Chapter 9: Corporate Strategy PDF

[Chapter 9: CORPORATE STRATEGY] ------------------------------------------- A **cooperative strategy** is a means by which firms collaborate to achieve a shared objective. Cooperating with others is a strategy firms use to create value for a customer that it likely could not create by itself Firms...

[Chapter 9: CORPORATE STRATEGY] ------------------------------------------- A **cooperative strategy** is a means by which firms collaborate to achieve a shared objective. Cooperating with others is a strategy firms use to create value for a customer that it likely could not create by itself Firms also try to create **competitive advantages** when using a cooperative strategy. A competitive advantage developed through a cooperative strategy often is called a **collaborative or relational advantage**, indicating that the relationship that develops among collaborating partners is commonly the basis on which to build a competitive advantage. Importantly, successfully using cooperative strategies finds a firm outperforming its rivals in terms of strategic competitiveness and above-average returns, often because they've been able to form a competitive advantage. A **strategic alliance** is a cooperative strategy in which firms combine some of their resources to create a competitive advantage. It involves firms with some degree of exchange and sharing of resources to jointly develop, sell, and service goods or services. In addition, firms use strategic alliances to leverage their existing resources while working with partners to develop additional resources as the foundation for new competitive advantages. To be certain, the reality today is that strategic alliances are a vital strategy that firms use as a means to try **to outperform rivals**. For all cooperative strategies, success is more likely when partners behave cooperatively. Actively solving problems, being trustworthy, and consistently pursuing ways to combine partners' resources to create value are examples of cooperative behavior known to contribute to alliance success. Three major types of strategic alliances: ========================================= - *[Joint ventures]* - strategic alliance in which two or more firms create a legally independent company to share some of their resources to create a competitive advantage. Typically, partners in a joint venture own equal percentages and contribute equally to the venture's operations. Often formed to improve a firm's ability to compete in uncertain competitive environments, it can be effective in establishing long- term relationships and in transferring tacit knowledge between partners. Overall, it is maybe the **optimal type of cooperative arrangement** when firms need to combine their resources to create a competitive advantage that is substantially different from any they possess individually and when the partners intend to compete in highly uncertain environments. - *[Equity strategic alliances]* - an alliance in which **two or more firms own different percentages of a company** that they have formed by combining some of their resources to create a competitive advantage. Firms sometimes form equity alliances in order to refocus their strategy as a means of creating a competitive advantage. - *[Nonequity strategic alliances]* - an alliance in which **two or more firms develop a contractual relationship to share some of their resources** to create a competitive advantage. Here, firms do not establish a separate independent company and therefore do not take equity positions. For this reason, nonequity strategic alliances are **less formal**, demand fewer partner commitments than do joint ventures and equity strategic alliances, and generally do not foster an intimate relationship between partners; nonetheless, research evidence indicates that they can create value Reasons Firms Develop Strategic Alliances ========================================= **Cooperative strategies** are an integral part of the competitive landscape and are quite important to many companies. Overall, there are many reasons firms choose to participate in strategic alliances. Making it possible for firms to create value they couldn't generate by acting independently and entering markets more rapidly combine to form the first important reason firms form strategic alliances. A **second major reason** firms form strategic alliances is that most (if not all) companies lack the full set of resources needed to pursue all identified opportunities and reach their objectives in the process of doing so, a reality indicating that partnering with others will increase the probability of reaching firm-specific performance objectives. In *[slow-cycle markets,]* are markets where the firm's competitive advantages are **shielded from imitation** for relatively long periods of time and where imitation is costly. Railroads and, historically, telecommunications, utilities, and financial services are industries characterized as slow-cycle markets. Firms here often use strategic alliances to enter restricted markets or to establish a franchise in a new market. In *[fast-cycle markets]*, the firm's competitive advantages are **not shielded from imitation**, preventing their long-term sustainability. This markets are unstable, unpredictable, and complex; in a word, **hypercompetitive**. Combined, these conditions virtually preclude establishing sustainable competitive advantages, forcing firms to constantly seek sources of new competitive advantages while creating value by using current ones. Alliances between firms with current excess resources and those with promising resources help companies competing in fast-cycle markets effectively transition from the present to the future and gain rapid entry into new markets. As such, a **"collaboration mindset"** is of paramount importance for firms competing in fast-cycle markets. In *[standard-cycle markets]*, alliances are more likely to be **made by partners** that have complementary resources. The alliances formed