978-1259278211 Case 3 Solution Manual Part 2

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1. What controls did AIG have in place, and how did those controls affect its

corporate behavior?

Carefully developed policies and procedures guide behavior so that all employees will be

encouraged to behave in an ethical manner. However, they must be reinforced with

Referencing Chapter 9: Strategic Control and Corporate Governance

Strategic control involves the process of monitoring and correcting a firm’s strategy and

In a traditional control system, top management formulates strategies and sets goals.

These strategies are implemented, and then performance is measured against the

predetermined goals. In a contemporary control system, managers continually monitor

both the internal and external environments, and identify trends and events that signal the

Students should therefore recognize the importance of involving all operating managers

In the traditional insurance business, firms such as AIG anticipate risk by using models

based on known risk factors (remember that a “risky environment” is one in which

information on the environment is not completely available, and decisions are made

based on an assessment of the probabilities of the occurrence of events). Therefore, well-

learned processes (risk models) are used to set goals, and performance is monitored

Strategic control focuses especially on the roles of informational and behavioral control

in the formulation and implementation of strategies. See Chapter 9, Exhibit 9.2.

Informational control is concerned with whether or not the organization is “doing the

AIG had used information from its standard risk models to determine if it was “doing the

right things” to accrue reputation and profits – this had set the stage for the firm’s choice

Chapter 9 emphasizes the importance of aligning both informational and behavioral

control systems with organizational strategy. The information gained from the internal

and external environment is reviewed against the firm’s strategy and goals. If the results

Jake DeSantis’ letter demonstrates how well AIG had utilized those behavioral controls in

the past – he and his employees were committed to the corporation, willing to work for

2. Provide a stakeholder analysis of those affected by the bonus issue. What

alternatives are present to prevent or lessen these sorts of events? How effective

are external regulations in encouraging ethical behavior?

Corporate governance refers to the need for a firm’s shareholders (the owners) and their

elected representatives (the board of directors) to ensure that the firm’s executives (the

management team) strive to fulfill their fiduciary duty of maximizing long-term

One party’s actions can impact the success and well-being of a much larger community:

AIG and other financial institutions had ultimate responsibility for maximizing long-term

value. Stakeholders who had claim on AIG: the shareholders, which included employees

such as Jake DeSantis; current and future employees – many of them would not be

The instructor might encourage students to come up with additional arguments to identify

which of these stakeholders were the most important, and whether the bonuses should

U.S. Taxpayers were concerned about possible misuse of the bailout loans and the

accountability of the firms who received these loans. U.S taxpayers could be considered

the most important because AIG had shown that it was already misusing funds when it

Edward M. Liddy, AIG’s CEO was concerned about keeping AIG financially viable and

out of bankruptcy, in this sense looking out for the shareholders. Edward M. Liddy was

the most important stakeholder because he was facilitating the bailout process and

AIG Managers and other employees were concerned about earning a living and keeping a

job. AIG managers were the most important because they were stuck in the middle with

no one to support them. Mr. Liddy abandoned his managers during questioning before

An argument can be made that the bonuses were necessary for three reasons:

1. The bonuses were a contractual tool that allowed AIG to redirect managers’ salaries to

2. The managers worked for an annual salary of $1 in response to the bonus offer. These

3. Disputes over the bonuses could have led to private, legal contests if they induced

managers to work for $1 and then AIG refused to uphold the contract. Disputes like this

Using concepts from the last part of Chapter 9, students should also reference the role of

external governance control mechanisms. External governance control mechanisms

Instructors may have to restrain students from discussing the underlying issue of lack of

regulation of investment banking in general, and the credit default swap (CDS)

The U.S. government proposed a 90% tax on any bonuses paid out to employees of firms

who received government bailout money. Both New York’s and Connecticut’s attorneys

general threatened legal action against the executives who received the bonuses. These

The main purpose of the tax on the bonuses was to recover misused Federal money

distributed for the purposes of a bailout. This was intended to serve as a deterrent for

Although the government may have felt obligated to act in this instance, due to public

and political pressures, external governance controls might not be as effective as controls

put in place by companies such as AIG. In the AIG case, students should be urged to

Secondary Concepts that might be discussed as well:

NOTE: there are no Powerpoint slides accompanying this part of the discussion.

