Shareholder relationship and agency theory

Shareholder relationship and agency theory
 

 The skill and experience of the senior management board are important to shareholder as they employed to manage the shareholder’s investment on their behalf. There must be trust in the integrity and ability of the managers, a dynamic board of management can make a significant different to the performance of a business and the way the market views.

 An agency relationship exists where one person on the behalf of another. The management / shareholder relationship is an example of an agency relationship. Goal congruence occurs when the objectives of the agents match those of the principals. The agency problem is the conflict that arises from the separation of management and ownership in many companies, leading to a lack of goal congruence. The financial and other rewards of managers may not be linked to the shareholder’s financial return. In theory, management should not be able to act contrary t the wishes of shareholders because shareholders can dismiss the managers or sell their shares. Unfortunately, it is often not the case. Small shareholders frequently have little knowledge about the running of the business and little power to alter its execution, and the large institutional shareholders have often been passive an uninvolved.

 However, a series of corporate raids in the late 1980s, when firms acquired and then asset stripped managerially focused companies believing them to be undervalued, has led to the large institutional shareholders considering the actions of management more carefully.

 A number of incentive schemes have been introduced in an attempt to encourage goal congruence between management and shareholders. The most popular is the stock option scheme. This allows senior management up to a certain number of the company’s shares at a fixed price at a specified time in the future. The management therefore has a financial incentive to act in ways o maximize the share price which benefits all shareholders. However, such schemes are of doubtful benefit management do not have to buy shares if the price has fallen, and the schemes can lead to volatility in the share price, which is counter to the principle of a stable share price which many shareholders desire.

 Another popular scheme involves profit related incentives in which bonuses are based on the annual growth in earnings per share, measured against a pre-set target such as companies in the sector. However, you will appreciate that accounting figures can easily be manipulated and also be affected by external factors such as a change in tax rates. Such measures therefore only give a partial picture of management’s activities.

 

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