LP 9

6 Dec 17 (Mba6A)
Chap 9
Strategic Controls and Corporate Governance
Learning Objectives
The value of effective Strat. Control systems in strategy
implementations
Key differences among Traditional and Contemporary Control
Systems
Benefits of having proper balance among the three levels of
behavior control
The three key participants of corporate governance
Aligning managerial interest with those of shareholders
Learning Outcomes
Students would NOT be surprised when they move into new jobs
/ assignments and interact with value of culture, boundaries and
rewards away from the typical HR Management practices

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 LEARNING FROM MISTAKES

Hewlett-Packard (HP) was sitting #10 on the Fortune 500 list

with $120 billion in sales in 2012. It lost $12.6 billion in 2012,
in contrast to earnings of almost $9 billion only two years
earlier. Their inability to effectively respond to the dramatic
shifts in the computing industry in the last several years has
been, at least partly, driven by their toxic corporate governance
culture.
Going back to 2002, HP was pushing hard for HP to acquire
one of its main rivals, Compaq. The members of the board of
Compaq took sides in this debate and started leaking corporate
secrets to the press to bolster their side of the argument.

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 THE UNETHICAL PRACTICES AT HP
Series of unethical practices
Patricia Dunn, the new CEO of HP was replaced as she was accused in
2006 of hiring private investigators to obtain the phone records of board
members and reporters to try to get at the root of leaks from the board. The
scandal was investigated by both the State of California and the U.S.
Congress.
Hurd, the firms CEO, was fired in 2010 when it came to light that he had an
inappropriate affair with a subordinate and had charged expenses related to
his affair to the firm. His departure only served to exacerbate the tension on
the board. He had been dismissed on a 6-4 vote by the board.
The tension between the pro- and anti-Hurd factions on the board got so
bad that some board members refused to be in the same room with other
directors. The board settled on Leo Apotheker to replace Hurd.
The new CEO Apotheker didnt fully disclose issues related to Apotheker
that led to his firing from his position of co-CEO at SAP, a software
company. Apotheker lasted all of 11 months as CEO and received $13.2
million dollar severance package from the board.
He was replaced by Meg Whitman, the former CEO of eBay, in 2011.
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 UNETHICAL PRACTICES AT CORPORATE LEVELS
Result
There has been very little information sharing within the organization, because
no one knows who they can trust and who will leak important information to
the press.
Pakistani Examples
An industrialist from Karachi, Mr Saleem Mandviwalla who has also been finance
minister during Feb-Jun 2013 refused to sit on BOD of PSM and other SOE as
independent Member since all the decisions taken at Board meetings are to be
vetted by the Ministry of Finance. The later changes / alters the decisions at will
without informing the BOD Members.
External / Independent BOD Members receive as much as $3000 for each meeting
Holding of Board meetings in Vienna by Fauji Fertilizer / Corporation etc
The FM of Pakistan is abroad and being quizzed by NAB for falsification of facts
Mr Zafar Hijazi ex chairman SECP is under scrutiny for fudging of records
Mr Saeed Ahmed, President NBP is under scrutiny for money laundering in the past
The commercial Banks despite losses low profits are drawing exaggerated salaries
The SOEs are making losses despite regular Board Meetings
4
 Women on Boards in Pakistan

Total Listed Companies on PSX 559

Women on BODs ---- 21
Independent Members on BODs--- 32
The 21 listed Pakistani companies that have women on their board and that
have reportedly been awarded the W-Corporate Enlistment Award include
Dawood Capital Management, First Dawood Mutual Fund, Hum TV
Network, ICI Pakistan, National Foods, Pakistan Cables, PNSC, Samba
Bank, Southern Electric Power, Standard Chartered Bank, Sui Southern
Gas Company, Unilever Foods and United Insurance, Abbott Laboratories,
Archroma Pakistan, Bestway Cement, Colgate Palmolive, IGI Insurance,
JS Bank, KSB Pumps and Pakistan Tobacco.

