Corporate Management of Diversified Companies - Information Demand and Information Processing

Index

Index of graphics

Index of abbreviations

1 Introduction
1.1 Motivation
1.2 Objective
1.3 Procedure

2 Diversification as a strategy in companies
2.1 Definition of strategy
2.2 Strategies in organisations
2.3 Strategy framework
2.4 Diversification
2.4.1 Definition of diversification
2.4.2 Motives for diversified expansion
2.4.3 Diversification vehicles
2.4.4 Diversification strategies and internationalisation
2.4.5 Requirements for success
2.5 Empirical evidence on the success of diversification

3 Corporate management and information in diversified companies
3.1 Definition of corporate management
3.2 Goals of corporate management
3.3 Roles of corporate management in a diversified company
3.4 Information as a requirement for effective corporate management
3.4.1 Information suppliers
3.4.2 Information demand
3.4.3 Information processing
3.4.4 Information system

4 Managing a diversified company
4.1 Framework for managing a diversified company
4.2 Managing the portfolio
4.2.1 The Boston Consulting Group matrix
4.2.2 Porter’s five forces
4.2.3 The core competence concept
4.2.4 The parenting advantage
4.2.5 The firm competence concept
4.3 Managing synergies
4.3.1 Identification and realisation of synergies
4.3.2 Synergy biases
4.4 Managing the businesses
4.4.1 Organisational structure
4.4.2 Systems and processes
4.4.2.1 Outcome control systems
4.4.2.1.1 Strategic planning
4.4.2.1.1.1 Strategic analysis
4.4.2.1.1.2 Strategic formulation
4.4.2.1.1.3 Strategy evaluation
4.4.2.1.1.4 Strategy control
4.4.2.1.1.5 Advantages and disadvantages of strategic planning
4.4.2.1.2 Financial control
4.4.2.1.2.1 Budgeting
4.4.2.1.2.2 Traditional performance measures
4.4.2.1.2.3 Economic profit measures
4.4.2.1.2.4 Value drivers
4.4.2.1.2.5 Advantages and disadvantages of financial control
4.4.2.1.3 Strategic control
4.4.2.1.3.1 Balanced scorecard
4.4.2.1.3.2 Advantages and disadvantages of strategic control
4.4.2.1.4 Empirical evidence on the success of management styles
4.4.2.2 Behaviour control systems
4.4.2.3 A blend of outcome and behaviour control systems

5 Conclusion

Appendix

Bibliography

Statutory Declaration

Index of graphics

Graphic 1: Deliberate and emergent strategies

Graphic 2: Classification of diversification strategies

Graphic 3: Information demand

Graphic 4: Framework for managing a diversified company

Graphic 5: Parenting-fit matrix for a diversified company

Graphic 6: The determinants of administrative context

Graphic 7: The style matrix

Graphic 8: Value creation measured through EVA

Graphic 9: Characteristics of EVA and CVA

Graphic 10: Which style is most profitable?

Graphic 11: Which style has most improved profits?

Index of abbreviations

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1 Introduction

1.1 Motivation

The ultimate management challenge is said to be the management of a conglomerate.^[1] Diversified companies, especially conglomerates, are complex organisations that in the larger cases resemble full-blown economies, rather than firms. They develop internal capital markets with billion dollar budgets, enormous internal labour markets, and often a decent amount of bureaucracy. The International Telephone and Telegraph Corporation (ITT) owned more than 150 businesses in the 1960s, ranging from electronics to insurance companies, with operations across the globe. The architect of ITT, Harold Greneen, once acquired 20 unrelated business in a single month and was strongly convinced that sound management principles could be applied to any type of business.^[2] He believed that information was key to good management. During his reign earnings increased a 100 consecutive quarters and seemed to support this management belief. In the late 1960s, earnings did not increase any longer and the stock price lost significantly in value. By the early 1980s the company was already heavily involved in deconglomeration and had divested more than a 100 businesses.^[3]

ITT was not the only diversified company in the 1980s that was on the search for focus. The conglomerate strategy went out of fashion with investors, due to poor performance associated with this strategy. The result was a conglomerate discount of an average 15 percent on the stock market that persists until today.^[4] Despite this investor aversion, some companies continued the conglomerate path and managed to be highly successful at the same time. General Electric has a broad product portfolio, which contains electronics and insurance businesses, too, and is currently the most valuable company in the world in terms of market capitalisation.^[5] Warren Buffet’s Berkshire Hathaway, Citigroup or Virgin are diversified as well and have created substantial value for their owners. These and other successful diversifiers have mastered managing the diversified company.

1.2 Objective

Diversification has been studied in strategic management, finance, economics, organisations theory and other subjects. Each of these subjects views the duties of corporate management of a diversified company slightly different. Combining the views yields an integrated approach for managing a diversified company. First is the management of the corporate portfolio that includes a selection of businesses that are desired and a continuous reassessment of the portfolio. The second duty comprises the management of synergies, which encloses the identification and promotion of synergies between the businesses. Third is the management of the businesses, which is greatly influenced by formulated and implemented business-level strategies. Business or corporate management, depending on the management style of corporate management, define these business-level strategies.^[6] For the completion of these duties management requires information.^[7] The objective of this thesis is to describe the integrated approach for managing a diversified company. The emphasis lies on the success factors and on the role of information demand and information processing within a diversified company.

