Strategic management

STRATEGIC MANAGEMENT

UNIT I NOTES

STRATEGY AND PROCESS

INTRODUCTION

Strategy word derives from the greek word stratçgos, which derives from two
words: stratos (army) and ago (ancient greek for leading). Stratçgos referred to a ‘military
commander’ during the age of Athenian Democracy.

Strategy - originally a military term, in a business planning context strategy/strategic
means/pertains to why and how the plan will work, in relation to all factors of influence
upon the business entity and activity, particularly including competitors (thus the use of a
military combative term), customers and demographics, technology and communications

LEARNING OBJECTIVES

After learning this unit you must be able to:

• Understand the concepts of strategic management
• Analyze the strategic formation process
• Explain the strategic planning process
• Describe the role of corporate governance
• Know the corporate governance responsibilities for society

1.1 CONCEPTUAL FRAMEWORK FOR STRATEGIC MANAGEMENT

Definition of strategy

Johnson and Scholes (Exploring Corporate Strategy) define strategy as follows:

“Strategy is the direction and scope of an organization over the long-term: which
achieves advantage for the organization through its configuration of resources within a

1 ANNA UNIVERSITY CHENNAI

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challenging environment, to meet the needs of markets and to fullfil stakeholder
NOTES expectations”.

In other words, strategy is about:

∗ Where is the business trying to get to in the long-term (direction)
∗ Which markets should a business compete in and what kind of activities is involved
in such markets? (markets; scope)
∗ How can the business perform better than the competition in those markets?
(Advantage)?
∗ What resources (skills, assets, finance, relationships, technical competence, and
facilities) are required in order to be able to compete? (Resources)?
∗ What external, environmental factors affect the businesses’ ability to compete?
(Environment)?
∗ What are the values and expectations of those who have power in and around the
business? (stakeholders)

1.2 THE CONCEPT OF STRATEGIC MANAGEMENT

Strategic management is the art and science of formulating, implementing and
evaluating cross-functional decisions that will enable an organization to achieve its objectives.
It is the process of specifying the organization’s objectives, developing policies and plans
to achieve these objectives, and allocating resources to implement the policies and plans to
achieve the organization’s objectives. Strategic management, therefore, combines the
activities of the various functional areas of a business to achieve organizational objectives.
It is the highest level of managerial activity, usually formulated by the Board of Directors
and performed by the organization’s Chief Executive Officer (CEO) and executive team.
Strategic management provides overall direction to the enterprise and is closely related to
the field of organization Studies.

“Strategic management is an ongoing process that assesses the business and the
industries in which the company is involved; assesses its competitors and sets goals and
strategies to meet all existing and potential competitors; and then reassesses each strategy
annually or quarterly [i.e. regularly] to determine how it has been implemented and whether
it has succeeded or needs replacement by a new strategy to meet changed circumstances,



new technology, new competitors, a new economic environment., or a new social, financial,
or political environment.” (Lamb, 1984:ix)
NOTES

1.3 BIRTH OF STRATEGIC MANAGEMENT

Strategic management as a discipline originated in the 1950s and 60s. Although
there were numerous early contributors to the literature, the most influential pioneers were
Alfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and Peter Drucker.

Alfred Chandler recognized the importance of coordinating the various aspects
of management under one all-encompassing strategy. Prior to this time the various functions
of management were separate with little overall coordination or strategy. Interactions
between functions or between departments were typically handled by a boundary position,
that is, there were one or two managers that relayed information back and forth between
two departments. Chandler also stressed the importance of taking a long term perspective
when looking to the future. In his 1962 groundbreaking work Strategy and Structure,
Chandler showed that a long-term coordinated strategy was necessary to give a company
structure, direction, and focus. He says it concisely, “structure follows strategy.”

In 1957, Philip Selznick introduced the idea of matching the organization’s internal
factors with external environmental circumstances. This core idea was developed into
what we now call SWOT anlysis by Learned, Andrews, and others at the Harvard Business
School General Management Group. Strengths and weaknesses of the firm are assessed
in light of the opportunities and threats from the business environment.

Igor Ansoff built on Chandler’s work by adding a range of strategic concepts and
inventing a whole new vocabulary. He developed a strategy grid that compared market
penetration strategies, product development strategies, market development strategies and
horizontal and vertical integration and diversification strategies. He felt that management
could use these strategies to systematically prepare for future opportunities and challenges.
In his 1965 classic Corporate Strategy, he developed the gap analysis still used today in
which we must understand the gap between where we are currently and where we would
like to be, then develop what he called “gap reducing actions”.

Peter Drucker was a prolific strategy theorist, author of dozens of management
books, with a career spanning five decades. His contributions to strategic management


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were many but two are most important. Firstly, he stressed the importance of objectives.
NOTES An organization without clear objectives is like a ship without a rudder. As early as 1954
he was developing a theory of management based on objectives. This evolved into his
theory of management by objectives (MBO). According to Drucker, the procedure of
setting objectives and monitoring your progress towards them should permeate the entire
organization, top to bottom. His other seminal contribution was in predicting the importance
of what today we would call intellectual capital. He predicted the rise of what he called the
“knowledge worker” and explained the consequences of this for management. He said
that knowledge work is non-hierarchical. Work would be carried out in teams with the
person most knowledgeable in the task at hand being the temporary leader.

In1985, Ellen-Earle Chaffee summarized what she thought were the main
elements of strategic management theory by the 1970s:

• Strategic management involves. adapting the organization to its business
environment.
• Strategic management is fluid and complex Change creates novel combinations of
circumstances requiring unstructured non-repetitive responses.
• Strategic management affects the entire organization by providing direction.
• Strategic management involves both strategy formation (she called it content) and
also strategy implementation (she called it process).
• Strategic management is partially planned and partially unplanned.
• Strategic management is done at several levels: overall corporate strategy, and
individual business strategies.
• Strategic management involves both conceptual and analytical thought processes.

1.4 STRATEGIC ANALYSIS

This is all about the analyzing the strength of businesses’ position and understanding
the important external factors that may influence that position. The process of Strategic
Analysis can be assisted by a number of tools, including:



NOTES

PEST Analysis - a technique for understanding the “environment” in which a business
operates

Scenario Planning - a technique that builds various plausible views of possible futures
for a business

Five Forces Analysis - a technique for identifying the forces which affect the level of
competition in an industry

Market Segmentation - a technique which seeks to identify similarities and differences
between groups of customers or users

Directional Policy Matrix - a technique which summarizes the competitive strength of a
businesses operations in specific markets

Competitor Analysis - a wide range of techniques and analysis that seeks to summaries
a businesses’ overall competitive position

Critical Success Factor Analysis - a technique to identify those areas in which a business
must outperform the competition in order to succeed

SWOT Analysis - a useful summary technique for summarizing the key issues arising from
an assessment of a businesses “internal” position and “external” environmental influences.


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1.5 BENEFITS OF STRATEGIC MANAGEMENT
NOTES
Studies have revealed that organizations following strategic management have out
performed those that do not. Strategic planning ensures a rational allocation of resources
and improves co-ordination between various divisions of the organization. It helps managers
to think ahead and anticipate problems before they occur. The main benefit of the planning
process is a continuous dialogue about the organisation’s future between the hierarchical
levels in the organization. In short, the most highly rated benefits of strategic management
are:

• Clarity of strategic vision for the organization
• Focus on what is strategically important to the organization
• Better understanding of the rapidly changing business environment.

Strategic management need not always be a formal process. It can begin with answering a
few simple questions:

1. Where are we now?
2. In no changes are made, where will we be in the next one year? Next two years?
Next three years? Next five years?