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 CASE STUDY

3 Scenarios
1. Greedy and unethical executives ---- sound strategic
controls ----- correctable

2. Employees working for achieving goals and objectives

----- poor strategic controls --- Deterioration can be

controlled BUT

3. Greedy and unethical executives ---- and unsound

strategic controls ----- disaster is on its way

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 CEO of Tyco Int Ltd., ---- Dennis Kozlowski
Most prolific corporate acquirer in US history who
acquired 200 companies. Resultantly, Tyco grew from
$3.1Bn to $36Bn in 10 years.
Year 2002
Cheated NY city by $1Mn and also blamed for running criminal
enterprise
CEO and CFO charged with 38 felony counts for stealing $170Mn
and obtaining $430Mn through tainted sale of stocks
Special about Tyco were financial controls, good incentive
programmes, strong manufacturing, and fairly independent
managers were nothing but a hoax. It was a one man show and that
led to disaster
The culture and reward system drove it too far, too fast, and nearly
off a cliff. Tyco became a poster child for poor corporate governance7
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 SOME FLAWED investment DECISIONS:

AOL buys Time Warner for $183Bn ---- writes

off $54Bn

Oracle buys 23Mn stock options worth $706Mn -

-- weeks before lowering earning forecast

Arthur Andersen, an accounting firms pays

$110Mn to its client for fraudulent audit

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 What is a Corporation?

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 ROLE OF CORPORATE GOVERNANCE

What is a Corporation?
A body of persons granted a charter legally recognizing
them as a separate entity having its own rights,
privileges, and liabilities distinct from those of its
members.
The Overriding Purpose ---- To enhance long term
shareholders value through investment decisions. Good
corporate governance plays an important role in the
investment decisions of major institutions, and a
premium is often reflected in the price of securities of
companies that practice it.

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 WHAT IS A CORPORATION?
It is a mechanism created to allow different parties to contribute:
Capital
Expertise and
Labor ------- for the max benefit of each party.
The shareholders / investors enjoy the profits without playing any
part in the operations of the firm. However, they have the right to
elect BOD to run the affairs of the Org and in turn protect their rights.
The management runs the firm without providing funds
(investments).
The separation of management and the stockholders have given
rise to a concept known as Agency theory.
Central to agency theory is the relationship between the principals
(The stockholders) and the agents (Management).
For a +ve outcome, the relationship should be congenial and happy
one.
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 UNITY OF COMMAND
Advocates of the unity of command perspective believe
when one person holds both roles, he or she is able to
act more efficiently and effectively.
CEO duality provides firms with a clear focus on both
objectives and operations as well as eliminates
confusion and conflict between the CEO and the
Chairman.
It enables smoother, more effective strategic decision
making. Holding dual roles as CEO/chairman creates
unity across a companys managers and board of
directors and ultimately allows the CEO to serve the
shareholders even better.

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 AGENCY THEORY

A theory explaining the relationship between principals,

such as a shareholders, and agents, such as a
company's executives.
In this relationship the principal delegates or hires an
agent (Corporation Executives) to perform work.
The theory attempts to deal with two specific problems:
First, that the goals of the principal and agent are not
in conflict (agency problem), and
Second, that the principal and agent reconcile
different tolerances for risk.

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 HOW TO GOVERN A CORPORATION?
To minimize the potential of managers to act in their self
interest, following can be done:
To ensure that the BOD remains committed and involved
Change CEO / CFO regularly. Follow Succession Plans. Ensure
adherence to local laws. Critically review financial reports, major
strategies and business plans etc
Shareholders to be viewed as shareowners due to their activism
Exercise right to vote in person or through proxy, file law suit
against the management or BOD for damages, obtain
information as and when required basis
Reward and compensation agreements be dealt with diligently
CEOs may be allowed to become substantial owners of the firm
Rewards for performance and penalties for poor performance
Threat of dismissal for poor performance may be realized

