reduce theinefficiencies that arise from morald hazard and adverse selection. For example, to monitormanagers’ behaviour, an independent third party (the auditor) attests the accuracy ofinformation provided by management to investors. An ideal control system should regulateboth motivation and ability.Internal corporate governance controls Internal corporate governance controls monitor activities and then take correctiveaction to accomplish organisational goals. Examples include: • Monitoring by the board of directors: The board of directors, with its legal authority to hire, fire and compensate top management, safeguards invested capital. Regular board meetings allow potential problems to be identified, discussed and avoided. Whilst non-executive directors are thought to be more independent, they may not always result in more effective corporate governance and may not increase performance. Different board structures are optimal for different firms. Moreover, the ability of the board to monitor the firm’s executives is a function of its access to information. Executive directors possess superior knowledge of the decision- making process and therefore evaluate top management on the basis of the quality of its decisions that lead to financial performance outcomes, ex ante. It could be argued, therefore, that executive directors look beyond the financial criteria. • Remuneration: Performance-based remuneration is designed to relate some proportion of salary to individual performance. It may be in the form of cash or non-cash payments such as shares and share options, superannuation or other benefits. Such incentive schemes, however, are reactive in the sense that they provide no mechanism for preventing mistakes or opportunistic behaviour, and can elicit myopic behaviour.External corporate governance controls External corporate governance controls encompass the controls externalstakeholders exercise over the organisation. Examples include: 27 ANNA UNIVERSITY CHENNAI
  28. 28. DBA 1703 • debt covenants NOTES • government regulations • media pressure • takeovers • competition • managerial labour market • telephone tapping 1.10.7 Systemic Problems Of Corporate Governance • Supply of accounting information: Financial accounts form a crucial link in enabling providers of finance to monitor directors. Imperfections in the financial reporting process will cause imperfections in the effectiveness of corporate governance. This should, ideally, be corrected by the working of the external auditing process. • Demand for information: A barrier to shareholders using good information is the cost of processing it, especially to a small shareholder. The traditional answer to this problem is the efficient market hypothesis (in finance, the efficient market hypothesis (EMH) asserts that financial markets are efficient), which suggests that the shareholder will free ride on the judgements of larger professional investors. • Monitoring costs: In order to influence the directors, the shareholders must combine with others to form a significant voting group which can pose a real threat of carrying resolutions or appointing directors at a general meeting. Role of the Accountant Financial reporting is a crucial element necessary for the corporate governance system to function effectively. Accountants and Auditors are the primary providers of information to capital market participants. The directors of the company should be entitled to expect that management prepare the financial information in compliance with statutory and ethical obligations, and rely on auditors’ competence. Current accounting practice allows a degree of choice of method in determining the method of measurement, criteria for recognition, and even the definition of the accounting entity. The exercise of this choice to improve apparent performance (popularly known as 28 ANNA UNIVERSITY CHENNAI
  29. 29. STRATEGIC MANAGEMENTcreative accounting) imposes extra information costs on users. In the extreme, it can involvenon-disclosure of information. NOTES. One area of concern is whether the accounting firm acts as both the independentauditor and management consultant to the firm they are auditing. This may result in a conflictof interest which places the integrity of financial reports in doubt due to client pressure toappease management. The power of the corporate client to initiate and terminatemanagement consulting services and, more fundamentally, to select and dismiss accountingfirms contradicts the concept of an independent auditor. Changes enacted in the UnitedStates in the form of the Sarbanes-Oxley Act (in response to the Enron situation as notedbelow) prohibit accounting firms from providing both auditing and management consultingservices. Similar provisions are in place under clause 49 of SEBI Act in India. The Enron collapse is an example of misleading financial reporting. Enron concealedhuge losses by creating illusions that a third party was contractually obliged to pay theamount of any losses. However, the third party was an entity in which Enron had a substantialeconomic stake. In discussions of accounting practices with Arthur Andersen, the partnerin charge of auditing, views inevitably led to the client prevailing. However, good financial reporting is not a sufficient condition for the effectivenessof corporate governance if users don’t process it, or if the informed user is unable toexercise a monitoring role due to high costs.Rules versus principles Rules are typically thought to be simpler to follow than principles, demarcating aclear line between acceptable and unacceptable behaviour. Rules also reduce discretionon the part of individual managers or auditors. In practice rules can be more complex than principles. They may be ill-equippedto deal with new types of transactions not covered by the code. Moreover, even if clearrules are followed, one can still find a way to circumvent their underlying purpose - this isharder to achieve if one is bound by a broader principle. 29 ANNA UNIVERSITY CHENNAI