1.3 Procedure

Section two explains diversification as a strategy. All relevant terms and concepts such as strategy and diversification are defined and outlined. Diversification motives, vehicles, and the relationship with internationalisation strategies are explained. Requirements for success and empirical evidence on the success of diversification strategies conclude this section. Section three focuses on the corporate management of a diversified company. Corporate management and its roles in a diversified company are defined. Information, information demand and processing are explained in the context of a diversified company. Section four describes the three duties of corporate management in a diversified company: portfolio, synergy and business management. The conclusion summarizes all important results of the thesis and gives suggestions for future research.

2 Diversification as a strategy in companies

2.1 Definition of strategy

Even though strategy had been described and taught by the ancient Chinese over 2,500 years ago, abundant definitions exist today.^[8] The most common definitions are associated with the classic view of strategy that assumes strategies to be the result of formal, rational planning.^[9] Following this school of thought, CHANDLER defines strategy as “the determination of the basic long-term goals and objectives of an enterprise, and the adoption of courses of action and the allocation of resources necessary for carrying out these goals”.^[10] MINTZBERG criticises this definition as too limited and identifies multiple definitions. He argues that strategy can be defined as a plan, a pattern, a ploy, a position or a perspective.^[11] His definitions enable strategies to be operationalized and allow deliberate as well as emerging strategies. Deliberate strategies are intended by corporate or business management. Emerging strategies appear within the organisation and are adopted by managers. These do not render management useless, they only appear before they are fully understood.^[12] The following graphic shows the difference between deliberate and emergent strategies.

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Graphic 1: Deliberate and emergent strategies

(Source: MINTZBERG, H. (1987), p. 12.)

2.2 Strategies in organisations

If strategies are analysed from an organisational point of view, they can be distinguished into functional, business and corporate strategies. In small companies and single-business firms there is typically no differentiation between strategies, as functional, business, and corporate strategies are often identical. Diversifiers tend to be large companies with an organisational structure that allows the separation into functional, business and corporate levels. Functional strategies are the detailed appliance of resources at the operational level. Strategies are devised for production, marketing, sales and other functions.^[13] Business strategies focus on how to built sustainable competitive advantages in discrete and identifiable markets.^[14] COLLIS and MONTGOMERY define corporate strategies as the way a company creates value through the configuration and coordination of its multimarket activities. This definition has three important aspects. First is the emphasis on value creation as the ultimate goal of corporate strategy. Second is the focus on the configuration of the company. Third is the emphasis on how a company manages its activities and businesses. Therefore, the importance of the corporate strategy formulation and implementation is given.^[15] PORTER argues that corporate strategy is the singularity that causes a company to be more worth than the sum of its parts. According to this view, conglomerates like ITT, which faced increasingly investor pressure during the 1980s to focus on their core businesses in order to improve corporate performance, lacked a sound corporate strategy.^[16]

2.3 Strategy framework

In the last decade most academics as well as managers have adopted the resource-based view of the company. In this school of thought, the foundation of a corporate strategy lies within the resources, businesses, structures, systems and processes of a firm. When aligned with a vision, goals and objectives, the system can produce a corporate strategy.^[17] PRAHALAD and HAMEL identified the core competence of a company, which is based on the resources and the ability and intention to utilise them, as the key competitive advantage of companies.^[18] Resources can be tangible assets, intangible assets or organisational capabilities. The value of resources is derived from the dynamic interaction of the dimensions scarcity, demand and appropriability.^[19] This resource-based view explains why some companies have competitive advantages in single businesses and a corporate advantage that extends across many businesses.^[20] Some highly successful companies adopted this philosophy decades ago. The Japanese diversifier Sharp Corporation considers only a few technologies like liquid crystal displays core and uses these as nuclei. All products and services are derived from these core technologies, which are based on Sharp’s unique resources.^[21]

2.4 Diversification

2.4.1 Definition of diversification

Analysing strategies from the perspective of corporate development yields growth, stabilisation and shrinking strategies.^[22] The classic view follows ANSOFF who differentiates growth strategies in a product-market matrix that results in four strategies: market penetration, product development, market development and diversification. Following this approach, diversification is defined as the entry into new product-market combinations.^[23] This definition seems broad as it describes diversification on horizontal, vertical and geographic dimensions. Following academic literature, diversification in this paper is associated only in terms of horizontal product markets.^[24] Vertical integration and geographical expansion are regarded as distinct growth strategies. In this sense, diversification may be related to the core business itself, otherwise it is referred to unrelated or conglomerate diversification.^[25]

The classic view on diversification shares some aspects with the resource-based view, but not all. In the resource-view relatedness is about resources, not products. Following this view, related diversification results, if the company is able to utilise similar resources for the new business.^[26] Unrelated diversification occurs, if there is no commonness between the resources of the company and the new business.^[27] Relatedness is based on tangible or intangible resources.^[28] This view yields four diversification strategies: intangible related, intangible unrelated, tangible related and tangible unrelated. The traditional and resource-based views are comparable when looking at tangible resources and related diversification strategies. Similar tangible resources are often used for similar tangible products. Intangible resources, however, are often used for very different products.^[29] The following graphic displays the four diversification strategies from a resource-based view.

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Graphic 2: Classification of diversification strategies

(Source: SZELESS, G. (2001), p. 28.)

