Chapter 9 - Download as DOC by Mg7kd8


									Chapter 9
Strategic Control and Corporate Governance

         The purpose of this chapter is to teach students how strategic control systems may be used to
effectively implement strategies. As the first of the four chapters in Part 3 of the text, it introduces students
to the issues surrounding implementation and leadership. It includes both traditional and contemporary
approaches to control, and outlines informational (e.g., monitoring, performance milestones) as well as
behavioral (e.g., rewards, culture, boundaries) techniques for achieving control as well as corporate
governance. The chapter is organized into four sections:

        1.       Informational control: Describe contrasting approaches to information control. The first is
                 termed “traditional” and emphasizes setting objectives and standards, and controlling by
                 comparing performance to achievements. The second is “contemporary” in which
                 conditions are continually monitored and strategy is modified in an interactive fashion to
                 adapt to changing conditions.

        2.       Behavioral control: Introduce the role of cultures, rewards and incentives, and boundaries
                 and how firms must achieve a proper balance between these forces in order to maintain
                 strategic control.

        3.       The role of contingencies in determining which control system is appropriate. Emphasize
                 there is no “one best way” to achieve control, but some approaches are likely to be more
                 effective depending on conditions. Business-level and corporate-level strategies may
                 require different approaches to strategic control.

        4.       The role of corporate governance in ensuring that managerial and shareholder (owner)
                 interests are aligned. Examples of effective and ineffective governance are given and we
                 address three mechanisms for effective governance: committed and involved board of
                 directors, shareholder activism, and effective managerial rewards and incentives. We also
                 propose several external control mechanisms: the market for corporate control, auditor,
                 banks and analysts, the media, and public activists.

                                  Transparency 74 (Learning Objectives)

                              LECTURE/DISCUSSION OUTLINE
          The introductory case is Tyco International—a company run by CEO Dennis Kozlowski that was
focused on increasing revenues and profits at all costs (largely through acquisitions). The result was an
aggressive culture and reward system that led to unethical behaviors and fraud. Use the Tyco case to
illustrate that a firm‟s control systems must match its overall mission and goals. If the goals are flawed, the
outcomes probably will be too. Control systems that reward the wrong behaviors or push employees to
make bad decisions do not lead to effective implementation. The case also demonstrates why control
systems need to be flexible enough to change when it is clear that they are not working or, worse, creating
problems such as lawsuits by shareholders. The case also demonstrates flawed corporate governance

       What mistakes did Tyco’s top managers, especially Dennis Kozlowski, make?

       How were strategic controls used to reinforce Tyco’s mistakes?

       How does this case illustrate flawed corporate governance?

       What does the case teach about the power of control systems to influence actions?


         An emphasis on growth at all costs led to a misalignment of culture, rewards, and boundaries that
resulted in unethical behavior and fraud.


        Point that two interrelated defects contributed to Tyco‟s problems:

        1.      An arbitrary and inflexible set of objectives.

        2.      An unbalanced system of strategic controls that drove the organization, but failed to define
                the boundaries of acceptable behavior.

         This section addresses “traditional” and “contemporary” approaches to informational control.
Although both have the same purpose—using information to select, monitor, and implement effective
strategies—they have a different impact on employees and organizational outcomes. Also, as
environmental conditions become more complex or unpredictable, the need for contemporary approaches
to informational control increases.


        With a traditional approach to strategic control, goals and objectives are set, strategies are
implemented, and performance is compared to the desired standards. Then there is a feedback loop in
which information about how performance compares to goals is used to revise strategies. Thus, it is a
highly sequential process. EXHIBIT 9.1 illustrates the traditional approach.

                    Transparency 75 (Ex. 9.1) Traditional Approach to Strategic…

        Examples of control systems that rely on feedback controls include sales quotas, operating
budgets, and production schedules.

       What is the value of feedback systems that compare performance to objectives?

         Point out that the traditional process can often be time consuming and many firms only update
budgets or other control devices once a year during annual planning meetings. Thus, it may be best suited
for environments that are relatively simple and stable.

       Under what conditions might a traditional sequential control system be inadequate?

         STRATEGY SPOTLIGHT 9.1 addresses three major corporations and how they responded when
the tech bubble burst. Cisco projected past growth rates into the future and ended up with too much
inventory. By contrast, Siebel Systems had accurate forecasts, in part, because it rewards salespeople for
good forecasting as well as making sales.


        Because business conditions change rapidly, information controls are needed that can quickly
adjust. With contemporary controls, an organization‟s assumptions, goals, and strategies are continuously
monitored, tested, and reviewed. Thus, anticipating and adapting to change is built into the control
process. EXHIBIT 9.2 illustrates the contemporary approach.
                   Transparency 76 (Ex. 9.2) Contemporary Approach to Strategic…

         Notice in EXHIBIT 9.2 that both informational and behavioral controls are needed for the
contemporary approach. Informational controls ask whether the organization is “doing the right things.”
Behavioral controls, by contrast, ask whether the organization is “doing things right.” With this
framework, therefore, you can illustrate how the combination of effectiveness (“doing the right things”)
and efficiency (“doing things right”) applies in the context of strategic controls.

       What is the advantage of continuously monitoring and updating information controls?

        The SUPPLEMENT below provides a more recent example of why a contemporary control system
is needed in a changing environment. It is from an article about how to out-manage the competition during
an economic slowdown.