Are the answers acceptable, if the answers are not acceptable, what actions should
the top management take with what results and payoffs. Today, as you know that business
is becoming more complex due to rapid changes in environment. It is becoming increasingly
difficult to predict the environment accurately. The internal and external environments of
organizations are now driven by multitudes of forces that were hitherto nonexistent. Earlier
the changes in technology were not so rapid but today the information from all over the
globe is pouring in through the computers. The world in fact has shrunk. This has created
fierce competition as the customers and stakeholders have become more aware of their
rights. Think of yourself as a consumer who has got several alternatives to choose from
you as a customer look for real value for your money. You have become aware of quality
and cost ratios and then diligently select the products. You are now more demanding for
better service in the least possible time. This has brought in new rules of business that
companies all over the world are evolving through their experience. The obsolence has
become so rapid that the time when you are in the process of buying a computer it might



have already become obsolete in some part of the globe. The number of events that affect
domestic and world market are now far too many and too often.
NOTES

Over reliance on experience in such situations may really work out to be very
costly for companies. (e.g) Reliance has shifted to more creativity, innovation and new
ways of looking at business and doing it in novel ways. The earlier concept of having highly
functionalized departments and developing specialization of labour is losing its credibility.
Organizations are becoming more responsive, flexible, and adaptable to changing business
situations. In such environments that are charged with high level of competition, developing
competitive edge for survival and growth has become imperative for companies. What do
you think will business strategy concepts and techniques benefit foreign businesses as
much as domestic firms? Fig1.1 The role of core values, purpose and visionary goals in a
strategy formation process

The need is now to distinguish between long-range planning and strategic planning.
The importance of strategic management in setting the directions for growth of organizations
is being increasingly realized these days. The evolution of objectives after setting directions
for growth of organisations has become necessary. The technique of strategic management
is used as a major vehicle for planning and implementing major changes in organisation.
The implementation of the strategic plans needs good teamwork and understanding of the
concept at grass root Have a look at the difference between the two:


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1.6 VARIOUS APPROACHES OF STRATEGIC MANAGEMENT
NOTES
In general terms, there are two main approaches, which are opposite but
complement each other in some ways, to strategic management:

Major approach of strategic management

I-The Industrial Organizational Approach

Based on economic theory — deals with issues like competitive rivalry, resource
allocation, economies of scale

Assumptions — rationality, self discipline behaviour, profit maximization

II-The Sociological Approach

Deals primarily with human interactions

Assumptions — bounded rationality, satisfying behaviour, profit sub-optimality. An example
of a company that currently operates this way is Google.

Strategic management techniques can be viewed as bottom-up, top-down, or
collaborative processes. In the bottom-up approach, employees submit proposals to their
managers who, in turn, funnel the best ideas further up the organization. This is often
accomplished by a capital budgeting process. Proposals are assessed using financial criteria
such as return on investment or cost benefit analysis. The proposals that are approved
form the substance of a new strategy, all of which is done without a grand strategic design
or a strategic architect. The top-down approach is the most common by far. In it, the CEO
(such as Don Sheelen, Jeff Bezos and Samuel J. Palmisano) possibly with the assistance of
a strategic planning team, decides on the overall direction the company should take. Some
organizations are starting to experiment with collaborative strategic planning techniques
that recognize the emergent nature of strategic decisions.



1.7 STRATEGY AND STRATEGY FORMATION PROCESS
NOTES
1.7.1 Strategic Management Processes

The strategic management formulation and implementation methods vary with
product profile, Company profile, environment within and outside the Organization and
various other factors. Large organizations which use sophisticated planning use detailed
strategic management Models whereas smaller organizations where formality is low use
simpler models. Small businesses concentrate on planning steps compared to larger
companies in the same industry. Large firms have diverse products, operations, markets,
and technologies and hence they have to essentially use complex systems. In spite of the
fact that companies have different structures, systems, product profiles, etc, various
components of models used for analysis of strategic management are quite similar. You
must have observed that different thinkers have defined business strategy differently, yet
there are some common elements in the way it is defined and understood. The strategic
management consists of different phases, which are sequential in nature.

There are four essential phases of strategic management, they are process. In
different companies these phases may have different, nomenclatures and the phases may
have a different sequences,

however, the basic content remains same. The four phases can be listed as below.

1. Defining the vision, business mission, purpose, and broad objectives.
2. Formulation of strategies.
3. Implementation of strategies.
4. Evaluation of strategies.

These phases are linked to each other in a sequence as shown in

It may not be possible to draw a clear line of difference between each phase, and
the change over from one phase to another is gradual. The next phase in the sequence may
gradually evolve and merge into the following phase. An important linkage between the
phases is established through a feedback mechanism or corrective action. The feedback
mechanism results in a course of action for revising, reformulating, and redefining the past
phase. The process is highly dynamic and compartmentalization of the process is difficult.


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The change over is not clear and boundaries of phases overlap. My purpose to depict this
NOTES diagram is to assist you in remembering and recalling it with ease Exhibit Phases of Strategic
Management Process

Strategic management process that could be followed in a typical organization is
presented in .The process takes place in the following stages:

1. The Strategic Planner has to define what is intended to be accomplished (not just
desired). This will help in defining the objectives, strategies and policies.
2. In the light of stage I, the results of the current performance of the organization are
documented.



3. The Board of Directors and the top management will have to review the current
performance of the documented.
NOTES
4. In view of the review, the organization will have to scan the internal environment
for strengths and weaknesses and the external environment for opportunities and
threats.
5. The internal and external scan helps in selecting the strategic factors.
6. These have to be reviewed and redefined in relation to the Mission and Objectives.
7. At this stage a set of strategic alternatives and generated.
8. The best strategic alternative is selected and implemented through programmed
budgets and procedures.
9. Monitoring, evaluation and review of the strategic alternative chosen is undertaken
in this mode. This can provide a feedback on the changes in the implementation if
required. As can be seen, this provides a rational approach to strategic decision
making and it can be successfully practiced by Indian organizations, which now
have to operate in a competitive environment.

1.7.2 Top Management Decisions On Strategic Issues

To establish the vision of the firm, stating of corporate objectives, and strategic
thrust areas, defining a comprehensive corporate philosophy and values, identifying the
domains in which an organization would operate, learning and recognizing worldwide
business trends, and allocation of resources in line with corporate priorities, are some of
the key areas wherein top management of organisations take decisions. Let us now look at
the domain of top management? Strategic Issues for Sharing of Concern and Resources to
meet certain specific needs of certain customers, use of common upgraded technologies
by certain business units, deployment of people, physical assets or money from internal or
external sources and to achieve economics of scale in deployment, certain decisions may
be taken by the management.

1.7.3 Strategic Issues Likely To Have Long Term Impact

Strategic decisions for implementing a course of action have broad implications
and long term ramifications and the people of an organisation have to commit themselves
to the decisions and plans for a long period of time. Once a firm takes strategic decisions
and implements the action programs, the impact is seen slowly on its competitive image
and the advantage tied to the particular strategy start pouring in. The companies become


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known in certain markets, products, or technologies or the decisions may adversely affect
NOTES the previous progress. In today’s business world, where changes are by leaps and bounds,
some organisations may decide for radical changes through reengineering of their business
processes to gain strategically better position

Strategic Directions are Futuristic

Strategies are essentially for the future. Strategic decisions are taken based o
forecasts that are in turn based on available data on trends. The managers involved in
strategic planning concentrate on developing projections that would take the company to
better strategic position. The companies thus become proactive rather than being reactive
to business situations. Strategies have Multi Functional and Multi Business Effects Every
company has several business units. Strategic decisions are coordinative in nature among
all the business units of the company. Many strategic decisions on product mix, competitive
edge, organisational structure etc. affect various departments and functions that may be
classified as strategic business units (SBUs). Each of these units get affected by the decision
taken at the top level, regarding allocation of resources and deployment of personnel etc.
So, Business Strategy as a discipline focuses at the organization as one single unit. Strategies
are Defined Based on Study of Environment The organisation culture internal to the
organisation and also the external environment must be thoroughly scanned and studied to
decide on strategies. The interaction between the organisations and the external environment
affects both of them. The organisation tends to change the environment and the same
environment makes an impact on the organisation. The firms have to define their strategic
position with regard to the environment and decide strategies that will take it to the desired
position. The firms are part of the system, where customers, stake holders, competitors
etc. exist and the firm cannot remain insulated from these determinants of the external
environment

1.8 STRATEGY PLANNING PROCESS

1.8.1 Strategic Planning Model

Elements In Strategic Management Process

Each phase of strategic management process can be viewed to be consisting of a
number of elements, which can be clearly defined with input and output relationships.



