The Modern Corporation

A corporation is a registered legal entity created by owners that exists distinctly and separately from those owners. Corporations may be established for many purposes. Nonprofit corporations, for example, are set up for specified charitable purposes. For-profit corporations, by contrast, are created to generate financial returns for owners.

Many of the lessons of strategic management are relevant for nonprofit organizational managers. However, this text focuses directly on the challenges and strategies of for-profit business leaders, the layers of leadership hierarchy, and governance considerations that relate to each of those layers (Figure 2.1).

A Brief History

Governance is inextricably linked to capitalism. Modern corporate governance has undergone significant transformations since the inception of capitalism in the 1600s, evolving through various phases to become the dominant economic system in the modern world. Be careful, however: While capitalism is often linked with democracy, from a technical perspective, capitalism refers to an economic system that relies on market mechanisms and competition, and democracy refers to a political system that relies on voting and the rule of law. While the two often operate hand-in-hand, capitalism with different political systems is also common. For example, China has the second largest economy in the world but is considered by most authorities as authoritarian (WorldData.info, n.d.; Truex, 2016; Yeung, n.d.). Likewise, Russia has the formal structure of a democracy, but in practice, it operates like an authoritarian state with a concentration of power in a few men (Oberoi, 2022).

The roots of modern capitalism can be traced back to the 1600s, during the age of mercantilism. This period was characterized by the establishment of joint-stock companies, which allowed for shared ownership and investment in large-scale ventures. The Dutch East India Company, founded in 1602, is a prime example of this early form of capitalism. These companies enabled pooling of resources and risk-sharing among investors, facilitating international trade and colonization (Gelderblom et al., 2013).

The Industrial Revolution marked a significant shift in capitalism. Beginning in the late 1700s, advancements in technology and manufacturing led to the rise of the factory system. This era saw the transition from agrarian economies to industrial ones, with mass production and mechanization becoming the norm. During this period, capitalism was characterized by the concentration of capital in the hands of industrialists and the growth of urban centers. The factory system also led to the exploitation of labor, prompting early labor movements and calls for reform (“Studies from Lancaster,” 2024).

The mid-20th century brought about the concept of welfare capitalism, where governments began to play a more active role in regulating economies and providing social safety nets. The New Deal in the United States and similar policies in Europe aimed to address the inequalities and instabilities inherent in capitalism. This era also saw the expansion of capitalism on a global scale, with multinational corporations emerging and international trade becoming more interconnected (“Studies from Lancaster,” 2024).

In recent years, there has been a growing movement toward sustainable capitalism. This approach seeks to balance economic growth with environmental sustainability and social responsibility. Advocates of sustainable capitalism argue that businesses should prioritize long-term value creation over short-term profits, considering the impact of their operations on the planet and society. Initiatives such as the United Nations’ Sustainable Development Goals and the rise of ESG (environmental, social, and governance) investment reflect this shift toward a more holistic and responsible form of capitalism (Scott, 2024).

Shareholders

The first stakeholder we will discuss is shareholders. Shareholders are the entities that own the corporation and may include individuals, investment funds, or other companies. A share is a financial instrument that represents a unit of ownership. Owning shares entitles the holder to a fractional claim on the profits and assets of the firm, and typically also includes voting rights on important decisions the company may take.

The number and proportionate ownership of shareholders is an important issue in corporate governance. When one entity owns all a company’s shares, the company is a wholly owned subsidiary and that owner has complete control (Figure 2.3). This concept is more fully explored in Chapter 8: International Strategy.

When one or a few entities own a voting majority of company shares, the company is said to have high ownership concentration. Owners with smaller stakes are minority shareholders and are said to have minority interests in the firm. In this scenario, the majority, if its members agree, can assert considerable influence on the firm’s strategic direction. However, even in this scenario, the majority shareholders have legal and ethical requirements to respect the interests of minority shareholders.

In situations where no entity or group owns a clear majority of voting shares, the company is said to have low ownership concentration. In this scenario, shareholders must form coalitions to achieve a majority and assert control.

The primary structures and mechanisms for managing governance issues between shareholders are laid out in a corporation’s articles of incorporation and bylaws (Hall, n.d.) described in Table 2.1.

An example of a dispute that was resolved with clear bylaws is the boardroom scandal at Hewlett-Packard (HP) in 2006. A conflict arose when HP’s president, CEO, and board chairperson, Patricia Dunn, accused one member of leaking confidential information to the press. Dunn ordered an investigation through a private third party that involved questionable tactics. Eventually, those practices were also made public, and the resulting public outcry led to her and several board members resigning from HP. The bylaws were well-defined, and the board members acted contrary to expected ethical behavior.^[1]

For legal and practical reasons, shareholders typically appoint a board of directors to make major decisions for the company and represent shareholders’ interests in accordance with the firm’s bylaws. Bylaws also specify when the board of directors will meet and rules by which they will make decisions among them. Boards of directors are not involved in day-to-day operations of the firm but are instead responsible for providing direction to the corporation as a whole.

