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TABLE OF CONTENTS
Corporations and the theory of the firm boundaries __________________________________________________4
Introduction to corporations and PLCs _________________________________________________________________ 4
What is a firm (corporation)? ________________________________________________________________________________ 4
5 legal characteristics of publicly listed companies (PLCs) ____________________________________________________ 4
1 Legal personality ______________________________________________________________________________________________ 4
2 Limited liability ________________________________________________________________________________________________ 4
3 Freely transferable shares ______________________________________________________________________________________ 4
4 Investor ownership _____________________________________________________________________________________________ 4
5 Delegated management ______________________________________________________________________________________ 5
the theory of (the) firm (boundaries) ___________________________________________________________________ 5
a multi-theoretical and causal approach ____________________________________________________________________ 5
Alternative theories of firm boundaries (Santos & eisenhardt, 2005) ____________________________________________ 5
Organizational boundaries ______________________________________________________________________________________ 5
Boundaries of efficiency _________________________________________________________________________________________ 5
Boundaries of power ____________________________________________________________________________________________ 6
Boundaries of competence _____________________________________________________________________________________ 6
Boundaries of entity _____________________________________________________________________________________________ 6
Towards a new agenda for boundaries research _________________________________________________________________ 7
Transaction cost theory ________________________________________________________________________________ 7
Introduction (Ketokivi & Mahoney, 2017) _____________________________________________________________________ 7
The goal of transaction cost theory __________________________________________________________________________ 7
The special case of vertical integration ______________________________________________________________________ 8
The general case of the governance decision _______________________________________________________________ 8
TCE implications on transactions ____________________________________________________________________________ 8
The evidence ______________________________________________________________________________________________ 8
Causal models ________________________________________________________________________________________ 8
Simple causal effects _______________________________________________________________________________________ 8
A moderated causal model ________________________________________________________________________________ 9
A mediated causal model __________________________________________________________________________________ 9
Confounding variables _____________________________________________________________________________________ 9
Control variables ___________________________________________________________________________________________ 9
Causality: a counterfactual conception _____________________________________________________________________ 9
Transaction cost theory: a causal model _____________________________________________________________________ 9
Takeaways __________________________________________________________________________________________ 10
Ownership of the firm ____________________________________________________________________________ 11
Capitalism ___________________________________________________________________________________________ 11
definitions of capitalism ___________________________________________________________________________________ 11
Ownership (Hansmann,1988)______________________________________________________________________________ 11
the structure of ownership ______________________________________________________________________________________ 11
Ownership: a functional bundle of rights _________________________________________________________________________ 11
The importance of ownership ___________________________________________________________________________________ 11
Is ownership a force for the good of mankind? __________________________________________________________________ 11
The theory of optimal ownership allocation ____________________________________________________________ 12
Step 1: Why ownership? __________________________________________________________________________________ 12
Step 2: Who would be the best owner? ____________________________________________________________________ 12
Optimal ownership allocation ___________________________________________________________________________________ 12
Contracting costs (non-owners) _________________________________________________________________________________ 12
Costs of ownership (for owners) _________________________________________________________________________________ 12
Benefits of ownership ___________________________________________________________________________________________ 12
The best owner lifetime (dOBBS ET AL, 2010) ________________________________________________________________ 12
What makes a better owner? ___________________________________________________________________________________ 13
the best-owner Lifecycle _______________________________________________________________________________________ 13
Optimal ownership allocation in different industries (hANSMANN, 1998) _________________________________ 13
Different forms of ownership ______________________________________________________________________________ 13
Costs of market contracting and costs of ownership _______________________________________________________ 14
Investor-owned firms _____________________________________________________________________________________ 14
Costs of market contracting ____________________________________________________________________________________ 14
Costs of Ownership _____________________________________________________________________________________________ 14
Customer-owned retail, wholesale, and supply firms________________________________________________________ 14
Retailers of consumer goods ____________________________________________________________________________________ 14
Wholesale and supply firms _____________________________________________________________________________________ 14
Farm supplies __________________________________________________________________________________________________ 14
Worker-owned firms ______________________________________________________________________________________ 15
Cost of contracting ____________________________________________________________________________________________ 15
Costs of ownership _____________________________________________________________________________________________ 15
Utilities ___________________________________________________________________________________________________ 16
Insurance ________________________________________________________________________________________________ 16
Costs of contracting ___________________________________________________________________________________________ 16
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Costs of ownership _____________________________________________________________________________________________ 16