Diversification often seems like a natural process for an organisation. It typically starts within the core industry, where a diversification strategy exploits similar tangible and intangible resources. Once markets are showing signs of saturation some companies move outside their initial industry. Diversifying into an unrelated market is challenging for management, since the company is forced to build up competitive advantages in an unknown business.^[30]

2.4.2 Motives for diversified expansion

As strategic management evolved in the business and academic world, motives for diversification evolved, too. Diversification in the corporate world has been under critical scrutiny for many years. In the 1960s, the spectacular performance of a few successful conglomerates like ITT seemed to prove that any degree of diversification was possible, if corporate managers had superior general management skills. In the 1970s, many diversified companies turned to portfolio planning, aiming to achieve an appropriate mix of growth and mature businesses. Efficient capital allocation and risk-reduction had been the major motives for diversification between the 1950s and the 1980s. In the 1980s, many diversified companies restructred and rationalised as investor pressure to see performance increased, returning to their core businesses. The contemporary management philosophy highlighted that companies created most value by sticking to their core businesses.^[31] Despite this change in management philosophy and the appearance of the conglomerate discount on stock markets, diversification increased in the 1990s.^[32] The resource-based view of the company and concept of core competencies evolved from the focus on the core business and rapidly gained popularity from managers and academics.^[33] Modern reasons for diversification are based on synergies, expanding core competencies, or profiting from dominant logic and management thinking. Motives based on managerial self-interest have occurred during all times.^[34] Various other reasons are possible, e.g. a regulatory environment such as the strong antitrust enforcement in the 1970s in the US, which made it difficult for firms to acquire their competitors, therefore leading to an increase in unrelated diversification.^[35] The major motives are outlined shortly.

Efficient capital allocation was one of the major arguments for diversification of the past, especially in the 1960s.^[36] Corporate headquarters characteristically have an informational advantage over the market. Corporate management is able to perform more efficient allocation decisions with complete information. Critics argue that the informational advantage of an internal capital market is diminished by agency costs^[37]. Chief executive officers (CEOs) can subsidise poorly performing businesses, if no market pressure exists.^[38] Some academics argued that capital markets are inefficient and experienced managers are better at capital allocation.^[39] In the case of external market failure, an internal capital market would provide an optimal allocation of resources.^[40] Most industrial nations have highly efficient capital markets today, reducing the validity of this argument. The capital markets in emerging countries, however, still often lack efficiency. It is also common that other institutions such as product and labour markets, regulatory and legal systems have not been fully developed, giving diversified companies competitive advantages in emerging countries. In emerging countries, value can be created by filling in institutional gaps.^[41] Therefore diversified groups dominate private-sector industrial markets in economies such as Brazil, Chile, Hong Kong, India, Indonesia, Malaysia, among others.^[42]

Reducing the risk of a company by combining several businesses is another motive that was commonly used in the 1960s and 1970s. Theoretically the combination of several uncorrelated cash flows decreases the volatility of the total cash flow, which represents the risk of the company. Since shareholders are characteristically risk-averse, a risk-reduction would be beneficial for them.^[43] According to the capital asset pricing model (CAPM) diversification strategies would only be able to eliminate unsystematic risk. Critics of the risk-reduction motive argue that shareholders are capable of decreasing the unsystematic risk more efficiently by simply buying uncorrelated stocks. They would have significantly less information and transaction costs than a company.^[44] Therefore the argument for risk-reduction is not consistent with the shareholder value concept. It is relevant for family businesses, however, as corporate and ownership risk are identical in these firms. In Western Europe 44.3 percent companies are still family controlled.^[45] It is often not economical for a major stakeholder to buy uncorrelated stocks that would decrease his portfolio risk, if not impossible due to a lack of sufficient financial resources.^[46] Since many of the businesses in Asia are family-owned, this is a further explanation for the large number of conglomerates in that region.^[47]

Modern arguments for a diversified strategy are mainly based on synergies.^[48] Synergies imply that the combined company is worth more than the two single businesses.^[49] GOOLD and CAMPBELL identified six forms of synergies: shared know-how, coordinated strategies, shared tangible resources, vertical integration, pooled negotiation power and combined business creation.^[50] From a resource-based point of view, synergies originate in the shared use of tangible or intangible resources.^[51] A second modern motive is expanding core competencies through a diversification strategy. It can be seen as a special case of synergy that creates value by making use of the unique skills and capabilities across a portfolio of businesses.^[52] Dominant logic and management thinking can also be regarded as a special type of synergy, which is based on intangible resources. Dominant logic is defined as a way of how managers conceptualise the company and make critical resource allocation decisions. Firms with strategically similar businesses can exploit a particular successful management style. The relatedness of businesses is based on strategic similarity and cognitive composition of the top management team, not on technological or market characteristics. The concept of synergy in this case is taken from the operative to the strategic level.^[53] Dominant logic is one of the few theories that is able to explain the success of conglomerates such as Tyco International.^[54] The company has six independent divisions and a corporate management that regards the general management skills as its unique resources. In 1997, only 50 of 40,000 employees worked in corporate headquarters and watched over the business performances. The company annually hires external analysts to compute the value of the businesses on stand-alone basis. Despite recent troubles, the dominant logic and management thinking of the Tyco management have proven to be value-creating, as the entity has always been valued higher than the sum of the parts.^[55]

Managerial self-interest, which is based on the principal-agent theory, is a motive that has occurred during all times. Managing a larger company yields more prestige and usually a higher salary, which provides a simple motive for diversification.^[56] Managers might lose their interest in their core business and become excited by growing, unrelated businesses. Middle managers might have an interest in diversification, due to better chances of acquiring control over an entire division.^[57] Managers devoted to realising synergies and planning activities gain job security and responsibility through further diversification. Abundant scenarios exist where diversification is beneficial for managers and not necessarily for shareholders.^[58]

Every diversification strategy must be critically examined by internal and external forces for value-creation capabilities. The benefits clearly have to exceed costs and must be computed transparently with sound assumptions, especially if operative or strategic synergies are the rational. The success of a diversification strategy is highly dependent on the motive.^[59]