                            MANAGING IN A DOWNTURN -- CHANGING GOALS

As the economy slows down, firms are in great danger that they will stop doing what they‟re already doing right. To
prevent this, according to senior consultant Ram Charan and Fortune Editor Geoffrey Colvin, it is important for
companies to remember three of the most important fundamentals for keeping any business successful:

1.      The first is to maintain a clear-eyed view of reality, no matter how unpleasant it is or how it may differ from
        what you expected. It is amazing how many companies chase after management fads when times are good
        but refuse to change when the environment changes dramatically. When the economy slows, firms need to
        wipe their whiteboard clean and rethink strategy based on what‟s realistically achievable. Firms should ask,
        how are we going to be No. 1 in a new environment. In other words, how do we continue to do the right
2.      The second is continual, day-by-day insistence on improving productivity. In other words, companies need
        to ask if they are doing things right. In an economic slowdown, productivity typically goes down, leading
        some executives to conclude that it is unavoidable in bad times. It‟s not. In fact, improving productivity
        during a downturn puts a company in a stronger competitive position when things turn up again.
3.      The third fundamental is to stay focused on people. The quality of the people a company hires is often its
        only major source of competitive advantage. Yet when times get tough, many companies ease up on
        recruiting, figuring a slow economy will drive more applicants their way. They also spend less on training
        as a way to raise profits quickly without doing immediate damage to the business. But the long-term
        damage can be devastating. If you were an airline, would you postpone aircraft maintenance for six
        months? Of course not. People also change and grow and even become obsolete if quality is not

Source: Charan, R., & Colvin, G. 2001. Managing for the slowdown. Fortune, February 5: 79-88.

       What kind of information controls can companies use to accurately assess the environment,
        evaluate productivity, and improve the quality of the work force?

        Emphasize that contemporary control systems—which require continually monitoring numerous
information sources and result in rapid revisions to corporate strategies or direction—may be “easier said
than done.” Sometimes, the most important thing strategic managers can do is to continually question
assumptions about the business and have frequent face-to-face meetings to discuss direction and outcomes.

       The SUPPLEMENT below emphasizes that old systems often have to be updated. It describes the
methods that Praxair recently used to overhaul its budget process and make it more timely.

                                CREATING A RESPONSIVE BUDGET PROCESS

In many companies, budgeting involves a ten-week cycle. Besides being overly drawn-out, the process can often
cause problems if lower level managers propose budgets that consider only their own priorities and not the
company‟s overall situation. Then, in budget negotiations, top managers typically ask for more ambitious goals
while lower level managers shoot for targets they know they can hit. The result is silo thinking and compromise.

But recently, Praxair has implemented a speedier and more comprehensive system. It begins with the company‟s
overall goal, articulated by top management and based on the big-picture environment. Managers from each unit
then state in a maximum of 50 budget lines, the most important things it believes it must accomplish to achieve that
goal. Then the critical 20 to 30 people get together and openly discuss key actions and assumption for each unit.
With information technology, managers can see the effects of changes to the budget instantly. The horse trading
goes on for about three days and in the end, everyone understands the total picture and collaboration between units
becomes easier.

Source: Charan, R., & Colvin, G. 2001. Managing for the slowdown. Fortune, February 5: 79-88.

        What are some examples of other information control systems that could benefit from the
         type of process used by Praxair?

        What are some examples from other companies of interactive information control systems?

        STRATEGY SPOTLIGHT 9.2 addresses the continuous monitoring and real-time decision
making techniques used by top managers at Gannett-owned USA Today. The type of information they
monitor includes actual versus budgeted advertising revenues and market shifts that created unexpected
opportunities. These methods have resulted in several innovations that have enhanced profitability.

        Behavioral control is an approach to implementing strategy that relies on three behavioral forces or
“levers” -- culture, rewards and incentives, and boundaries. The aim is to use these levers to evoke
appropriate actions in the workforce and also to maintain a proper balance between these three factors.
Depending on the type of organization and the business environment, the way these forces are manipulated
may vary in order to achieve goals with the greatest degree of efficiency. EXHIBIT 9.3 illustrates the three
behavioral controls.
                           Transparency 77 (Ex. 9.3) Essential Elements of Strategic…

         Point out that there are two reasons why behavioral controls are important for strategic managers

         1.       Increasingly complex and unpredictable environments make it important that all workers
                  respond quickly. Reward systems and culture provide an implicit type of coordination

         2.       Today‟s work force includes younger managers who see themselves as free agents.
                  Traditional controls such as rules and regulations typically will not motivate such
                  employees. Behavioral controls are needed to build loyalty and commitment.


         Culture refers to the shared values, unspoken understandings, and sense of purpose within
organizations. It provides unwritten standards of acceptable behavior. When a culture is strong and
positive, it can be a powerful force for accomplishing company goals.

       What makes an organizational culture strong? What are some examples of companies with
        a strong culture?

       What would be the effect on an organization if its culture was “negative” rather than
        “positive?” What are examples of companies that have a negative culture?

        1.       THE ROLE OF CULTURE

        Point out that a company‟s culture is often what makes it unique compared to other firms in an
industry. This uniqueness gives workers a sense of specialness. It may also influence other stakeholders.

          The SUPPLEMENT below shows how Siebel Systems has used dress code as a way to distinguish
itself in the laid back Silicon Valley environment.

                               DRESSING UP IN THE VALLEY OF BLUE JEANS

Tom Siebel, CEO of Siebel Systems, a 5200-employee Silicon Valley software company, runs a tight ship. In a
location otherwise known for its casual and unstructured workplaces, Siebel stands out. What really gives Siebel the
distinction of being the most un-Silicon Valley CEO in Silicon Valley, however, is his insistence on a dress code.
Untouched by the trend toward “business casual,” Siebel mandates that employees who deal with customers, which
amounts to about half the work force, dress “professionally” at all times.

Siebel is aware how old-fashioned this seems but he says he doesn‟t care because it impresses customers. “When
people get off the plane from Munich or New York, they think they‟re in an environment that looks and is
professional. Then they go to other companies, and there‟s Nerf balls in the hall and people are wearing jeans. They
come back and buy our products,” he says.

Source: Warner, M. 2000. Confessions of a control freak. Fortune, September 4: 130-140.

       What are some of the other examples of culture that give companies a sense of uniqueness or
        set them apart in the mind of employees or customers?


          Companies use many different techniques to foster a positive culture and create an environment
that is fun and motivating. Another advantage of a strong culture is that it builds cohesion within the work
force. This can become a critical management activity. Southwest Airlines, known for its culture of
enthusiasm and openness, has a culture committee to perpetuate its strong culture.

        The SUPPLEMENT below describes how one division of Sprint uses fun and group activities to
generate cohesion and build enthusiasm.


At Sprint‟s small business sales division in Kansas City, Missouri, more than 150 people sell telecommunication
services to small businesses. Because it primarily involves cold calling for eight hours a day, it can be tedious work.
The result is often high employee turnover.

