Chapter 12 Corporate Governance and Control of Global Operations.

Chapter 12

Corporate Governance and Control of Global Operations

International Accounting & Multinational Enterprises – Chapter 12 – Radebaugh, Gray, Black

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



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 R&D closely tied to a specific market Government barriers to trade are too high Distribution systems are fragmented and impenetrable



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



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



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



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


Components of a Total Global Strategy – Fig. 12.1



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


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.


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 firm’s organization is constantly evolving Failure to adjust to a changing environment can lead

to internal conflict and poor performance


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


Domestic Organization with Export Group


International Division Structure

May become necessary to develop foreign production facilities

A new international division replaces the old export division with substantial autonomy

The firm can possibly be split into two rival factors (domestic and international)


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 product structure is favored by companies with

simple, stable product lines Global geographic structure is favored by companies with a

wide range of complex products New conflict emerges between product divisions

and geographic divisions


Geographic Structure


Product Structure


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


Matrix or Grid Organization


Corporate Governance

All business activities consist of two things A set of resources People who make those resources profitable

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


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 management’s compensation Composed of multiple committees Board members are appointed by the owners Should have a majority of “outside” members


Corporate 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



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


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


International Importance of Governance

Recent corporate meltdowns have shattered customer confidence worldwide

As a result, Codes of Best Practice have been created

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


International Importance of Governance

Scorecard for German Corporate Governance Reflects Germany’s legalistic approach

Governance alone is not enough to combat fraud


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

Japan – appoint outside directors when in trouble Use banks for the role of outside governance

Russia – insiders control the board



Board of Directors – 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

Independent directors are more likely to fire management



Executive Compensation Goal is to align management’s 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



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 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



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



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)


Cross National Differences in Corporate Governance


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


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 – Japan’s 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


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)


Cross National Differences in Corporate Governance - Management

Ideology General knowledge and hierarchical 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


Internal Controls

COSO Framework Control Environment – control consciousness of

the people 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


The Sarbanes-Oxley Act of 2002

Section 404 Establishes management’s responsibility for

internal controls Management must assess controls annually Management’s assessment must be assessed by

an independent auditor Effective November 15, 2004 Foreign firms listing in the U.S. – July 15, 2005


The Sarbanes-Oxley Act of 2002

Cost of compliance is tremendous! E&Y 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


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


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


Theories and Realities of Global Information Processing

Egelhoff’s (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


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


MNEs and Transborder Data Flows

Management of info is as important as management of assets and production

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


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


Knowledge Flows in MNEs


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


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


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

Chapter 12 Corporate Governance and Control of Global Operations.

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Transcript of Chapter 12 Corporate Governance and Control of Global Operations.