The steps have logical connectivity and hence these are sequential. These steps
can be illustrated with the help of a flow diagram. The following discrete twelve steps can
NOTES
be considered as comprehensive.

1. Defining the vision of the company
2. Defining the mission of the company
3. Determining the purposes or goals
4. Defining the objectives
5. Environment scanning
6. Carrying out corporate appraisal
7. Developing strategic alternatives
8. Selecting a strategy
9. Formulating detailed strategy
10. Preparing a plan
11. Implementing a strategy
12. Evaluating a strategy

Figure 1.2 The Strategic Planning Process


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1.8.2 Strategic Management Models
NOTES
Firstly have a look at the various models which has got relevance to the strategic
process. Now think of a firm which in your opinion has been successful over the past 15
years and list down the things you think have attributed to its success: Some of the strategic
management models are shown. Now, I will discuss each of the elements of strategic
management model.

Exhibit Strategic Management Model:

• Company vision statement
• Company mission statement
• Company profile
• External environment and internal environment
• Evolution strategic choices and selection
• Long term objectives
• Grand strategy
• Annual objective
• Functional strategy
• Operating policies
• Institutionalizing Strategy
• Control and evaluation

1.8.3 Working Model Of Strategic Management

After looking at the above given fig 1.2, we will now discuss each phase in detail.

Vision

Let us, now discuss in details the model of strategic management Vision of The
Company

Vision of a company is rather a permanent statement articulated by the CEO of the
company who may be Managing Director, President, Chairman, etc.



The purpose of a vision statement is to:
NOTES
1. Communicate with the people of the organisation and to those who are in some
way connected or concerned with the organisation about its very existence in
terms of corporate purpose, business scope, and the competitive leadership.
2. Cast a framework that would lead to development of interrelationships between
firm and stakeholders viz. employees, shareholders, suppliers, customers, and
various communities that may be directly or indirectly involved with the firm.
3. Define broad objective regarding performance of the firm and its growth in various
fields vital to the firm. So, lets talk about our own Rai University, find out what is
the vision statement and list down various purposes of our vision statement.

Vision is a theme which gives a focused view of a company. It is a unifying statement
and a vital challenge to all different units of an organisation that may be busy pursuing their
independent objectives. It consists of a sense of achievable ideals and is a fountain of
inspiration for performing the daily activities. It motivates people of an organisation to
behave in a way which would be congruent with the corporate ethics and values. Many
firms do not have clear vision statements. An indirect method of knowing whether a firm
has reached the stage of corporate strategic management is emergence of a vision statement.
Vision of a firm cannot be high jacked from a company; however, a firm may definitely get
inspired by the vision statement of another firm. It has to be evolved after a lot of
deliberations, brain storming, and thinking. It is pertinent that you as an individual working
in a firm should become an active participant and collaborator in accomplishing corporate
objectives. You must understand and share the vision of the firm because you would have
to contribute in transformation of vision into a reality through his or her actions. Total
behaviour of people of an organization should get conditioned by the basic framework of
vision. Personal objectives of individuals are very important to them and only to fulfill these
objectives people join organisations.

Vision of a company when translated into action programme must be able to meet
personal needs of people. This includes the need of achievement also. Vision of a firm thus
encompasses personal objectives of people which they try to achieve.

Step 1: Name of the company

Step 2: Practices that have made the company successful


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The primary purpose of the strategic management process is to enable companies
NOTES to achieve strategic competitiveness and earn above average returns. Researches have
indicated that companies that engage in strategic management generally out perform those
that do not. The attainment of an appropriate match or fit between a company’s environment
and its strategy, structure, and processes has positive effects on the company’s performance.
Bruce Henderson, founder of the Boston Consulting Group, pointed out that a company
cannot afford to follow intuitive strategies once it becomes large, has layers of management,
or its environment changes substantially. As the world’s environment becomes increasingly
complex and changing, today’s companies, as one way to make the environment more
manageable, use strategic management.

Strategic competitiveness is achieved when a company successfully formulates
and implements a value creating strategy. By implementing a value creating strategy that
current and potential competitors are not simultaneously implementing and that competitors
are unable to duplicate, a company achieves a sustained or sustainable competitive advantage.
So long as a company can sustain (or maintain) a competitive advantage, investors will
earn above average returns. Above average returns represent returns that exceed returns
that investors expect to earn from other investments with similar levels of risk (investor
uncertainty about the economic gains or losses that will result from a particular investment).
In other words, above average returns exceed investors’ expected levels of return for
given levels of risk. In the long run, companies must earn at least average returns and
provide investors with average returns if they are to survive. If a company earns below
average returns and provides investors with below average returns, investors will withdraw
their funds and place them in investments that earn at least average returns. Internationally
these types of companies are prime take over targets, a concept that is picking up in India.
A framework that can assist companies in their quest for strategic competitiveness is the
strategic management process, the full set of commitments, decisions and actions required
for a company to systematically achieve strategic competitiveness and earn above average.

Mission

An organization’s mission is the purpose or reason for the organizations existence.
A well convinced mission statement defines the fundamental, unique purpose that sets a
company apart other firms of its and identifies the scope of the company’s operations in
terms of products offered and market served.



Objectives
NOTES
It is the end results of planned activity. The corporate objectives achievement
should result in the fulfillment of a corporation’s mission.

Some of the areas in which corporations might establish its goals and objectives are:

• Profitability
• Efficiency
• Growth
• Shareholder wealth
• Utilization of resources
• Reputation
• Contribution to employees
• Contribution to society through taxes paid etc..,
• Market leadership
• Technological leadership
• Survival

Strategy

Strategy at Different Levels of a Business

Strategies exist at several levels in any organization - ranging from the overall
business (or group of businesses) through to individuals working in it.

• Corporate Strategy - is concerned with the overall purpose and scope of the
business to meet stakeholder expectations. This is a crucial level since it is heavily
influenced by investors in the business and acts to guide strategic decision-making
throughout the business. Corporate strategy is often stated explicitly in a “mission
statement”.
• Business Unit Strategy - is concerned more with how a business competes
successfully in a particular market. It concerns strategic decisions about choice of
products, meeting needs of customers, gaining advantage over competitors,
exploiting or creating new opportunities etc.


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• Operational Strategy - is concerned with how each part of the business is
NOTES organized to deliver the corporate and business-unit level strategic direction.
Operational strategy therefore focuses on issues of resources, processes, people
etc.

Policies

A Policy is a broad guideline for decision making that links the formulation of
strategy with its implementation

Programs

A program is a statement of the activities or steps needed to accomplish a single
use plan. It makes the strategy action oriented.

Budgets

A Budget is a statement of a corporation’s programs in term of dollars/money
Used in planning and control, a budget lists the detailed cost of each program.

