Corporate Governance and Organizational Architecture

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					   Corporate Governance and Organizational
                Architecture


               Clifford W. Smith




 FMA                                SIMON
Chicago
      Organizational Architecture

   Allocation of decision rights within the
    organization

   Structure of systems to evaluate
    performance

   Methods of rewarding individuals
        Our analysis draws heavily
              on economics
   Differs from much of the management
    literature
   Finance, accounting, organizations
    historically were institutional/normative
   Five decades ago, finance began to
    change
        -Positive analysis
        -Empirical evidence
   Three decades ago, accounting followed
    Corporate Governance involves
   The partitioning of decision rights among
    shareholders, board members, management and
    others

   Systems to monitor and evaluate their
    performance

   Methods by which these groups are rewarded
Corporate Governance is Organizational
  Architecture at the Top of the Firm
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
  Corporate Governance thus
involves a broad array of facets
   Some (charter, bylaws, organizational
    structure, accounting system, budgeting
    system, HR system and financial
    architecture) are largely chosen internally

   Others (oversight agencies, input and
    output markets and legal/regulatory/tax)
    are largely external to the firm

   These various facets are interrelated
Internal   Charter/Bylaws
              -Ownership Structure
              -Voting Rules
              -Anti-Takeover Provisions
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter/Bylaws
           Board Structure
              - Board Composition
              - Board Compensation
              - Committee Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Decision Management vs. Decision Control

   Initiation
   Ratification
   Implementation
   Monitoring
Internal   Charter/Bylaws
           Board Structure
           Organizational Structure
              -Centralization vs. Decentralization
              -Business Units: Function vs.
               Product vs. Geography
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
              -Financial Reporting
              -Managerial (cost) accounting
              -Internal Audit
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
              -Fixed vs. Incentive Compensation
              -Accounting Based vs. Stock Based
               Incentive Compensation
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
              -Leverage
              -Contract Structure (Covenants…)
              -Risk Management
              -Leasing
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
              -Public Accounting Firms
              -D & O Insurance
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
              -Exchange Listing
              -Investment Banks
              -Institutional Investors,
               Blockholders, Analysts
              -Bond Rating Agencies
              -Mergers/Tender Offers
           Labor Markets
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
              -Managerial
              -Board
           Input Markets
           Product Markets
External   Legal/Regulatory/Tax
Internal   Charter and Bylaws
           Board Structure
           Organizational Structure
           Accounting System
           Budgeting System
           HR System
           Financial Architecture
           Oversight Agencies
           Capital Markets
           Labor Markets
           Input Markets
           Product Markets
           Legal/Regulatory/Tax
              -State Incorporation
              -Federal/State Securities
              -Sarbanes-Oxley
External      -Williams Act
Corporate Governance is an integrated system—For
example, if a hostile takeover is contemplated:
  Internal      Charter and Bylaws
                        -Antitakeover provisions
                Board Structure
                Organizational Structure
                Accounting System
                Budgeting System
                HR System
                        -Golden parachutes
                Financial Architecture
                         -Antitakeover debt covenants
                Oversight Agencies
                Capital Markets
                        -Tender Offers
                        -Investment Banks
                        -Bond Rating Agencies
                Labor Markets
                Input Markets
                Product Markets
                Legal/Regulatory/Tax
     External           -Williams Act
                    Conclusions
   Despite widely reported governance failures (Enron,
    Tyco, WorldCom, Adelphia) thousands of firms uniformly
    have avoided such problems

       -This extensive press coverage reflects the rarity of
        the events

       -Governance failures are like commercial airplane
        crashes
                     Conclusions
   Private incentives exist within the contracting process to
    resolve these problems in the least costly manner
                     Conclusions
   The most rapid, effective, and flexible response to a
    corporate control failure is within the internal systems of
    the organization

       -Is this problem occurring in my firm?

       -Can we do anything to reduce the likelihood of a
        similar failure?

       -Can we credibly convince external parties that such
        a failure is unlikely?
                    Conclusions
   Regulation imposes costs
          -Direct compliance costs have been discussed
            more extensively but I believe represent the
            smaller component
           -Opportunity costs are large and will grow
           -Some regulation (Williams Act, antitakeover
            statutes) reduce the effectiveness of the
                   corporate control process
           -Regulation limits firm’s abilities to craft
            customized policies reflecting their specific
            circumstances
           -Regulation limits experimentation
   Corporate Governance and Organizational
                Architecture


               Clifford W. Smith




 FMA                                SIMON
Chicago