  30. 30. DBA 1703 Principles on the other hand are a form of self regulation. It allows the sector to NOTES determine what standards are acceptable or unacceptable. It also pre-empts over zealous legislations that might not be practical. Enforcement Enforcement can affect the overall credibility of a regulatory system. They both deter bad actors and level the competitive playing field. Nevertheless, greater enforcement is not always better, for taken too far it can dampen valuable risk-taking. In practice, however, this is largely a theoretical, as opposed to a real, risk. Action Beyond Obligation Enlightened boards regard their mission as helping management lead the company. They are more likely to be supportive of the senior management team. Because enlightened directors strongly believe that it is their duty to involve themselves in an intellectual analysis of how the company should move forward into the future, most of the time, the enlightened board is aligned on the critically important issues facing the company. Unlike traditional boards, enlightened boards do not feel hampered by the rules and regulations of the Sarbanes-Oxley Act. Unlike standard boards that aim to comply with regulations, enlightened boards regard compliance with regulations as merely a baseline for board performance. Enlightened directors go far beyond merely meeting the requirements on a checklist. They do not need Sarbanes-Oxley to mandate that they protect values and ethics or monitor CEO performance. At the same time, enlightened directors recognize that it is not their role to be involved in the day-to-day operations of the corporation. They lead by example. Overall, what most distinguishes enlightened directors from traditional and standard directors is the passionate obligation they feel to engage in the day-to-day challenges and strategizing of the company. Enlightened boards can be found in very large, complex companies, as well as smaller companies. 30 ANNA UNIVERSITY CHENNAI
  31. 31. STRATEGIC MANAGEMENT1.10.8 Corporate Governance Models Around The World NOTES Although the US model of corporate governance is the most notorious, there is aconsiderable variation in corporate governance models around the world. The intricatedshareholding structures of keiretsus in Japan, the heavy presence of banks in the equity ofgerman firms, the chaebols in South Korea and many others are examples of arrangementswhich try to respond to the same corporate governance challenges as in the US. • Anglo-American Model There are many different models of corporate governance around the world. Thesediffer according to the variety of capitalism in which they are embedded. The liberal modelthat is common in Anglo-American countries tends to give priority to the interests ofshareholders. The coordinated model that one finds in Continental Europe and Japan alsorecognizes the interests of workers, managers, suppliers, customers, and the community.Both models have distinct competitive advantages, but in different ways. The liberal modelof corporate governance encourages radical innovation and cost competition, whereas thecoordinated model of corporate governance facilitates incremental innovation and qualitycompetition. However, there are important differences between the U.S. recent approachto governance issues and what has happened in the U.K.. In the United States, a corporation is governed by a board of directors, which hasthe power to choose an executive officer, usually known as the chief executive officer. TheCEO has broad power to manage the corporation on a daily basis, but needs to get boardapproval for certain major actions, such as hiring his/her immediate subordinates, raisingmoney, acquiring another company, major capital expansions, or other expensive projects.Other duties of the board may include policy setting, decision making, monitoringmanagement’s performance, or corporate control. The board of directors is nominally selected by and responsible to the share holders,but the bylaws of many companies make it difficult for all but the largest shareholders tohave any influence over the makeup of the board; normally, individual shareholders are notoffered a choice of board nominees among which to choose, but are merely asked torubberstamp the nominees of the sitting board. Perverse incentives have pervaded manycorporate boards in the developed world, with board members beholden to the chief 31 ANNA UNIVERSITY CHENNAI
  32. 32. DBA 1703 executive whose actions they are intended to oversee. Frequently, members of the boards NOTES of directors are CEOs of other corporations, which some see as a conflict of interest. The U.K. has pioneered a flexible model of regulation of corporate governance, known as the “comply or explain” code of governance. This is a principle based code that lists a dozen of recommended practices, such as the separation of CEO and Chairman of the Board, the introduction of a time limit for CEOs’ contracts, the introduction of a minimum number of non-executives Directors, of independent directors, the designation of a senior non executive director, the formation and composition of remuneration, audit and nomination committees. Publicly listed companies in the U.K. have to either apply those principles or, if they choose not to, to explain in a designated part of their annual reports why they decided not to do so. The monitoring of those explanations is left to shareholders themselves. The tenet of the Code is that one size does not fit all in matters of corporate governance and that instead of a statuary regime like the Sarbanes-Oxley Act in the U.S., it is best to leave some flexibility to companies so that they can make choices most adapted to their circumstances. If they have good reasons to deviate from the sound rule, they