Current evolution ______________________________________________________________________________________________ 16
Firms without owners: nonprofit enterprise __________________________________________________________________ 16
Conclusion ______________________________________________________________________________________________ 16
The professional partnership (P²) ______________________________________________________________________ 17
The structure of professional service firms __________________________________________________________________ 17
Human rather than financial capital dependency _________________________________________________________ 17
Ascension to ownership: The up-or-out model ______________________________________________________________ 17
Reputation is a critical asset ______________________________________________________________________________ 17
Takeaways __________________________________________________________________________________________ 17
the corporate governance challenges and practices of publicly listed firms ________________________ 18
A case in point _______________________________________________________________________________________ 18
Tyco _____________________________________________________________________________________________________ 18
Valeant__________________________________________________________________________________________________ 18
Similarities between the cases ____________________________________________________________________________ 18
Similarities: _____________________________________________________________________________________________________ 18
Differences: ____________________________________________________________________________________________________ 18
Agency costs and agency theory_____________________________________________________________________ 18
Overview (Dalton et al, 2007) _____________________________________________________________________________ 18
Agency costs __________________________________________________________________________________________________ 19
Approaches to minimize the agency problem ___________________________________________________________________ 19
Corporate governance as a solution ______________________________________________________________________ 19
Two basic treatments (in a listed firm) TO REDUCE AGENCY COSTS __________________________________________ 19
Corporate governance treatments in PLCs (Aguilera, et al, 2015) ___________________________________________ 19
Internal corporate governance treatments to limit agency costs _______________________________________ 20
Board of directors ________________________________________________________________________________________ 20
Features of boards:_____________________________________________________________________________________________ 20
Equity ownership _________________________________________________________________________________________ 20
Alignment – the effects of insider ownership _____________________________________________________________________ 20
Control – the effects of outsider ownership ______________________________________________________________________ 20
Executive pay ____________________________________________________________________________________________ 21
Leverage ________________________________________________________________________________________________ 21
external corporate governance treatments to limit agency costs _______________________________________ 21
legal system _____________________________________________________________________________________________ 21
Market for corporate control ______________________________________________________________________________ 21
External auditing _________________________________________________________________________________________ 22
Rating organizations ______________________________________________________________________________________ 22
Stakeholder activism _____________________________________________________________________________________ 22
Media ___________________________________________________________________________________________________ 23
Liquidity _________________________________________________________________________________________________ 23
Proxy advisors ____________________________________________________________________________________________ 23
Presence of multiple external corporate GOVERNANCE MECHANISMS ______________________________________ 23
Agency theory: a causal model of the theory ______________________________________________________________ 23
Takeaways __________________________________________________________________________________________ 24
The corporate governance challenges and practices of family owned firms ________________________ 25
introduction to Family firms ___________________________________________________________________________ 25
characteristics of family firms ______________________________________________________________________________ 25
Differences between family and non-family firms ___________________________________________________________ 25
Prevalence and economic significance ___________________________________________________________________ 25
Governance of family firms (Amit & Vilalonga, 2013) ___________________________________________________ 25
family governance systems _______________________________________________________________________________ 26
Informal elements of family governance ________________________________________________________________________ 26
Formal elements of family governance __________________________________________________________________________ 26
Conflict management f famly governance ______________________________________________________________________ 26
Governance challenges of family firms (Villalonga et al, 2015) __________________________________________ 26
(Founder) succession _____________________________________________________________________________________ 26
The ownership dilemma __________________________________________________________________________________ 27
Agency problems in family firms ___________________________________________________________________________ 27
Agency problem 1: conflict of interest between owners and managers ___________________________________________ 27
Agency problem 2: conflict of interest between controlling (family) shareholders and non-controlling shareholders__ 27
Type 3: Agency problems between owners/managers and external creditors (voluntary and involuntary)___________ 28
Type 4: Multi-layered agency problems between the family and family owners and/or managers __________________ 28
Alternative theories on family firms ________________________________________________________________________ 28
Family firm governance ______________________________________________________________________________ 28
Ownership structure ______________________________________________________________________________________ 28
Control-enhancing mechanisms __________________________________________________________________________ 28
Board of directors ________________________________________________________________________________________ 29
Executive compensation _________________________________________________________________________________ 29
Dividend policy __________________________________________________________________________________________ 29
Debt ____________________________________________________________________________________________________ 29
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The market for corporate control __________________________________________________________________________ 30
