Session 12 Corporate Governance, Innovation and Entrepreneurship

1. Session 12 Corporate Governance, Innovation and Entrepreneurship

2. Corporate Governance Issues discussed in the case or discovered in your research? If so, recommend corrective action. If no, move on to an evaluation of the BOD.

3. Board of Director Facts & Statistics The average board size of Fortune 500 companies is 12, of whom 9 are outside board members 16.9% of board seats in the Fortune 100 are held by women Current average tenure of a CEO is between three to five years

4. Criteria used in BW’s The Best & Worst Boards • shareholder accountability • corporate social responsibility • board quality • board independence • corporate performance • independence • stock ownership • environment • director quality • board activism

5. Attributes of a Good Board • INDEPENDENCE Friends and cronies of the CEO are out. Crucial panels like audit should contain no insiders. Cross-directorships are taboo

6. Attributes of a Good Board • QUALITY Board meetings should include real, open debate. Directors need to be familiar with managers and conditions in the field

7. Attributes of a Good Board • ACCOUNTABILITY Directors ought to hold serious stakes in the company. They should also be prepared to challenge under-performing CEOs

8. ENHANCING BOARD EFFECTIVENESS No More than Two Insiders No Insiders on Audit, Nominating, and Compensation Committees No Outsiders Drawing Fees from Company

9. ENHANCING BOARD EFFECTIVENESS • No Interlocking Directorships • Outsiders Meet Regularly without CEO • All Directors Own Minimum of $100k of Stock • Board Stands for Election Every Year

10. ENHANCING BOARD EFFECTIVENESS • Board’s Evaluate their own Performance Yearly • Employed Directors sit on No More than 3 Boards • Non-Employed Directors sit on No More than 6 Boards

11. ENHANCING BOARD EFFECTIVENESS • At Least One Outsider with Experience in Core Business • All Directors Attend at Least 75% of Meetings • Board Size No Larger than 15

12. Best Boards of Directors 1. 3M - With just one insider on its nine-member board the company gets high marks for independence. Outside directors include the CEOs of Lockheed-Martin, Allstate, and Amgen. Audit-committee chairman is the former CFO at Sears. No directors have business ties to the company. 2. APRIA HEALTHCARE - The board includes three top shareholder activists and features a separate chairman and CEO, a rarity. It moved quickly to accept the resignation of a former CEO when directors discovered that his wife had been hired for a company job.

13. Best Boards of Directors 3. COLGATE-PALMOLIVE - Directors are well-invested in the company and sit on few additional boards. The compensation committee has awarded premium-priced options to CEO Reuben Mark, which pay off only if stock appreciates by 10% to 70%. A new section on governance has been added to the latest proxy. 4. GENERAL ELECTRIC - This talent-packed board, with an unrivaled record of creating shareholder value, remains a favorite with governance experts. it recently added Ralph Larsen, former CEO of Johnson & Johnson and a longtime champion of good governance.

14. Best Boards of Directors 5. HOME DEPOT - With the departure of co-founder Bernard Marcus, the 12-member board now has only two insiders. Independent directors meet regularly without management. Directors are required to visit 20 stores a year. 6. INTEL - One of the few boards that have a lead director. No insiders sit on the audit, compensation, or nominating committees. The board conducts an annual self-evaluation. Directors have big stakes in the company.

15. Best Boards of Directors 7. JOHNSON & JOHNSON - The high-powered board includes Delta Air Lines CEO Leo Mullin, Lucent Technologies Chairman Henry Schacht, and CSX CEO John Snow. The outside board members own plenty of J&J stock. Only one director sits on more than four boards. 8. MEDTRONIC - Governance gurus applaud the board's practice of holding regular meetings without the CEO and its performance evaluations for directors. Members are graded on willingness to "hold management accountable" and "meaningful participation" at meetings.

16. Best Boards of Directors 9. PFIZER - The board was second only to GE in overall approval by governance experts. Independent directors meet without the CEO. No Pfizer executives sit on the audit, nominating, or compensation committees. Stock transactions for directors and executives are posted on the company Web site. 10.TEXAS INSTRUMENTS - Making its third appearance on Business Week's Best Boards list, this highly independent board boasts a roster of well-invested outside directors, including the chief executives of Norfolk Southern, Kimberly-Clark, and Eastman Kodak.

17. Worst Boards of Directors 1. APPLE - Founder Steve Jobs owns just two shares in the company. Recently departed director Larry Ellison had none and had missed more than 25% of meetings in the past five years. The CEO of Micro Warehouse, which accounted for nearly 2.9% of Apple's net sales in 2001, sits on the compensation committee. Since 2000, the board has awarded Jobs 27.5 million stock options and a $90 million jet. 2. CONSECO - In 2000, the company spent a hefty $45 million to recruit CEO Gary Wendt from GE Capital. Despite the company's recent slide, in July--with the stock hovering at $1--the board awarded Wendt an $8 million bonus. In August, the shares were delisted from the Big Board and now trade at 7 cents. None is a CEO. The board doesn't meet without the CEO present.