should be able to convincingly explain those to their shareholders. The code has been in place since 1993 and has had drastic effects on the way firms are governed in the U.K. A study by Arcot, Bruno and Faure-Grimaud from the Financial Markets Group at the London School of Economics shows that in 1993, about 10% of the UK companies member of the FTSE 350 were compliants on all dimensions while they were more than 60% in 2003. The same success was not achieved when looking at the explanation part for non compliant companies. Many deviations are simply not explained and a large majority of explanations fail to identify specific circumstances justifying those deviations. Still, the overall view is that the U.K.’s system works fairly well and in fact is often branded as a benchmark, followed by several countries. • Non Anglo-American Model In East Asian countries, family-owned companies dominate. A study by Claessens, Djankov and Lang (2000) investigated the top 15 families in East Asian countries and found that they dominated listed corporate assets. In countries such as Pakistan, Indonesia and the Philippines, the top 15 families controlled over 50% of publicly owned corporations through a system of family cross-holdings, thus dominating the capital markets. Family- owned companies also dominate the Latin model of corporate governance, that is companies 32 ANNA UNIVERSITY CHENNAI
  33. 33. STRATEGIC MANAGEMENTin Mexico, Italy, Spain, France (to a certain extent), Brazil, Argentina, and other countriesin South America. NOTES Europe and Asia exemplify the insider system: Shareholder and stakeholder • asmall number of listed companies, • an illiquid capital market where ownership and controlare not frequently traded • high concentration of shareholding in the hands of corporations,institutions, families or government. • the insider model uses a system of interlockingnetworks and committees. At the same time that developing countries are undergoing a process of economicgrowth and transformation, they are also experiencing a revolution in the business andpolitical relationships that characterize their private and public sectors. Establishing goodcorporate governance practices is essential to sustaining long-term development and growthas these countries move from closed, market-unfriendly, undemocratic systems towardsopen, market-friendly, democratic systems. Good corporate governance systems will alloworganizations to realize their maximum productivity and efficiency, minimize corruption andabuse of power, and provide a system of managerial accountability. These goals are equallyimportant for both private corporations and government bodies. Because of the implicit relationship between private interests and the largergovernment, good corporate governance practices are essential to establishing goodgovernance at the national level in developing countries. A number of ties the keep thepublic and private sectors closely linked. On one hand, judiciary and regulatory bodies aswell as legislatures play a role in corporate management and oversight. At the same timecartels and large corporate interests use their size to exert not only economic, but alsopolitical power. These two sectors are so intertwined that a country cannot significantlychange one without simultaneously instituting changes in the other. According to Nicolas Meisel, there are four priorities which developing countriesshould concentrate on while experimenting with new forms of corporate and publicgovernance. The first is to focus on improving the quality of information and increasing thespeed at which it is created and distributed to the public. Good communication is importantto the functioning of any organization. The second is to allow individual actors more autonomywhile at the same time maintaining or increasing accountability. Thirdly, if a hierarchicalorganization used to orient private activities toward the general interest, new countervailingpowers should be encouraged to fill this role. Finally, the part the state plays and how 33 ANNA UNIVERSITY CHENNAI
  34. 34. DBA 1703 government officials are selected must be considered if a developing economy is to achieve NOTES sustainable growth. This may involve making it easier for newcomers with new ideas incumbents who may hold to older, possibly outdated, models. Codes and guidelines Corporate governance principles and codes have been developed in different countries and issued from stock exchanges, corporations, institutional investors, or associations (institutes) of directors and managers with the support of governments and international organizations. As a rule, compliance with these governance recommendations is not mandated by law, although the codes linked to stock exchange listing requirements may have a coercive effect. For example, companies quoted on the London and Toronto Stock Exchanges formally need not follow the recommendations of their respective national codes. However, they must disclose whether they follow the recommendations in those documents and, where not, they should provide explanations concerning divergent practices. Such disclosure requirements exert a significant pressure on listed companies for compliance. In the United States, companies are primarily regulated by the state in which they incorporate though they are also regulated by the federal government and, if they are public, by their stock exchange. The highest number of companies are incorporated in Delaware, including more than half of the Fortune 500. This is due to Delaware’s generally business-friendly corporate legal environment and the existence of a state court dedicated solely to business issues (Delaware Court of Chancery). Most states’ corporate law generally follow the American Bar Association’s Model Business Corporation Act. While Delaware does not follow the Act, it still considers its provisions and several prominent Delaware justices, including former Delaware Supreme Court Chief Justice E.Norman veasey participate on ABA committees. One issue that has been raised since the Disney decision in 2005 is the degree to which companies manage their governance responsibilities; in other words, do they merely try to supersede the legal threshold, or should they create governance guidelines that ascend to the level of best practice. For example, the guidelines issued by associations of directors (see Section 3 above), corporate managers and individual companies tend to be wholly 34 ANNA UNIVERSITY CHENNAI