After the discussion of specific case questions, students might benefit from a brief review

of how a firm strategizes for competitive advantage – specifically how strategy is derived

Referencing Chapter 4: Assessing Intellectual Capital

Consider the concepts of intellectual capital, human capital, and social capital, all of

which are intangible assets that a company such as AIG needs to have in order to compete

successfully. Intellectual capital is a measure of the value of a firm’s intangible assets, its

Human capital involves the individual capabilities, knowledge, skills, and experience of

the company’s employees and managers. This knowledge is relevant to the task at hand,

Success in retaining human capital could also be attributed to the nurturing of the “social

ties” or social capital. Social capital includes the network of friendships and working

AIG had built itself up to a global insurance giant by acquiring and developing assets that

were essential to its performance. Given the nature of AIG’s business, most of those

Referencing Chapter 10: Creating Effective Organizational Designs

Organizational structure refers to formalized patterns of interactions that link a firm’s

tasks, technologies, and people. Structures help to ensure that resources are used

Structure identifies the executive, managerial, and administrative organization of a firm

Factors that facilitate the effective coordination and integration of key activities include

having a common culture and shared values, horizontal organization structures,

An effective organizational design can encourage the flow of information and enhance

working relationships between functional departments and activities. However, achieving

the coordination and integration necessary to maximize the potential of an organization’s

human capital involves much more than just creating a new structure. Different structures

In the case of AIG, the firm was in trouble because of the actions of just one of its

divisions, Financial Services. As of 2013, AIG is in several lines of business, primarily

The original structure of the firm was meant to enhance the overall operation of the

insurance business, coordinating and integrating the various activities so each could

benefit from the tasks, technology, and people involved. Although it appears that the

In this case, the actions of that one division had a significant impact on relationships

See http://www.theofficialboard.com/org-chart/american-international for a current

organizational chart of AIG. Compare that with the expanded chart from 2008 at

NOTE – ADDITIONAL READING, VIDEO NEWS STORIES:

By April 2009, the outrage in Congress over the AIG bonuses seemed to be lessening:

http://www.politico.com/news/stories/0409/20844.html

And by July 2009, AIG was planning to issue its second round of bonuses to Financial

Products executives, and was asking Kenneth Feinberg, appointed by President Obama to

employees necessary to make this happen:

http://www.washingtonpost.com/wp-

dyn/content/article/2009/07/11/AR2009071100419.html?hpid=moreheadlines

See a July 2009 video report about this, and whether bonuses work to retain employees,

here:

http://www.youtube.com/watch?v=u3FNaHTke0w

Many people have made suggestions about reducing “excessive” executive

compensation, such as increasing shareholder’s influence, reducing board members’

What does the AIG story tell us, ultimately, about the role of corporate governance?

3. OPTIONAL DISCUSSION QUESTION: Is there any way to reconcile the

reasoning behind the bonuses and the government response? Consider if you

had complete control over the administration of the bonuses back in March

2009. Draft a plan integrating the best points of the different perspectives.

NOTE – NO POWERPOINT SLIDES ACCOMPANY THIS DISCUSSION. The

teaching notes that follow are provided by the case authors:

For this example, we draw on the dialectical inquiry. This is a conflict-inducing decision

making process. In the paragraphs below we outline two alternatives. The government

Alternative 1. THESIS: Government Position

The main reasoning behind the government response is accountability and stopping

misuse. From the perspective of the government, issuing bonuses to managers of the

Alternative 2. ANTITHESIS: AIG Manager Position

The main purpose of the bonuses was to compensate managers and to free-up resources

going to salaries to use for recovery from the CDS problem. From the perspective of the

managers who signed the bonus contracts, the bonuses are legal, ethical, and necessary

Alternative 3. SYNTHESIS: Developing a More Optimal Solution

Alone, these positions do not appear to provide an optimal solution. One of the reasons

the positions are in such stark contrast is the lack of transparency. The government did

1. You could draft a public document outlining AIG’s commitment to the bailout process.

2. You could relabel the distribution of the bonuses a compensation package or deferred

salary reimbursements. Either seems more accurate than a bonus, and may increase

transparency of the intent in the eyes of the taxpayer. Bonus often implies a reward given

3. You could communicate with the managers. A pay-out of this nature may meet some

public resistance, particularly if AIG does this unilaterally. Under a scenario where there

is resistance or one could avoid public embarrassment, since AIG has been under close

Epilogue

AIG paid over $1 billion in different plans and compensation packages over the course of

the year following its initial Federal loan acceptance. Some of this continued to impact

Dialectic Teaching Tip

Many of us can benefit from the dialectical inquiry in our professional and personal lives.

A recent conversation with a colleague speaks directly to the potential benefits. His

This is a practical example to explore with students. A possible synthesis is that the

Suggestion: Ask students to reflect on a professional or personal decision that could have