by airline companies are an example of standard-cycle market alliances. Competitive advantages are moderately shielded from imitation in **standard-cycle markets**, typically allowing them to be sustained for a longer period of time than in fast-cycle market situations, but for a shorter period of time than in slow-cycle markets. *[Business-level cooperative strategy]* is a strategy through which firms **combine some of their resources** to create a competitive advantage by competing in one or more product markets. It details what the firm intends to do to gain a competitive advantage in specific product markets. Thus, the firm forms a business-level cooperative strategy when it believes that combining some of its resources with those of one or more partners will create competitive advantages that it can't create by itself and will lead to success in a specific product market. In a *[vertical complementary strategic alliance]*, firms share some of their resources from different stages of the value chain for the purpose of creating a competitive advantage. Formed to adapt to environmental changes; sometimes the changes represent an opportunity for partnering firms to innovate while adapting. Firms sometimes use business-level strategic alliances **to hedge against risk and uncertainty**, especially in fast-cycle markets. These strategies are also used where uncertainty exists, such as in entering new product markets, especially those within emerging economies. Used to reduce competition, collusive strategies differ from strategic alliances in that collusive strategies are often an illegal cooperative strategy. **Explicit collusion and tacit collusion** are the two types of collusive strategies. *[Tacit collusion]* exists when several firms in an industry **indirectly coordinate their production and pricing decisions** by observing each other's competitive actions and responses. It tends to take place in industries dominated by a few large firms. "With tacit collusion, competitors don't agree to pricing, but since there are so few of them they all understand very well how their competition will behave, and are able to prevent dramatic prices slides by using this understanding. It results in production output that is below fully competitive levels and above fully competitive prices. In addition to the effects on competition within a particular market, research suggests that tacit collusion between two firms can lead to **less competition in other markets** in which both firms operate. A *[corporate-level cooperative strategy]* is a strategy through which a **firm collaborates with one or more companies to expand its operations**. **Diversifying alliances, synergistic alliances, and franchising** are the most commonly used corporate-level cooperative strategies. Firms use diversifying and synergistic alliances to improve their performance by diversifying their operations through a means other than or in addition to internal organic growth or a merger or acquisition. When a firm seeks to diversify into markets in which the host nation's government prevents mergers and acquisitions, alliances become an especially appropriate option. Corporate-level strategic alliances are also **attractive compared with mergers**, and particularly acquisitions, because they require fewer resource commitments and permit greater flexibility in terms of efforts to diversify partners' operations. An **alliance** can be used as a way to determine whether the partners might benefit from a future merger or acquisition between them. This **"testing"** process often characterizes alliances formed to combine firms' unique technological resources and capabilities. Assessing Corporate-Level Cooperative Strategies ================================================ International Cooperative Strategy ================================== Alliance Network Types ====================== Competitive Risks with Cooperative Strategies ============================================= partnership has potential complementarities and synergies, alliance success is elusive. Although failure is undesirable, it can be a valuable learning experience, meaning that firms should carefully study a cooperative strategy's failure to gain insights with respect to how to form and manage future cooperative arrangements. One **cooperative strategy risk** is that a **firm may act in a way that its partner thinks is opportunistic**. In general, **opportunistic behaviors** surface either when formal contracts fail to prevent them or when an alliance is based on a false perception of partner trustworthiness. Typically, an **opportunistic firm** wants to acquire as much of its partner's tacit knowledge as it can. Full awareness of what a partner wants in a cooperative strategy reduces the likelihood that a firm will suffer from another's opportunistic actions. Some cooperative strategies fail when it is discovered that a firm has misrepresented the resources it can bring to the partnership. This risk is more common when the partner's contribution is based on some of its intangible assets. **Superior knowledge of local conditions** is an **example of an intangible asset** that partners often fail to deliver. An effective way to deal with this risk may be to ask the partner to provide evidence that it does, in fact, possess the resources (even when they are largely intangible) it will share in the cooperative strategy. A **firm's failure to make available to its partners the resources** (such as the most sophisticated technologies) that it committed to the cooperative strategy is a **third risk**. This particular risk surfaces most commonly when firms form an international cooperative strategy, especially in emerging economies. In these instances, different cultures and languages can cause misinterpretations of contractual terms or trust-based expectations. A **final risk is that one firm may make investments that are specific to the alliance while its partner does not**. If the partner isn't also making alliance-specific