2.4.3 Diversification vehicles

Firms can implement their diversification strategies through internal development, acquisitions, mergers, joint ventures, alliances or contracting with external partners. Acquiring an existing company is often regarded as the easiest approach. Advantages are speed, access to complementary assets, and possibly a removal of a competitor. Disadvantages are costs for the acquisition, hidden drawbacks and the complexity of the post-acquisition integration process. The acquired company can be absorbed, preserved, molded or simply held. Mergers have very similar characteristics. Conglomerates such as Citigroup derive most of their growth from mergers and acquisitions.^[60] Internal development is another approach for diversification that utilises the given resources and capabilities of a company. Advantages are a compatibility with corporate culture, an encouragement for intrapreneurship and internal investment. Disadvantages are slow speed, the need to built new resources and a pressure to succeed. 3M is an example of a diversified company that tends to prefer internal development to growth by acquisitions.^[61] Alliances describe a number of cooperative agreements such as joint ventures, franchises, equity investments, or long-term contractual commitments.^[62] Advantages are speed, a use of complementary resources and low failure costs, compared to an acquisition. Disadvantages are issues of control and leadership as well as a potential change in the partner’s strategy. Japanese diversifiers such as Matsushita frequently use all forms of alliances for diversification purposes. The method of diversification depends on the resources available within the organisation and on the management style.^[63]

2.4.4 Diversification strategies and internationalisation

Diversification and internationalisation seem to be positively related. A company that has successfully diversified nationally can enjoy benefits through internationalisation. Multinational diversification offers great potential for exploiting economies of scope and scale. The diversity of national markets exposes firms to multiple stimuli, which provides firms with a broader learning experience than available to purely domestic firms. Different nations might also enable a company to acquire cost advantages that are not available in its home market, thus gaining a further competitive advantage.^[64] GRANT and JAMMINE and THOMAS discovered that diversified companies that were active in profitable markets in their home country were likely to increase profitability through an internalisation strategy.^[65] Global market diversification is one possibility of achieving superior risk-return performance, regardless of related or unrelated diversification. Empirical evidence revealed that corporate risks could be reduced by following an internalisation strategy without facing a declining profitability.^[66]

Internationalisation strategies of diversifiers express themselves differently across the globe. LASSERRE identified that diversified companies in the West can be classified into industrial groups, industrial holdings and financial holdings. These groups tend to exert a strong financial control. The most common forms in Asia are labeled entrepreneurial conglomerates, keiretsus^[67] and national holdings. The preferred control style in Asian diversifiers is behaviour control. Corporate management needs to be aware of these cultural differences for reducing conflicts within a global diversified company.^[68]

2.4.5 Requirements for success

PORTER designed three tests for a diversification strategy that are necessary for the value creation. First, the industry chosen for diversification must be structurally attractive or capable of being made attractive. Second, the cost of entering the industry should not consume all future profits. Finally, the new business must gain a competitive advantage of the relationship to the core business or vice versa.^[69] Considering the resource-based view, similar tests arise for a diversification strategy. According to this view, the diversification motive is based on resources. COLLIS and MONTGOMERY argue that the resource involved in the diversification strategy is required to have certain characteristics. The resource should be difficult to imitate, be durable, appropriate for the company, not substituted easily, and competitively superior. Expanding or acquiring such a resource is bound to be value-creating.^[70]

2.5 Empirical evidence on the success of diversification

A vast amount of research has been conducted on performance linked to diversification; however, due to the complexity, a mixed picture of success factors has emerged.^[71] The complexity arises from measuring the degree of diversification, measuring performance in an industry over a long period of time and evaluating the resources and capabilities of a company before its diversification strategy.^[72] Some companies have strong core businesses that allow them to survive a loss-making diversification strategy for years.^[73]

Despite the missing transparency on success factors for a diversification strategy, some links were found. RUMELT was first to identify the link between relatedness of businesses and profitability of diversified companies. The highest level of profitability was found in companies that diversified into businesses related to their core resources and capabilities. Economies of scope in shared resources make related diversifiers more profitable than unrelated diversified firms.^[74] PORTER showed that large companies in the U.S. divested more than half of their acquisitions over a period of 36 years. The study confirmed the link between performance and relatedness of the businesses, as companies divested 74 percent of unrelated acquisitions, significantly more than the divestment of related businesses.^[75] Studies on British diversifiers by GRANT and JAMMINE and THOMAS revealed that there are limits to the degree of diversity that can be managed profitable. Despite relatedness, diversified companies may simply become to complex to manage, which is reflected by a deteriorating profitability.^[76] Research by MONTGOMERY indicated that the structure of the industry in which a firm competes and a firm’s position within this industry are key determinants for successful diversification. PRAHALAD and BETTIS theorise that these are only partial explanations and that the quality of management, termed as the dominant logic, should not be neglected. Further research is required to explain why some companies such as General Electric succeed at transferring intangible resources such as management skills while others such as ITT fail.^[77]

3 Corporate management and information in diversified companies

3.1 Definition of corporate management

Managing a diversified company comprises all duties of corporate management. Corporate management can be understood by two different concepts: as an institution or as a process. Corporate management as an institution describes the corporate management as the highest level of management, which is responsible for managing and controlling the company. Corporate management as a process describes the decision responsibilities that originate in the managerial functions of the organisation.^[78]