Procedures

It is a system of sequential steps or techniques that describe in detail how a particular
task or job is to be done.

1.9 MINTZBERG’S MODES OF STRATEGIC DECISION MAKING

• Entrepreneurial Mode
• Adaptive Mode
• Planning Mode
• Logical Incrementalism

1.10 CORPORATE GOVERNANCE & SOCIAL RESPONSIBILITY

Corporate governance is the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed, administered or controlled. Corporate



governance also includes the relationship stakeholders among the many players involved
(the stakeholders) and the goals for which the corporation is governed. The principal
NOTES
players are the shareholders, management and the board of directors. Other stakeholders
include employees, suppliers, customers, banks and other lenders, regulators, the
environment and the community at large.

Corporate governance is a multi-faceted subject. An important theme of corporate
governance is to ensure the accountability of the impact of a corporate governance system
in economic efficiency, with a strong emphasis on shareholders welfare. There are yet
other aspects to the corporate governance subject, such as the stake holder view and
certain individuals in an organization through mechanisms that try to reduce or eliminate the
principal –agent problem. A related but separate thread of discussions focus on the corporate
governance models around the world.

1.10.1 Definition Of Corporate Governance

In A Board Culture of Corporate Governance business author Gabrielle
O’Donovan defines corporate governance as ‘an internal system encompassing policies,
processes and people, which serves the needs of shareholders and other stakeholders, by
directing and controlling management activities with good business savvy, objectivity and
integrity. Sound corporate governance is reliant on external marketplace commitment and
legislation, plus a healthy board culture which safeguards policies and processes’.

O’Donovan goes on to say that ‘the perceived quality of a company’s corporate
governance can influence its share price as well as the cost of raising capital. Quality is
determined by the financial markets, legislation and other external market forces plus the
international organisational environment; how policies and processes are implemented and
how people are led. External forces are, to a large extent, outside the circle of control of
any board. The internal environment is quite a different matter, and offers companies the
opportunity to differentiate from competitors through their board culture. To date, too
much of corporate governance debate has centred on legislative policy, to deter fraudulent
activities and transparency policy which misleads executives to treat the symptoms and not
the cause.

Corporate Governance is a system of structuring, operating and controlling a
company with a view to achieve long term strategic goals to satisfy shareholders, creditors,


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employees, customers and suppliers, and complying with the legal and regulatory
NOTES requirements, apart from meeting environmental and local community needs.

Report of SEBI committee (India) on Corporate Governance defines corporate
governance as the acceptance by management of the inalienable rights of shareholders as
the true owners of the corporation and of their own role as trustees on behalf of the
shareholders. It is about commitment to values, about ethical business conduct and about
making a distinction between personal & corporate funds in the management of a company.”

The definition is drawn from Gandhian principle of Trusteeship and Directive
Principle of constitution. Corporate Governance is viewed as ethics and a moral duty.

1.10.2 History Of Corporate Governance

In the 19th century, state corporation law enhanced the rights of corporate boards
to govern without unanimous consent of shareholders in exchange for statutory benefits
like appraisal rights, to make corporate governance more efficient. Since that time, and
because most large publicly traded corporations in the US are incorporated under corporate
administration friendly Delaware law, and because the US’s wealth has been increasingly
securitized into various corporate entities and institutions, the rights of individual owners
and shareholders have become increasingly derivative and dissipated. The concerns of
shareholders over administration pay and stock losses periodically has led to more frequent
calls for corporate governance reforms.

In the 20th century in the immediate aftermath of the Wall Street Crash of 1929
legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means
pondered on the changing role of the modern corporation in society. Berle and Means’
monograph “The Modern Corporation and Private Property” (1932, Macmillan) continues
to have a profound influence on the conception of corporate governance in scholarly debates
today.

From the Chicago school of economics, Ronald Coase’s “Nature of the Firm”
(1937) introduced the notion of transaction costs into the understanding of why firms are
founded and how they continue to behave. Fifty years later, Eugene Fama and Michael
Jensen’s “The Separation of Ownership and Control” (1983, Journal of Law and
Economics) firmly established agency theory as a way of understanding corporate



governance: the firm is seen as a series of contracts. Agency theory’s dominance was
highlighted in a 1989 article by Kathleen Eisenhardt (Academy of Management Review).
NOTES

US expansion after World War II through the emergence of multinational
corporations saw the establishment of the managerial class. Accordingly, the following
Harvard Business School Management professors published influential monographs studying
their prominence: Myles Mace (entrepreneurship), Alfred D Chandler, Jr (business history),
Jay Lorsch (organizational behavior) and Elizabeth MacIver (organizational behavior).
According to Lorsch and MacIver “many large corporations have dominant control over
business affairs without sufficient accountability or monitoring by their board of directors.”

Since the late 1970’s, corporate governance has been the subject of significant
debate in the U.S. and around the globe. Bold, broad efforts to reform corporate governance
have been driven, in part, by the needs and desires of shareowners to exercise their rights
of corporate ownership and to increase the value of their shares and, therefore, wealth.
Over the past three decades, corporate directors’ duties have expanded greatly beyond
their traditional legal responsibility of duty of loyalty to the corporation and its shareowners.

In the first half of the 1990s, the issue of corporate governance in the U.S. received
considerable press attention due to the wave of CEO dismissals (e.g.: IBM, Kodak, Honey
well) by their boards. CALERS led a wave of institutional shareholder activism (something
only very rarely seen before), as a way of ensuring that corporate value would not be
destroyed by the now traditionally cozy relationships between the CEO and the board of
directors (e.g., by the unrestrained issuance of stock options, not infrequently back dated).

In 1997, the East Asian Financial Crisis saw the economies of Thailand, Indonesia,
South Korea, Malaysia and The Philippines severely affected by the exit of foreign capital
after property assets collapsed. The lack of corporate governance mechanisms in these
countries highlighted the weaknesses of the institutions in their economies.

In the early 2000s, the massive bankruptcies (and criminal malfeasance) of Enron
and Worldcom, as well as lesser corporate debacles, such as Aldelphia
Communications,AOL, Arthur Andersen, Global Crossing Tyco, and, more recently, Fannie
Mae and Freddie Mac, led to increased shareholder and governmental interest in corporate
governance. This culminated in the passage of the Sarbanes-Oxley Act of 2002. But, since
then, the stock market has greatly recovered, and shareholder zeal has waned accordingly.


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1.10.3 Impact Of Corporate Governance
NOTES
Positive effect of good corporate governance on different stakeholders ultimately
results into strong economy and hence good corporate governance is tool for socio-
economic development. After East Asia economy collapse in late 20th century, World
Bank president warned those countries, that for sustainable development, corporate
governance is must to be good. Economic health of a nation depends substantially how
sound and ethical businesses are.

Enlightened Corporate Governance

Corporate governance, the unwieldy name given to the systems that guide the
control and management of corporations, is a relatively recent term that came into being in
the 1970s. Because corporate governance structures and processes specify the various
roles and duties of corporate directors, senior executives, shareholders, and other
stakeholders in the corporation, they play a large role in determining how responsible and
accountable a corporation’s leaders will be in exercising their authority. When properly
designed, governance processes guide companies toward useful objectives and help them
monitor and measure their progress in achieving those objectives; when poorly designed,
these processes permit companies to drift toward painful losses for shareholders and
everyone else with a stake in the company.

A company’s corporate governance—whether good or bad—is established by its
board of directors. Ideally, these directors will be energetic, experienced people deeply
concerned about the company’s welfare. Because the board’s most pivotal responsibilities
are to hire and supervise the company’s chief executive officer (CEO), these directors
should not be company employees who work under the CEO’s direction; instead, they
should be independent of the company’s management. When independent directors know
how to work effectively with the company’s senior management team, they are likely to
produce a corporate climate that accelerates the growth of long-term shareholder value.