Like officers, board directors are typically experienced businesspersons, selected for their leadership, knowledge, reputations, and connections. Also, the composition of directors on the board can affect the nature and performance of the board. Inside board members are people with experience working within the firm who possess deep knowledge and understanding of the firm’s internal culture, operations, and existing strategies. Outside board members are those with experience in other organizations, often in other industries, who bring different perspectives and ideas to the table, and can promote fresh thinking and change. Shareholders who wish to capture the strengths of both types may deliberately select members from both groups to create a mixed board composition.

The primary responsibility of the board of directors is to hire, advise, oversee, and determine compensation packages for officers. Boards of directors may also remove corporate officers when necessary. A typical scene in corporate governance may involve a meeting in a boardroom whereby the chief executive officer and other corporate officers report to the board of directors on the company’s progress over the past quarter and outlook for the future.

Managers and Directors

Managers, in this context, are individuals hired by shareholders, usually through the board of directors. They are assigned responsibility to run the company on a day-to-day basis. A firm may have one, a few, or many managers. High-level managers are known as executives and typically have deep experience with demonstrated leadership, capability, and dedication.

Some executive roles, especially those at the very top of the organizational chart, are specifically named and defined in the corporate bylaws. Those holding such roles are corporate officers. Officer roles often carry impressive job titles, such as those with “chief” or “president” in the name.

While the shareholder and manager roles are distinct, some shareholders are directly involved in the strategic and day-to-day management of the firm they own. For example, Jen-Hsun “Jensen” Huang is the largest single shareholder and chief executive officer of the technology company NVIDIA, which provides software and hardware for advanced computing applications such as gaming, data science, and AI. In 2024, NVIDIA became the most valuable publicly traded company, with a market capitalization greater than $3 trillion. Huang acquired his ownership of NVIDIA as a co-founder and has led the company through its meteoric growth phase (Figure 2.5).

Other times, shareholders hire and entrust others to professionally manage the firm. Bill Gates founded Microsoft in 1975 with a partner, Paul Allen. By 2000, the company had grown to revenue of $23 billion with 40,000 employees when Gates hired an internal professional manager, Steve Ballmer. After multiple CEO transitions, Microsoft is considered one of the most influential technology companies in the world. In 2024, the company reported revenue of $245 billion and 228,000 people worldwide.

When governance principles and fiduciary responsibilities break down, disaster is usually close behind. In 2022, the cryptocurrency exchange FTX, created by Sam Bankman-Fried, collapsed in less than a week (Yaffe-Bellany, 2022). FTX experienced an $8 billion shortfall, through a complex scheme to deceive investors and regulators about the financial health of FTX, forcing the firm into bankruptcy. Bankman-Fried was secretly transferring customer funds to FTX’s trading firm, Alameda Research. A court found him guilty of fraud and conspiracy, using company resources to purchase luxury properties and private planes, and to make substantial political donations.

Agency Costs

The principal-agent model describes the relationship between a principal and an agent where the principal delegates decision-making authority to the agent. This dynamic is prevalent in many contexts, but especially in business. The fundamental risk in the principal-agent model is the potential divergence of interests between the two roles.

While law and ethical norms bind corporate agents to their obligations, people are not perfect by nature. Individuals naturally have self-interests which is where the principal-agent problem arises (Li et al., 2021). This conflict has significant implications for business strategy (Figure 2.6). Effective corporate governance mechanisms are crucial to aligning the interests of shareholders and management. Such mechanisms include:

• Board of Directors: An independent board can oversee management and ensure they act in the best interests of shareholders.
• Executive Compensation: Designing compensation packages that link executive pay to long-term company performance (e.g., stock options, performance-based bonuses) can incentivize agents to act in line with shareholder interests.
• Monitoring and Audit Systems: Robust internal controls, audits, and performance evaluation systems can help principals monitor agent behavior and detect potential conflicts of interest.
• Shareholder Activism: Shareholders exert influence through voting rights, shareholder proposals, and engaging with management.
• Market for Corporate Control: The threat of hostile takeovers can incentivize managers to act in the best interests of shareholders.
• Bankruptcy: The ultimate agency cost, if a firm does not operate effectively, is its creditors may call in their debts, causing the liquidation of the firm’s assets and jeopardizing its very existence.