3.2 Goals of corporate management

The formulation of goals is one of the elemental tasks of corporate management. A goal is the perception of a future state of the company or a part of the company. Defining a goal is a complex process that starts with identifying, operationalising, analysing, and selecting a goal from alternatives. A strategy is then devised for achieving the goal. Finally, the accomplished result is compared to the predicted result.^[79] There are hundreds of possible goals for corporate management, which can be analysed by various criteria. Common criteria are time and functionality. Time differentiates goals into short-, medium- or long-term goals. Important functions are the motivation, coordination and evaluation functions of goals.^[80]

Identifying a superior goal for a company is a difficult task and partially depends on the beliefs and education of corporate management. In the early 1980s most corporate managements devoted themselves to short-term profits. As corporate raiders such as Thomas Boone Pickens or Carl Icahn evolved into the fear of corporate management, the focus turned on maximising the value of the company. In some cases the sum of the parts seemed to be more worth than the entity. Managers that did not follow the game became game.^[81] Even though the leveraged buy-out frenzy ceased in the 1990s, managers had to continue to show performance, as large mutual funds acquired the role of corporate raiders. Institutional investors put pressure on chief executive officers to see performance on their investments. Shareholder value creation became the standard measure to evaluate the work of a CEO. The shareholder value concept has been accepted as the primary purpose of companies in the United States.^[82] Empirical studies reveal that in most economies in Europe shareholder value creation has been defined at least as an important goal in companies, if not as the superior one. As the International Financial Reporting Standards (IFRS) replaces national reporting systems the shareholder value concept is gaining further acceptance, due to the investor-orientation of IFRS.^[83]

As research indicates the concept of shareholder value creation is widespread, however, often misunderstood. A company only creates value for its shareholders if shareholder return exceeds the required return to equity. First the equity market value, the shareholder value added, the shareholder return, and the required return to equity need to be defined. The equity market value equals to the number of outstanding shares multiplied by the stock price.^[84] If capital markets are efficient, then the equity market value equals to the net present value of future free cash flows. There are several computation methods, the most common being the enterprise discounted cash flow model (DCF).^[85] The equity of a company is valued as the company’s operations less the value of debt and other liabilities that are superior to equity. The value of operations is computed by discounting the future free cash flows by a discount rate that reflects the operations riskiness. Debt and other liabilities such as preferred stock are valued to market. The enterprise DCF is highly useful for a diversified company, since the equity value simply equals to the sum of values of the businesses, plus cash-generating corporate assets, less the present value of the corporate centre and the market value of debt and other liabilities.^[86] The discount rate in this model is the weighted average cost of capital (WACC), which reflects the percentage and cost of equity as well as the percentage and after-tax cost of debt.^[87]

Shareholder value added needs to be defined next. It equals to the increase in equity market value, plus dividends paid out during the year, minus outlays for capital increases, plus other payments to shareholders, and minus the conversion of convertibles. Shareholder return is the shareholder value that is added in one year, divided by the equity market value at the beginning of the year.^[88] The required return to equity is what investors expect to gain by holding a stock. It depends on the long-term treasury bonds and the risk of a company, which is expressed as the risk premium. The concept is based on the capital asset pricing model, which basically states the expected return is a function of the investment risk.^[89] Having defined the components, created shareholder value equals to the product of the spread between shareholder return and cost of equity and the equity market value. In other terms, shareholder value is created when shareholder value added exceeds the product of equity market value and the cost of equity. Companies commonly compare shareholder return to benchmarks like treasury bonds, competitor shareholder returns, or the market return. These benchmarks are only relevant if shareholder return exceeds the cost of equity.^[90]

As corporate management sets the creation of shareholder value as the ultimate goal, the question of control over the stock price arises. The price is determined by many other factors, not only by managerial decisions. Therefore managers are partially rewarded or penalised for events that are outside their control.^[91] The solution to this bias is that management is not required to manage the company’s price on the stock market, but that is should increase cash flows and lower the cost of capital, which will ultimately determine the stock price.^[92]

Despite these arguments for shareholder value, there has been also severe criticism of measuring the performance by the creation of shareholder value.^[93] The concept has been accused for being myopic and only in the interest of management, due to the widespread use of stock options as part of management compensation.^[94] European companies tend to view shareholder value as insufficiently social.^[95] These arguments lead to the stakeholder approach, which tends to emphasize maximising the interests of all groups related to the company. Goals of stakeholders can be complementary, neutral or opposing to each other. The discussion of maximising shareholder or stakeholder value is unnecessary, despite much attention in the public, since both concepts are complementary. It is highly unlikely that a company is able to maximise company value over a longer period of time by neglecting the interests of its other stakeholders such as its customers.^[96] All stakeholders are interested in the survival of the company, which is only possible in the long-term if the firm earns a profit above its cost of capital.^[97] Therefore, the ultimate goal of corporate management in this paper is seen as sustainably creating shareholder value.

