Corporate Governance in Global Operations

1. Chapter 12 Corporate Governance and Control of Global Operations

2. 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

3. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues Hout, Porter, and Rudden (1982) findings Multi-domestic strategic companies Have products that differ from country market to country market High transportation costs Economies of scale may be too modest R&D closely tied to a specific market Government barriers to trade are too high Distribution systems are fragmented and impenetrable

4. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues Hout, Porter, and Rudden (1982) findings Global strategic companies Benefits gained from worldwide volume exceed costs of serving that volume Usually more centralized than multi-domestic strategic companies See example at chapter end Proctor and Gamble and Unilever

5. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues What does global mean? Hamel and Prahalad (1992) definitions Global Competition Firms attack competition in markets worldwide Example U.S. auto industry in the 1980s Global Business Minimum volume required for cost efficiency is not available in home market, so overseas markets are pursued, possibly supplied with domestic production Examples Chinese textiles, Boeing and Airbus

6. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues Hamel and Prahalad (1992) definitions Global Companies Have distribution systems in key markets that enable cross- subsidization, international retaliation, and world-scale volume Example Airline industry

7. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues Bartlett and Ghoshal (1989) findings 3 Global Imperatives Forces for global integration the need for efficiency Forces for local differentiation the need for responsiveness Forces for worldwide innovation the need for learning Companies must deal with all 3 simultaneously Companies should use a transnational strategy Corporate assets are dispersed, interdependent, and specialized

8. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Components of a Total Global Strategy Fig. 12.1

9. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Global Strategic Issues Example Toyota Toyota partnered with PSA Peugeot Citro n to build small cars in the Czech Republic to supply the European market The factory was designed, built, and tested in a virtual factory in Japan (Edmondson, 2005) The plant will be run by Japanese and French managers and monitored in Japan

10. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Informal and Subtle Mechanisms of Control Lateral relations Task forces and meetings help throughout the formal structure to accomplish corporate objectives Informal communication Involves the network of personal contacts that one develops over time in the organization Organizational culture The outcome of the process of socializing individuals within a firm and across national boundaries, which allows things to be done by different people in similar or consistent ways.

11. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Organizational Structure Two major classifications for coordinating activities in MNEs Structural and formal mechanisms Informal and subtle mechanisms Control is shifting from formal to informal mechanisms A firms organization is constantly evolving Failure to adjust to a changing environment can lead to internal conflict and poor performance

12. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Evolution of Organizational Structure Export activities start in the form of occasional orders from foreign buyers An export department is then developed with internal, rather than external, experts Foreign sales increase and foreign sales offices are established

13. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Domestic Organization with Export Group

14. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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)

15. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

16. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Geographic Structure

17. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Product Structure

18. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

19. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Matrix or Grid Organization

20. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

21. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Internal Governance Mechanisms Internal governance mechanisms are established to insure the proper actions of management Roles of the Board of Directors Hire, control, and fire management Determine managements compensation Composed of multiple committees Board members are appointed by the owners Should have a majority of outside members

22. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Corporate Governance Mechanisms

23. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Internal Governance Mechanisms Ownership structure Determines how capital will come into the firm Determines how wealth will be distributed Difficulties occur when firms from one structure invest in a country with a different structure

24. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Internal Governance Mechanisms Example - Millman and Wonacott (2005) Chinese firms have invested in South America to gain access to raw materials and markets Chinese managers are accused of separating Chinese workers from regular workers and of not working with local suppliers and businesses The Chinese are having difficulty coping with a different labor and ownership environment

25. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

26. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

27. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black International Importance of Governance Scorecard for German Corporate Governance Reflects Germanys legalistic approach Governance alone is not enough to combat fraud

28. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

29. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Studies on International Corporate Governance Practices 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

30. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Studies on International Corporate Governance Practices Executive Compensation Goal is to align managements goals with investors goals U.S. studies have shown that sensitivity of pay to performance has increased over time Stock options are the fastest growing type of executive compensation in the U.S. Japan and Spain are following suit

31. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Studies on International Corporate Governance Practices Ownership Structure Market-centered economies U.S. and U.K. Ownership tends to be dispersed Bank-centered economies Japan and Germany Ownership tends to be concentrated 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

32. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Studies on International Corporate Governance Practices The External Control Market A hostile takeover occurs when a firm is purchased without soliciting bids U.S. has the most active market Example Molson and Coors U.K. also has an active takeover market External market has not been shown to be a common governance control tool

33. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Studies on International Corporate Governance Practices The Legal System Preference for concentrated ownership can be explained by legal system (La Porta et al. 1998) Common law system U.S. and U.K. Provide strongest degree of protection for shareholders Tend to have more dispersed ownership Three largest shareholders own 20% of the firm Civil law system France and Germany Provide the least amount of protection for shareholders Tend to have more concentrated ownership Three largest shareholders own 45% of the firm If the law does not protect the owners from the controllers, the owners will seek to be controllers. (Denis and McConnell 2003)

34. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Cross National Differences in Corporate Governance

35. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

36. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Cross National Differences in Corporate Governance - Capital Three Factors of Shareholder Control Property Rights In countries that favor large shareholders, owners tend to exercise control through commitment Example Japans property rights favor banks U.S. laws tend to favor small shareholders, who exercise control through liquidity Financial System Bank-based system commitment (Germany) Market-based system liquidity (U.S.) Interfirm Networks Japan and Europe have these; tendency toward commitment U.K. tendency toward liquidity

37. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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)

38. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

39. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

40. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black The Sarbanes-Oxley Act of 2002 Section 404 Establishes managements responsibility for internal controls Management must assess controls annually Managements assessment must be assessed by an independent auditor Effective November 15, 2004 Foreign firms listing in the U.S. July 15, 2005

41. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

42. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

43. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

44. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Theories and Realities of Global Information Processing Egelhoffs (1991) 4 dimensions of processing Routine inputs are frequent and homogeneous Nonroutine info is unique and infrequent Sequential info flows in a predetermined direction Reciprocal info flows in a manner not previously determined

45. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

46. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

47. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

48. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black Knowledge Flows in MNEs

49. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

50. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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

51. International Accounting & Multinational Enterprises Chapter 12 Radebaugh, Gray, Black 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