Role of Institutional Investors

Many years ago, worldwide, buyers and sellers of corporation stocks were
individual investors, such as wealthy businessmen or families, who often had a vested,
personal and emotional interest in the corporations whose shares they owned. Over time,



markets have become largely institutionalized: buyers and sellers are largely institutions
(e.g., pension funds, insurance companies, mutual funds, hedge funds, investor groups,
NOTES
and banks).

The rise of the institutional investor has brought with it some increase of professional
diligence which has tended to improve regulation of the stock market (but not necessarily
in the interest of the small investor or even of the naïve institutions, of which there are
many). Note that this process occurred simultaneously with the direct growth of individuals
investing indirectly in the market (for example individuals have twice as much money in
mutual funds as they do in bank accounts). However this growth occurred primarily by
way of individuals turning over their funds to ‘professionals’ to manage, such as in mutual
funds. In this way, the majority of investment now is described as “institutional investment”
even though the vast majority of the funds are for the benefit of individual investors.

Program trading, the hallmark of institutional trading, is averaging over 60% a day
in 2007. Unfortunately, there has been a concurrent lapse in the oversight of large
corporations, which are now almost all owned by large institutions. The Board of Directors
of large corporations used to be chosen by the principal shareholders, who usually had an
emotional as well as monetary investment in the company (think Ford), and the Board
diligently kept an eye on the company and its principal executives (they usually hired and
fired the President, or Chief Executive Officer— CEO).

Nowadays, if the owning institutions don’t like what the President/CEO is doing
and they feel that firing them will likely be costly (think “golden handshake”) and/or time
consuming, they will simply sell out their interest. The Board is now mostly chosen by the
President/CEO, and may be made up primarily of their friends and associates, such as
officers of the corporation or business colleagues. Since the (institutional) shareholders
rarely object, the President/CEO generally takes the Chair of the Board position for his/
herself (which makes it much more difficult for the institutional owners to “fire” him/her).
Occasionally, but rarely, institutional investors support shareholder resolutions on such
matters as executive pay and anti-takeover measures.

Finally, the largest pools of invested money (such as the mutual fund ‘Vanguard
500’, or the largest investment management firm for corporations, State Street Corp) are
designed simply to invest in a very large number of different companies with sufficient
liquidity, based on the idea that this strategy will largely eliminate individual company financial


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or other risk and, therefore, these investors have even less interest in a particular company’s
NOTES governance.

Since the marked rise in the use of Internet transactions from the 1990’s, both
individual and professional stock investors around the world have emerged as a potential
new kind of major (short term) force in the direct or indirect ownership of corporations
and in the markets: the casual participant. Even as the purchase of individual shares in any
one corporation by individual investors diminishes, the sale of derivatives (e.g., exchange
traded funds (ETFs), Stock market index options, etc.) has soared. So, the interests of
most investors are now increasingly rarely tied to the fortunes of individual corporations.

But, the ownership of stocks in markets around the world varies; for example, the
majority of the shares in the Japanese market are held by financial companies and industrial
corporations (there is a large and deliberate amount of cross-holding among Japanese
keirestu corporations and within S. Korean chaebol ‘groups’), whereas stock in the USA
or the UK and Europe are much more broadly owned, often still by large individual investors.

1.10.4 Parties To Corporate Governance

Parties involved in corporate governance include the regulatory body (e.g. the
Chief Executive Officer, the board of directors, management and shareholders). Other
stakeholders who take part include suppliers, employees, creditors, customers and the
community at large.

In corporations, the shareholder delegates decision rights to the manager to act in
the principal’s best interests. This separation of ownership from control implies a loss of
effective control by shareholders over managerial decisions. Partly as a result of this
separation between the two parties, a system of corporate governance controls is
implemented to assist in aligning the incentives of managers with those of shareholders.
With the significant increase in equity holdings of investors, there has been an opportunity
for a reversal of the separation of ownership and control problems because ownership is
not so diffuse.

A board of directors often plays a key role in corporate governance. It is their
responsibility to endorse the organisation’s strategy, develop directional policy, appoint,



supervise and remunerate senior executives and to ensure accountability of the organisation
to its owners and authorities.
NOTES

The Company Secretary, known as a Corporate Secretary in the US and often
referred to as a Chartered Secretary if qualified by the Institute of Charted Secretaries and
Administrators (ICSA), is a high ranking professional who is trained to uphold the highest
standards of corporate governance, effective operations, compliance and administration.

All parties to corporate governance have an interest, whether direct or indirect, in
the effective performance of the organisation. Directors, workers and management receive
salaries, benefits and reputation, while shareholders receive capital return. Customers receive
goods and services; suppliers receive compensation for their goods or services. In return
these individuals provide value in the form of natural, human, social and other forms of
capital.

A key factor in an individual’s decision to participate in an organisation e.g. through
providing financial capital and trust that they will receive a fair share of the organisational
returns. If some parties are receiving more than their fair return then participants may
choose to not continue participating leading to organizational collapse.

1.10.5 Principles Of Corporate Governance

Key elements of good corporate governance principles include honesty, trust and
integrity, openness, performance orientation, responsibility and accountability, mutual
respect, and commitment to the organization.

Of importance is how directors and management develop a model of governance
that aligns the values of the corporate participants and then evaluate this model periodically
for its effectiveness. In particular, senior executives should conduct themselves honestly
and ethically, especially concerning actual or apparent conflicts of interests, and disclosure
in financial reports.

Commonly accepted principles of corporate governance include:

• Rights and equitable treatment of shareholders: Organizations should respect
the rights of shareholders and help shareholders to exercise those rights. They can


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help shareholders exercise their rights by effectively communicating information
NOTES that is understandable and accessible and encouraging shareholders to participate
in general meetings.
• Interests of other stakeholders: Organizations should recognize that they have
legal and other obligations to all legitimate stakeholders.
• Role and responsibilities of the board: The board needs a range of skills and
understanding to be able to deal with various business issues and have the ability
to review and challenge management performance. It needs to be of sufficient size
and have an appropriate level of commitment to fulfill its responsibilities and duties.
There are issues about the appropriate mix of executive and non-executive directors.
The key roles of Chairperson and CEO should not be held by the same person.
• Integrity and ethical behaviour: Organizations should develop a code of conduct
for their directors and executives that promotes ethical and responsible decision
making. It is important to understand, though, that systemic reliance on integrity
and ethics is bound to eventual failure. Because of this, many organizations establish
Compliance and Ethics Programs to minimize the risk that the firm steps outside of
ethical and legal boundaries.
• Disclosure and transparency: Organizations should clarify and make publicly
known the roles and responsibilities of board and management to provide
shareholders with a level of accountability. They should also implement procedures
to independently verify and safeguard the integrity of the company’s financial
reporting. Disclosure of material matters concerning the organization should be
timely and balanced to ensure that all investors have access to clear, factual
information.

Issues involving corporate governance principles include:

• oversight of the preparation of the entity’s financial statements
• internal controls and the independence of the entity’s auditors
• review of the compensation arrangements for the chief executive officer and other
senior executives
• the way in which individuals are nominated for positions on the board
• the resources made available to directors in carrying out their duties
• oversight and management of risk
• dividend policy



1.10.6 Mechanisms And Controls
NOTES
Corporate governance mechanisms and controls are designed to reduce the
inefficiencies that arise from morald hazard and adverse selection. For example, to monitor
managers’ behaviour, an independent third party (the auditor) attests the accuracy of
information provided by management to investors. An ideal control system should regulate
both motivation and ability.

