Corporate Governance and Control of Global Operations

1
Chapter 12

• Corporate Governance and Control of Global
  Operations

2
Global Strategic Issues

• Globalization refers to the deepening of
  relationships and interdependence between people
  throughout the world
• Companies are multi-domestic or global
• Multi-domestic approach allows subsidiaries to
  compete independently in domestic markets
• Example Philips
• Global approach pits the worldwide system of
  product and market position against the
  competition
• Example - Matsushita

3
Global Strategic Issues

• Hout, Porter, and Rudden (1982) findings
• Multi-domestic strategic companies
• Have products that differ from country market to
  country market
• High transportation costs
• Economies of scale may be too modest
• RD closely tied to a specific market
• Government barriers to trade are too high
• Distribution systems are fragmented and
  impenetrable

4
Global Strategic Issues

• Hout, Porter, and Rudden (1982) findings
• Global strategic companies
• Benefits gained from worldwide volume exceed
  costs of serving that volume
• Usually more centralized than multi-domestic
  strategic companies
• See example at chapter end Proctor and Gamble
  and Unilever

5
Global Strategic Issues

• What does global mean?
• Hamel and Prahalad (1992) definitions
• Global Competition
• Firms attack competition in markets worldwide
• Example U.S. auto industry in the 1980s
• Global Business
• Minimum volume required for cost efficiency is
  not available in home market, so overseas markets
  are pursued, possibly supplied with domestic
  production
• Examples Chinese textiles, Boeing and Airbus

6
Global Strategic Issues

• Hamel and Prahalad (1992) definitions
• Global Companies
• Have distribution systems in key markets that
  enable cross-subsidization, international
  retaliation, and world-scale volume
• Example Airline industry

7
Global Strategic Issues

• Bartlett and Ghoshal (1989) findings
• 3 Global Imperatives
• Forces for global integration the need for
  efficiency
• Forces for local differentiation the need for
  responsiveness
• Forces for worldwide innovation the need for
  learning
• Companies must deal with all 3 simultaneously
• Companies should use a transnational strategy
• Corporate assets are dispersed, interdependent,
  and specialized

8
Components of a Total Global Strategy Fig. 12.1
9
Global Strategic Issues

• Example Toyota
• Toyota partnered with PSA Peugeot Citroën to
  build small cars in the Czech Republic to supply
  the European market
• The factory was designed, built, and tested in a
  virtual factory in Japan (Edmondson, 2005)
• The plant will be run by Japanese and French
  managers and monitored in Japan

10
Informal and Subtle Mechanisms of Control

• Lateral relations
• Task forces and meetings help throughout the
  formal structure to accomplish corporate
  objectives
• Informal communication
• Involves the network of personal contacts that
  one develops over time in the organization
• Organizational culture
• The outcome of the process of socializing
  individuals within a firm and across national
  boundaries, which allows things to be done by
  different people in similar or consistent ways.

11
Organizational Structure

• Two major classifications for coordinating
  activities in MNEs
• Structural and formal mechanisms
• Informal and subtle mechanisms
• Control is shifting from formal to informal
  mechanisms
• A firms organization is constantly evolving
• Failure to adjust to a changing environment can
  lead to internal conflict and poor performance

12
Evolution of Organizational Structure

• Export activities start in the form of occasional
  orders from foreign buyers
• An export department is then developed with
  internal, rather than external, experts
• Foreign sales increase and foreign sales offices
  are established

13
Domestic Organization with Export Group
14
International Division Structure

• May become necessary to develop foreign
  production facilities joint venture, licensing
  agreements, subsidiary may minimize some
  stresses, such as transfer price issues,
  scheduling, production allocation, etc.
• A new international division replaces the old
  export division with substantial autonomy
  foreign operations still not significant to total
  activities of the corporation
• The firm can possibly be split into two rival
  factors (domestic and international)

15

• But as the international division grows, the need
  for control increases, complexity increases, and
  competition for broad corporate resources may
  increase.

