Chapter 10 - STRATEGY
INTRODUCTION
Activist shareholders = individuals or groups that purchase a significant share
in a company in order to influence its management and decisions (increase its
value, long-term, e.g. through restructuring, management changes, specific
business strategies)
– Increased accountability of corporate governance BUT can lead to
increased pressure (e.g. to show improved performance quickly,
excessive risk-taking) leading to unethical behaviour such as financial
fraud
Corporate governance = a set of mechanisms used to manage the relationships
among stakeholders and to determine and control the strategic direction and
performance of organisations
– Identifying ways to ensure decisions are made efficiently (fairness,
transparency, accountability - to avoid frauds, ensure long-term
success)
– Ensure firms can achieve strategic competitiveness
In modern corporations, the main objective of the corporate governance is:
To ensure that top-level managers’ interests are aligned with other
stakeholders (especially shareholders)
Corporate governance is a concern to nations as well as firms (e.g.
independence of board members and their practices) -> firms invest in national
with acceptable national governance
Capitalism = private ownership of: assets in general, means of production, firms
by the financiers of that firm
Private ownership: 1. Gives the right to partial control, 2. partial ownership
– Leads to optimal alignment of incentives (assumption of maximising
profits)
SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL
(Who owns the company and who makes day-to-day decisions)
Small companies -> less separation since managers also own a significant
percentage of the firm
Family-owned firms -> no separation
Issues related to their corporate governance:
– May not have access to all the skills needed to effectively manage the
, –
firm and maximise returns for the family -> outsiders might be needed
to help them grow
– As they grow, they may need to seek capital -> giving up some
ownership
Family-owned firms using managerial specialists (compensated on a basis for
their decision-making) -> usually make the best strategic decisions
Separation and specialisation of ownership (risk-bearing) and managerial
control (decision making) -> production of highest returns for owners
– This creates an agency relationship
Agency relationship = when one party delegates decision-making responsibility
to a second party for compensation
(e.g. top level managers and owners / top level managers and subsidiary
managers)
Problems due to:
– Different interests and goals of the principal and the agent
– Shareholders lack direct control of large publicly traded corporations
Managerial opportunism = the seeking of self-interest with guile - e.g. cunning,
deceit (managers want to minimise their personal risk or maximise their
personal welfare)
– Can be an attitude or a behaviour
Product diversification as an example of an agency problem
Can create benefits that shareholders don’t enjoy but managers do:
. Usually increases the size and complexity of a firm -> higher executive
compensation
. Diversification of a firm’s portfolio can reduce top executives’
managerial employment risk (job loss, loss of compensation,
reputation) -> managers are less vulnerable to reduction in demand of
a product
Free cash flow as an example of an agency problem
= the cash remaining after the firm has invested in all projects that have
positive net present value within the current business (cash flow - capital
expenditures)
Top managers may invest free cash flow in a project that is not within the firm’s
current line of business -> to increase degree of diversification
Over diversification -> self-serving, opportunistic managerial behaviour
Shareholders’ and managers optimal level of diversification:
(They may prefer free cash flows to be distributed to them as dividends0
INTRODUCTION
Activist shareholders = individuals or groups that purchase a significant share
in a company in order to influence its management and decisions (increase its
value, long-term, e.g. through restructuring, management changes, specific
business strategies)
– Increased accountability of corporate governance BUT can lead to
increased pressure (e.g. to show improved performance quickly,
excessive risk-taking) leading to unethical behaviour such as financial
fraud
Corporate governance = a set of mechanisms used to manage the relationships
among stakeholders and to determine and control the strategic direction and
performance of organisations
– Identifying ways to ensure decisions are made efficiently (fairness,
transparency, accountability - to avoid frauds, ensure long-term
success)
– Ensure firms can achieve strategic competitiveness
In modern corporations, the main objective of the corporate governance is:
To ensure that top-level managers’ interests are aligned with other
stakeholders (especially shareholders)
Corporate governance is a concern to nations as well as firms (e.g.
independence of board members and their practices) -> firms invest in national
with acceptable national governance
Capitalism = private ownership of: assets in general, means of production, firms
by the financiers of that firm
Private ownership: 1. Gives the right to partial control, 2. partial ownership
– Leads to optimal alignment of incentives (assumption of maximising
profits)
SEPARATION OF OWNERSHIP AND MANAGERIAL CONTROL
(Who owns the company and who makes day-to-day decisions)
Small companies -> less separation since managers also own a significant
percentage of the firm
Family-owned firms -> no separation
Issues related to their corporate governance:
– May not have access to all the skills needed to effectively manage the
, –
firm and maximise returns for the family -> outsiders might be needed
to help them grow
– As they grow, they may need to seek capital -> giving up some
ownership
Family-owned firms using managerial specialists (compensated on a basis for
their decision-making) -> usually make the best strategic decisions
Separation and specialisation of ownership (risk-bearing) and managerial
control (decision making) -> production of highest returns for owners
– This creates an agency relationship
Agency relationship = when one party delegates decision-making responsibility
to a second party for compensation
(e.g. top level managers and owners / top level managers and subsidiary
managers)
Problems due to:
– Different interests and goals of the principal and the agent
– Shareholders lack direct control of large publicly traded corporations
Managerial opportunism = the seeking of self-interest with guile - e.g. cunning,
deceit (managers want to minimise their personal risk or maximise their
personal welfare)
– Can be an attitude or a behaviour
Product diversification as an example of an agency problem
Can create benefits that shareholders don’t enjoy but managers do:
. Usually increases the size and complexity of a firm -> higher executive
compensation
. Diversification of a firm’s portfolio can reduce top executives’
managerial employment risk (job loss, loss of compensation,
reputation) -> managers are less vulnerable to reduction in demand of
a product
Free cash flow as an example of an agency problem
= the cash remaining after the firm has invested in all projects that have
positive net present value within the current business (cash flow - capital
expenditures)
Top managers may invest free cash flow in a project that is not within the firm’s
current line of business -> to increase degree of diversification
Over diversification -> self-serving, opportunistic managerial behaviour
Shareholders’ and managers optimal level of diversification:
(They may prefer free cash flows to be distributed to them as dividends0