investments, the firm is at a relative disadvantage in terms of returns earned from the alliance compared with investments made to earn the returns. Managing Cooperative Strategies =============================== Although they are difficult to manage, *[cooperative strategies]* are an **important means of growth and enhanced firm performance**. Because the ability to effectively manage cooperative strategies is unevenly distributed across organizations in general, assigning managerial responsibility for a firm's cooperative strategies to a high-level executive or to a team improves the likelihood that the strategies will be well managed. In turn, being able to **successfully manage cooperative strategies can itself be a competitive advantage**. Those responsible for managing the firm's cooperative strategies should take the actions necessary to coordinate activities, categorize knowledge learned from previous experiences, and make certain that what the firm knows about how to effectively form and use cooperative strategies is in the hands of the right people at the right time. Firms must also learn how to manage both the tangible and intangible assets (such as knowledge) that are involved with a cooperative arrangement. Too often, partners concentrate on managing tangible assets at the expense of taking action to also manage a cooperative relationship's intangible assets. **prepared to take advantage of unexpected opportunities** to learn from each other and to explore additional marketplace possibilities. Less formal contracts, with fewer constraints on partners' behaviors, make it possible for partners to explore how their resources can be shared in multiple value-creating ways. Firms can successfully use both approaches to manage cooperative strategies. However, the **costs to monitor the cooperative strategy are greater with cost minimization** because writing detailed contracts and using extensive monitoring mechanisms is expensive, even though the approach is intended to reduce alliance costs. Although monitoring systems may prevent partners from acting in their own self- interests, they also often preclude positive responses to new opportunities that surface to productively use each alliance partner's unique resources. Thus, formal contracts and extensive monitoring systems tend to stifle partners' efforts to gain maximum value from their participation in a cooperative strategy and require significant resources to be put into place and used. The **relative lack of detail and formality** that is a part of the contract developed when using the opportunity-maximization approach means that **firms need to trust that each party** will act in the partnership's best interests. The **psychological state of trust** in the context of cooperative arrangements is the **belief that a firm will not do anything to exploit its partner's vulnerabilities**, even if it has an opportunity to do so. When partners trust each other, there is less need to write detailed formal contracts to specify each firm's alliance behaviors, and the cooperative relationship tends to be more stable. On a relative basis, **trust tends to be more difficult to establish in international cooperative strategies than domestic ones**. Differences in trade policies, cultures, laws, and politics that are part of cross-border alliances account for the increased difficulty. Research showing that trust between partners increases the likelihood of success when using alliances highlights the benefits of the opportunity-maximization approach to managing cooperative strategies. Trust may also be the most efficient way to influence and control alliance partners' behaviors. Research indicates that trust can be a capability that is valuable, rare, imperfectly imitable, and often nonsubstitutable. Thus, firms known to be trustworthy can have a competitive advantage in terms of how they develop and use cooperative strategies. Increasing the importance of trust in alliances is the fact that it is not possible to specify all operational details of a cooperative strategy in a formal contract. As such, being confident that its partner can be trusted reduces the firm's concern about its inability to contractually control all alliance details. [Chapter 10: CORPORATE GOVERNANCE] ---------------------------------------------- *[Corporate governance]* - a **set of mechanisms used to manage the relationships among stakeholders** and to determine and control the strategic direction and performance of organizations. At its core, it is concerned with identifying ways to ensure that decisions (especially strategic decisions) are made effectively and that they facilitate a firm's efforts to achieve strategic competitiveness. Governance can also be thought of as a means to establish and maintain harmony between parties (the firm's owners and its top-level managers) whose interests may conflict. management of CEO pay and more focused supervision of director pay, and the corporation's overall strategic direction are examples of areas in which oversight is sought. Because corporate governance is an ongoing process concerned with how a firm is to be managed, its nature evolves in light of the types of never-ending changes in a firm's external environment. The three internal governance mechanisms: ========================================= 1. *[ownership concentration]*, represented by types of shareholders and their different incentives to monitor managers; 2. the *[board of directors]*; and 3. *[executive compensation]* *[Separation of Ownership and Managerial Control -]* **allows shareholders to purchase stock**, which entitles them to income (residual returns) from the firm's operations after paying expenses. This right, however, requires that shareholders take a risk that the firm's expenses may exceed its revenues. To manage this investment risk, shareholders maintain a diversified portfolio by investing in several companies to reduce their overall risk. The poor performance or failure of any one firm in