16
Global Structure

• To avoid a divisional conflict, a company adopts
  a global product structure or global geographic
  structure
• Differences between domestic and international
  divisions are eliminated
• Companies select structure based on products and
  market
• Global geographic structure is favored by
  companies with simple, stable product lines
  local adaptations or expert knowledge of local
  practices, government policies, etc., is critical
• Global geographic structure is favored by
  companies with a wide range of complex products
  product knowledge and expertise are more
  important than local differences
• New conflict emerges between product divisions
  and geographic divisions

17
Geographic Structure
18
Product Structure
19
Global Structure

• Global grid/matrix structure emerged
• Product dimensions, geographic areas, and
  functional areas share power and responsibilities
• The matrix has shortcomings
• Bartlett and Ghoshal (1989) point out that
  confusion and turf battles occurred.
• Organizational problems are more complex than
  organizational structure
• Many involve the attitude of top management

20
Matrix or Grid Organization
21
Corporate Governance

• All business activities consist of two things
• A set of resources
• People who make those resources profitable
• Providers of resources are usually different than
  managers of those resources

22

• Corporate Governance the determination of the
  broad uses to which organizational resources will
  be deployed and the resolution of conflicts among
  the myriad participants in organizations (Daily
  et al, 2003)

23

• Shareholders have been concerned lately with how
  resources have been used
• Examples Enron, WorldCom, Parmalat
• The role of the board of directors to check
  management has been a hot topic lately
• Large institutional investors are focusing on
  shareholder activism

24
Internal Governance Mechanisms

• Internal governance mechanisms are established to
  insure the proper actions of management
• Roles of the Board of Directors
• Hire, control, and fire management
• Determine managements compensation
• Composed of multiple committees
• Board members are appointed by the owners
• Should have a majority of outside members
• Ultimately responsible for internal controls of
  the firm

25
Corporate Governance Mechanisms
26
Internal Governance Mechanisms

• Ownership structure
• Determines how capital will come into the firm
• Determines how wealth will be distributed
• Difficulties occur when firms from one structure
  invest in a country with a different structure

27
Internal Governance Mechanisms

• Example - Millman and Wonacott (2005)
• Chinese firms have invested in South America to
  gain access to raw materials and markets
• Chinese managers are accused of separating
  Chinese workers from regular workers and of not
  working with local suppliers and businesses
• The Chinese are having difficulty coping with a
  different labor and ownership environment

28
External Governance Mechanisms

• Takeover market
• Firms can be purchased by new owners who believe
  they can make the firms more profitable
• More developed in countries with highly developed
  securities markets
• Legal system
• Can offer protection to investors and encourage
  the investment
• Example common law in U.S. and U.K.
• Example code law in Germany and France
• Can deter investors if there is a lack of
  protection

29
International Importance of Governance

• Recent corporate meltdowns have shattered
  customer confidence worldwide
• As a result, Codes of Best Practice have been
  create
• This effort started BEFORE ENE and recent
  scandals, and in several countries, including,
  but not limited to, the U.S.
• Cadbury Report (U.K.) board requirements
• A specific number of outside directors
• Committees to carry out board functions
• Separating the roles of chairman and CEO
• ISSUE OF OUTSIDE DIRECTORS

30
International Importance of Governance

• How to Measure Compliance with Code?
• Scorecard for German Corporate Governance
• Reflects Germanys legalistic approach
• Based on a series of questions, a corporation is
  given a score between 0 and 100.
• Governance alone is not enough to combat fraud

31

• Had a Code such as ours been in existence in the
  past, we believe that a number of the recent
  examples of unexpected company failures and cases
  of fraud would have received attention earlier.
  It must, however, be recoginsed that no system of
  control can eliminate the risk of fraud without
  so shackling companies as to impede their ability
  to complete in the market place.
• Source Cadbury Report

32
Studies on International Corporate Governance
Practices

• Board of Directors - Denis and McConnell (2003)
• U.S. main goal is to protect shareholder
  interests
• Europe most countries do not have laws
  governing the role of the board of directors
• Some have two-tiered boards, as in Germany
  managing board, and supervisory board, which must
  include employees
• Japan appoint outside directors when in trouble
• Use banks for the role of outside governance
  (Keieretsu groupings)
• Russia insiders control the board