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Policy Measures for Effective Top Management
Boards need to be diligent in building executive compensation
packages that will incentivize executives to build long-term
shareholder value and to address the concerns that regulators
and the public have about excessive compensation. The key is
to have open, fair, and consistent pay plans. Here are six
policies to achieve that.
Increase transparency
Build long-term performance with long-term pay
Reward executives for performance, not simply for
changes in the companys stock price.
Have executives put some skin in the game.
Avoid overreliance on simple metrics.
Increase equity between workers and executives.
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 BALANCING CULTURE, REWARDS AND
BOUNDARIES
Hallmarks of Behavioral Control Doing things right

Competitive environment is increasingly

complex and unpredictable demanding both
flexibility and quick response to challenges
The implicit long term contracts between the org
and employees have eroded.
Henceforth, each of the three levers culture,
rewards and boundaries must work in balanced and
consistent manner.

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 STRATEGIC CONTROLS
Informational Controls
Traditional v/s Contemporary Controls
Vision, Mission, Goals linked to performance v/s Ext & Inter
analysis leading to continuous monitoring

Behavioral Controls ---

Implementing Culture & Rewards and determining their
Boundaries

Strategic Control Systems

No best option other than creating Incentives and Culture

Role of Corporate Governance

Role of BoD, shareholders and linking them to rewards
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 GOVERNANCE MECHANISM
Internal: Aligning the interest of Owners and
Managers and minimizing the potential for
managers to act in self interest by instituting:
A committed and involved BOD
Shareholders activism
Managerial rewards and Incentives
External: Take into consideration roles of:
Market for corporate control
Auditors
Banks and analysis
Regulatory Bodies
Media and Public Activists
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 INFORMATIONAL CONTROLS --- A COMPARISON
BETWEEN TRADITIONAL & CONTEMPORARY CONTROLS

Traditional Controls Contemporary Controls

Ext & Internal analysis leads
Vision, Mission, Goals linked
to continuous monitoring
to performance
Must focus on constantly
Feedback loop from changing information
performance measurement to Information leads to frequent
strategy formulation and regular attention
Most appropriate when Data and information
environment is stable discussed face to face among
Sales quotas, operating managers
budgets, production Information and data leads to
schedules, and similar assumptions, and action plans
quantitative control Org concerned with doing
mechanisms are typical things right a behavioral
control
Org Doing the right things
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 BUILDING A STRONG AND EFFECTIVE CULTURE
Organizational culture is a system of shared values
(what is important) and beliefs (how things work) that
shape a companys people, organizational structures,
and control systems to produce behavioral norms. and
beliefs
Culture sets implicit boundaries.
Role of Culture in an Org
Renewed Focus on customer service
Emphasizing product quality
Creating Value through innovation
Ensuring operational efficiency
Success lies in sustaining organizational culture.

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 REWARDS AND INCENTIVES
Rewards and incentives systems represent a
powerful means of influencing an organizations
culture:
Focusing efforts on high priority tasks,
Motivating individual and
Collective task performance.
Downside
His or her personal interests remain supreme.
However, effective reward and incentive system can be created
by implementing : -------- Next slide

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 EFFECTIVE REWARD AND INCENTIVE SYSTEM

Organizational Objectives must be clear, concise, well

accepted and equally well understood
Rewards must be linked with performance and desired
behavior (achievement of objectives)
Performance measures must be highly visible
Feedback be prompt, clear and un-ambiguous
Compensation system must be perceived as fair and
equitable
The Organizational structure must be able to adapt to
changing circumstances

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 SETTING BOUNDARIES

Boundaries and constraints, when used properly, can

serve many useful purposes:
Focusing individual efforts on strategic priorities -- any
business in the corporate portfolio must be ranked 1st or 2nd in
industry
Providing short-term objectives and action plans to
channel efforts -- Be specific, achievable, and measurable
Improving operating efficiency and effectiveness -- Make
environments stable and predictable, ensure consistency in product
and service, and implement controls to avoid malfeasance
Minimizing improper and unethical conduct Ensure
observance of rules and regulations for interaction between the
managers, suppliers and customers etc

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 EVOLVING FROM BOUNDARIES TO REWARDS AND
CULTURE

Hire the right people (Best and Talented)

