Strategic Management and Business Policy by: Thomas L. Wheelen and J. David Hunger
Link to Course Book: http://www.tec-digital.itcr.ac.cr/file/9565503/www.bloomberg.com
Required Readings: Chapters 1-3 Topics: Strategic Management and Governance
Upon completion of the Required Readings, write a thorough, well-planned narrative answer to the following discussion question. Rely on the Required Readings and the Lecture and Research Update attached to this assignment for specific information to answer the discussion question, but turn to your original thoughts when asked to apply, evaluate, analyze, or synthesize the information. Your Discussion Question responses should be both grammatically and mechanically correct, and formatted in the same fashion as the questions themselves. You must include an abstract and appropriately cite all resources used in your responses and document in a bibliography using APA style.
The Assignment: Describe at least six (6) recommendations that you would make to improve the effectiveness of today’s boards of directors. Explain your rationale for the recommendations by discussing how your recommendations would improve the performance of the boards and the companies they oversee. Then give your opinion as to which of these would be the most important recommendation and justify your opinion. (A 1-page response is required.)
Lecture and Research Update from the Professor
You will receive the greatest benefit from the following Lecture and Research Update if you first read this narrative, review the lesson, study the Required Readings, then come back to this section and carefully re-read this Lecture and Research Update. The “lecture” portion of this narrative focuses on issues from the textbook that need further explanation, while the “research update” portion integrates supportive information from recent professional academic and trade articles with the textbook information.
Strategic Management is at the base of the company’s ability to succeed or fail. Every position within a company and the actions that every employee takes should be based on relevant strategic management plans, goals and objectives. Without these, it is tantamount to the company’s members moving, but without any ultimate destination.
There are four phases of strategic management:
1.Basic financial planning which revolves around the strategic management goals and objectives that have been set and what type of budget will be needed to support those goals and objectives.
2.Forecast-based planning which targets long range planning since the length of time it takes to reach major goals and objectives and reach a substantial point of measurement has increased to more than just one year.
3.Externally oriented (strategic) planning which emphasizes formulation and leaves the implementations to lower management levels.
4.Strategic management which focuses not just on employees at the top of the hierarchical structure but goes from top to bottom and across lines to ensure that every department is included and is working toward its particular goals and objectives of the strategic management.
If strategic management is being correctly performed, it should involve four areas. These are (1) environmental scanning, (2) strategy formulation, (3) strategy implementation and (4) evaluation and control. Environmental scanning’s purpose in to identify external and internal strategic factors that will determine the future of the corporation. The easiest, most traditional and most widely accepted way to do this is through the SWOT (Strengths, Weaknesses, Opportunities, and Threats) Analysis. Rupcic and Zekan (2012) explain that“overall corporate performance is dependent upon various constituents, both internal, as well as external. The long term sustained competitive advantage can therefore be based on continual scanning and reflection upon environmental constituents. Despite the fact that most of these changes come from initiatives within, it is essentially the impulses from the external environment that drive the redesign of organizational mental models following modifications of other organizational constituents.” (p. 1132).
Strategy formulation refers to development of long-range plans based on the results of the SWOT analysis, utilizing the company’s mission and vision which need to have been identified prior to this time. Strategy implementation is the next step and uses the strategies that have been designated to put policies and procedures into measureable action. Evaluation and control is the final step and utilizes data from the first three steps to determine how closely the results match with formerly designated goals and objectives.
The economic assumption underlying agency theory is that rational individuals take actions that are consistent with the maximization of their wealth or, in economic terms, maximum utility. As a consequence, individuals investing in an enterprise (shareholders) are likely to have as a goal the attainment of the highest possible rate of return on their invested money. When the owners of a firm (the principals) entrust non-owners (managers, or agents) with the power of deciding how the firm’s resources are to be deployed, the interests of the owners must precisely match those of the agents. If this is not the case, the agents will decide to use the enterprise’s resources for purposes that stray from the owner’s utility maximization objectives because by assumption they will pursue their self-interest.
One way for shareholders to avoid this conflict of interest is to assume full responsibility for the management of the enterprise and not delegate their decision power to agents. While this solution is indeed attractive from a theoretical standpoint, today’s organizations are often too complex and too large for that approach to be feasible. One solution to this problem, the theory of the firm, suggests that owners hire agents whose interests are aligned with those of the owners.