Because no two people have perfectly aligned interests, the principal-agent problem arises to some degree in many relationships. Consider when a car owner (principal) goes to an auto mechanic (agent) for auto repair. The car owner wants the mechanic to correctly diagnose the issue, provide honest advice, and then diligently repair the vehicle using high-quality parts without charging an excessive price. The mechanic wants to get paid highly for their services while minimizing costs and maintaining a good reputation and positive customer relationships.

Their interests are aligned in some ways and misaligned in others. For example, the mechanic may recommend services that are not needed, do the job sloppily, or use cheap sub-standard parts if they believe the client will not notice. The risk from principal-agent problems tends to be exacerbated in situations of information asymmetry, whereby one party has greater knowledge—even one-sided—or visibility of the situation than the other.

Managing Agency Costs and Risks

Those entrusted to manage a company, especially those in officer roles, carry obligations known as duties that require the individual to act responsibly and ethically in their role and to comply with applicable law. Roles with more power and responsibility, such as those of corporate officers, are beholden to fiduciary duties, which outline high-level principles:

• Duty of Care: Exercising reasonable diligence and prudence in decision making
• Duty of Loyalty: Placing the corporation’s interests above personal interests, avoiding conflicts of interest
• Duty of Good Faith: Acting honestly and with integrity
• Duty of Confidentiality: Protecting sensitive information from unauthorized disclosure (Ortega, 2024)

Fiduciaries can delegate certain tasks to professionals, like accountants, lawyers, or financial advisors, to manage specific aspects of their responsibilities. This delegation allows fiduciaries to focus on strategic oversight while ensuring that specialized tasks are handled by experts. However, fiduciaries remain ultimately responsible for outcomes and must ensure proper supervision and accountability. By adhering to fiduciary duties, organizations foster a culture of accountability and trust, enabling effective governance and long-term sustainability.

Essentially, the core issues behind the principal-agent problem are duty, risk, and oversight. That is, agents hired by a corporation have explicit duties to perform in the company’s interests. The principal’s trust that the agent will act on their behalf creates risks. And certain oversight controls are employed to reduce risk (Figure 2.7).

Strong control systems and guarding against the principal-agent problem is crucial for ensuring effective corporate governance, protecting shareholder investments, and promoting efficient capital markets. If principal-agent problems are allowed to remain, lower firm value, misallocation of resources, and economic inefficiency may result.

International Governance

Governance models vary significantly across different countries, reflecting diverse cultural, economic, and legal contexts (Diligent, 2017). As the primary focus of this chapter, the Anglo-American Model is practiced in the United States, United Kingdom, Canada, and Australia. It features a one-tier board structure with a mix of executive and non-executive directors. The CEO often serves as the chairman in the United States, but not typically in the United Kingdom. This model of board focuses on maximizing shareholder profits.

Variations in Europe include the German Model, which is used in both Germany and Austria and features a two-tier board structure separating the management board (executives) and the supervisory board (non-executives). Shareholders appoint members of the supervisory board, which then appoints the management board. The Nordic Model that is used in the countries of Sweden, Norway, Denmark, and Finland looks like the German Model with a strong emphasis on stakeholder engagement and social responsibility. These boards often include employee representatives.

In Asia, the Japanese Model features large boards with up to 60 members, including representatives from banks and government agencies. This model emphasizes consensus decision making and long-term relationships. The Chinese Model is a hybrid incorporating elements of the Anglo-American and German models. It gives emphasis to a strong state influence and control, with a focus on strategic national interests.

Elsewhere, variations abound with differences primarily driven by one- or two-tier systems, which stakeholders are likely to be represented, how members are selected, the focus of decisions they make, and the rules that control their behaviors. In general, governance structures are tailored to fit the unique needs and values of different societies.

In summary, the roles and responsibilities of shareholders, boards of directors, and corporate officers are distinct and unique. Shareholders are the owners, who assign board members to meet periodically and make decisions in the shareholders’ best interests, and boards in turn assign officers to manage day-to-day operations (Patrick, 2023).

Toolkit: Shareholder Versus Stakeholder

Why do corporations exist? What are their primary purposes? And what are the responsibilities of corporate strategic managers?

These questions touch upon issues of fundamental importance to every firm, the business world generally, and society as a whole. However, the answers are widely disputed. There are two main competing views—shareholder and stakeholder primacy (Figure 2.8).

One view is known as shareholder primacy. A share (also known as stock or equity) is a security that represents a unit of partial or fractional ownership and control of a business entity. In the United States, publicly traded firms are joint-stock companies, meaning shareholders are entitled to control of the company and a share of all returns it generates.