Internal corporate governance controls

Internal corporate governance controls monitor activities and then take corrective
action to accomplish organisational goals. Examples include:

• Monitoring by the board of directors: The board of directors, with its legal
authority to hire, fire and compensate top management, safeguards invested capital.
Regular board meetings allow potential problems to be identified, discussed and
avoided. Whilst non-executive directors are thought to be more independent, they
may not always result in more effective corporate governance and may not increase
performance. Different board structures are optimal for different firms. Moreover,
the ability of the board to monitor the firm’s executives is a function of its access to
information. Executive directors possess superior knowledge of the decision-
making process and therefore evaluate top management on the basis of the quality
of its decisions that lead to financial performance outcomes, ex ante. It could be
argued, therefore, that executive directors look beyond the financial criteria.
• Remuneration: Performance-based remuneration is designed to relate some
proportion of salary to individual performance. It may be in the form of cash or
non-cash payments such as shares and share options, superannuation or other
benefits. Such incentive schemes, however, are reactive in the sense that they
provide no mechanism for preventing mistakes or opportunistic behaviour, and
can elicit myopic behaviour.

External corporate governance controls

External corporate governance controls encompass the controls external
stakeholders exercise over the organisation. Examples include:


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• debt covenants
NOTES • government regulations
• media pressure
• takeovers
• competition
• managerial labour market
• telephone tapping

1.10.7 Systemic Problems Of Corporate Governance

• Supply of accounting information: Financial accounts form a crucial link in
enabling providers of finance to monitor directors. Imperfections in the financial
reporting process will cause imperfections in the effectiveness of corporate
governance. This should, ideally, be corrected by the working of the external
auditing process.
• Demand for information: A barrier to shareholders using good information is the
cost of processing it, especially to a small shareholder. The traditional answer to
this problem is the efficient market hypothesis (in finance, the efficient market
hypothesis (EMH) asserts that financial markets are efficient), which suggests that
the shareholder will free ride on the judgements of larger professional investors.
• Monitoring costs: In order to influence the directors, the shareholders must
combine with others to form a significant voting group which can pose a real
threat of carrying resolutions or appointing directors at a general meeting.

Role of the Accountant

Financial reporting is a crucial element necessary for the corporate governance
system to function effectively. Accountants and Auditors are the primary providers of
information to capital market participants. The directors of the company should be entitled
to expect that management prepare the financial information in compliance with statutory
and ethical obligations, and rely on auditors’ competence.

Current accounting practice allows a degree of choice of method in determining
the method of measurement, criteria for recognition, and even the definition of the accounting
entity. The exercise of this choice to improve apparent performance (popularly known as



creative accounting) imposes extra information costs on users. In the extreme, it can involve
non-disclosure of information.
NOTES
.
One area of concern is whether the accounting firm acts as both the independent
auditor and management consultant to the firm they are auditing. This may result in a conflict
of interest which places the integrity of financial reports in doubt due to client pressure to
appease management. The power of the corporate client to initiate and terminate
management consulting services and, more fundamentally, to select and dismiss accounting
firms contradicts the concept of an independent auditor. Changes enacted in the United
States in the form of the Sarbanes-Oxley Act (in response to the Enron situation as noted
below) prohibit accounting firms from providing both auditing and management consulting
services. Similar provisions are in place under clause 49 of SEBI Act in India.

The Enron collapse is an example of misleading financial reporting. Enron concealed
huge losses by creating illusions that a third party was contractually obliged to pay the
amount of any losses. However, the third party was an entity in which Enron had a substantial
economic stake. In discussions of accounting practices with Arthur Andersen, the partner
in charge of auditing, views inevitably led to the client prevailing.

However, good financial reporting is not a sufficient condition for the effectiveness
of corporate governance if users don’t process it, or if the informed user is unable to
exercise a monitoring role due to high costs.

Rules versus principles

Rules are typically thought to be simpler to follow than principles, demarcating a
clear line between acceptable and unacceptable behaviour. Rules also reduce discretion
on the part of individual managers or auditors.

In practice rules can be more complex than principles. They may be ill-equipped
to deal with new types of transactions not covered by the code. Moreover, even if clear
rules are followed, one can still find a way to circumvent their underlying purpose - this is
harder to achieve if one is bound by a broader principle.


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Principles on the other hand are a form of self regulation. It allows the sector to
NOTES determine what standards are acceptable or unacceptable. It also pre-empts over zealous
legislations that might not be practical.

Enforcement

Enforcement can affect the overall credibility of a regulatory system. They both
deter bad actors and level the competitive playing field. Nevertheless, greater enforcement
is not always better, for taken too far it can dampen valuable risk-taking. In practice,
however, this is largely a theoretical, as opposed to a real, risk.

Action Beyond Obligation

Enlightened boards regard their mission as helping management lead the company.
They are more likely to be supportive of the senior management team. Because enlightened
directors strongly believe that it is their duty to involve themselves in an intellectual analysis
of how the company should move forward into the future, most of the time, the enlightened
board is aligned on the critically important issues facing the company.

Unlike traditional boards, enlightened boards do not feel hampered by the rules
and regulations of the Sarbanes-Oxley Act. Unlike standard boards that aim to comply
with regulations, enlightened boards regard compliance with regulations as merely a baseline
for board performance. Enlightened directors go far beyond merely meeting the requirements
on a checklist. They do not need Sarbanes-Oxley to mandate that they protect values and
ethics or monitor CEO performance.

At the same time, enlightened directors recognize that it is not their role to be
involved in the day-to-day operations of the corporation. They lead by example. Overall,
what most distinguishes enlightened directors from traditional and standard directors is the
passionate obligation they feel to engage in the day-to-day challenges and strategizing of
the company. Enlightened boards can be found in very large, complex companies, as well
as smaller companies.



1.10.8 Corporate Governance Models Around The World
NOTES
Although the US model of corporate governance is the most notorious, there is a
considerable variation in corporate governance models around the world. The intricated
shareholding structures of keiretsus in Japan, the heavy presence of banks in the equity of
german firms, the chaebols in South Korea and many others are examples of arrangements
which try to respond to the same corporate governance challenges as in the US.

• Anglo-American Model

There are many different models of corporate governance around the world. These
differ according to the variety of capitalism in which they are embedded. The liberal model
that is common in Anglo-American countries tends to give priority to the interests of
shareholders. The coordinated model that one finds in Continental Europe and Japan also
recognizes the interests of workers, managers, suppliers, customers, and the community.
Both models have distinct competitive advantages, but in different ways. The liberal model
of corporate governance encourages radical innovation and cost competition, whereas the
coordinated model of corporate governance facilitates incremental innovation and quality
competition. However, there are important differences between the U.S. recent approach
to governance issues and what has happened in the U.K..

In the United States, a corporation is governed by a board of directors, which has
the power to choose an executive officer, usually known as the chief executive officer. The
CEO has broad power to manage the corporation on a daily basis, but needs to get board
approval for certain major actions, such as hiring his/her immediate subordinates, raising
money, acquiring another company, major capital expansions, or other expensive projects.
Other duties of the board may include policy setting, decision making, monitoring
management’s performance, or corporate control.

The board of directors is nominally selected by and responsible to the share holders,
but the bylaws of many companies make it difficult for all but the largest shareholders to
have any influence over the makeup of the board; normally, individual shareholders are not
offered a choice of board nominees among which to choose, but are merely asked to
rubberstamp the nominees of the sitting board. Perverse incentives have pervaded many
corporate boards in the developed world, with board members beholden to the chief


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executive whose actions they are intended to oversee. Frequently, members of the boards
NOTES of directors are CEOs of other corporations, which some see as a conflict of interest.