Manager Nancy Deibler and her crew, however, have found a way to counteract the tedium. They‟ve created a
strong rapport within the sales team by building fun into their work. Making fun a legitimate part of work isn‟t all
that difficult, says Deibler. For example, Deibler‟s team might leave work at 3:00 p.m. to go bowling. “After doing
something like that,” she says, “the difference that it makes is measurable and it lasts for weeks.” Add baseball
games, cookouts, goofy hats, evenings of karaoke and a host of other ways to introduce positive energy and
playfulness into a work world that is often all-too-serious. Deibler knows that all of this may seem hokey to some
people -- but she doesn‟t care. “It lifts productivity,” she says. As a result, Deibler has been able to keep and attract
top performers.

Source: Reich, R. 1998. The company of the future. Fast Company, November: 124-150.

        Is there any “downside” to a workplace that emphasizes fun and playfulness?

        What are examples of other companies that use culture in unusual ways to build cohesion
         and enhance productivity?

        Emphasize that dress codes and “fun parties” are not the only way companies cultivate and
maintain a strong culture. In fact, the company leadership is one of the most important sources of a strong
and positive culture. Sam Walton was known for his pep talks. Home Depot founders Bernard Marcus
and Arthur Blank often held pep rallies over closed circuit TV.

       The SUPPLEMENT below discusses the importance of culture at Southwest Airlines in CEO
Herb Kelleher‟s own words:


Herb Kelleher believes that it‟s the intangibles that set Southwest apart from the competition. “You can get
airplanes, you can get ticket counter space, you can get tugs, you can get baggage conveyors. But the spirit of
Southwest is the most difficult thing to emulate. So my biggest concern is that somehow, through maladroitness,
through inattention, through misunderstandings, we lose the esprit de corps, the culture, the spirit. If we ever do lose
that, we will have lost our most valuable competitive asset.”

Source: Huey, J., & Colvin, G. 1999. The Jack and Herb show. Fortune, January 11: 163-166.

        Do you think culture is a firm’s most valuable asset? Why or why not?

        What are some examples of other companies that derive competitive advantages from their
         corporate culture?

Teaching Tip: Ask students how they define organizational culture and how it can be a source of
competitive advantage that can be sustainable over time. Point out that it is particularly important in
the knowledge economy for several reasons: it helps to combine/leverage resources, it enhances firm-
specific ties (which is particularly important given that human capital is highly “mobile”), it can help
the firm convert tacit knowledge into codified knowledge, etc. You may wish to draw on some of the
core concepts in Chapter 4 to reinforce your points.


         Reward systems specify who gets rewarded and why. They can have a powerful influence on
individual performance and overall firm outcomes. Reward systems need to be closely linked to culture
since they “put the money where the mouth is” of the organization. If rewards don‟t match up to the
espoused values and beliefs, reward systems can also be a powerful de-motivator.

        STRATEGY SPOTLIGHT 9.3 addresses how the China-based Legend Group varies its incentives
based upon the different hierarchical levels in its organization.

       Are you familiar with other firms that have different incentives and rewards for individuals
        at different hierarchical levels? Is the reward system effective? Why? Why not?


        Emphasize that one of the challenges for strategic managers is to design and implement reward
systems in which what is best for the rational individual is also best for the organization. Rewards and
incentive systems can trigger unexpected or unwanted behaviors if organizational members feel they are
being rewarded unfairly or sub-cultures within an organization feel disenfranchised. These feelings can
deteriorate the cohesion of the workforce or damage the organization.

       What is it about reward systems and incentives that make them an emotional flashpoint
        within organizational control systems?

       What are some examples of companies that have effectively aligned their reward systems
        with their goals and culture?


         Another challenge for strategic managers is to create reward and incentive programs that are
effective across all parts of the organization.

        Discuss the qualities and characteristics of a good reward system:

        1.      Objectives are clear, well understood, and broadly accepted
        2.      Rewards are clearly linked to performance and desired behaviors
        3.      Performance measures are clear and highly visible
        4.      Feedback is prompt, clear, and unambiguous
        5.      The compensation “system” is perceived as fair and equitable
        6.      The structure is flexible—it can adapt to changing circumstances

        The SUPPLEMENT below addresses what can go wrong when a reward system is abused in order
to make performance look better than it really is.


One way to motivate strong performance is to empower employees to take initiative in responding to customers‟
needs. Whether managers realize it or not, however, there are built-in dangers when empowered employees are held
accountable for performance goals—especially for difficult ones—and then left to their own devices to achieve them.

Take, for example, Nordstrom, the upscale fashion retailer known for extraordinary customer service. It found itself
embroiled in a series of lawsuits related to its sales-per-hour performance measurement system. Used to track the
performance of its entrepreneurial salespeople, the system was designed to support the service orientation for which
Nordstrom is famous. But without counterbalancing controls, the system created the potential for both exemplary
customer service and abuse. Some employees claimed that first-line supervisors were pressuring them to under-
report hours on the job in an attempt to boost sales per hour. Settling those claims cost Nordstrom more than $15

Source: Simons, R. 1995. Control in an age of empowerment. Harvard Business Review, 73(2): 80-88.

        What kind of “counterbalancing” incentives could Nordstrom use to create a reward system
         that would not be abused?

        Do some professions or types of work lend themselves to abuses of their rewards and
         incentive systems more than others? Which ones? Why?

         Emphasize that there is a close link between reward systems and an organization‟s culture. A
culture of risk taking may be present in firms that are entrepreneurial, but then a reward system is needed
that encourages risk taking. Similarly, if technological superiority is an organization‟s key distinctive
competence, then reward systems must be created that highlight technical skills development and
performance. Emerson Electric is presented as an example of how reward systems are helping it realign its

        The SUPPLEMENT below addresses how Magna International, the huge automotive components
and systems supplier, fosters innovation through the use of rewards and its strong culture.


    At Magna International, the giant automotive components and systems supplier, innovation is built into the
    “corporate constitution” that outlines the firm‟s core principles—one of which is to foster inventive thinking on
    the part of its employees. According to Belinda Stronach, president and CEO of the $11 billion company,
    “Incremental innovation requires the right environment—one built on fairness, security, safety, and proper
    communications”. She states that a comprehensive incentive program helps motivate its 72,000 employees to be
    creative and to “slice up the pie of profits before it‟s baked.”