33
Studies on International Corporate Governance
Practices

• Board of Directors U.S. Firms Denis and
  McConnell (2003)
• Higher proportion of outside directors does not
  mean higher profitability
• Higher proportion of outside directors positively
  impacts decisions concerning
• Acquisitions
• Executive compensation
• CEO turnover
• Board size is negatively related to
• Firm performance
• Quality of decision making
• International Research also shown a lack of
  association between the proportion of outside
  directors and firm performance.
• However, Independent directors are more likely to
  challenge managements decisions and to fire
  management

34
Studies on International Corporate Governance
Practices

• Executive Compensation
• Goal is to align managements goals with
  investors goals
• U.S. studies have shown that sensitivity of pay
  to performance has increased over time
• Stock options are the fastest growing type of
  executive compensation in the U.S.
• Japan and Spain are following suit

35
Studies on International Corporate Governance
Practices

• Ownership Structure
• Market-centered economies U.S. and U.K.
• Ownership tends to be dispersed
• Bank-centered economies Japan and Germany
• Ownership tends to be concentrated
• Excluding U.S. and U.K., most common form of
  ownership
• Outside of the U.S., concentrated ownership
  indicates positive firm performance
• Study of East Asian countries revealed a positive
  relationship between government and bank
  ownership and firm performance
• Privitization of business has a positive effect
  on profitability

36
Studies on International Corporate Governance
Practices

• The External Control Market
• A hostile takeover occurs when a firm is
  purchased without soliciting bids
• U.S. has the most active market
• Example Molson and Coors
• U.K. also has an active takeover market
• External market has not been shown to be a common
  governance control tool

37
Studies on International Corporate Governance
Practices

• The Legal System
• Preference for concentrated ownership can be
  explained by legal system (La Porta et al. 1998)
• Common law system U.S. and U.K.
• Provide strongest degree of protection for
  shareholders
• Tend to have more dispersed ownership
• Three largest shareholders own 20 of the firm
• Civil law system France and Germany
• Provide the least amount of protection for
  shareholders
• Tend to have more concentrated ownership
• Three largest shareholders own 45 of the firm
• If the law does not protect the owners from the
  controllers, the owners will seek to be
  controllers.
• (Denis and McConnell 2003)

38

• Corporate Governance interplay between 3 key
  groups
• Capital (shareholders)
• Management
• Labor (employees)
• Traditional corporate governance theory did not
  consider labor, so this is an evolving concept

39
Cross National Differences in Corporate Governance
40
Cross National Differences in Corporate
Governance - Capital

• Refers to the shareholders or owners
• Shareholders exercise control in 2 ways
• Commitment length of holding shares
• Liquidity active buying and selling of shares

41
Cross National Differences in Corporate
Governance - Capital

• Three Factors of Shareholder Control
• Property Rights
• In countries that favor large shareholders,
  owners tend to exercise control through
  commitment
• Example Japans property rights favor banks
• U.S. laws tend to favor small shareholders, who
  exercise control through liquidity
• Financial System
• Bank-based system commitment (Germany)
• Market-based system liquidity (U.S.)
• Interfirm Networks
• Japan and Europe have these tendency toward
  commitment
• U.K. tendency toward liquidity

42
Labor

• External Control vs. Internal participation
• External control management retains decision
  making rights labor attempts to control with
  threat of collective action such as strikes
• Internal participation codetermination of
  management decisions. Does not end managerial
  authority but aims at a more democratic process
  for arriving at decisions

43
Cross National Differences in Corporate
Governance - Labor

• Influence exercised by employees depends on three
  factors
• Representation rights
• Strong representation internal participation
• European countries have strong representation
• Union organization
• Class-based and craft-based unionism external
  participation
• Enterprise-based unionism internal
  participation
• Skills formation
• Portable skills external participation (U.S.)
• Firm-based skills internal participation (Japan)

44
Cross National Differences in Corporate
Governance - Management

• Ideology
• General knowledge and hierarchical (top-down)
  decisions
• U.S. and France finance focus
• Scientific specialization and consensual
  decisions
• Greater commitment to the firm (Germany)
• Career Formation
• Closed managerial labor markets (Japan)
• Greater commitment to the firm/very specialized
• Open managerial labor markets (U.S.)
• Less commitment to one firm/more autonomy