Compensating managers commensurately with performance is one policy that seeks to align the interests of the agent with the interests of the corporation and, therefore, the owners. While this reward-based system has yielded some benefits, it is far from an optimal solution for the reason that agents often have short careers at a particular company while shareholders may invest in 401(k)s for the long term. The agent, therefore, may make decisions that allow him to obtain large profits in the short run, but that hurt the company’s ability to make long-term profits. The agent and the stockholders will not, then, have the same goals and interests.
A company may decide to pay its CEO with stock options, which are instruments that allow the holder to purchase the stock of the company for a fixed price in the future when the market price of the stock might be much higher than it was when the agent was hired. As a consequence, in pursuit of his own wealth, the CEO may make strategic decisions to drive up the value of the firm in order to make the gap between the option and the market prices as wide as possible. Therefore, it would appear that providing the CEO with stock options would constitute an optimal solution to the agency problem.
Since options have a set expiration date, however, it is likely that the CEO will time his strategic decisions to maximize the company’s performance at around the date he may take his stock options even if this course of action entails passing on more attractive investment decisions that have different return windows. Also, fixation on achieving a striking price for the exercise of options leaves incentives for management to manipulate financial statements, as recent corporate scandals have revealed. Clearly, this scenario is not consistent with the objectives of the principals as their investment horizon is unlikely to be as short-lived as that of the CEO. The complexity of the problem increases as more agents enter the relationship since each of them holds different expectations and goals.
Another way shareholders have attempted to circumvent the agency problem is through the Board of Directors (BOD). All state laws on the chartering of corporations require a board of directors, but there can be wide variations in operation. When companies began to form boards, directors were often family members who sat on the board to make decisions that impacted the entire family. They usually received no pay. Later, company insiders, some of whom might have been family members, sat on the board for a stipend. Now, however, being a board member for a large corporation can be both lucrative and prestigious; hence, people’s willingness to sit on several boards even if they contribute little to the overall good of the company.
Today, the responsibilities of Board Members within the United States face no clear national standards or federal laws. Rather, the standards vary from state to state. There has been, however, a decision made that relates to the major responsibilities of the Board. That decision is that the corporation should be managed in accordance with the laws of the state in which it is incorporated. Thus, state laws regulate the Boards of Directors and not national laws.
The role of the Board Members has been divided into three areas. These areas are:
1.Monitor – This is a minimum task that is carried forward through bringing developments that might have been overlooked to the attention of the management of the company.
2.Evaluate and Influence – This requires examination of management’s proposals, decisions and actions and agree or disagree with them.
3.Initiate and Determine – This requires using the corporate mission and specifying strategic options to its management.
Standard and Poor’s has developed a Corporate Governance Scoring System, based on four major issues. These issues are:
2.Financial Stakeholder Rights and Relations
3.Financial Transparency and Information Disclosure
4.Board Structure and Processes
In addition, the trends in corporate governance point to the BOD’s involvement getting stronger with time. Specifically:
1.Boards are becoming more involved in shaping company strategy which is at the foundation of the company’s strategic management goals and objectives.
2.Institutional investors have attained increasing power and influence on top management to improve corporate performance.
3.Shareholders are requiring that BOD own more than just a minimum share of stock in the corporation for which it directs.
4.Outside members of the Board are expanding their role by taking charge of CEO evaluations.
5.An increasing amount of minorities and women are being appointed to the BOD.
6.Members of the BOD are required to have specialized instead of just general knowledge, thus decreasing the amount of members on the Board but increasing the level of expertise that they bring to the Board.
7.A mandatory retirement age for BOD has been established.
8.BODs have been successful in either splitting the combined Chair and CEO position into two separate jobs or creating, as an additional safeguard, a new position: one of lead outside director
9.BODs have been able to eliminate the antiquated 1970s anti-takeover defenses.
10.BODs are adding more members with international experience than in the past.
11.BODs have gained support for being able to vote out directors who do not uphold shareholders’ interests.
12.BODs are being required to examine and pay equal attention to profitability society’s needs.