which they invest has less overall effect on the value of the entire portfolio of investments. Thus, shareholders specialize in managing their investment risk. Without owner (shareholder) specialization in risk bearing and management specialization in decision making, a firm may be limited by its owners' abilities to simultaneously manage it and make effective strategic decisions relative to risk. Thus, the separation and specialization of ownership (risk bearing) and managerial control (decision making) should produce the highest returns for the firm's owners. *[Managerial opportunism]* is the **seeking of self-interest with guile** (i.e., cunning or deceit). *[Opportunism]* is both an **attitude** (i.e., an inclination) and a **set of behaviors** (i.e., specific acts of self- interest). Principals do not know beforehand which agents will or will not act opportunistically. A top-level manager's reputation is an imperfect predictor; moreover, opportunistic behavior cannot be observed until it has occurred. Thus, principals establish governance and control mechanisms to prevent agents from acting opportunistically, even though only a few are likely to do so. Interestingly, research suggests that when CEOs feel constrained by governance mechanisms, they are more likely to seek external advice that, in turn, helps them make better strategic decisions. The agency relationship suggests that any time principals delegate decision-making responsibilities to agents, the opportunity for conflicts of interest exists. Top-level managers, for example, may make strategic decisions that maximize their personal welfare and minimize their personal risk. Decisions such as these prevent maximizing shareholder wealth. Decisions regarding product diversification demonstrate this situation. Product Diversification as an Example of an Agency Problem ========================================================== *[Product diversification]* can create two benefits for top-level managers that shareholders do not enjoy, meaning that they may prefer product diversification more than shareholders do. One reason managers prefer more diversification compared to shareholders is the fact that it usually increases the size of a firm and size is positively related to executive compensation. **Diversification** also increases the complexity of managing a firm and its network of businesses, possibly requiring additional managerial pay because of this complexity. Thus, increased product diversification provides an opportunity for top-level managers to increase their compensation. *[Free cash flow]* is the **source of another potential agency problem**. Calculated as operating cash flow minus capital expenditures, free cash flow represents the cash remaining after the firm has invested in all projects that have positive net present value within its current businesses. Top-level managers may decide to invest free cash flow in product lines that are not associated with the firm's current lines of business to increase the firm's degree of diversification. However, when managers use free cash flow to diversify the firm in ways that do not have a strong possibility of creating additional value for stakeholders and certainly for shareholders, the firm is overdiversified. **Over diversification** is an **example of self-serving and opportunistic managerial behavior**. In contrast to managers, shareholders may prefer that free cash flow be distributed to them as dividends, so they can control how the cash is invested. In general, **shareholders prefer riskier strategies and more focused diversification**. Shareholders reduce their risk by holding a diversified portfolio of investments. Alternatively, managers cannot balance their employment risk by working for a diverse portfolio of firms; therefore, managers may prefer a level of diversification that maximizes firm size and their compensation while also reducing their employment risk. Finding the appropriate level of diversification is difficult for managers. Research has shown that too much diversification can have negative effects on the firm's ability to create innovation (managers' unwillingness to take on higher risks). Alternatively, diversification that strategically fits the firm's capabilities can enhance its innovation output. However, too much or inappropriate diversification can also divert managerial attention from other important firm activities such as corporate social responsibility. Product diversification, therefore, is a potential agency problem that could result in principals incurring costs to control their agents' behaviors. Agency Costs and Governance Mechanisms ====================================== In general, *[managerial interests]* may prevail when governance mechanisms are weak and therefore ineffective, such as in situations where managers have a significant amount of autonomy to make strategic decisions. If, however, the board of directors controls managerial autonomy, or if other strong governance mechanisms are used, the firm's strategies should better reflect stakeholders and certainly shareholders' interests. *[Ownership concentration]* is defined by the **number of large- block shareholders** and the **total percentage of the firm's shares they own**. Large-block shareholders typically own at least 5 percent of a company's issued shares. Ownership concentration as a governance mechanism has received considerable interest because large-block shareholders are increasingly active in their demands that firms adopt effective governance mechanisms to control managerial decisions so that they will best represent owners' interests. In recent years, the number of individuals who are large-block shareholders has declined. **Institutional owners** have replaced individuals as large-block shareholders. *[Ownership concentration]* influences decisions made about the strategies a firm will use and the value created by their use. In general, ownership concentration's influence on strategies and firm performance is positive. The