MGMT 4000 Chapter Notes - Chapter 2: Rubber Stamp, Strategic Management, Succession Planning
Chapter 2 – MGMT 4000
Corporate Governance
Role of the Board of Directors
• A corporation is a mechanism established to allow different parties to contribute capital,
expertise, and labour for their mutual benefit
o Management runs the company without being responsible for personally
providing funds
o The board of directors/shareholders have both the authority and responsibility
to establish basic corporate policies and to ensure that they are followed
o Board of directors have to therefore, approve all decisions that might affect the
long-term performance of the corporation
o Board of directors oversees management
• Corporate governance refers to relationship between shareholders, board of directors
and top management
• Shareholders and activist investors have been concerned about BOD
o Inside board members may use their position to feather their own nests
o Outside board members may lack sufficient knowledge, involvement and
enthusiasm to do an adequate job monitoring
Responsibilities of the board
• Effective board leadership including the processes, makeup, and output of the board
• Strategy of the organization
• Risk vs. initiative and the overall risk profile of the organization
• Succession planning for the board and top management team
• Sustainability
The board is also required to act with due care
Role of the board in strategic management
• Monitor
• Evaluate and influence
• Initiate and determine
Board of directors continuum
• Possible degrees of involvement (from low to high) in strategic management process
• Boards can range from phantom boards with no involvement to catalyst boards with
very high degree of involvement
• Levels:
o Phantom
o Rubber stamp
▪ Votes as officers recommend on actions
o Minimal review
▪ Formally reviews selected issues officers bring to attention
o Nominal participation
▪ Involved to limited degree in the performance
o Active participation
▪ Approves, questions, and makes final decisions on mission, strategy,
policies, objectives, etc
o Catalyst
• Key investors want a seat on the board so they can oversee their investment
Board of directors composition
• Inside directors
o Management directors
o Usually officers or executives employed by the organization
• Outside directors
o Non-management directors
o May be executives of other firms
o Outside directors are becoming more popular
• USA on avg has 10 board members (8 outside, 2 inside)
• Small USA corp usually has 4-5 members where only 1 or 2 are outsiders
• People who favour high proportion of outsiders state that outside directors are less
biased and more likely to evaluate objectively
• Agency theory
o Problems arise in corporations because top management are not willing to bear
responsibility for their decisions unless they own a substantial amount of stock in
the corporation
o Large number from board should be outsiders so that top management does not
behave selfishly
o Concerned with analyzing and resolving 2 problems that occur in relationships
between owners/shareholders and their agents (top management):
▪ Conflict of interest
▪ Moral hazard
• Situation where it is difficult or expensive for owners to verify
what the agents are actually doing
• Research shows that manager controlled firms with weak board are more likely to go
into debt to diversify into unrelated markets
• Stewardship theory
o Because of long-term tenure with the corporation, insiders tend to identify with
the corporation and its success
o Excluding all insiders other than the CEO reduces the opportunity for outside
directors to see potential successors in action or to obtain alternate points of
view of management decisions
Document Summary
Inside board members may use their position to feather their own nests: outside board members may lack sufficient knowledge, involvement and enthusiasm to do an adequate job monitoring. The board is also required to act with due care. Role of the board in strategic management: monitor, evaluate and influence. Involved to limited degree in the performance: active participation, approves, questions, and makes final decisions on mission, strategy, policies, objectives, etc, catalyst, key investors want a seat on the board so they can oversee their investment. Improving governance: securities and exchange commission (sec, sec made a rule that company has to disclose a code of ethics that applies to the ceo and to the cfo. Evaluating governance: to help evaluate a firm"s corporate governance, a number of independent rating services such as, s&p, moody"s, morningstar, the corporate library. Insiders, usually company founders, get stock with extra votes: another way to side-step corporate governance: if one single company owns.
