1
CHAPTER TWO
CORPORATE GOVERNANCE
This chapter describes the basic governance mechanisms of the corporation: the board of directors and top
management. These are the people who are primarily tasked with the strategic management process if the
corporation is to have long-term success in accomplishing its mission. The responsibilities of both are described and
explained. It proposes a board of directors’ continuum on which boards can be placed in terms of their involvement
in strategic management. Agency theory is contrasted with stewardship theory. The chapter explains how the
composition of the board can affect both its performance and that of the corporation. It also describes the impact of
the Sarbanes-Oxley Act on corporate governance in the United States and trends in corporate governance around the
world. Top management is discussed in terms of executive leadership, strategic vision, and managing the strategic
planning process.
LEARNING OBJECTIVES
1. Describe the role and responsibilities of the board of directors in corporate governance.
2. Explain how the composition of a board can affect its operation.
TOPICS OUTLINE COVERED
1. Role of the Board of Directors
a. Responsibilities of the Board
b. Board of Directors Composition
c. Nomination and Election of Board Members
d. Organization of the Board
2. The Role of Top Management
SUGGESTED ANSWERS TO MYMANAGEMENTLAB QUESTIONS
2-1. What are the roles and responsibilities of an effective and active board of directors?
The board of directors is required by law to direct the affairs of the corporation, but not to manage them. Stuart has
2-2. What are the issues that suggest the need for oversight of a particular company’s management team?
The board of directors holds the top management team responsible for implementing and guiding the strategy set
2
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
2-3. When does a corporation need a board of directors?
A board of directors is needed to protect the interests of the corporation’s owners, its shareholders. By law, when a
company incorporates, it must have a board of directors—even if the stock is held only by the founder and his/her
spouse. A good case can be made that a small, closely held corporation has no need for a board. Because the owners
2-4. Is there a close relationship between the composition of a board of directors and the organizational
performance?
The relationship between corporate performance and the composition of a board of directors has been well
documented in management literature. Organizational outcomes, such as strategies and performance, are expected to
reflect the characteristics of the organization’s leaders. It is known that pressure from institutional investors who
2-5. Why is the combined Chair/CEO (or Managing Director) position being increasingly criticized by
most management scholars?
It has been observed in many studies on management that boards of directors tend to be more effective when an
individual does not simultaneously occupy the positions of Chief Executive Officer (CEO) and chairperson. Such a
2-6. What would be the impact if the only insider on a corporation’s board were the CEO?
One result would be a board composed primarily of outsiders who would be objective, but also dependent upon the
CEO for information about the company and its activities. Thanks to Sarbanes-Oxley and other actions by the New
3
2-7. How should a board of directors be involved in the executive leadership of an organization?
A board of directors can actively play the executive leading role of its organization. A governing board is mainly
responsible for the setting of strategies, and in many cases, it is able to influence numerous strategy-related
ADDITIONAL DISCUSSION QUESTIONS FOR INSTRUCTORS
These are not found in the text and may be used by the instructor for classroom discussion or exams.
A2-1. What recommendations would you make to improve the effectiveness of today’s boards of directors?
The following are among the many suggestions often made:
• Add more outsiders (people not affiliated with the corporation) to the board of directors. Keep the
percentage of insiders (typically top management) to less than 50% of board membership.
A2-2. Is there a conflict between agency theory and the concept of organizational stakeholders?
Agency theory is concerned with problems that occur in relationships between principals (owners) and their agents
(top management). Because agents are, in effect, “hired hands,” their interests are not usually aligned with those of
the owner (stockholders) of a corporation. Consequently, agency theory is primarily interested in ways to better
4
SUGGESTIONS FOR STRATEGIC PRACTICE EXERCISE
The end of chapter exercise asks the student to evaluate the “best” and the “worst” manager for whom the student
has worked. The questionnaire is based on the concept of French and Raven’s “bases of power.” This concept is
usually discussed in Introduction to Management as well as in Organizational Behavior textbooks as a part of their
discussion of leadership. You may need to briefly explain what each base means as part of your discussion of their
ADDITIONAL TEACHING MODULE
CORPORATE GOVERNANCE STYLES
Just as boards of directors vary widely on a continuum of involvement in the strategic management process, so do
top management teams. For example, a top management team with a low involvement in strategic management will
tend to be functionally oriented and will focus its energies on day-to-day operational problems; this type of team is
5
Styles of Corporate Governance
Management
Management
Degree of Involvement
by
High
Entrepreneurship
Management
Partnership
Management
Degree of Involvement by Board of Directors
Chaos Management
When both the board of directors and top management have little involvement in the strategic management process,
their style is referred to as chaos management. The board waits for top management to bring it proposals. Top
Entrepreneurship Management
A corporation with an uninvolved board of directors but a highly involved top management has entrepreneurship
management. The board is willing to be used as a rubber stamp for top management’s decisions. The CEO,
operating alone or with a team, dominates the corporation and its strategic decisions. An example is Control Data
Corporation under the leadership of its founder, William C. Norris. For twenty-nine years, Norris dominated both
Marionette Management
Probably the rarest form of strategic management style, marionette management occurs when the board of directors
is deeply involved in strategic decision making, but top management is primarily concerned with operations. Such a
style evolves when a board is composed of key stockholders who refuse to delegate strategic decision making to the
6
Partnership Management
Probably the most effective style of strategic management, partnership management is epitomized by a highly
involved board and top management. The board and top management team work closely to establish the corporate