The U.K. has pioneered a flexible model of regulation of corporate governance,
known as the “comply or explain” code of governance. This is a principle based code that
lists a dozen of recommended practices, such as the separation of CEO and Chairman of
the Board, the introduction of a time limit for CEOs’ contracts, the introduction of a minimum
number of non-executives Directors, of independent directors, the designation of a senior
non executive director, the formation and composition of remuneration, audit and nomination
committees. Publicly listed companies in the U.K. have to either apply those principles or,
if they choose not to, to explain in a designated part of their annual reports why they
decided not to do so. The monitoring of those explanations is left to shareholders themselves.
The tenet of the Code is that one size does not fit all in matters of corporate governance
and that instead of a statuary regime like the Sarbanes-Oxley Act in the U.S., it is best to
leave some flexibility to companies so that they can make choices most adapted to their
circumstances. If they have good reasons to deviate from the sound rule, they should be
able to convincingly explain those to their shareholders.

The code has been in place since 1993 and has had drastic effects on the way
firms are governed in the U.K. A study by Arcot, Bruno and Faure-Grimaud from the
Financial Markets Group at the London School of Economics shows that in 1993, about
10% of the UK companies member of the FTSE 350 were compliants on all dimensions
while they were more than 60% in 2003. The same success was not achieved when looking
at the explanation part for non compliant companies. Many deviations are simply not
explained and a large majority of explanations fail to identify specific circumstances justifying
those deviations. Still, the overall view is that the U.K.’s system works fairly well and in
fact is often branded as a benchmark, followed by several countries.

• Non Anglo-American Model

In East Asian countries, family-owned companies dominate. A study by Claessens,
Djankov and Lang (2000) investigated the top 15 families in East Asian countries and
found that they dominated listed corporate assets. In countries such as Pakistan, Indonesia
and the Philippines, the top 15 families controlled over 50% of publicly owned corporations
through a system of family cross-holdings, thus dominating the capital markets. Family-
owned companies also dominate the Latin model of corporate governance, that is companies



in Mexico, Italy, Spain, France (to a certain extent), Brazil, Argentina, and other countries
in South America.
NOTES

Europe and Asia exemplify the insider system: Shareholder and stakeholder • a
small number of listed companies, • an illiquid capital market where ownership and control
are not frequently traded • high concentration of shareholding in the hands of corporations,
institutions, families or government. • the insider model uses a system of interlocking
networks and committees.

At the same time that developing countries are undergoing a process of economic
growth and transformation, they are also experiencing a revolution in the business and
political relationships that characterize their private and public sectors. Establishing good
corporate governance practices is essential to sustaining long-term development and growth
as these countries move from closed, market-unfriendly, undemocratic systems towards
open, market-friendly, democratic systems. Good corporate governance systems will allow
organizations to realize their maximum productivity and efficiency, minimize corruption and
abuse of power, and provide a system of managerial accountability. These goals are equally
important for both private corporations and government bodies.

Because of the implicit relationship between private interests and the larger
government, good corporate governance practices are essential to establishing good
governance at the national level in developing countries. A number of ties the keep the
public and private sectors closely linked. On one hand, judiciary and regulatory bodies as
well as legislatures play a role in corporate management and oversight. At the same time
cartels and large corporate interests use their size to exert not only economic, but also
political power. These two sectors are so intertwined that a country cannot significantly
change one without simultaneously instituting changes in the other.

According to Nicolas Meisel, there are four priorities which developing countries
should concentrate on while experimenting with new forms of corporate and public
governance. The first is to focus on improving the quality of information and increasing the
speed at which it is created and distributed to the public. Good communication is important
to the functioning of any organization. The second is to allow individual actors more autonomy
while at the same time maintaining or increasing accountability. Thirdly, if a hierarchical
organization used to orient private activities toward the general interest, new countervailing
powers should be encouraged to fill this role. Finally, the part the state plays and how


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government officials are selected must be considered if a developing economy is to achieve
NOTES sustainable growth. This may involve making it easier for newcomers with new ideas
incumbents who may hold to older, possibly outdated, models.

Codes and guidelines

Corporate governance principles and codes have been developed in different
countries and issued from stock exchanges, corporations, institutional investors, or
associations (institutes) of directors and managers with the support of governments and
international organizations. As a rule, compliance with these governance recommendations
is not mandated by law, although the codes linked to stock exchange listing requirements
may have a coercive effect.

For example, companies quoted on the London and Toronto Stock Exchanges
formally need not follow the recommendations of their respective national codes. However,
they must disclose whether they follow the recommendations in those documents and,
where not, they should provide explanations concerning divergent practices. Such disclosure
requirements exert a significant pressure on listed companies for compliance.

In the United States, companies are primarily regulated by the state in which they
incorporate though they are also regulated by the federal government and, if they are
public, by their stock exchange. The highest number of companies are incorporated in
Delaware, including more than half of the Fortune 500. This is due to Delaware’s generally
business-friendly corporate legal environment and the existence of a state court dedicated
solely to business issues (Delaware Court of Chancery).

Most states’ corporate law generally follow the American Bar Association’s Model
Business Corporation Act. While Delaware does not follow the Act, it still considers its
provisions and several prominent Delaware justices, including former Delaware Supreme
Court Chief Justice E.Norman veasey participate on ABA committees.

One issue that has been raised since the Disney decision in 2005 is the degree to
which companies manage their governance responsibilities; in other words, do they merely
try to supersede the legal threshold, or should they create governance guidelines that ascend
to the level of best practice. For example, the guidelines issued by associations of directors
(see Section 3 above), corporate managers and individual companies tend to be wholly



voluntary. For example, The GM Board Guidelines reflect the company’s efforts to improve
its own governance capacity. Such documents, however, may have a wider multiplying
NOTES
effect prompting other companies to adopt similar documents and standards of best practice.

One of the most influential guidelines has been the 1999 OECD Principles of
Corporate Governance. This was revised in 2004. The OECD remains a proponent of
corporate governance principles throughout the world.

The World Business Council for Sustainable Development WBCSD has also done
substantial work on corporate governance, particularly on accountability and reporting,
and in 2004 created an Issue Management Tool: Strategic challenges for business in the
use of corporate responsibility codes, standards, and frame works. This document aims to
provide general information, a “snap-shot” of the landscape and a perspective from a
think-tank/professional association on a few key codes, standards and frameworks relevant
to the sustainability agenda.

1.10.9 Corporate Governance And Firm Performance

In its ‘Global Investor Opinion Survey’ of over 200 institutional investors first
undertaken in 2000 and updated in 2002, McKinsey found that 80% of the respondents
would pay a premium for well-governed companies. They defined a well-governed company
as one that had mostly out-side directors, who had no management ties, undertook formal
evaluation of its directors, and was responsive to investors’ requests for information on
governance issues. The size of the premium varied by market, from 11% for Canadian
companies to around 40% for companies where the regulatory backdrop was least certain
(those in Morocco,Egypt and Russia).

Other studies have linked broad perceptions of the quality of companies to superior
share price performance. In a study of five year cumulative returns of Fortune Magazine’s
survey of ‘most admired firms’, Antunovich et al found that those “most admired” had an
average return of 125%, whilst the ‘least admired’ firms returned 80%. In a separate study
Business Week enlisted institutional investors and ‘experts’ to assist in differentiating between
boards with good and bad governance and found that companies with the highest rankings
had the highest financial returns.


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On the other hand, research into the relationship between specific corporate
NOTES governance controls and firm performance has been mixed and often weak. The following
examples are illustrative.