Dual class unification _____________________________________________________________________________________ 30
Legal investor protection _________________________________________________________________________________ 30
Family governance mechanisms __________________________________________________________________________ 30
Family assembly________________________________________________________________________________________________ 30
Family council _________________________________________________________________________________________________ 30
Shareholders’ or owner’s council ________________________________________________________________________________ 31
Family constitution _____________________________________________________________________________________________ 31
Governance of other family entities ___________________________________________________________________ 31
Family office _____________________________________________________________________________________________ 31
Family foundation ________________________________________________________________________________________ 31
Family dynamics _____________________________________________________________________________________ 31
Family businesses have strange dynamics _________________________________________________________________ 31
A case in point: The Murdochs ____________________________________________________________________________ 32
The family _____________________________________________________________________________________________________ 32
The Fox acquisition of New Corps _______________________________________________________________________________ 32
Takeaways __________________________________________________________________________________________ 32
Stakeholders in corporate governance ___________________________________________________________ 33
introduction to Stakeholders __________________________________________________________________________ 33
Stakeholder model of the firm _____________________________________________________________________________ 33
Beneficiaries ___________________________________________________________________________________________________ 33
Owner vs stakeholders ____________________________________________________________________________________ 33
Stakeholders: a definition _________________________________________________________________________________ 33
Primary versus secondary stakeholders ________________________________________________________________ 33
types of stakeholders _____________________________________________________________________________________ 33
2 different types of challenges ____________________________________________________________________________ 34
Resource dependence theory (Hillman, et al, 2009) ____________________________________________________ 34
The theory _______________________________________________________________________________________________ 34
Challenge: Managing strategic dependence _____________________________________________________________ 34
Minimzing enverionmental dependence __________________________________________________________________ 34
RDT and mergers _______________________________________________________________________________________________ 34
RDT and joint ventures __________________________________________________________________________________________ 35
RDT and board of directors _____________________________________________________________________________________ 35
RDT and political action ________________________________________________________________________________________ 35
RDT and executive succession __________________________________________________________________________________ 35
Stakeholder theory (Bridoux & Stoelhorst, 2022) ________________________________________________________ 35
Present: the stakeholder turn in strategy ___________________________________________________________________ 35
Stakeholder strategy theory _______________________________________________________________________________ 36
Stakeholder governance _________________________________________________________________________________ 36
A case in point: Ben & Jerry’s and Unilever ____________________________________________________________ 36
Drama in Israel ___________________________________________________________________________________________ 36
Search for Euphoria ______________________________________________________________________________________ 36
Profit or purpose _________________________________________________________________________________________ 37
Takeaways __________________________________________________________________________________________ 37
Securing the Societal License to Operate: Developing a Non-Market Strategy for the Firm ___________ 38
The societal license to operate (SLTO) _________________________________________________________________ 38
Definition ________________________________________________________________________________________________ 38
SLTO: Components _______________________________________________________________________________________ 38
A case in point: Uber _____________________________________________________________________________________ 38
SLTO as a treatment against misconduct ______________________________________________________________ 38
A treatment against misconduct? _________________________________________________________________________ 38
Corporate governance and misconduct __________________________________________________________________ 39
Strategic CSR ________________________________________________________________________________________ 39
The enhanced firm reputation mechanism ________________________________________________________________ 39
The stakeholder reciprocation mechanism ________________________________________________________________ 39
The risk mitigation mechanism ____________________________________________________________________________ 40
The improved innovation capacity mechanism ____________________________________________________________ 40
Integrated strategy: Market and non-market components _____________________________________________ 40
Introduction______________________________________________________________________________________________ 40
Nonmarket environment __________________________________________________________________________________ 41
A case in point: Cemex ___________________________________________________________________________________ 41
Market and nonmarket strategies _________________________________________________________________________ 41
Effects of nonmarket strategies _________________________________________________________________________________ 41
Integrating market and nonmarket analysis ________________________________________________________________ 42
Nonmarket assets and distinctive competencies ___________________________________________________________ 42
Strategies and borders ___________________________________________________________________________________ 42
Conclusion nonmarket strategy ___________________________________________________________________________ 43
conclusion: Take on ownership and governance strategy ______________________________________________ 43
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CORPORATIONS AND THE THEORY OF THE
FIRM BOUNDARIES
Main strategic issue
- Which (kind of) economic activities should take place within the corporate boundaries of a single firm and which
are best left outside of it?
Theories used: Theory of the firm/firm boundaries, TCE, Law and Economics
INTRODUCTION TO CORPORATIONS AND PLCS
WHAT IS A FIRM (CORPORATION)?