To proponents of the shareholder primacy view, the primary purpose of a company, and thus the primary responsibility of company managers, is to enrich the company’s owners. The origins of this view can be traced back to perspectives shared by moral philosopher Adam Smith (Figure 2.9) in The Wealth of Nations (1776), which established foundations for modern economic thought, exemplified by one famous passage:

It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our necessities but of their advantages (Book 1, Chapter 2).

In this passage, Smith is not arguing that “greed is good,” as often quoted from the Hollywood movie Wall Street quoting the character Gordon Gekko (“Gordon Gekko,” 1987). Instead, Smith is describing how society can be enriched by rational self-interested agents engaging in mutually beneficial exchange within a market economy.

Modern proponents of shareholder primacy—often referred to as shareholder capitalism— observe that this principle extends to corporate shareholders who seek returns for themselves. Profit-seeking corporations serve customers, employ workers, and transact with other businesses. All this activity, presumptively, enhances prosperity in aggregate for stakeholders, including the communities and nations in which companies operate (Business Roundtable, n.d.).

Economist Milton Friedman provided one highly influential argument for shareholder primacy in a New York Times op-ed in 1970 (Figure 2.10). Friedman described how Smith’s insight implies corporate executives have a direct responsibility to shareholders to act in their interests, which implies profit maximization in most cases. He added the careful caveat that businesses must conform to “the basic rules of the society, both those embodied in law and those embodied in ethical custom.” But he decried the notion that executives should have “social responsibility” as both poorly defined and creating irrevocable conflicts of interest (Friedman, 1970).

Maureen Kline argued that the debate between stakeholder value and shareholder value is misguided. Instead of viewing them as opposing concepts, Kline suggests that businesses should integrate both approaches. In contrast to Friedman’s ideas, companies can achieve lasting, long-term success by considering the interests of all stakeholders, including employees, customers, suppliers, and the community, while also delivering value to shareholders. Focusing solely on shareholder value can lead to short-term thinking and neglect of broader societal impacts, whereas a balanced approach can foster sustainable growth and positive outcomes for all parties involved (Kline, 2019).

In the 2024 podcast, Scene on Radio, Season 7, Episode 9, John Beiwan and Ellen McGirt explore the tipping point of the limits to growth as identified by a team of scientists at Massachusetts Institute of Technology led by Donella Meadows in 1972 (Biewan & McGirt, 2024). They warned about the unsustainable nature of exponential economic and population growth, predicting environmental collapse if current trends continued. Some policymakers saw the group’s formula forward as a roadmap while many economists flat out dismissed its premises. Ultimately, the episode highlighted the importance of systems thinking and the need for a shift in economic models to prioritize long-term environmental health and social equity that is only recently being fully understood and incompletely addressed.

Mission, Vision, Values, Culture

Whether you believe in the primacy of shareholders or stakeholders, all want to know what the company is about beyond simply making money. We must also consider the needs and interests of customers, employees, suppliers, shareholders, communities, and others who look to company leaders to provide a sense of purpose and an identity for the firm.

When a leadership team can provide compelling answers to this pivotal question, and communicate the answer clearly and consistently, stakeholders will feel as though the firm has direction and a reason for existing. By contrast, when leadership fails to establish clear answers, stakeholders are left to feel directionless and uncertain. Defining the purpose and direction of the company in terms of key elements that include mission, vision, values, and culture helps strategic managers lead.

• Mission: Why do we exist?
• Vision: Where are we going?
• Values: What is important?
• Culture: How do we do things here?

In his 2022 book, Future Skills, world-renowned futurist, influencer, and thought leader, Bernard Marr, provides practical advice on how to write an effective mission statement. He emphasizes that a mission statement should clearly articulate the company’s purpose and what it does right now, rather than its future aspirations (which belong in a vision statement). Marr highlights common mistakes, such as confusing mission with vision, being overly grandiose, or using generic language. He advises keeping the mission statement specific, concise, and focused on the company’s current operations. By doing so, businesses can create a meaningful mission statement that resonates with both internal and external audiences (Marr, 2022).

On the other hand, Marr advises us that an effective vision statement should clearly describe the company’s goals and aspirations for the future, setting a direction for where the business wants to go. He advises being specific, creating a mental picture of a concrete medium-term target tied to business and industry. By focusing on meaningful and motivating language, companies can craft vision statements that effectively communicate their future aspirations (Marr, 2022).