    How does it work? Six percent of profits are distributed to Magna‟s management team, all of whom—Stronach
    included—receive low base salaries. “Employees receive 10 percent of profits, of which a portion is in shares
    and a portion is in cash,” she noted. “We‟re all motivated to generate profits because we receive a percentage,
    and we‟re also required to hold shares so that we look out for the long-term interests of the company.”

    Since profit incentives alone won‟t deliver innovation, Magna also encourages creative thinking and idea
    sharing by promoting open communications and a sense of security among employees. To encourage dialogue
    and collect ideas, for example, each division holds monthly meetings between employees and the general
    manager. Claims Stronach: “We recently created an employee advocate position—an individual jointly selected
    by the employees and by management who cannot be fired by management, only by an employee ballot—to
    foster communications between employees and management. The mandate is to facilitate communications, keep
    employees happy and bring forward new ideas.”

    “Without safeguards, employees will not have the confidence or the motivation to come forward with new ideas.
    We found that by making employees stakeholders and providing the right entrepreneurial environment,
    incremental innovation is a byproduct,” says Stronach.

    Source: Anonymous. 2003. Winning through incremental innovation. Chief Executive. January-February, 32-

        The SUPPLEMENT below addresses how Novell uses its promotion and rewards system to
recognize technical contributions and foster a culture of technical superiority.


Eric Schmidt, former CEO of Novell, believes that technical “geeks” are one of his organization‟s most important
assets. In fact, according to Schmidt, being a geek at Novell “is a badge of honor,” Thus, Novell has created a
system designed to reward geeks, provide them with a career path, and create opportunities for them to have an
impact on the bottom line:

“Twenty years ago, we developed the notion of a dual career ladder, with an executive career track on one side and a
technical career track on the other. Creating a technical ladder is a big first step. But it‟s also important to have
other kinds of incentives, such as awards, pools of stock, and nonfinancial kinds of compensation.”

“At Novell, we just added a new title: distinguished engineer. To become a distinguished engineer, you have to get
elected by your peers. That requirement is a much tougher standard than being chosen by a group of executives. It‟s
also a standard that encourages tech people to be good members of the tech community. It acts to reinforce good
behavior on everyone‟s part.”

Source: Mitchell, R. 1999. How to manage geeks. Fast Company, June: 176-180.

        What other type of employees might be excluded from advancement or promotion if systems
         are not created to recognize their contribution?

       What types of rewards and incentives could be developed for such employees?


        This section discusses how rules and regulations, as well as aspiration levels and goals, can
provide effective forms of organizational control. Point out that culture and reward systems often need to
be supplemented or reinforced by boundaries and constraints. Used properly they can:

        1.       Focus individual efforts on organizational priorities
        2.       Provide short-term objectives and action plans that channel efforts
        3.       Improve efficiency and effectiveness
        4.       Minimize improper and unethical conduct

        Emphasize that boundaries and constraints must be used sparingly in order to be effective.
Excessive regulations or rules that are enforced with poor judgement can be counterproductive.

        The SUPPLEMENT below illustrates a rather humorous example of regulations being enforced in
an excessive fashion in the midst of public emergency.


State officials near Coeur d‟Alene Idaho issued $100 citations recently to two drivers whose U.S. Government water
trucks were on their way to fight forest fires in Montana. The officials discovered that the trucks exceeded the
highway weight limit of 17 tons (by 1 and 2 tons respectively). According to the Helena (Montana) Independent
Record newspaper, the trucks were permitted to head out to the front lines only after they had dumped enough water
to satisfy the inspectors.

Source: Shepherd, C. 2000. Water weight. Lexington Herald-Leader, October 27: 29.

       Do you think the inspectors acted properly or excessively?

       Have you ever been asked to observe a rule that was excessive? What is an example from
        your own experience?

       What effect does an excessive rule or an overly strict regulation have on your behavior?
        How do you think such rules and regulations affect organizational performance?


         Vision, mission, and strategic objectives are a type of boundary that was introduced in Chapter 1.
These types of goals can take several forms. For example, GE Chairman Jack Welch set a goal of having
all of the business in GE‟s portfolio ranked first or second in their industry. Point out that this type of goal
gives all organization members a boundary in the sense of a goal line to shoot for.

       Can broad corporate goals such as GE’s help control individual behaviors?

       What must strategic managers do to enact their organization’s mission and vision?


         Strategic objectives and actions plans may have a more direct impact on the behavior of an
organization‟s employees. Discuss the attributes of short-term objectives that need to be present for them
to be effective. They must:

        1.      Be specific and measurable.
        2.      Include a specific time horizon for their attainment.
        3.      Be achievable yet challenging enough to motivate managers who must strive to
                accomplish them.

          Short-term objectives must provide proper direction but also be flexible enough to keep pace with
changing conditions and unexpected circumstances. We use the example of the resignation or death of a
key executive, wildcat strikes, industrial accidents, and intense competition in the automobile industry to
illustrate unanticipated change.

       What are some examples of short-term goals that you have been faced with as a student? In
        your place of work?

       Did you find that those goals had a positive influence on your behavior?

         Action plans are another type of boundary or constraint because they provide specific, measurable
frameworks for how a strategy is to be implemented. Once managers understand the outcome that is to be
achieved, developing an action plan gives them a sense of ownership of the company‟s goals. They also
feel a degree of autonomy since they can often select (or modify) the specific means for accomplishing the

         STRATEGY SPOTLIGHT 9.4 describes the process of creating an action plan at MSA Aircraft
Interior Products, Inc. It demonstrates how a company goes from an overarching mission to a detailed
action plan. EXHIBIT 9.4 illustrates an action plan that was created to achieve one of MSA‟s objectives.

                            Transparencies 78a, 78b (S.S. 9.4) Developing…

                         Transparency 79 (Ex. 9.4) Action Plan for Objective #3


        Discuss why rules-based controls are most appropriate in organizations where:

        1.      Environments are stable and predictable.
        2.      Employees are largely unskilled and interchangeable.
        3.      Consistency in product and service is critical.
        4.      The risk of malfeasance is extremely high (as in banking or casino operations), and
                controls must be implemented to guard against improper conduct.