3.3 Roles of corporate management in a diversified company

The role of corporate management is interwined with the goals of a company, especially with the ultimate goal - shareholder value creation. In a diversified company corporate management has four roles that describe its tasks. First, it decides on a corporate strategy. Second, it acts as the resource guardian of the company. Third, corporate management has to manage the general overhead functions. Decentralisation and outsourcing have a significant impact on that role. Finally, corporate management has to establish an administrative context, which describes the structures, systems and processes of the diversified company.^[98]

3.4 Information as a requirement for effective corporate management

A blind resource guardian serves no purpose. Corporate management requires information for each of its four roles. Information is defined as the relevant knowledge.^[99] The economic view on information is that it is an independent good that distinguishes itself from labour and capital through its intangibility. It is traded for services, financial or non-financial goods.^[100] For information being economical, information benefits need to equal or exceed costs.^[101] Information characteristics can be categorised into content and presentation characteristics. Content characteristics are concerned with the quality of information. Determinants of information quality are relevance, probability, degree of confirmation, audit compatibility, accuracy, and actuality. The presentation of information covers the linguistic characteristics of information. Management has certain expectations of quality and presentation of information, which need to be considered carefully by information suppliers.^[102]

Information can be differentiated by various criteria. The exterior appearance leads to verbal or written information. A process-oriented view distinguishes planning, realisation and control information. Using modality as criterion creates further information types.^[103]

Corporate managers seem to have preferences on the type of information. Empirical evidence by MINTZBERG indicates that corporate managers strongly prefer verbal media such as telephone calls and meetings to documents. Research revealed that CEOs spent 78 percent of their time in verbal communications and highly value soft information such as gossip and speculation. It is reasoned that verbal information is more actual than aggregated information, which usually lags in time.^[104] EDVINSSON and KIVIKAS support this by arguing that “future earnings values lie in intangible values such as key persons, networks and relationships, alliances, culture, knowledge recipes”, and not in financial statements.^[105] This is supported by stock markets, which frequently support companies, where tangible assets account for a fraction of their market values.^[106]

3.4.1 Information suppliers

The role of the information supplier is classically regarded as one of the functions of controlling.^[107] The information function of controlling should incorporate more than a simple supply of information. The purpose of controlling in regard to information should be considered as a supply of information as well as methods and models.^[108] Controlling is understood as aiding corporate management in managing the diversified company. The role of controlling in this process depends on the importance of the subject. Empirical evidence revealed that the involvement of controlling tends to decrease, the more relevant a business is to a diversified company. Corporate management seems to take care of the core businesses themselves.^[109] Recent research indicates that controlling seems to loose its traditional role as the key information provider within companies. In the study conducted by SANDT only seven percent of the managers received their information out of one source. Controlling provided financial information while other departments provided information related to their functions. In contrast to the current situation, management expressed that they strongly preferred one information supplier to a network of sources.^[110] Corporate management has further frequently indicated that they require information in the right quantity at the appropriate time. There is a trade-off between supplying too much and too little knowledge to corporate management. Costs arise if too much time is spent on searching for information. Uncertainty increases if not sufficient information is made available, which can lead to value-destroying decisions by corporate management.^[111] The challenge of controlling in regard to its information function is fulfilling the information demand of corporate management efficiently.^[112]

3.4.2 Information demand

Information has been defined as the relevant knowledge. The sum of all external and internal available knowledge is termed the knowledge supply. It can be defined as all knowledge that is available upon request by an employee at a certain point of time. Knowledge demand is the request for knowledge and unique for every employee in a diversified company. The information demand of corporate management is defined as the information that enables it to fulfill its duties.^[113] The following graphic displays the concept of information demand.

illustration not visible in this excerpt

Graphic 3: Information demand

(Source: GLADEN, W. (2001), p. 2.)

At the intersection of all three circles, knowlegde supply, knowledge demand, and information demand match. It is impossible to accomplish a complete overlap of all three categories, however, the maximisation of the intersection remains one of the superior goals of controlling.^[114]

Information demand is distinguished into objective and subjective information demand. Objective information demand is defined as information that is determined to enable the manager to execute his duties. Subjective information demand is the information determined to be relevant by the manager who executes the duties. For determining the information demand this differentiation has little value, since they are two views on the same subject. Corporate management’s information preferences as well as the actual information necessary to execute the duties need to be considered.^[115]

Determining the information demand is a complex organisational problem. Information demand origins at corporate and business management. It can be measured through inductive or deductive methods. Deriving the information inductively is achieved by studying business documents, information systems, and the information user. Analysing the information demand deductively is accomplished by studying the goals and deriving the theoretically or logically required information. Both methods enable controlling to deliver the relevant knowledge.^[116]

3.4.3 Information processing

Once information demand has been identified, the next two phases in the information process are information procurement and processing. This view is ideological, as information is often first obtained and then analysed for usefulness.^[117] Information is retrieved from external or internal sources. The most important internal source is the reporting system. External sources vary and depend on the information demand.^[118] Once information has been gained, it requires to be processed for being effective.^[119] Information processing is defined as transforming information into data according to its future utilisation.^[120] This yields three types of reports for corporate management: standard or planned reports, triggered reports, and requested reports. Information demand needs to be measured only once for standard reports that are created periodically. Triggered reports are provoked by certain events such as a strong variance from expected numbers. Requested reports ask for an individual assessment of the information demand of the information user.^[121] As controlling is responsible for the evaluation of the information value, significant power is delegated to the information supplier.^[122]

3.4.4 Information system

Information demand, procurement and processing are subsystems of an information system. An information system is a specific management system that consists of structures, processes and instruments for information and communication within a company.^[123] It consists of five related activities. These are information demand, information procurement, information processing, information storage, and information transmission.^[124] The primary function of an information system in a diversified company is to enable corporate management to monitor business performance and measure deviations from targets.^[125] For efficiency reasons the information system is likely to be developed so that it minimises differences between information delivered to corporate managers and information delivered to shareholders. If shareholder value creation is the ultimate goal, then the information system will reflect this. The diversifier DaimlerChrysler devised the principle „internal = external“, implying that internal information is supposed to conform to external information.^[126] An information system further has to display a high degree of customisation, which is possible today through modern technology that allows the creation of incredibly advanced and complex systems. The costs for the system are another criterion.^[127]

