PART2 | KEY PRINCIPLES OF FINANCE
CHAPTER5 | PRINCIPAL-AGENT PROBLEM
Nowadays, most of large corporations are run by professional managers while the company is legally owned by shareholders. These professional managers are often called C-Suites.
Unfortunately, the professional managers’ objectives are not always in line with that of shareholders’.
While shareholders expect the management to “maximize the shareholders’ value”, the management may not behave accordingly. For example, some managers would solely focus on sales revenues or market shares to build their resume and prepare for their future career. Some managers would focus on short-term achievements so that they can be re-elected.
In finance, these conflicts of interests are called the “Principal-Agent Problem” or “Management Versus Owner Objectives”. A lot of studies have been conducted on how to align the objectives of both the shareholders and the management, but no concrete conclusions have been arrived. Stock options for the managers or bonuses based on the performance of stock price are some of examples of the efforts that have been commonly implemented to align the interests of the two different parties.
Although this Principal-Agent Problem is more readily discussed in corporate finance area, it is still applicable to our everyday lives. One of the applicable examples is that the bankers’ or brokers’ incentives are not always in line with our own, so keep that in mind when you face them.
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