While mission and vision describe purpose and direction, values express what the organization considers most important, and culture reflects the shared behaviors that bring those priorities to life. For example, if a company’s mission were to provide affordable health care and its vision is to lead in patient-centered innovation, values such as integrity and compassion guide decision making, and a culture of collaboration and continuous improvement ensures those ideals are practiced daily. Together, values and culture create the foundation that supports the mission and drives progress toward the vision.

We often tell clients in our consulting practices that the proper way to write a mission or vision statement is to be inclusive. The practice is less about what is written than who contributes and whether they believe there is meaning in the statement. Dwight D. Eisenhower, the 34th president of the United States and a former five-star general in the U.S. Army said, “Plans are useless, but planning is indispensable” (Eisenhower, 1953). His context was the rapidly shifting conditions that happened in wartime, but many similarities exist in our fast-paced changing business environment today. Eisenhower emphasized the importance of the planning process, even though specific plans may become obsolete once a situation unfolds.

Organizational Performance

Organizational performance refers to how well an organization is doing to reach its vision, mission, and goals. Assessing organizational performance is a vital aspect of strategic management. Executives must know how well their organizations are performing to figure out what strategic changes, if any, to make. Performance is a very complex concept, however, and a lot of attention needs to be paid to how it is assessed.

Two important considerations are (1) performance measures and (2) performance benchmarks. A performance measure is a metric by which an organization’s progress can be gauged. Most executives examine measures such as profits, stock price, and sales to better understand how well their organizations are competing in the market. But these measures provide just a glimpse of organizational performance. Performance benchmarks are also needed to assess whether an organization is doing well. A performance benchmark is used to make sense of an organization’s standing compared to its own or a competitor’s financial measures and/or performance indicators. Suppose, for example, that a firm has a profit margin of 20% in 2024. This sounds great on the surface but suppose that the firm’s profit margin in 2023 was 35% and that the average profit margin across all firms in the industry for 2024 was 40%. Viewed relative to these two benchmarks, the firm’s 2023 performance is cause for concern.

The number of performance measures and benchmarks that are relevant for understanding an organization’s performance can be overwhelming. For example, a study of what performance metrics were used within restaurant organizations’ annual reports found that 788 different combinations of measures and referents were used within this one industry in a single year (Short & Palmer, 2003). Thus, executives need to choose a rich yet limited set of performance measures and benchmarks to focus on.

The Balanced Scorecard

To organize performance measures, Professor Robert Kaplan and Professor David Norton of Harvard University developed a tool called the balanced scorecard (Kaplan & Norton, 1992). Using the scorecard helps managers resist the temptation to fixate on financial measures and instead monitor a diverse set of important measures (Table 2.3). Indeed, the idea behind the framework is to provide a balance between financial measures and other strategic measures that are important for understanding organizational activities that lead to sustained, long-term performance. The balanced scorecard recommends that managers gain an overview of the organization’s performance by tracking a small number of key measures that collectively reflect four perspectives: (1) financial, (2) customer, (3) internal business process, and (4) staff learning and growth.

Financial measures of performance relate to organizational effectiveness and profits. Examples include financial ratios such as return on assets, return on equity, and return on investment. Other common financial measures include profits and stock prices. Such measures help answer the key question, “How do we look to shareholders?”

Customer measures of performance relate to customer attraction, satisfaction, and retention. These measures provide insight to the key question, “How do customers see us?” Examples might include the number of new customers, customer satisfaction, and the percentage of repeat customers.

Internal business process measures of performance relate to organizational efficiency. These measures help answer the key question, “What must we excel at?” Examples include the time it takes to manufacture the organization’s goods or deliver a service or the time it takes to create a new product and bring it to market. Productivity and quality data are measures often targeted for improvement.

Learning and growth measures of performance relate to the future. Such measures provide insight to ask the question, “Can we continue to improve and create value?” Learning and growth measures focus on innovation and proceed with an understanding that strategies change over time. Consequently, developing new ways to add value are needed as the organization adapts to an evolving environment. Employees may need additional training and skills to make a strategy achievable, or the firm may need to hire for the skills needed. An example of a learning and growth measure is the number of new skills learned by employees every year.

The Triple Bottom Line

Ralph Waldo Emerson once noted, “Doing well is the result of doing good. That’s what capitalism is all about” (Emerson, n.d.). While the balanced scorecard provides a popular framework to help executives understand an organization’s performance, other frameworks highlight areas such as corporate social responsibility (CSR). One such framework, the triple bottom line, emphasizes the three P’s: people (making sure that the actions of the organization are socially responsible), planet (making sure organizations act in a way that promotes environmental sustainability), and traditional organization profits. This notion was introduced in the early 1980s but did not attract much attention until the late 1990s.

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