        McDonald‟s, the Ritz Carlton, and Computer Associates are used as examples.


         Rules and guidelines are often used to control commercial practices such as bribes, kickbacks, and
other forms of payment that may be illegal. These guidelines are used in many arenas including
maintaining customer confidentiality and developing sourcing strategies for dealing with suppliers.

        The SUPPLEMENT below illustrates an example of how rules and regulations can be used to
influence a change in company practices leading to a change in culture.


Few companies have a reputation for cost cutting that is as tough as General Electric‟s. Recently, GE declared war
on desktop printers, fax machines, and copiers. Such devices are literally being removed by the truckload. Dumping
printers and faxes is the idea of Gary Reiner, GE‟s head of Internet strategy. It‟s part of a ploy to persuade the
300,000-plus workers at GE to live and breathe Net culture. Big cultural shifts take time, and we‟re just at the
beginning of this one, says Reiner. So far, there are no loud complaints from the paper-deprived. They say they‟re
happy to store data in laptops and smart phones, as long as GE provides them. And there‟s an added bonus: Paper
consumption is already down 28 percent and GE anticipates the change will save it $18 million per year.

Source: Moore, P. L. 2001. GE embraces the paperless office. Business Week, June 25: 10.


        In this section, we take a contingency approach to behavioral control. That is, the effective use of
rewards/incentives, culture, and boundaries are dependent on a variety of internal and external factors.

        To summarize, we suggest that culture is most associated with professional organizations, where
high autonomy and norms are the basis for behavior; rules/boundaries are best where there are
standardized output, repetitive tasks, and a minimal need for creativity; and rewards are most appropriate
when performance evaluation is quite straight-forward.

        EXHIBIT 9.5 summarized our arguments.

                         Transparency 80 (Ex. 9.5) Organizational Control . . .


        In general, the use of culture and reward systems provides a more favorable “internalized” control
system than a set of rules and regulations. Often, however, companies have to develop in this direction.
We provide four guidelines:

        1.       Hire the right people, those who identify with the company‟s dominant values.
        2.       Use training and indoctrination to build a strong identity and sense of the company
        3.       Encourage managers to set examples for the whole company with their behaviors.
        4.       Align company reward systems with organizational goals and objectives.

        STRATEGY SPOTLIGHT 9.5 draws on the example of Brazil-based Semco to illustrate the
successful use of culture and rewards as a means of strategic control. Rather than rules and regulations,
Semco relies on trust, openness, and fairness to motivate employees and generate loyalty.

        There is not “one best way” to set up a control system for an organization. Point out that effective
controls, as with other elements of strategy, are contingent on many factors. In this section, we discuss
how business-level and corporate-level strategies create needs for different strategic controls.


         Two major generic strategies—overall cost leadership and differentiation—require fundamentally
different approaches to control, rewards, and incentive systems.


        Cost leadership strategies require that companies pay close attention to every element of cost.
They also work best in stable environments where the rate of innovation is low and efficiencies are
achieved in the production process. Thus, firms competing on the basis of cost rely on tight cost controls,
frequent and comprehensive reports to monitor the cost of inputs and outputs, and highly structured tasks
and responsibilities. Incentives are based on financial targets. We use the example of Nucor to illustrate
how its approach to rewards and incentives contributes to successful cost leadership.

        The SUPPLEMENT below provides additional information and detail about Nucor‟s production
incentive plan to illustrate how rewards are linked to culture and strategy.


Nucor uses a performance-related compensation system. Under this plan, employees directly involved in
manufacturing are paid weekly bonuses based on actual output in relation to anticipated production tonnages
produced. The bonuses pay only for work that meets quality standards. They are not pegged to individual output but
to that of work groups of 25-40 workers. Once the standard output is determined, it is not revised unless there is a
significant change in the way a production process is performed due to a source other than the workers in the bonus
group. Bonuses are also tied to attendance and tardiness standards. If one worker‟s tardiness or attendance
problems cause the group to miss its weekly output target, every group member is denied a bonus for that week.
“This bonus system is very tough,” says former CEO Ken Iverson. “If you are late, only five minutes, you lose your
bonus for the day. If you are thirty minutes late or you are absent for sickness or anything else, you lose your bonus
for the week. Now, we have four forgiveness days per year when you might need to close on a house or your wife is
having a baby, but only four.”

Source: Anonymous. 1986. Steel man Ken Iverson. Inc. Magazine, April: 44-45.

        What do you think of the incentive program at Nucor? Would you find it depressing or
         energizing to work under a system such as this?

        What other types of business processes could benefit from this type of control system?

        2.       DIFFERENTIATION

          Differentiation involves the development of unique product and service offerings, often involving
innovation and creativity. As a result, it may be hard to evaluate success using hard behavioral measures.
Instead, qualitative and intangible incentives may be needed to reward the kind of specialized design work
and/or scientific expertise that is necessary to successfully differentiate. We use the example of 3M to
describe a system in which experimentation is encouraged and managers are not penalized for product


        The type of diversification strategy that a firm follows has implications for the type of controls it
should use.

        Related diversification often involves coordination across multiple product lines in order to enjoy
the synergies of relatedness. Rewards need to be linked to overall behaviors such as teamwork and
communication rather than short-term objectives only. We use the example of Sharp Corporation where
promotions are tied to teamwork skills and seniority that encourages employees to pursue what is best for
the corporation and keeps turnover low.

         Unrelated diversification, by contrast, is most successful when each company or division in a
portfolio of businesses is entrepreneurial and competes with others for resources and rewards. Corporate
policy usually involves top-down budgeting. Controls focus division presidents on financial performance
and the reward system is linked to achieving outstanding results. We use the example of Hanson plc to
demonstrate how corporate strategies are rewarded.

        EXHIBIT 9.6 summarizes our discussion of the relationship between strategies and control
                          Transparency 81 (Ex. 9.6) Summary of Relationships

         In this section, we focus on the need for both shareholders (the owners of the corporation) and
their elected representatives, the board of directors, to actively ensure that management fulfills its
overriding purpose: increasing long-term shareholder value.