Train (Develop) them well
Make managerial role vital to success
Align reward system with organizational goals and
objectives
Institute Self Accountability
Be ethical always

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LINKING STRATEGIC CONTROL TO BUSINESS
LEVEL STRATEGIES

Overall Cost Leadership Differentiation

Each shift and production Pay suitable
line be made bonus
incentives / bonuses
group
to highly trained
Pay bonuses on
divisional performance professionals, for
Bonuses be paid on devising, assessing,
divisional and on implementing and
corporate returns continually changing
Make incentive programs complex product
tax free designs.
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Linking Strategic Control to Corporate Level Strategies

Related
Employees pursue what is best for the entire
company. Rewards and incentives are
interdependent.
Unrelated strategies
Unrelated diversification with an emphasis on
individual accountability. Rewards and
incentives are independent --- Engro paying
rewards differently to those working in
Fertilizer and Engro Foods

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 SUMMARY OF RELATIONSHIP BETWEEN STRATEGIC
CONTROLS AND BL & CL STRATEGIES
Level of Types of Need for Types of
Strategy Interdependence Rewards
Strategy
& Controls
Business-level Overall Cost Low Financial
(BL) Leadership
--------- --------- Differentiation High Behavioral
Corporate level Related High Behavioral
diversification
--------- --------- Unrelated Low Financial
diversification

BL Strat. Reward and control systems focus more on the use of

financial indicators because unit costs, profits, and revenues can be
rather easily attributed to a given business unit or division.
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 Thank you for investing your time with me.
Please go to the library and learn more
about culture and rewards of a Corporation.

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 General reading what
corporations / Firms can do

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 FMCG FIRMS IN PAKISTAN REAP HARVEST
WITH consumerism thriving, stock prices of listed consumer
goods companies have provided investors a juicy return of 42%
in 2014-to-date, outperforming the KSE-100 index`s gains of
22pc by a wide margin. Last year, the consumer goods stocks
did even better, rising 85pc against the benchmark index`s
return of 49pc.
`Sales revenue of a sample of 47 consumer goods companies
listed on the Karachi Stock Exchange with a market
capitalization of Rs1.5trn and accounting for 21pc of the
bourse`s aggregate market capitalization grew by 12.4pc, and
their earnings rose by 17.9pc in the first nine-months of 2014,`
says Vahaj Ahmed, head of research at Topline Securities.
Food, beverages, pharmaceuticals, tobacco, footwear and
personal care products have witnessed growing demand,
regardless of the weak economy.
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 Contd
Following the departure of Unilever Pakistan Ltd from the KSE
when its parent company bought back its shares, Nestle Pakistan
whose products range from milk to juice, water, baby food and cereal
stands out as the largest fast moving consumer goods (FMCG)
company on the bourse, with a market capitalization of Rs378bn.
The company has posted stellar growth over the past five years, with
sales rising from Rs34bn in 2008 to Rs86bn in 2013. This
corresponded with an increase in earnings from Rs1.6bn to Rs6bn.
The second biggest company, Rafhan Maize, saw sales surge from
Rs11bn to Rs24bn and after-tax profit from Rs1.5bn to Rs3bn in the
five-year period. Excluding companies that can be counted on one
hand, almost all FMCGs have done equally well.
Interestingly, Murree Brewery, which derives its revenue from
several lines of products besides its well-known brew, stands out in
terms of stock market performance this year, having rallied 151pc
year-to-date.