45
COSO

• Committee of Sponsoring Organizations of the
  Treadway Commission
• Internal control a process, effected by an
  entitys board of directors, management, and
  other personnel, designed to provide reasonable
  assurance regarding the achievement of
• Effectiveness and efficiency of operations
• Reliability of financial reporting
• Compliance with applicable laws and regulations

46
Internal Controls

• COSO Framework 5 components of an internal
  control system
• Control Environment tone of an organization,
  control consciousness of the people discipline
  and structure of the organization
• Risk Assessment risk management of all sources
  of risk
• Control Activities policies and procedures
• Information and Communication communicating
  significant information to the right functions
• Monitoring assessment of system performance
  over time

47

• MNEs face added challenges due to their size and
  the complexity of operating in different
  environments.
• Establishing a control environment is difficult
  when it involves integration of different
  philosophies, operating styles, and ethical
  values among several cultures. The risk
  assessments are more complex. Monitoring a
  geographically diverse organization can be
  difficult.

48
The Sarbanes-Oxley Act of 2002

• Section 404
• Establishes managements responsibility for
  internal controls
• Management must assess controls annually
• Managements assessment must be assessed by an
  independent auditor
• Effective November 15, 2004
• Foreign firms listing in the U.S. July 15, 2005

49
The Sarbanes-Oxley Act of 2002

• Cost of compliance is tremendous!
• EY showed that large U.S. firms would spend more
  than 100,000 hours to comply with 404
• Foreign listings on NYSE are decreasing
• Large new listings have not declined
• Some say increased transparency is an advantage
  to firms
• Countries must be compliant in all countries of
  operation

50
The Role of Information Technology in MNEs

• I.T. is now a key strategic function in firms
• Enterprise Resource Planning (ERP) has helped to
  link departments and functions into one system

51
The Role of Information Technology in MNEs

• Advantages of ERP include
• Integration of customer order information
• Reduction in inventory

• Problems of ERP include
• Training costs
• Integration and testing
• Consulting fees

52
Theories and Realities of Global Information
Processing

• Egelhoffs (1991) 4 dimensions of processing
• Routine inputs are frequent and homogeneous
• Nonroutine info is unique and infrequent
• Sequential info flows in a predetermined
  direction
• Reciprocal info flows in a manner not
  previously determined a back-and-forth path

53
Theories and Realities of Global Information
Processing

• Accounting info for MNEs tends to be routine and
  sequential
• Accounting info must have extensive reach
• Internationally, the key is to determine how to
  share information across organizational lines

54

• However, standardization of the IT platform may
  be a nightmare!

55
MNEs and Transborder Data Flows

• Management of info is as important as management
  of assets and production, and free flow of
  information across national borders is vital to
  the successful operation of an MNEs management
  information system, and the MNE itself
• Some countries have legislation affecting
  transborder data flows
• Concerns over transborder data include
• Employee information
• Industrial espionage involving data piracy
• Political espionage
• Theft of industrial properties and designs
• Fiber optics are improving data flow worldwide

56
Final Thoughts on MIS and Strategy

• Firms with a multi-domestic approach do not
  integrate as much as firms with a global
  orientation
• MNEs that follow the transnational model tend to
  be more interactive
• These MNEs will be more reciprocal than
  sequential in data flow

57
Knowledge Flows in MNEs
58
Final Thoughts on MIS and Strategy

• Mirchandani and Lederer (2004) found that the
  systems function is treated differently than
  traditional functions (marketing, finance,
  manufacturing)
• MNEs may want less autonomy in systems to ensure
  compatibility among systems
• MNEs are concerned with data security, so systems
  design may be less autonomous

59
Centralization, Strategy, and the Accounting
Function

• The degree of centralization may affect the
  nature of the accounting control function
• MNEs need to implement a system that provides
  flows of information between all combinations of
  affiliates and parents
• This needed system is not highly decentralized or
  centralized
• Record-keeping is often complex, but can be
  controlled by the parent company
• Example Coke and its policy manuals

60
The Use of Internal Controls

• 3 methods used to develop a global orientation
  are
• Develop and communicate a clear and consistent
  corporate vision
• Manage human resource tools effectively
• Integrate individual thinking and activities into
  the broad corporate agenda by means of co-option
  (developing a more global perspective)
• Accountants must have a global vision