Lin-Hi and Blumberg (2011) use the BP oil spill disaster in the Gulf of Mexico to highlight the importance of good corporate governance. “The oil spill disaster in the Gulf of Mexico demonstrates that BP’s corporate governance rules were not sufficiently effective in terms of their relevance for every-day action. Rather, BP strove for the realization of quick wins and accepted that its internal corporate governance rules were bypassed. Ultimately, the company acted at the expense of sustainability… It is important to highlight that corporate long-term success does not depend on more or less rules, rather on good institutions. Corporate governance efforts undertaken to secure the long-term success of corporations can only engender their effectiveness if the external incentives stemming from the institutional environment do not oppose this aim. Thus, corporate governance, global governance, and sustainable profits are closely inter-related.” (p. 582)
Due to the importance of the role of the BOD, shareholders must find a reasonable means of appointing responsible board members. Some advocate that all directors appointed meet the CIAO test (Commitment, Independence, Attendance, and Ownership). In many of the well-publicized corporate scandals, directors owed their positions to senior management and thus were less than fully independent, and many held multiple directorships, leaving them inadequate time to attend to the business of one corporation. Further, some directors have little ownership of the company stock and consequently little financial stake in the success of the corporation. Obviously, they did not meet the CIAO test.
The Board of Directors is intended to be a powerful body, charged with the responsibility for the success of the corporation. All too often, however, directors have been only rubber stamps for the management, possibly assuming that top executives are working in the best interest of the shareholders and stakeholders of the corporation. No longer are the directors insulated from scrutiny and legal prosecution, however. Directly in response to the corporate scandals, Congress enacted the Sarbanes-Oxley Act, making directors and top executives criminally liable for misstatements of financial reports. “Following the collapse of Enron and several other leading global firms, US legislators responded swiftly with the Sarbanes Oxley Act of 2002, a stringent rules-based system widely considered the most comprehensive economic regulation since the New Deal. Research suggests the law may produce serious unintended harmful consequences, resulting in a call for further research to evaluate its impact upon firms. However, the law’s impact upon CEO perception is potentially more relevant than its actual costs, as this factor can be expected to directly influence how firms respond to the new law.” (Vakkur, 2010, p. 213)
Because of the Sarbanes-Oxley Act, the responsibility of being a corporate director is far greater than it had been prior to the aforementioned scandals. The downside of the new law is that talented people may avoid taking positions on boards or in top management because they fear being prosecuted for a mistake over which they truly had no control. There are short term advantages because of this act, but also long term disadvantages. As an example, Siegel, O’Shaughnessy and Franz (2010) analyzed the effect that the Sarbanes-Oxley Act has had on the American banking industry. Comparative results from their study indicate that during the period that the Act has been in effect there is a marked negative divergence for SEC-registered banks as opposed to those banks that do not report to the SEC.
Vakkur’s study (2010) suggested “that large firm CEOs consider that the costs of Sarbanes Oxley outweigh any potential benefits, such that it represents a tax upon firms. Furthermore, the survey reveals that this negative perception is due to three primary factors, which are generally believed to have been induced by the law:
•Centralization resulting in increased corporate rigidity
•A conservative bias in decision making in favor of defensive management over the strategic pursuit of profits.
•An emboldened role for accountants who are believed to have used the law to bolster revenues.” (p. 225)
Only time will tell whether the Sarbanes-Oxley Act has caused more harm than good in corporate America.
PowerPoint Lecture Notes
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Lecture and Research Update Bibliography
Lin-Hi, N. and Blumberg, I. (2011). The relationship between corporate governance, global governance, and sustainable profits: lessons learned from BP. Corporate Governance, 11.5, pp. 571-584.
Rupcic, N. and Zekan, S. (2012). BUSINESS ENVIRONMENT SCANNING: PREREQUISITE FOR SUSTAINABLE LEARNING COMPANY. An Enterprise Odyssey. International Conference Proceedings, Zagreb: University of Zagreb, Faculty of Economics and Business, pp. 1132-1142.
Siegel, P., O’Shaughnessy, J., and Franz, D. (Jun 2010). The Sarbanes-Oxley Act: A Cost Benefit Analysis Using the U.S. Banking Industry. SSRN Working Paper Series.
Vakkur, N. (2010). CEO Perception and the Sarbanes Oxley Act of 2002. Journal of Strategic Management Education 6.3: pp. 213-227.
Wheelen, T. L., & Hunger, J. D. (2012). Strategic management and business policy (11th ed.). Upper Saddle River, NJ: Prentice Hall.
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