  35. 35. STRATEGIC MANAGEMENTvoluntary. For example, The GM Board Guidelines reflect the company’s efforts to improveits own governance capacity. Such documents, however, may have a wider multiplying NOTESeffect prompting other companies to adopt similar documents and standards of best practice. One of the most influential guidelines has been the 1999 OECD Principles ofCorporate Governance. This was revised in 2004. The OECD remains a proponent ofcorporate governance principles throughout the world. The World Business Council for Sustainable Development WBCSD has also donesubstantial work on corporate governance, particularly on accountability and reporting,and in 2004 created an Issue Management Tool: Strategic challenges for business in theuse of corporate responsibility codes, standards, and frame works. This document aims toprovide general information, a “snap-shot” of the landscape and a perspective from athink-tank/professional association on a few key codes, standards and frameworks relevantto the sustainability agenda.1.10.9 Corporate Governance And Firm Performance In its ‘Global Investor Opinion Survey’ of over 200 institutional investors firstundertaken in 2000 and updated in 2002, McKinsey found that 80% of the respondentswould pay a premium for well-governed companies. They defined a well-governed companyas one that had mostly out-side directors, who had no management ties, undertook formalevaluation of its directors, and was responsive to investors’ requests for information ongovernance issues. The size of the premium varied by market, from 11% for Canadiancompanies to around 40% for companies where the regulatory backdrop was least certain(those in Morocco,Egypt and Russia). Other studies have linked broad perceptions of the quality of companies to superiorshare price performance. In a study of five year cumulative returns of Fortune Magazine’ssurvey of ‘most admired firms’, Antunovich et al found that those “most admired” had anaverage return of 125%, whilst the ‘least admired’ firms returned 80%. In a separate studyBusiness Week enlisted institutional investors and ‘experts’ to assist in differentiating betweenboards with good and bad governance and found that companies with the highest rankingshad the highest financial returns. 35 ANNA UNIVERSITY CHENNAI
  36. 36. DBA 1703 On the other hand, research into the relationship between specific corporate NOTES governance controls and firm performance has been mixed and often weak. The following examples are illustrative. Board composition Some researchers have found support for the relationship between frequency of meetings and profitability. Others have found a negative relationship between the proportion of external directors and firm performance, while others found no relationship between external board membership and performance. In a recent paper Bagahat and Black found that companies with more independent boards do not perform better than other companies. It is unlikely that board composition has a direct impact on firm performance. Remuneration/Compensation The results of previous research on the relationship between firm performance and executive compensation have failed to find consistent and significant relationships between executives’ remuneration and firm performance. Low average levels of pay-performance alignment do not necessarily imply that this form of governance control is inefficient. Not all firms experience the same levels of agency conflict, and external and internal monitoring devices may be more effective for some than for others. Some researchers have found that the largest CEO performance incentives came from ownership of the firm’s shares, while other researchers found that the relationship between share ownership and firm performance was dependent on the level of ownership. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders. Some argue that firm performance is positively associated with share option plans and that these plans direct managers’ energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants as documented by University of Iowa academic Erik Lie and reported by James Blander and Charles Forelle of the Wall Street Journal. 36 ANNA UNIVERSITY CHENNAI
  37. 37. STRATEGIC MANAGEMENT Even before the negative influence on public opinion caused by the 2006 backdatingscandal, use of options faced various criticisms. A particularly forceful and long running NOTESargument concerned the interaction of executive options with corporate stock repurchaseprograms. Numerous authorities (including U.S. Federal Reserve Board economistWeisbenner) determined options may be employed in concert with stock buybacks in amanner contrary to shareholder interests. These authors argued that, in part, corporatestock buybacks for U.S. Standard & Poors 500 companies surged to a $500 billionannual rate in late 2006 because of the impact of options. A compendium of academicworks on the option/buyback issue is included in the study Scanda by author M.Gumportissued in 2006. A combination of accounting changes and governance issues led options to becomea less popular means of remuneration as 2006 progressed, and various alternativeimplementations of buybacks surfaced to challenge the dominance of “open market” cashbuybacks as the preferred means of implementing a share repurchase plan.1.10.10 Initiative Of Indian Government Of Corporate GovernanceNational foundation for corporate governance (A Trust formed by MCA, CII, ICAI& ICSI)Vision: • Be A Catalyst In Making India The Best In Corporate Governance PracticesMission: • To foster a culture for promoting good governance, voluntary compliance and facilitate effective participation of different stakeholders; • To create a framework of best practices, structure, processes and ethics; • To make significant difference to Indian Corporate Sector by raising the standard of corporate governance in India towards achieving stability and growthInvites Companies to Showcase their Good Corporate Governance Practices: In order to promote Corporate Governance in India, NFCG has undertaken amajor campaign to disseminate, to public at large, the good corporate governance practices 37 ANNA UNIVERSITY CHENNAI