- A corporation is an entity in itself – it has legal personality
- Firms are one of the most important institutions of modern capitalism
- With firms, we typically mean entities separate from the individuals that own and/or manage them : i.e. Corporations
- A corporation is a legal construction: corporations cannot exist without the law enabling us to create them – this is the
essential role of corporate law
- Corporate law gives us the legal personality, the structure, housekeeping rules, and the rules of the game of the country or
countries
- Not all corporations are PLCs. There exist quite a few of other types of incorporated firms -LLCs, cooperatives, LLPs,
foundations-
- Yet, the PLC is often taken as the paradigm case because of visibility and data availability
5 LEGAL CHARACTERISTICS OF PUBLICLY LISTED COMPANIES (PLCS)
1 LE G A L P E R S O N A LITY
- This means that the company is a separate entity with rights and obligations
from the owner of the company
- The defining feature of a corporation
- The firm is protected against the owners of the company or the creditors
- The firm owns the assets of the company, the owners own the company but
not its assets (this limits the owners to reduce the value of the firm to the
liquidation of the assets) - liquidation protection –
- Affirmative asset partitioning = you patrician the assets within the company,
form those of the owners. The owners only have claims for the assets of the
company in the case of bankruptcy (but they are last in line, all the creditor’s
come first)
- Separate patrimony = Ability of the firm to own assets that are distinct from
the property of other persons -investors- and that the firm is free to use and sell but also pledge to creditors
- Possible exam question: Is the legal personality at stake/explain what it means and the reason to have a legal personality
2 LIM ITE D LIA B ILITY
- When a firm goes bankrupt, it is not able to pay its creditors its debts, the owners are limitedly reliable for those debts. They
are reliable up to the amount they have invested in the firm – except in cases when owners were actively involved in the
reason for bankruptcy
- Limited liability reserves shareholder’s personal assets exclusively for their personal creditors
- Why limited liability? It facilitates investors to invest in a firm and protects their own assets in case their investments go
wrong
- Why should you protect investors? = To protect them because they do not have control
- Is a feature that helps external investors to come on board without the risk of being held liable if things go wrong
3 FR E E LY TR A N S FE R A B LE S H A R E S
- This only applies to listed companies; in most companies, you cannot freely trade your shares as you need the consent of
other owners/shareholders
- Equity ownership means that you have property/ownership of the firm, those are not tradeable
- Transferability permits the firm to conduct business uninterruptedly as the identity of its owners changes, avoiding the
complications of member withdrawal
- Free tradability maximized the liquidity of shareholders and the ability of shareholders to diversify their investments
- Free tradability gives the firm maximal flexibility in raising capital
4 IN V E S TO R O W N E R S H IP
- Not all firms are owned by investors, but also by a subset of employees -partners-
- PLC firms are owned by investors – financial investors- and they can trade their ownership at any time- creating a liquid
market
- The right to control the firm and the right to receive the firm’s net earnings are proportional to the amount of capital
contributed to the firm
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5 D E LE G A TE D M A N A G E M EN T
- If the owners are involved at arm’s length – they are liquid with no control- someone has to manage the company
- Therefore, corporate law, as a matter of default, delegates 99% of the decisions made to the board, and the board can
delegate it further
- In practice, managers make most of the decisions because shareholders have no way to be involved
- One of the biggest problems of founder-led firms is that founders are too involved in their firms and cannot let go
- Decisions which shareholders needed for: changing the articles of association or bylaws, moving the company legally to
another country, issuing new shares beyond a certain percentage, typically 30%
- Delegation permits the centralization of management necessary to coordinate productivity activity
THE THEORY OF (THE) FIRM (BOUNDARIES)
A MULTI-THEORETICAL AND CAUSAL APPROACH
- It is unlikely that there will be a single theory that explains everything
- Different theories look at different things -unit of analysis- , highlight different properties – concepts, variables- , and
therefore produce different explanations – causal relations-
- Sometimes: competing/alternative explanations
- Other times: complementary explanations
- A multi-theoretical causal approach is most useful for practical reasons
- Compare what different theories are looking at and how they would define your question/problem
- Do alternative theories offer competing or complementary explanations?
- In management, we often use theories to develop solutions – treatments- to managerial challenges – diseases-
- We need causal knowledge about treatments: what is effect of a certain treatment on a given outcome?
- Different theories usually focus on different outcomes and suggest different treatments
ALTERNATIVE THEORIES OF FIRM BOUNDARIES (SANTOS & EISENHARDT, 2005)
O R G A N IZ A TIO N A L B O U N D A R IES
- Organizational boundary = the demarcation between the organization and its environment
- There are four distinct conceptions of boundaries – efficiency, power, competence, and identity
B O U N D A R IES O F EFFIC IEN C Y
- Key theories: transaction cost theory and agency theory
- Focusing on minimizing governance costs, the efficiency conception asks
whether a transaction should be governed by a market or organization
- This conception is grounded in a legal understanding of organizations
as governance mechanisms distinct from markets
- A boundary decision is the choice of whether to conduct a particular
transaction inside the organization or outside through a market
exchange
- There are three steams of thought on the source of governance costs
differences – transaction costs, measurement difficulties, and knowledge
differences
- The efficiency conception is most applicable in industries characterized by
intense price competition and stable structure, situations where efficiency
is paramount, and equilibrium can emerge
- Contributions are the compelling argument that governance form matters, the legal view of boundaries, and the
specification of the appropriate boundary choice, especially in stable and competitive industries where efficiency is
crucial
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