Increasing Influence of Institutional Owners ================================================ Ownership of many modern corporations is now concentrated in the hands of institutional investors rather than individual shareholders. *[Institutional owners]* are **financial institutions**, such as mutual funds and pension funds, that control large-block shareholder positions. Because of their prominent ownership positions, institutional owners, as large-block shareholders, have the potential to be a powerful governance mechanism. Though important to all shareholders, a firm's individual shareholders with small ownership percentages are very dependent on the board of directors to represent their interests. Unfortunately, evidence suggests that **boards have not been highly effective in monitoring and controlling top-level managers' decisions and subsequent actions**. Because of their relatively ineffective performance and in light of the recent financial crisis, boards are experiencing increasing pressure from shareholders, lawmakers, and regulators to become more forceful in their oversight role to prevent top-level managers from acting in their own best interests. Moreover, in addition to their monitoring role, board members increasingly are expected to provide resources to the firms they serve. These resources include their personal knowledge and expertise and their relationships with a wide variety of organizations. - *[Insiders]* are **active top-level managers** in the company who are **elected to the board because they are a source of information about the firm's day-to-day operations**. - *[Related outsiders]* **have some relationship with the firm**, **contractual** or otherwise, that may create questions about their independence, but these individuals are **not involved with the corporation's day-to-day activities**. - *[Outsiders]* provide **independent counsel to the firm** and may **hold top-level managerial positions in other companies** or may have been elected to the board prior to the beginning of the current CEO's tenure. Alternatively, having a **large number of outside board members can also create some problems**. For example, because outsiders typically do not have contact with the firm's day-to-day operations and do not have ready access to detailed information about managers and their skills, they lack the insights required to fully and effectively evaluate their decisions and initiatives. Outsiders can, however, obtain valuable information through frequent interactions with inside board members and during board meetings to enhance their understanding of managers and their decisions. Because they work with and lead the firm daily, **insiders have access to information** that facilitates forming and implementing appropriate strategies. Accordingly, some evidence suggests that boards with a critical mass of insiders typically are better informed about intended strategic initiatives, the reasons for the initiatives, and the outcomes expected from pursuing them. Without this type of information, outsider-dominated boards may emphasize financial, as opposed to strategic, controls to gather performance information to evaluate managers' and business units' performances. A virtually exclusive reliance on financial evaluations shifts risk to top-level managers who, in turn, may make decisions to maximize their interests and reduce their employment risk. Reducing investments in R&D, further diversifying the firm, and pursuing higher levels of compensation are some of the results of managers' actions to reach the financial goals set by outsider-dominated boards. Additionally, boards can make mistakes in strategic decisions because of poor decision processes, and in CEO succession decisions because of the lack of important information about candidates as well as the firm's specific needs. Overall, knowledgeable and balanced boards are likely to be the most effective over time. Enhancing the Effectiveness of the Board of Directors ===================================================== The demand for greater accountability and improved performance is stimulating many boards to voluntarily make changes. Among these changes are: 1. increases in the diversity of the backgrounds of board members (e.g., a greater number of directors from public service, academic, and scientific settings; a greater percentage of ethnic minorities and women; and members from different countries on boards of U.S. firms); 2. the strengthening of internal management and accounting control systems; 3. establishing and consistently using formal processes to evaluate board member's performance; 4. modifying the compensation of directors, especially reducing or eliminating stock options as a part of their package; and 5. creating the "lead director" role that has strong powers with regard to the board agenda and oversight of non-management board member activities. Increasingly, **outside directors are being required to own significant equity stakes** as a prerequisite to holding a board seat. In fact, some research suggests that firms perform better if outside directors have such a stake; the trend is toward higher pay for directors with more stock ownership, but with fewer stock options. However, other research suggests that too much ownership can lead to lower independence for board members. In addition, other research suggests that diverse boards help firms make more effective strategic decisions and perform better over time. Although questions remain about whether more independent and diverse boards enhance board effectiveness, the trends for greater independence and increasing diversity among board members are likely to continue. *[Executive compensation]* is a **governance mechanism** that seeks to align the interests of managers and owners through **salaries, bonuses, and long-term incentives such as stock awards and options**. **Long-term incentive plans** (typically involving stock options and stock awards) are an increasingly important part of compensation