Managing the information system is itself a subsystem of information management. This comprises all duties related to the planning, design, organisation, coordination, and controlling of technology-based information and communication in a diversified company. Information management has the objective of increasing corporate success.^[128]

4 Managing a diversified company

4.1 Framework for managing a diversified company

Managing a diversified company requires information for three interrelated duties, which create a framework for an integrated approach. The information demand and information processing requirements of corporate management are derived from these duties. First are the definition of corporate strategy and the management of the portfolio. This includes the definition of desired activities and the continuous reassessment of the portfolio. Second is the management of synergies between the businesses, which consists of identifying and realising synergies. Third is managing the businesses, which is accomplished by creating an effective administrative context.^[129] The following graphic outlines the framework for managing a diversified company.

illustration not visible in this excerpt

Graphic 4: Framework for managing a diversified company

(According to SZELESS, G. (2001), p. 135.)

As all three duties are interrelated, the corporate management of a diversified company should be seen as an integrated concept. The balance between these activities depends on the degree of diversification. The management of a conglomerate will have more emphasis on portfolio management and less or none on synergy management. A related diversifier is likely to have equal interests in all three management tasks.^[130] The following section describes the three duties of corporate management in a diversified company.

4.2 Managing the portfolio

The corporate strategy determines the general direction of a diversified company. Portfolio management is dependent on the type of corporate strategy. The three types of corporate directional strategies are growth, stabilisation and shrinking strategies.^[131] The management of a portfolio comprises changes in the portfolio through acquisitions, divestments and internal developments. Important changes in one of the businesses or their environment require immediate assessment of the corporate strategy and company portfolio. A well-designed information system will recognize changes quickly and enable corporate management to make decisions efficiently.^[132]

[...]

^[1] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 127.

^[2] Cf. CHANDLER, A. D. (1996), p. 357f.

^[3] Cf. WASSERSTEIN, B. (2001), p. 77f.

^[4] Cf. BERGER, P./OFFEK, E. (2002), p. 39f.

^[5] Cf. NEW YORK STOCK EXCHANGE (Publisher) (2005).

^[6] Cf. SZELESS, G. (2001), p. 131.

^[7] Cf. GLADEN, W. (2001), p. 2.

^[8] Cf. BAUM, H. G./COENENBERG, A. G. et al (2004), p. 1.

^[9] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 13.

^[10] CHANDLER, A.D (2001), p. 23.

^[11] Cf. MINTZBERG, H. (1987), p. 10f.

^[12] Cf. MINTZBERG, H./WATERS, J. (1985), p. 257.

^[13] Cf. GRANT, R. M. (1997), p. 43.

^[14] Cf. PORTER, M. E. (1987), p. 274.

^[15] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 5.

^[16] Cf. PORTER, M. E. (1987), p. 274.

^[17] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 7.

^[18] Cf. PRAHALAD, C. K./HAMEL, G. (1991), p. 310f.

^[19] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 28f.

^[20] Cf. PRAHALAD, C. K./HAMEL, G. (1990), p. 79f.

^[21] Cf. COLLIS, D. J./MONTGOMERY, C. A (1998), p. 14.

^[22] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 327.

^[23] Cf. ANSOFF, H. I. (1988), p. 74.

^[24] Cf. BAMBERGER, I./WRONA, T. (2004), p. 160.

^[25] Cf. MINTZBERG, H. (1988), p. 347.

^[26] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1998), p. 5.

^[27] Cf. SZELESS, G. (2001), p. 28.

^[28] Cf. PORTER, M. E. (1996), p. 415f.; RUMELT, R. P. (1982), p. 60.

^[29] Cf. SZELESS, G. (2001), p. 28.

^[30] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 75.

^[31] Cf. GOOLD, M./LUCHS, K. (1993), p. 146f.

^[32] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 84.

^[33] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 49f.

^[34] Cf. GOOLD, M./LUCHS, K. (1993), p. 165.

^[35] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 183.

^[36] Cf. GOOLD, M./LUCHS, K. (1993), p. 151.

^[37] The concept of agency costs and the principal-agent-theory are explained on page 33 in detail.

^[38] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 132.

^[39] Cf. MINTZBERG, H. (1979b), p. 342.

^[40] Cf. HILL, C. W. L./HOSKINSSON, R. E.(1987), p. 260.

^[41] Cf. KHANNA, T./PALEPU, K. (1997), p. 148.

^[42] Cf. KALI, R. (2003), p. 672.

^[43] Cf. SZELESS, G. (2001), p. 42.

^[44] Cf. MINTZBERG, H. (1979b), p. 342.

^[45] Cf. FACCIO, M./LANG, L. H. P. (2002), p. 365.

^[46] Cf. PORTER, M. (1987), P. 258.

^[47] Cf. DAMODARAN, A. (2002), p. 973.

^[48] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 452.

^[49] Cf. GOOLD, M./LUCHS, K. (1993), p. 157.

^[50] Cf. GOOLD, M./CAMPBELL, A. (1998), p. 92f.

^[51] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 453.

^[52] Cf. GOOLD, M./LUCHS, K. (1993), p. 159.

^[53] Cf. PRAHALAD, C. K./BETTIS, R. A. (1986), p. 85f.

^[54] Cf. GOOLD, M./LUCHS, K. (1993), p. 161.

^[55] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1998), p. 20.

^[56] Cf. WASSERSTEIN, B. (2001), p. 177.

^[57] Cf. MINTZBERG, H. (1979b), p. 340f.

^[58] Cf. GOOLD, M./CAMPBELL, A. (1998), p. 67.