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 Contd --- High Outlook
Among the listed FMCGs, food producers are the highest in
number. Of the 50 food manufacturing companies, 32
declared a profit in 2013. Household goods, personal
products and pharmaceutical and leisure goods are other
segments of FMCG companies that are separately grouped
on the KSE. Almost all these sectors have performed well,
thanks to higher consumer spending.
Some economists suggest that increased consumerism is
stemming from the burgeoning middle class, rising health
awareness, falling family size and an improving literacy rate,
among other factors.
`With a population nearing 200m, Pakistan is the fifth largest
country in the world,` says Professor Hasan Zaidi, who
teaches at a business school in Karachi. He asserts that in
the last five years, an additional 25m people have joined
the middle class, of whom 7m fall in the upper middle
class segment.
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 Contd --- Low side of Progress
Answering to a written query, the chairman and CEO of Unilever Pakistan
recently explained that sales of most FMCG companies originate 66:34
from urban and rural areas respectively, whereas the population split is the
other way round.
Recognizing the potential of rural areas, Unilever stepped up its distribution
and sampling efforts, targeted melas, harvest periods and created
excitement through sampling activities. Our sales of butter, soap,
shampoos, tea and ghee have doubled from Rs31bn in 2008 to Rs61bn
in 2013, and profits have jumped from Rs2bn to Rs6bn in five years.
Muzammil Aslam, managing director of Emerging Economics Research,
says higher usage of consumer goods is a healthy sign, as this creates
uniformity in prices of products of everyday use. He believes that the recent
phenomenal growth in use of packaged goods is due to their low penetration
earlier on.
But another economist admitted that the consumption of items that are
not produced in the country but merely assembled is a burden on the
economy. Lavish consumer habits like owning several sets of expensive cell
phones, apart from non-essential electronic items and luxurious automobiles
are merely fattening the import bill, resulting in a wider current account
deficit.
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 Contd the worst case scenario
`Besides, when people start to spend more, they mostly do so by
compromising their savings,` says a mutual fund manager.
Some experts also raised other disconcerting questions.
`The stunted GDP growth rate and the big leap in sales and turnover
of FMCGs are in stark contrast to each other,` says one such critic.
He posed a pertinent question: `Where does all the wealth spent
on the consumer goods come from?` Higher remittance inflow by
expatriate workers to their families is one known source of spending
on quality goods, particularly by the rural population. But that is
scarcely enough to explain the billions of rupees-worth of sales of
consumer good items every year.
Many economists suspect that the massive undocumented economy
is bankrolling the hefty spending on consumer and durable goods.
The KSE`s Managing Director Nadeem Naqvi subscribes to this
view. He observes that while the economic growth is at an anemic 4-
4.2pc, the undocumented economy is growing at a much faster
pace. `It provides purchasing power to consumers, which helps
consumer goods companies post stunning sales growth, improved
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margins and glossy bottom lines. Daily Dawn, Nov 17, 2014
 CEOs are not immune from termination
In September 2010, Jonathan Klein, the president of the CNN was
fired because CNNs ratings had suffered.
Don Blankenship, CEO of coal mining giant Massey Energy,
resigned in December 2010 after a deadly explosion in Masseys
Upper Big Branch mine in West Virginia, a mine that had received
numerous citations for safety violations in the last few years.
Tony Hayward, CEO of oil and energy company British Petroleum
(BP), was forced to step down in October 2010 after the Deepwater
Horizon oil spill in the Gulf of Mexico led to an environmental
disaster and a $20 billion recovery fund financed by BP.
Carol Bartz was ousted as the CEO of Yahoo after two and a half
years when the board observed limited improvement in the firms
market position.
Vikram Pandit was pressured to resign from his position as CEO of
Citigroup after five tumultuous years and increasing investor
unhappiness over the performance of the firm.
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 At times, top-level managers engage in actions
that reflect their self-interest rather than the interests of
shareholders:
The CEO of Wynn Resorts, had a great year in 2011, even though
his stockholders barely broke even. He received a starting salary of
$3.9 million. On top of that, he received two bonuses, one worth $2
million and another for $9 million. In addition to cash compensation,
he received over $900,000 worth of personal flying time on the
corporate jet and over $500,000 worth of use of the companys villa.
John Sperling retired as chairman emeritus of Apollo Group in
2013. He founded Apollo, the for-profit education company best
known for its University of Phoenix unit, in 1973. The board of
directors, which included his son as a member, granted him a
special retirement bonus of $5 million, gave him two cars, and
awarded him a lifetime annuity of $71,000 a month. He received all
of these benefits even though Apollos stock at the time of his
retirement was worth one fourth of its value in early 2009.
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