        As noted by Robert Monks and Nell Minow, two of the leading scholars in corporate governance,
the primary participants in corporate governance are: (1) the shareholders, (2) the management (led by the
Chief Executive Officer), and (3) the board of directors. In recent years, there have been many instances of
poor corporate governance and we provide brief, bulleted examples of AOL Time Warner, Oracle, Arthur
Andersen, former Sunbeam CEO Al Dunlap, Global Crossing, Tyco International, and Merril Lynch.

        This is certainly a topic that should create a lot of student interest. You may want to pose some
“lead-off questions” such as:

       What are some of the recent examples of flawed corporate governance? What do you feel
        were the causes? How could they have been avoided? (You should get some pretty
        interesting responses.)

Teaching Tip: Clearly, there are few topics that have received as much “business press” as flawed
corporate governance in recent years. Ask students for some examples of illegal and unethical behavior
by corporate executives. Ask if these behaviors/actions could have been prevented? It should bring out
some interesting discussions and help to introduce some of the central concepts in corporate


         Here, we address some of the implications for the separation of ownership and management in the
modern corporation. We begin with some definitions of the corporation, including a humorous one from
The Devil’s Dictionary: An ingenious device for obtaining individual profit without individual
responsibility. In a nutshell, we mention that a corporation is a mechanism created to allow different
parties to contribute capital, expertise, and labor for the maximum benefit of each party.

         We briefly draw on the classic work of Adolf Berle and Gardiner C. Means who roughly seventy
years ago advanced the idea of the divergence of the interests of the owners of the firm (shareholders) and
its managers. Such separation is central to agency theory, which addresses the relationship between two
primary players—the principals who are the owners of the firm (stockholders) and agents who are the
people paid by the board of directors to perform a job on their behalf (management). Agency theory is
concerned with resolving two problems that can occur in agency relationships: (1) when the goals of the
principals conflict, and (2) when it is difficult or expensive for the principal to verify what the agent is
actually doing.

         STRATEGY SPOTLIGHT 9.7 provides examples from corporations outside of the United States
that have experienced flawed corporate governance. Thus, despite all of the bad press associated with
faulty governance in the U.S., there is no monopoly on bad practices in a single country!


         Three key governance mechanisms are addressed in this section. The first two address the primary
means by which the behavior of managers can be monitored: (1) a committed and involved board of
directors that acts in the best interests of shareholders, and (2) shareholder activism, wherein the owners of
the corporation become actively involved in the governance of the corporation. In addition, a third
mechanism of governance is the effective use of managerial incentives, which are intended to align the
interests of management with those of the stockholders.


        In effect, the board of directors is the “middlemen” or “middlewomen” who provide a balance
between a small group of key managers in the firm and a vast group of shareholders. In the United States,
the law requires that the board have a strict and fiduciary duty to ensure that the company is run consistent
with the long term-interests of the owners (shareholders).

         We provide five duties of the board of directors, according to the Business Roundtable. These
include such issues as the selecting, evaluation, and replacement (if necessary) of the CEO; review of
strategies; financial objectives; providing advice and counsel to top management; etc.

        A key element of effective boards is director influence, i.e., that board members are free of all ties
to the CEO or the company. Clearly, this is not always the case, and we provide the example of Walt
Disney Co. under the direction of Michael Eisner.

        The SUPPLEMENT below provides more information (which your students may find interesting)
on the conflicts of interest on the board at Disney.


Among some revelations at Disney in 2002… In 2002, Walt Disney paid $232,782 to a private company for use of a
plane by Vice-Chairman Roy Disney. The company, Air Shamrock, is owned by the Disney family and a holding
company run by director Stanley Gold. Disney also disclosed that in 1997 it had pledged $25 million to build the
Walt Disney Concert Hall and has donated $20 million so far. Who was the chairman and CEO of the arts center?
“Independent” director Andrea Van de Kamp, who joined the board the year after Disney pledged the cash.

Ira Millstein, Disney‟s governance advisor, responded by saying that the board should be applauded for making the
disclosures, which in most cases were not required. Claims Millstein: “As long as you tell everybody what you‟re
doing, that‟s good governance”. Might Disney shareholders have a different opinion?

Source: Lavelle, L. 2002. Disney: More insiders at the castle. BusinessWeek. December 30: 14.

        You may consider asking:

       How can such conflicts of interests be avoided by firms?

       Do you agree with Millstein’s perspective in the last paragraph of the SUPPLEMENT?
        (This should generate some interesting discussion!)

       EXHIBIT 9.7 lists some of the excellent governance practices of Intel, the world‟s largest
semiconductor chip manufacturer with $27 billion in revenues in 2002.

                            Transparency 82a, 82b, 82c (Ex. 9.7) Intel Corporation‟s
         The SUPPLEMENT below provides some initiatives that some firms are undertaking to improve
their corporate governance:



        Why Change? Critics say that combining the jobs of CEO and Chairman of the Board gives one executive
        too much power. Companies balk at splitting the jobs, but the idea of a “presiding director” to lead the
        board‟s outsiders is quickly gaining support.
        Examples: GE, H & R Block, Tyco


        Why Change? A new Security and Exchange Commission (SEC) rule requires companies to disclose
        whether they have a financial expert on their boards‟ audit committees. General business experience
        doesn‟t count.
        Examples: AT & T. Kimberly Clark, Sun Microsystems, Alberto-Culver, W. R. Berkle


        Why Change? The New York Stock Exchange (NYSE) will require a majority of outsiders on boards,
        with strict standards for independence. Recruiting is tougher because companies are reducing the number
        of outside boards on which their CEOs can serve.
        Examples: Sun Microsystems, BMC Software, Interpublic Group


        Why Change? To keep a tight focus on corporate control, firms are hiring chief governance officers,
        instituting governance codes, or overhauling board nominating committees. Boards are adding formal
        evaluations of directors.
        Examples: Computer Associates, Motorola, Charles Schwab

Source: Borrus, A. & McNamee, M. 2003. Reform: Business gets religion. BusinessWeek, February 3: 40-41.