packages for top-level managers, especially those leading U.S. firms. Theoretically, using long-term incentives facilitates the firm's efforts (through the board of directors' pay- related decisions) to avoid potential agency problems by linking managerial compensation to the wealth of common shareholders. Effectively using executive compensation as a governance mechanism is particularly challenging for firms implementing international strategies. The Effectiveness of Executive Compensation =========================================== As an internal governance mechanism, executive compensation---especially long-term incentive compensation--- is **complicated**, for several reasons. **First**, the strategic decisions top-level managers make are **complex and nonroutine**, meaning that direct supervision (even by the firm's board of directors) is likely to be ineffective as a means of judging the quality of their decisions. The result is a tendency to link top-level managers' compensation to outcomes the board can easily evaluate, such as the firm's financial performance. This leads to a **second issue** in that, typically, the effects of top-level managers' decisions are stronger on the firm's long-term performance than its short-term performance. This reality makes it difficult to assess the effects of their decisions on a regular basis (e.g., annually). **Third**, a number of other factors affect a firm's performance besides top- level managerial decisions and behavior. Unpredictable changes in segments (economic, demographic, political/legal, etc.) in the firm's general environment make it difficult to separate the effects of top-level managers' decisions and the effects (both positive and negative) of changes in the firm's external environment on the firm's performance. Properly designed and used incentive compensation plans for top-level managers may increase the value of a firm in line with shareholder expectations, but such plans are subject to managerial manipulation. Additionally, **annual bonuses** may provide incentives to pursue short-run objectives at the expense of the firm's long-term interests. Although long-term, performance-based incentives may reduce the temptation to underinvest in the short run, they increase executive exposure to risks associated with uncontrollable events, such as market fluctuations and industry decline. The longer term the focus of incentive compensation, the greater are the long-term risks top- level managers bear. Also, because long-term incentives tie a manager's overall wealth to the firm in a way that is inflexible, such incentives and ownership may not be valued as highly by a manager as by outside investors who have the opportunity to diversify their wealth in a number of other financial investments. Thus, firms may have to overcompensate for managers using long-term incentives. The Strategic Focus provides an examination of some of the issues that confront boards of directors with regard to how much to pay the CEO. The media often focuses on the size of the CEO compensation package, especially if it is exceptionally large and compares it to the pay of the average worker. The *[market for corporate control]* is an **external governance mechanism** that is active when a firm's internal governance mechanisms fail. It is composed of individuals and firms that buy ownership positions in or purchase all of potentially undervalued corporations typically for the purpose of forming new divisions in established companies or merging two previously separate firms. Because the top-level managers are assumed to be responsible for the undervalued firm's poor performance, they are usually replaced. An effective market for corporate control ensures that ineffective and/or opportunistic top-level managers are disciplined. Commonly, target firm managers and board members are sensitive about takeover bids emanating from the market for corporate control since being a target suggests that they have been ineffective in fulfilling their responsibilities. For top-level managers, a board's decision to accept an acquiring firm's offer typically finds them losing their jobs because the acquirer usually wants different people to lead the firm. At the same time, rejection of an offer also increases the risk of job loss for top-level managers because the pressure from the board and shareholders for them to improve the firm's performance becomes substantial. A *[hedge fund]* is an **investment fund** that can pursue many different investment strategies, such as taking long and short positions, using arbitrage, and buying and selling undervalued securities for the purpose of maximizing investors' returns. In general, *[activist pension funds]* (as institutional investors and as an internal governance mechanism) are reactive in nature, taking actions when they conclude that a firm is underperforming. In contrast, *[activist hedge funds]* (as part of the market for corporate control) are proactive, "identifying a firm whose performance could be improved and then investing in it." However, another possibility is suggested by research results--- namely, that as a governance mechanism, investors sometimes use the market for corporate control to take an ownership position in firms that are performing well. A study of active corporate raiders in the 1980s showed that takeover attempts often were focused on above-average performance firms in an industry. This work and other recent research suggest that the market for corporate control is an imperfect governance mechanism. Actually, mergers and acquisitions are highly complex strategic actions with many purposes and potential outcomes. In summary, the *[market for corporate control]* is a **blunt instrument** for corporate governance; nonetheless, this governance mechanism does have the potential to represent shareholders' best interests. Accordingly, top-level managers want to lead their firms in ways that make disciplining by activists outside the company unnecessary and/or inappropriate. There