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Strategy Implementation – Controls, Organizational Culture, and Corporate Governance

UNCW-CSB MGT455 Spring 2009 Based on DL&E, Ch. 9 and other sources Prof. Carlos L. Rodriguez

Outline  Strategy implementation and Strategic Control Systems  Informational Control  Behavioral Control  Culture, Rewards, and Boundaries

 Corporate Governance  Governance Mechanisms

Recent Issues re: Control and Governance  A combination of:  Pressures from the capital markets  ‘suspension of disbelief’…

 Inadequate internal control systems  Greedy, unmonitored, and unethical executives  Passive, manipulated boards of directors  Ineffective market mechanisms for corporate governance

Strategy Implementation  Three basic tools:  An organizational structure to distribute tasks among employees and group together activities  A set of control systems to keep managers informed  An organizational culture to provide employees with sets of values to guide behavior

Control Systems – Basic Approaches  Traditional approach  Sequential  Formulation, Implementation, Measurement, Control (and feedback)

 Strategies, goals and objectives are usually not revised until the end of the measurement period (time lags)  Appropriate when:  Environment is stable  Goals and performance are easily measured

Control Systems – Basic Approaches  Contemporary approach  Continuous monitoring of internal and external environments, for the identification of trends  Requires interactive relationship among strategy formulation, implementation, and control (organizational learning)  Environmental scanning is key  Assumes that environments are essentially dynamic

Effective Control Systems  Key Characteristics:  Accurate  Providing reliable information

 Timely  Providing current information

 Flexible  Capturing information in a way that allows managers to respond/act/decide

Contemporary Approach  Two types of control systems  Informational Control  Concerned with whether or not the organization is “doing the right things”  Is there still a ‘fit’ between the firm’s strategy and the current competitive environment?

 Behavioral control  Concerned with whether or not the organization is “doing things right” in the implementation of its strategy

Behavioral Control Systems  Impossibility of relying on rigid rules due to environmental dynamism  Shorter employee tenure  Less organizational loyalty The importance of balancing culture, rewards, and boundaries

Organizational Culture  System of values and beliefs that shapes  People – Structure - Control systems

 ‘The way things are done here’  Examples of companies with great cultures

 By setting implicit boundaries, it can  Establish (unwritten) standards of behavior  Reduce monitoring costs

Organizational Culture  Effective cultures are  Created  Encouraged  Maintained

 The role of leadership and socialization  The importance of appropriate rewards and incentive systems  To motivate and monitor behavior

Rewards and Incentive Programs  Clear and well accepted goals  Rewards linked to performance

 But make sure you are really rewarding the desired performance (examples from ‘On the Folly…’)

 Accepted standards for performance measurement  Prompt feedback  Fair compensation system  Adaptable general structure  But also:

 Well-known boundaries and constraints…

‘On the Folly of Rewarding A, while Hoping for B’ (S. Kerr, AME 1995)  Politicians and ‘pork’  ‘Going home’: WWII vs. Vietnam  Health Care Costs: Excessive exams vs. Risk of Malpractice Suit  In Government:  Cost-plus type contracts and budget allocation policies (next year’s budget as a f of this year’s expenditures)  Whistleblowing: employees receive 30% of amount of reported fraud (no stated limit)

 An Insurance Company: ‘performance’ as low rates of complaint from policyholders

Boundaries and Constraints  The more effectively culture and incentive systems work, the less you are going to need boundaries (budgets, manuals, etc) (But you shouldn’t get rid of them entirely…)  They keep the organization focused

 Priorities and Short-term goals  They help in the decisions re. allocation of resources  They establish limits to spending and to possible unethical behaviors But they are more effective in certain types of environments and for specific organizations

Behavioral Controls in Use  Professional organizations  Emphasis on culture (values and norms)

 Companies where output/performance is easily measurable/observable  Reliance on rewards systems

 Bureaucratic organizations  Dependence on set of explicit rules

 Advantages and ways of moving from boundaries to rewards systems and culture  Having the boundaries internalized…

Controls and Strategy Types  Choice of the appropriate set of controls depends on the firm’s strategies at the business and corporate levels  Business-level Strategies  Cost-leadership: strict cost controls, structured tasks, rewards and incentives based on measurable output  Differentiation: behavioral controls emphasizing creativity and collaboration, rewards and incentives to create the right culture

Controls and Strategy Levels  Corporate-level Strategies  Related Diversification  High interdependence (to create synergies)  Rewards systems to foster cooperation and sharing

 Unrelated Diversification  Low/no interdependencies  Financial indicators at the unit level

The Balanced Scorecard  Provides a meaningful integration of many issues that come into evaluating a firm’s performance  Increasingly used system  Four key perspectives  How do customers see us? (customer perspective)  What must we excel at? (internal perspective)  Can we continue to improve and create value? (innovation and learning perspective)  How do we look to shareholders? (financial perspective)

The Balanced Scorecard  Customer Perspective    

Time Quality Performance and service Cost

 Internal Perspective  Processes (e.g., Cycle time, Quality, Employee skills, Productivity)  Decisions and Actions  Coordination  Resources and capabilities

The Balanced Scorecard  Innovation and Learning Perspective  Introduction of new products and services  Greater value for customers  Increased operating efficiencies

 Financial Perspective      

Profitability Growth Shareholder value Increased market share Reduced operating expenses Higher asset turnover

Strategy and Corporate Governance  Relationship among shareholders, management (led by the CEO), and the board of directors  Roles and characteristics of each

 An issue of aligning interests, created by the separation between ownership and management  Information asymmetry and opportunism  The Agency problem and Agency Theory

 Strong corporate governance is associated with superior financial performance

Examples of Agency Issues  Bad managerial behavior    

On-the-job consumption Excessive compensation ‘Empire building’: growth vs. profitability Diversification to reduce risk

 BoD issues  CEO duality  Insider x outsider balance (director independence)  Current trends: active, heterogeneous, committed, and involved BoDs

Other Governance Mechanisms (to monitor managerial behavior)  Shareholder activism  Right to influence on the direction of corporations  Especially effective in the case of large and institutional shareholders

 Managerial incentives  Stock compensation: benefits and issues  Rewards should be tied to long-term financial performance of the organization

External Mechanisms of Corporate Governance  Market for corporate control and the takeover constraint  External auditors  Financial institutions and reputational issues  Regulatory bodies  SEC and NYSE requirements, and SOX

 Media and other public activists (?)

Major Provisions of Sarbanes-Oxley Act of 2002  Auditors

 Barred from certain types of nonaudit work  Not allowed to destroy records for five years  Lead partners auditing a firm should be changed at least every five years

 CEOs and CFOs

 Must fully reveal off-balance sheet finances  Vouch for the accuracy of information revealed

 Executives

 Must reveal the sale of shares in firms they manage  Are not allowed to sell shares when other employees cannot