       How do you think these reforms will enhance corporate governance? What else is needed?


        Although, as a practical matter, individual shareholders hold relatively little influence, they do—
acting collectively—have power to bring about shareholder action suits and demand that key issues be
brought up for proxy votes at annual board meetings. In addition, shareholder influence has intensified in
recent years because of the growing influence of large institutional holders such as retirement (e.g., TIAA-
CREF, CalPERS) and mutual funds (e.g., Fidelity, Vanguard). In fact, institutional investors hold about
50 percent of all listed corporate stock in the United States.

         Some institutional shareholders are being very proactive in demanding changes. EXHIBIT 9.8
identifies two companies that CalPERS has put on its Focus List for 2003. (These are corporations to
which CalPERS directs specific suggested governance reforms—which, given CalPERS influence, merits
significant public and market attention.)

                             Transparency 83 (Ex. 9.8) The 2003 CalPERS Focus List

         It is interesting to note that while the companies that CalPERS have targeted trailed the Standard
& Poors Index by 89 percent in the 5-year period before CalPERS acted, the same stocks outperformed the
index by 23 percent in the following five years. This has added approximately $150 million in additional
returns to the Fund.


         From a corporate governance perspective, one of the most critical roles of the board of directors is
to create incentives that align the interests of the CEO and top executives with the interests of the owners
of the corporations. After all, shareholders rely on CEOs to adopt policies and strategies that maximize the
value of their shares.

        There must be an effective combination of three basic policies to create the right financial
incentives for CEOs to maximize the value of their companies:

        1.      Boards can require that the CEOs become substantial owners of company stock.
        2.      Salaries, bonuses, and stock options can be structured so as to provide rewards for
                superior performance and penalties for poor performance.
        3.      Threat of dismissal for poor performance can be a realistic outcome.

        We address some figures on the tremendous pay packages that top executives of publicly-owned
corporations have earned in recent years. For example, in 2001, the CEOs of major corporations averaged
$11million in total income—a figure that is 411 times the average factory worker. And, over the past
decade, the wages of the rank-in-file have increased by only 36 percent while the pay of the CEO has risen
360 percent. We provide contrasting examples of Howard Solomon, CEO of Forest Laboratories and CEO
Laurence Ellison of Oracle to give some insights on how such pay may be considered as “earned” or “not
earned”, respectively.

Teaching Tip: You can spur a lot of debate by asking if the amount of executive pay in recent years
has become excessive. Some students will claim that it helps to attract top talent and that, if tied to
corporate performance, any level is justified. Others may feel that there should be some realistic limits
because, after all, many factors can explain the success (or lack thereof) of a corporation besides the
actions of its top executives. Still other students may feel that such huge levels of compensations are
simple examples of agency conflicts, i.e., that members of the boards of directors are too closely aligned
(i.e., not independent) with top executives and do not effectively represent shareholders.

        Much of the wealth that CEOs and other top executives have created for themselves is attributed to
the exercising of stock options. EXHIBIT 9.9 addresses some of the principles on the role of stock in
executive compensation that have been proposed by TIAA-CREF, the huge retirement funds management
                          Transparency 84 (Ex. 9.9) TIAA-CREF‟s Principles …


        Thus far, our discussion has been on internal governance mechanisms. However, internal controls
do not always ensure good governance. The separation of ownership and control that is central to the
concept of the corporation requires multiple control mechanisms. In this section, we address several
external control mechanisms that have been developed in most modern economies. These include the
market for corporate control; governmental regulatory bodies; auditors; analysts; and the business press
and public activists.


        If a company‟s internal control mechanisms are failing—that is, the board is not effectively
monitoring managers and shareholders are largely indifferent, there is a strong likelihood that managers
will behave opportunistically. Such behavior can take many forms, including shirking (failure to exert
maximum effort), on the job consumption (perks such as private jets, luxurious club memberships,
expensive artwork for their offices), or excessive product-market diversification (which serves to reduce
employment risk but often results in lower shareholder value).

        The market for corporate control is one external mechanism that provides a potential solution to
the problems above. Rather than “fight”, shareholders will eventually sell their share, which will depress
the value of the stock. At some point, the low stock price will make the firm an inviting target for a
corporate raider—because the market value of the firm may be less than the book value.

         The first thing a “successful” corporate raider may do upon gaining control of the corporation is to
fire the management and replace it with its own appointed leaders. The risk of being taken over is often
referred to as the takeover constraint, which deters management from engaging in opportunistic behavior.
         In recent years, the threat of the takeover constraint has become less effective as the result of a
number of defense tactics that have been employed by management. These include poison pills,
greenmail, and golden parachutes.

        2.      AUDITORS

        Despite stringent disclosure requirements, there is no guarantee that the information disclosed by a
firm will be accurate. Managers may purposely disclose false information or withhold negative financial
information. Thus, accounting statements are required to be audited by external auditors.

         Recent developments leading to the bankruptcy of firms such as Enron and World Com and a
spate of earnings restatements have raised questions about the failure of auditing firms to act as effective
control mechanisms. One of the conflicts-of-interests that have occurred many times in the recent business
press is that auditing firms may overlook financial irregularities in order to better position themselves to
earn lucrative consulting contracts from the firms that they audit. We provide the example of KPMG‟s
questionable auditing of Xerox‟s books. Here, of the $82 million that Xerox paid to KPMG, only $26
million was for auditing fees—the balance was for consulting services. (For example, when one of the
auditors objected to Xerox‟s practice of booking revenues for equipment leases earlier than it should have,
Xerox asked KPMG to replace him. KPMG did!)

        3.      BANKS AND ANALYSTS

         Financial institutions and stock analysts are two external groups that monitor publicly-held firms.
Commercial and investment banks have a vested interest because they lend money to corporations and
must ensure that the borrowing firm‟s finances are in order and that the loan covenants are being followed.
 And, stock analysts conduct studies of the firms that they follow and make recommendations to their
clients to buy, hold, or sell.

         In practice, analyst recommendations have been more optimistic than warranted by the facts.
“Sell” recommendations are very infrequent, in part, because most analysts work for firms that also have
investment banking relationships with the companies that they follow. And, negative recommendations
can displease a firm‟s management who may decide to take their investment banking business elsewhere.