^[59] Cf. GRANT, R. M. (1997), p. 389.

^[60] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 89f.

^[61] Cf. BAMBERGER, I./WRONA, T. (2004), p. 191f.

^[62] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 19f.

^[63] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 95f.

^[64] Cf. KIM, W. C./HWANG, P. et al (1993), p. 130.

^[65] Cf. GRANT, R. M./JAMMINE, A. P. et al (1988), p. 119.

^[66] Cf. KIM, W. C./HWANG, P. et al (1993), p. 142.

^[67] Keiretsus are Japanese clustered groups, which are vertically integrated or horizontally connected. See LASSERRE, P. (1992), p. 352 for further information.

^[68] Cf. LASSERRE, P. (1992), p. 351f.

^[69] Cf. PORTER, M. E. (1987), p. 283.

^[70] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1995), p. 47f.

^[71] Cf. PRAHALAD, C. K./BETTIS, R. A. (1986), p. 73.

^[72] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 85.

^[73] Cf. PORTER, M. E.(1987), p. 247.

^[74] Cf. RUMELT, R. P. (1982), p. 59f.

^[75] Cf. PORTER, M. E.(1987), p. 247.

^[76] Cf. GRANT, R. M./JAMMINE, A. P. et al (1988), p. 96.

^[77] Cf. PRAHALAD, C. K./BETTIS, R. A. (1986), p. 85.

^[78] Cf. ALT, A. (2004), p. 2.

^[79] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 114f.

^[80] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 8.

^[81] Cf. GOOLD, M./LUCHS, K. (1993), p. 154.

^[82] Cf. RAPPAPORT, A. (1999), p. 2.

^[83] Cf. HORVATH, P./MINNING, F. (2001), p. 273f.; FISCHER, T. M. (2002), p. 161.; CHAHED,Y./KAUB, M. et al (2004), p. 33.

^[84] Cf. FERNANDEZ, P. (2001), p. 2f.

^[85] All approaches lead to the same value of equity if applied correctly. See DRUKARCZYK, J. (2001), p. 204 for further information.

^[86] Cf. COPELAND, T./KOLLER, T. et al (2000), p. 132.

^[87] Cf. DRUKARCZYK, J. (2001), p. 205.

^[88] Cf. FERNANDEZ, P. (2001), p. 4.

^[89] Cf. DRUKARCZYK, J. (2001), p. 350f.

^[90] Cf. FERNANDEZ, P. (2001), p. 6f.

^[91] Cf. COPELAND, T./KOLLER, T. et al (2000), p. 57f.

^[92] Cf. GRANT, R. M. (1997), p. 40.

^[93] Cf. BÜHNER, R./TUSCHKE, A. (1999), p. 8.

^[94] Cf. VOLKERT, R. (1998), p. 36.

^[95] Cf. RAPPAPORT, A. (1999), p. 3.

^[96] Cf. WELGE, M./AL-LAHAM, A. (2003), p. 170f.

^[97] Cf. GRANT, R. M. (1997), p. 41.

^[98] Cf. COLLIS, D. J./MONTGOMERY, C. A. (1997), p. 143f.

^[99] Cf. FANK, M. (1996), p. 31.

^[100] Cf. HILDEBRAND, K. (1995), p. 4.

^[101] Cf. HORVATH, P. (1998), p. 335f.

^[102] Cf. HORVATH, P. (1998), p. 335f.

^[103] Cf. KÜPPER, H.-Ü./WEBER, J. (1997), p. 154.

^[104] Cf. MINTZBERG, H. (1975), p. 21.

^[105] EDVINSSON, L./KIVIKAS, M. (2003), p. 163f.

^[106] Cf. BLACHFELLNER, M. (2004), p. 101.

^[107] Cf. GLADEN, W. (2001), p. 3.

^[108] Cf. HORVATH, P. (1998), p. 366.

^[109] Cf. LITTKEMANN, J. (2004), p. 42.

^[110] Cf. SANDT, J. (2003), p. 75f.

^[111] Cf. FANK, M. (1996), p. 32.

^[112] Cf. KÜPPER, H.-Ü. (1995), p. 11.

^[113] Cf. GLADEN, W. (2001), p. 1f.

^[114] Cf. FANK, M. (1996), p. 32.

^[115] Cf. HINTERHUBER, H. H./RENZL, B. et al (2004), p. 452.

^[116] Cf. HORVATH, P. (1998), p. 351f.

^[117] Cf. HORVATH, P. (1998), p. 339f.

^[118] Cf. REICHMANN, T. (1995), p. 10.

^[119] Cf. JENSEN, M. C./MECKLING, W. H. (1998), p. 4.

^[120] Cf. HORVATH, P. (1998), p. 339f.

^[121] Cf. REICHMANN, T. (1995), p. 12.

^[122] Cf. HORVATH, P. (1998), p. 339f.

^[123] Cf. BAMBERGER, I./WRONA, T. (2004), p. 240.

^[124] Cf. GLADEN, W. (2001), p. 6.

^[125] Cf. GRANT, R. M. (1997), p. 408.

^[126] WEBER, M. P./VEIT, G. (2004), p. 25.

^[127] Cf. PREISSLER, P. R. (1996), p. 75.

^[128] Cf. HILDEBRAND, K. (1995), p. 34f.

^[129] Cf. SZELESS, G. (2001), p. 135.

^[130] Cf. SZELESS, G. (2001), p. 134f.

^[131] Cf. BAUM, H. G./COENENBERG, A. G. et al (2004), p. 32.

^[132] Cf. SZELESS, G. (2001), p. 131.