18. Worst Boards of Directors 3. DILLARDS - Before his death in February, Chairman William Dillard presided over a board that included seven directors with ties to the company, including four of his children. No nominating committee--allowing the CEO to hand-pick directors. With two-thirds of board elected by holders of privately held Class B shares, Dillard's is exempt from NYSE governance rules. 4. GAP - Self-dealing includes contracts with the chairman's brother to build and remodel stores and a consulting deal with the__chairman's wife. Slow to replace outgoing CEO Mickey Drexler as performance declined. Interlocking directorship with Drexler sitting on the Apple board, while Apple's Steve Jobs sits on Gap's.

19. Worst Boards of Directors 4. KMART - The board's woes include multiple investigations of company accounting, a $501 million profit restatement, and a federal grand jury probe into pay practices. The board was passive as the company's performance deteriorated before a bankruptcy filing in January. Meanwhile, the board approved $28 million in retention loans to 25 top executives. 6. QWEST - Founder Philip Anschutz has extensive dealings with the company and sits on compensation and nominating committees. The SEC is probing whether Qwest used "swap" transactions to boost revenue. The compensation committee--described as "comatose" by one expert--awarded ex-CEO Joseph Nacchio an $88 million pay package in 2001, one of the worst years in the company's history. No outside director has operating experience in company's core business.

20. Worst Boards of Directors 7. TYSON FOODS - Out of 15 board members, 10 have ties to the company, including seven who have extensive business dealings. CEO John Tyson got a $2.1 million bonus for negotiating the acquisition of meatpacker IBP--which Tyson Foods tried unsuccessfully to back out of--in a year when net income fell 42%. Feds say the company for years conspired to smuggle workers from Mexico for its U.S. poultry-processing plants, a charge Tyson denies. 8. XEROX - The bungled succession of Paul Allaire, accusations of funny accounting, billions in shareholder wealth up in smoke, and a decades-long failure to keep up with changing technology add up to an ineffectual board. With departures of Allaire and CFO Barry Romeril, the board is far more independent. But too many directors sit on too many boards. Director Vernon Jordan's law firm provides legal services.

21. Incremental Innovation • Toyota’s CCC21: construction of cost competitiveness for the 21st century • Six Sigma is a rigorous and analytical approach to quality and continuous improvement with an objective to improve profits through defect reduction, yield improvement, improved consumer satisfaction, and best-in-class performance

22. Define quality and customer value Develop a customer orientation Focus on the company’s business processes Develop customer and supplier partnerships Take a preventive approach Adopt an error-free attitude Get the facts first Encourage every manager and employee to participate Create an atmosphere of total involvement Strive for continuous improvement 10 Essential Elements that Lead to Incremental Innovation

23. Breakthrough Innovation • A breakthrough innovation is an innovation in a product, process, technology, or the cost associated with it that represents a quantum leap forward in one or more of those ways • Breakthrough approaches to innovation are inherently more risky than incremental innovation approaches

24. Risks Associated with Innovation • Innovation involves creating something that doesn’t now exist • Long odds for success • Market risk • Technology risk

25. Idea Factors • Need spotting • Solution spotting • Mental inventions • Random events • Market research • Trend following

26. Treacy’s Useful Points about Managing Risks • The point of innovation is growth • Get the most from the minimum innovation • Incremental product innovations can lock in existing customers • Incremental business process innovations can generate more revenue gain or cost savings with less risk than radical ones • Radical innovations are often too radical • The time to launch breakthrough innovations is when they are essential to the marketplace

27. Ways to Lower Risk • Product teams • Cross-functional groups • Joint ventures • Cooperation with lead users • “Do it yourself” innovation • Acquiring innovation • Outsourcing innovation

28. Entrepreneurship • Entrepreneurship is the process of bringing together creative and innovative ideas and actions with the management and organizational skills necessary to mobilize the appropriate people, money, and operating resources to meet an identifiable need and create wealth in the process • Inventors • Promoters • Administrators • Entrepreneurs

29. Who Is the Entrepreneur?

30. Three Elements Central to Entrepreneurial Process • Opportunity • Entrepreneurial Teams • Resources

31. Resources • Debt financing is generally obtained from a commercial bank to pay for property, equipment, and maybe provide working capital • Equity financing is usually obtained from one or more of three sources: friendly sources, informal venture investors, or professional venture capitalists

32. Intrapreneurship • Intrapreneurship, or entrepreneurship in large companies, is the process of attempting to identify, encourage, enable, and assist entrepreneurship within a large, established company so as to create new products, processes, or services that become major new revenue streams and sources of cost savings for the company

33. Self-selection No hand-offs The doer decides Corporate “slack” End the “home run” philosophy Tolerance of risk, failure, and mistakes Patient money Freedom from turfness Cross-functional teams Multiple options Pinchot’s 10 Freedom Factors