This conflict-of-interest has led to substantial litigation. The most recent and visible was the April, 2003
settlement between the Securities and Exchange Commission and the New York State Attorney General
with 10 banks that requires them to pay $1.4 billion in penalties and to fund independent research for

          The SUPPLEMENT below provides an interesting perspective on analyst recommendations. In
short, firms with “sell” recommendations outperformed firms with “buy” recommendations!

                                  FAULTY ANALYST RECOMMENDATIONS…

One could argue that all of the sparring between regulators and Wall Street over analyst recommendations may be
overdone. Investors can profit from analysts‟ advice—as long as they do the opposite!

After Wall Street‟s $1.4 billion settlement with regulators in April, equity research groups have simplified their stock
ratings. In September, Citigroup‟s Smith Barney analysts will use just buy, hold, and sell. Prudential, Merrill Lynch,
Legg Mason, and A. G. Edwards have made similar changes. Already, sell recommendations account for 11 percent
of ratings, up from less than 1 percent in May, 2000.

Nonetheless, simplicity does not ensure accuracy! Eric Shkolnik, president of analyst rating service, studied the top firms during the year ending August 8, 2003. He found that investors who buy
stocks hit with a “sell” did better than those who purchase stocks awarded a “buy.” At Morgan Stanley the “buy”
upgrades yielded 13.5 percent—but the “sell” downgrades gained 32 percent. Amazingly, no firms did better with
“buys” than with “sells”. A note to analysts: Call recommendations what you will—just be sure you call them right.

Source: Hovanesian, M. D. 2003. When „sell‟ means „buy‟. BusinessWeek, September 18: 12.

         4.       REGULATORY BODIES

         All corporations are subject to some regulation by the government and the extent of regulation is
largely a function of the industry within which they compete. Industries such as banks, utilities, and
pharmaceuticals are subject to more regulatory oversight because of their importance to society. Public
corporations are subject to more regulatory requirements than private-held corporations. Public
corporations are required to disclose a substantial amount of financial information by bodies such as the
Securities and Exchange Commission.

        The failure of a variety of external control mechanisms has led the U. S. Congress to pass the
Sarbanes-Oxley Act in 2002. This act calls for stringent measures to ensure better governance of U. S.
corporations. We address several measures that affect auditors, CEOs, executives, and corporate lawyers.

        STRATEGY SPOTLIGHT 9.8 describes some of the complex issues and implications associated
with the Sarbanes-Oxley Act for foreign companies that are listed on the U. S. stock exchanges.


         Although the press is not typically recognized as an external control mechanism in the corporate
governance literature, it would be hard not to argue that the financial press and media play an important
role in monitoring the management of public corporations. In the United States, business magazines such
as BusinessWeek and Fortune, financial newspapers such as the Wall Street Journal and Investors Business
Daily, and television networks such as CNBC and Financial News Network are constantly reporting on
companies. In fact, as we discussed in Chapter 5, Food Lion‟s reputation was damaged by an ABC Prime
Time Live report in 1992 that questioned its employment practices, false packaging data, and unsanitary
meat handling practices.

        Consumer groups and activists can also play a very visible role by crusading against what they
perceive as corporate malfeasance. EXHIBIT 9.10 summarizes the many watchdog groups founded by
Ralph Nader to monitor and change the behavior and strategies of major corporations.

                         Transparency 85 (Ex. 9.10) Watchdogs for Corporate…

       Do you feel that Ralph Nader’s groups constitute an effective external governance
        mechanism for corporations? Why? Why not?

        For firms to be successful, they must implement their strategies by means of effective strategic
controls. Without such controls, the firm will not be able to achieve competitive advantages and
outperform rivals in the marketplace.

         We began the chapter with the key role of informational control. We contrasted two types of
control systems: what we termed “traditional” and “contemporary” information control systems. Whereas
traditional control systems may have their place in placid, simple competitive environments, there are
fewer of those in today‟s economy. Instead, we advocated the contemporary approach wherein the internal
and external environment is constantly monitored and, when surprises emerge, the firm must modify its
strategies, goals, and objectives.

         Behavioral controls are also a vital part of effective control systems. We argued that firms must
develop the proper balance between culture, rewards and incentives, and boundaries and constraints.
Additionally, where there are strong and positive cultures and rewards, employees tend to internalize the
organization‟s strategies and objectives. This permits a firm to spend fewer resources on monitoring
behavior and the firm is assured that the efforts and initiatives of employees are more consistent with the
overall objectives of the organization.

         In the next section of the chapter, we took a contingency approach to the subject of control
systems, that is, we argued that there is no one best way to design a strategic control system; rather, it is
dependent on a variety of factors. The two that we discussed were the firm‟s business- and corporate-level
strategies. We argued that with overall cost leadership strategies it is appropriate to rely on cultures and
reward systems that emphasize the production outcomes of the organization because it is rather easy to
quantify such indicators. On the other hand, with differentiation strategies, there must be culture and
incentive systems that encourage and reward creativity initiatives as well as cooperation among
professionals in many different functional areas. Here it becomes more difficult to measure accurately
each individual‟s contribution and more subjective indicators become necessary.

         With regard to corporate-level strategies, we discussed the need for firms following related
diversification strategies to develop cultures and incentives that reward information and resource sharing as
well as overall goals of the corporation. However, in the case of unrelated strategies wherein there is
limited need or opportunity for resource sharing and collaboration, cultures and incentives that are highly
based on a manager‟s individual business-unit performance will suffice.

         In the final section of this chapter, we addressed corporate governance, which can be defined as
the relationship between the various participants in determining the direction and performance of the
corporation. The primary participants include shareholders, management (led by the chief executive

officer), and the boards of directors. We reviewed studies that indicated a consistent relationship between
effective corporate governance and financial performance. There are also several internal and external
mechanisms that can serve to align managerial interests and shareholder interests. The internal mechanisms
include a committed and involved board of directors, shareholder activism, and effective managerial
incentives and rewards. The external mechanisms include the market for corporate control, banks and
analysts, regulators, the media, and public activists.


To top