Board composition

Some researchers have found support for the relationship between frequency of
meetings and profitability. Others have found a negative relationship between the proportion
of external directors and firm performance, while others found no relationship between
external board membership and performance. In a recent paper Bagahat and Black found
that companies with more independent boards do not perform better than other companies.
It is unlikely that board composition has a direct impact on firm performance.

Remuneration/Compensation

The results of previous research on the relationship between firm performance and
executive compensation have failed to find consistent and significant relationships between
executives’ remuneration and firm performance. Low average levels of pay-performance
alignment do not necessarily imply that this form of governance control is inefficient. Not all
firms experience the same levels of agency conflict, and external and internal monitoring
devices may be more effective for some than for others.

Some researchers have found that the largest CEO performance incentives came
from ownership of the firm’s shares, while other researchers found that the relationship
between share ownership and firm performance was dependent on the level of ownership.
The results suggest that increases in ownership above 20% cause management to become
more entrenched, and less interested in the welfare of their shareholders.

Some argue that firm performance is positively associated with share option plans
and that these plans direct managers’ energies and extend their decision horizons toward
the long-term, rather than the short-term, performance of the company. However, that
point of view came under substantial criticism circa in the wake of various security scandals
including mutual fund timing episodes and, in particular, the backdating of option grants as
documented by University of Iowa academic Erik Lie and reported by James Blander and
Charles Forelle of the Wall Street Journal.



Even before the negative influence on public opinion caused by the 2006 backdating
scandal, use of options faced various criticisms. A particularly forceful and long running
NOTES
argument concerned the interaction of executive options with corporate stock repurchase
programs. Numerous authorities (including U.S. Federal Reserve Board economist
Weisbenner) determined options may be employed in concert with stock buybacks in a
manner contrary to shareholder interests. These authors argued that, in part, corporate
stock buybacks for U.S. Standard & Poors 500 companies surged to a $500 billion
annual rate in late 2006 because of the impact of options. A compendium of academic
works on the option/buyback issue is included in the study Scanda by author M.Gumport
issued in 2006.

A combination of accounting changes and governance issues led options to become
a less popular means of remuneration as 2006 progressed, and various alternative
implementations of buybacks surfaced to challenge the dominance of “open market” cash
buybacks as the preferred means of implementing a share repurchase plan.

1.10.10 Initiative Of Indian Government Of Corporate Governance

National foundation for corporate governance (A Trust formed by MCA, CII, ICAI
& ICSI)

Vision:

• Be A Catalyst In Making India The Best In Corporate Governance
PracticesMission:
• To foster a culture for promoting good governance, voluntary compliance and
facilitate effective participation of different stakeholders;
• To create a framework of best practices, structure, processes and ethics;
• To make significant difference to Indian Corporate Sector by raising the
standard of corporate governance in India towards achieving stability and
growth

Invites Companies to Showcase their Good Corporate Governance Practices:

In order to promote Corporate Governance in India, NFCG has undertaken a
major campaign to disseminate, to public at large, the good corporate governance practices


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followed by the Industries especially among the Small and Medium Enterprises (SMEs)
NOTES and unlisted Companies.

In case you believe that your company has initiated some benchmark Corporate
Governance initiatives then we invite you to forward. A brief audio-visual presentation
highlighting the following:-

• The Corporate Governance practices followed in your Company;
• The net worth of the Company in the terms of assets, turnover and profit before
the implementation of the good Corporate Governance practices;
• The cost of implementation of the Corporate Governance Practices;
• The effect on the net worth and business Operations of the Company after the
implementation of the good Corporate Governance practices
• The short listed presentations will be telecast on one of the prominent business TV
Channels and also given awards /certificate by NFCG.

SUMMARY

Strategic management is the art and science of formulating, implementing and
evaluating cross-functional decisions that will enable an organization to achieve its objectives.
It is the process of specifying the organization’s objectives, developing policies and plans
to achieve these objectives, and allocating resources to implement the policies and plans to
achieve the organization’s objectives. Strategic management as a discipline originated in
the 1950s and 60s. Although there were numerous early contributors to the literature, the
most influential pioneers were Alfred D. Chandler, Jr., Philip Selznick, Igor Ansoff, and
Peter Drucker.

The steps involved in strategic management process are:

1. Defining the vision, business mission, purpose, and broad objectives.2. Formulation
of strategies.3. Implementation of strategies. 4. Evaluation of strategies.

The four phases can be listed as below. 1. Defining the vision, business mission,
purpose, and broad objectives.2. Formulation of strategies.3. Implementation of strategies.4.
Evaluation of strategies.



Corporate governance is the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed anagement are: Clarity of strategic
NOTES
vision for the? organization, Focus on what is strategically? important to the
organization,Better understanding of the rapidly? changing business environment.

The four phases can be listed as administered or controlled. Corporate governance
also includes the relationship stakeholders among the many players involved (the
stakeholders) and the goals for which the corporation is governed. The principal players
are the shareholders, management and the board of directors. Other stakeholders include
employees, suppliers, customers, banks and other lenders, regulators, the environment
and the community at large.

Short Questions

Q1.Define strategy.
Q2. What is policy, procedure and budget?
Q3. Mention the three types of strategies.
Q4.Define Corporate Governanace.

Review questions

Q5.Explain the strategic formulation process.
Q6.Discuss the evolution and growth of strategic management.
Q7.Explain the different approaches of strategic management.
Q8. Discuss the key role to be played by the all levels of management in strategic
formulations.
Q9.Discuss the role of corporate governance and its influences in corporations
performances.


DBA 1703

NOTES



UNIT II NOTES

COMPETITIVE ADVANTAGE

INTRODUCTION

The interaction of the four environmental dimensions creates further sub-dimensions
such as political and economic environments that act as a filter between the internal and
external environment and profoundly affect the performance of the corporation. Culture
here refers to transmitted patterns of behaviour shared by members of a group which
provide them with effective mechanisms for interaction (Krefting & Krefting, 1991). Culture
can be thought of as an overriding concept (eg. western cultures and indigenous cultures)
that directs the sociocultural specificity of group environments each with its own beliefs
and rituals that are used to determine behavioural norms.

Michael Porter provided a framework that models an industry as being influenced
by five forces. The strategic business manager seeking to develop an edge over rival firms
can use this model to better understand the industry context in which the firm operates.When
a rival acts in a way that elicits a counter-response by other firms, rivalry intensifies.The
intensity of rivalry commonly is referred to as being cutthroat, intense, moderate, or
weak,based on the firms’ aggressiveness in attempting to gain an advantage

Learning Objectives

After learning this unit you must be able to:

• Analyze the external environment influencing the industry as well as strategy
• Understand the porter’s five forces model and its uses in strategic management
• Know the competitive changes and the stages of industrial analysis
• Predict the changes in the industry structure due to the globalization
• Analyze the importance of capabilities and competencies in gaining competitive
advantage


DBA 1703

• Implement the porter’s model on Gaining Competitive Advantage
NOTES • Planning for the sustainability of competitiveness.

2.1 EXTERNAL ENVIRONMENT

The external environment is all the conditions surrounding a person, and has been
classified in various ways. Any organization before they begin the work of strategy
formulations, it must scan the external environment to identify possible opportunities and
threats and its internal environment for strengths and weaknesses. Environmental scanning
is the monitoring , evaluating, and disseminating of information from the external and internal
environment to key people within the corporation.

The major four environmental dimensions are as follows

1. Economical factors
2. Technological factors
3. Political factors
4. Socio-cultural factors

Let us see each of the factors some influencing variables:

A Economical factors :

• GDP trends
• Interest rates
• Money supply
• Inflation rates
• Unemployment levels
• Wage/price controls
• Devaluation/revaluation
• Energy availability and cost
• Disposable and discretionary income


Strategic management

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