are a number of defense tactics top-level managers can use to fend off a takeover attempt. Managers leading a target firm that is performing well are almost certain to try to thwart the takeover attempt. Even in instances when the target firm is underperforming its peers, managers might use defense tactics to protect their own interests. In general, managers' use of defense tactics is considered to be self-serving in nature. Managerial Defense Tactics ========================== In the majority of cases, *[hostile takeovers]* are the principal means by which the market for corporate control is activated. It is an acquisition of a target company by an acquiring firm that is accomplished "not by coming to an agreement with the target company's management but by going directly to the company's shareholders or fighting to replace management in order to get the acquisition approved. Firms targeted for a hostile takeover may use multiple defense tactics to fend off the takeover attempt. Increased use of the market for corporate control has enhanced the sophistication and variety of managerial defense tactics that are used in takeovers. Because the market for corporate control tends to increase risk for managers, managerial pay may be augmented indirectly through golden parachutes (where a CEO can receive up to three years' salary if his or her firm is taken over). Golden parachutes, similar to most other defense tactics, are controversial. Another takeover defense strategy is traditionally known as a "**poison pill**." This strategy usually allows shareholders (other than the acquirer) to convert "shareholders' rights" into a large number of common shares if an individual or company acquires more than a set amount of the target firm's stock (typically 10 to 20 percent). Increasing the total number of outstanding shares dilutes the potential acquirer's existing stake. This means that, to maintain or expand its ownership position, the potential acquirer must buy additional shares at premium prices. The additional purchases increase the potential acquirer's costs. Some firms amend the corporate charter so board member elections are staggered, resulting in only one third of members being up for reelection each year. Research shows that this results in managerial entrenchment and reduced vulnerability to hostile takeovers. Most institutional investors oppose the use of defense tactics. TIAA-CREF and CalPERS have taken actions to have several firms' poison pills eliminated. Many institutional investors also oppose severance packages (golden parachutes), and the opposition is increasing significantly in Europe as well. However, an advantage to severance packages is that they may encourage top-level managers to accept takeover bids with the potential to best serve shareholders' interest. International Corporate Governance ================================== *[Corporate governance]* is an increasingly important issue in economies around the world, including emerging economies. Globalization in trade, investments, and equity markets increases the potential value of firms throughout the world using similar mechanisms to govern corporate activities. Moreover, because of globalization, major companies want to attract foreign investment. For this to happen, foreign investors must be confident that adequate corporate governance mechanisms are in place to protect their investments. Although globalization is stimulating an increase in the intensity of efforts to improve corporate governance and potentially to reduce the variation in regions and nations' governance systems, the reality remains that different nations do have different governance systems in place. Recognizing and understanding differences in various countries' governance systems, as well as changes taking place within those systems, improves the likelihood a firm will be able to compete successfully in the international markets it chooses to enter. Governance Mechanisms and Ethical Behavior ========================================== The three internal and one external governance mechanisms are designed to ensure that the agents of the firm's owners---the corporation's top-level managers---make strategic decisions that best serve the interests of all stakeholders. In the United States, shareholders are commonly recognized as the company's most significant stakeholders. Increasingly though, top-level managers are expected to lead their firms in ways that will also serve the needs of product market stakeholders (e.g., customers, suppliers, and host communities) and organizational stakeholders (e.g., managerial and non- managerial employees). Therefore, the firm's actions and the outcomes flowing from them should result in, at least, minimal satisfaction of the interests of all stakeholders. Without at least minimal satisfaction of its interests, a dissatisfied stakeholder will withdraw its support from the firm and provide it to another (e.g., customers will purchase products from a supplier offering an acceptable substitute). Some believe that the internal corporate governance mechanisms designed and used by ethically responsible leaders and companies increase the likelihood the firm will be able to, at least, minimally satisfy all stakeholders' interests. The issue of ethical behavior by top-level managers as a foundation for best serving stakeholders' interests is being taken seriously in countries throughout the world. The decisions and actions of the board of directors can be an effective deterrent to unethical behaviors by top-level managers. Indeed, evidence suggests that the most effective boards set boundaries for their firms' business ethics and values. After the boundaries for ethical behavior are determined, and likely formalized in a code of ethics, the board's ethics-based expectations must be clearly communicated to the firm's top- level managers and to other stakeholders (e.g., customers and suppliers) with whom interactions are necessary for the firm to produce and sell its products.