  38. 38. DBA 1703 followed by the Industries especially among the Small and Medium Enterprises (SMEs) NOTES and unlisted Companies. In case you believe that your company has initiated some benchmark Corporate Governance initiatives then we invite you to forward. A brief audio-visual presentation highlighting the following:- • The Corporate Governance practices followed in your Company; • The net worth of the Company in the terms of assets, turnover and profit before the implementation of the good Corporate Governance practices; • The cost of implementation of the Corporate Governance Practices; • The effect on the net worth and business Operations of the Company after the implementation of the good Corporate Governance practices • The short listed presentations will be telecast on one of the prominent business TV Channels and also given awards /certificate by NFCG. SUMMARY Strategic management is the art and science of formulating, implementing and evaluating cross-functional decisions that will enable an organization to achieve its objectives. It is the process of specifying the organization’s objectives, developing policies and plans to achieve these objectives, and allocating resources to implement the policies and plans to achieve the organization’s objectives. Strategic management as a discipline originated in the 1950s and 60s. Although there were numerous early contributors to the literature, the most influential pioneers were Alfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and Peter Drucker. The steps involved in strategic management process are: 1. Defining the vision, business mission, purpose, and broad objectives.2. Formulation of strategies.3. Implementation of strategies. 4. Evaluation of strategies. The four phases can be listed as below. 1. Defining the vision, business mission, purpose, and broad objectives.2. Formulation of strategies.3. Implementation of strategies.4. Evaluation of strategies. 38 ANNA UNIVERSITY CHENNAI
  39. 39. STRATEGIC MANAGEMENT Corporate governance is the set of processes, customs, policies, laws andinstitutions affecting the way a corporation is directed anagement are: Clarity of strategic NOTESvision for the? organization, Focus on what is strategically? important to theorganization,Better understanding of the rapidly? changing business environment. The four phases can be listed as administered or controlled. Corporate governancealso includes the relationship stakeholders among the many players involved (thestakeholders) and the goals for which the corporation is governed. The principal playersare the shareholders, management and the board of directors. Other stakeholders includeemployees, suppliers, customers, banks and other lenders, regulators, the environmentand the community at large.Short QuestionsQ1.Define strategy.Q2. What is policy, procedure and budget?Q3. Mention the three types of strategies.Q4.Define Corporate Governanace.Review questionsQ5.Explain the strategic formulation process.Q6.Discuss the evolution and growth of strategic management.Q7.Explain the different approaches of strategic management.Q8. Discuss the key role to be played by the all levels of management in strategicformulations.Q9.Discuss the role of corporate governance and its influences in corporationsperformances. 39 ANNA UNIVERSITY CHENNAI
  41. 41. STRATEGIC MANAGEMENT UNIT II NOTES COMPETITIVE ADVANTAGEINTRODUCTION The interaction of the four environmental dimensions creates further sub-dimensionssuch as political and economic environments that act as a filter between the internal andexternal environment and profoundly affect the performance of the corporation. Culturehere refers to transmitted patterns of behaviour shared by members of a group whichprovide them with effective mechanisms for interaction (Krefting & Krefting, 1991). Culturecan be thought of as an overriding concept (eg. western cultures and indigenous cultures)that directs the sociocultural specificity of group environments each with its own beliefsand rituals that are used to determine behavioural norms. Michael Porter provided a framework that models an industry as being influencedby five forces. The strategic business manager seeking to develop an edge over rival firmscan use this model to better understand the industry context in which the firm operates.Whena rival acts in a way that elicits a counter-response by other firms, rivalry intensifies.Theintensity of rivalry commonly is referred to as being cutthroat, intense, moderate, orweak,based on the firms’ aggressiveness in attempting to gain an advantageLearning ObjectivesAfter learning this unit you must be able to: • Analyze the external environment influencing the industry as well as strategy • Understand the porter’s five forces model and its uses in strategic management • Know the competitive changes and the stages of industrial analysis • Predict the changes in the industry structure due to the globalization • Analyze the importance of capabilities and competencies in gaining competitive advantage 41 ANNA UNIVERSITY CHENNAI