“While Shareholders and Managers Will Have Different Objectives, the Extent to Which Managers Will Have Discretion to Pursue Actions That Are Not Consistent with Shareholder Wealth Maximization Is Severely Limited.”

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Managers are hired to act on behalf of the shareholders of a firm. However, this is not always the case as both parties have different objectives. The difference in interests between shareholders and managers ‘derives from the separation of ownership and control in a corporation’ (Berk and DeMarzo, 2011: 921). Whereas shareholders are interested in maximising their own wealth, managers may have more personal interests which differ to that of the shareholders. Downs and Monsen (no date, cited in Chin, Cooley and Monsen, 1968:435) suggest that managers self-interest lies in maximising their life-time income and that ‘such self-interest will be congruent with profit maximisation for the firm only in special cases’. This conflict between both…show more content…
Although it may be a simple solution, there are costs involved. Berk and DeMarzo (2011:922) state that as no one shareholder has an incentive to bear these costs, as the benefits are then divided between all shareholders, they instead elect a board of directors to monitor the managers on their behalf. The directors’ duties include hiring the executive team, approving major investments and acquisitions, and dismissing executives if necessary (Berk and DeMarzo, 2011: 922). The level of monitoring required differs across firms and is ‘based on the magnitude of the incentive gap between principal and agent’ (Beatty and Zajac, 1994, cited in Westphal and Zajac, 1994:125). However, the main factor affecting the level of monitoring provided is the cost, otherwise ‘all rational firms would monitor maximally, irrespective of the strength of incentive compensation contracts or other factors’ (Westphal and Zajac, 1994:125). Although the board of directors are hired to keep a close eye on top management, the agency problem may still exist. This will occur when the director’s duties in monitoring have been compromised as they have connections with management. A way of overcoming this problem is to hire directors who are independent to the company, as they are deemed to be better monitors of managerial effort. As Mehran (1995:166) states, outside directors are ‘more independent of top management and thus better represent the interests of shareholders than do inside

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