M2 - U1 - Class 17 - Agency Theory and Shareholder Value Flashcards
agency theory
Primary objective of corporation is to maximize shareholder value
An application of agency theory to corporate governance is known as “shareholder value principle.”..
stakeholder theory
Primary objective of corporation is to attend to the stakeholder interests
Supports Corporate Social Responsibility (CSR), Environmental, Social, and Governance (ESG)
discussion question
- Think of an asset of interest; e.g., the car
Financial advisor investing stocks for you - Who owns that asset?
The person with the account - Who controls that asset?
Financial advisor - What are the behavioral problems?
The actions
Lied to, mistreated, stolen from, deceived, overcharged for services - What are the causes of the problems?
They don’t invest right, lose your money/steal, not checking on accounts often enough - How do you prevent the problems?
Learn how to save/invest yourself
agency theory
A general economic theory that explains a wide variety of economic relations
Key assumptions about human nature:
Selfish, opportunistic, individualistic
Principals (owners) vs. agents (managers)
Key characteristics of publicly traded corporations: separation of ownership and control (“agency problem”)
why is there an agency problem
goal incongruence
In a control system, goal congruence is the state that leads individuals or groups to take actions that are in their own interest and the best interest of the entity.
Goal congruence can best be achieved, and the ‘agency problem‘ treated better, providing incentives to managers that are related to profit or share price. For instance, Performance-related pay, share options
Information asymmetry
Agency problems arise from incomplete and asymmetric information as principals attempt to motivate agents to act in their interest.
Informational asymmetry creates an imbalance between transaction partners with unfair results namely moral hazard
goal incongruence
In a control system, goal congruence is the state that leads individuals or groups to take actions that are in their own interest and the best interest of the entity.
Goal congruence can best be achieved, and the ‘agency problem‘ treated better, providing incentives to managers that are related to profit or share price. For instance, Performance-related pay, share options
information asymmetry
Agency problems arise from incomplete and asymmetric information as principals attempt to motivate agents to act in their interest.
Informational asymmetry creates an imbalance between transaction partners with unfair results namely moral hazard
agency cost
Agency cost: Inefficiencies created by agency problem
key players - principals
Principals
Those who own assets
Shareholders (investors, owners)
Pursue shareholders’ interest (maximize shareholder value)
Can diversify portfolio
Less risk averse
key players - agents
Agents
Those who control assets
Managers
Pursue managerial interest (career, pay, status, reputation)
Cannot easily diversify portfolio
More risk averse
agency theory: bottom line
Corporate governance in publicly traded corporations is fraught with “agency problem”
Agency problem creates inefficiencies (“agency cost”)
Therefore, corporate governance should mitigate agency problem by minimizing agency cost
By minimizing agency cost, corporations maximize the principal’s (owner’s or shareholder’s) wealth (or value)
Two approaches to minimize agency cost and maximize shareholder value …
monitoring discripline
= board of directors, shareholders, market
Monitoring discipline takes care of
info assymetry
incentrives
= compensation contracts, managerial ownership
Incentives takes care of
goal incogruence
milton friendman
The discussions of the “social responsibilities of business” are notable for their analytical looseness and lack of rigor. What does it mean to say that “business” has responsibilities? Only people have responsibilities. A corporation is an artificial person and in this sense may have artificial responsibilities, but “business” as a whole cannot be said to have responsibilities, even in this vague sense. The first step toward clarity in examining the doctrine of the social responsibility of business is to ask precisely what it implies for whom.
If we wish, we may refer to some of these responsibilities as “social responsibilities.”
But in these respects he is acting as a principal, not an agent; he is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. If these are “social responsibilities,” they are the social responsibilities of individuals, not business
50 years since friedman
“I’ll never forget reading Friedman’s essay when I was in business school in the 1980s. It influenced — I’d say brainwashed — a generation of C.E.O.s who believed that the only business of business is business. The headline said it all. Our sole responsibility to society? Make money. The communities beyond the corporate campus? Not our problem.” (Marc Benioff, Salesforce CEO)
a friedman doctrine
- Can business have responsibilities?
No. individuals can though - What is the nature of a corporate executive? What is his or her fundamental duty?
We as a society created corp. Corp did not create a problem. Manager’s responsibility is to make money. - Does it mean that a corporate executive cannot exercise his or her individual responsibility to society?
Its ok if they do it off duty and not for the company but as an individual.
theoretical distinctions
“This process [CSR] raises political questions on two levels: principle and consequences.”
theoretical distinctions - What is the political principle that CSR undermines?
Taxpayers fund public sphere
In business, individuals vote by purchasing stock
theoretical distinctions - What are the consequences of CSR?
Shareholders will stop buying stocks
Employees will leave according to Friedman
Might get paid more at other companies who do not commit to CSR
According to Friedman, what is the fundamental difference between market mechanism and political mechanism? Why does it matter?
Market you don’t have to conform and be unanimous
Politically you follow the leader
shareholder value
Any economic value, profit, or wealth that is created by the corporation as a direct result of its business operations, and that is distributed to the owners of corporate equities (i.e., shareholders)
shareholder value principle
A business principle that the primary objective of corporations is to maximize shareholder value
five justifications (sundaram and inkpen)
- Maximizing shareholder value maximizes the value of the whole firm
- Stakeholder management distorts good risk-taking incentives
- Having more than one objective function is a recipe for confusion
- Non-shareholding stakeholders can become shareholders, but the reverse is not easy
- The law fills the judicial void for stakeholders
- Maximizing shareholder value maximizes the value of the whole firm
A. Fixed claimants
B. Residual claimants
Who has the incentive to maximize the total value of the firm (fixed claim + residual claim)?
- Stakeholder management distorts good risk-taking incentives
A. Who is more risk averse: shareholders or stakeholders? Why?
stakeholders
B. Who are the residual claimants: shareholders or stakeholders?
Shareholders can get more by taking more risk which is better in this case
- Having more than one objective function is a recipe for confusion
Stakeholders are diverse
- Non-shareholding stakeholders can become shareholders, but the reverse is not easy
A. How easy is it for a Google employee to buy a Google stock?
B. How easy is it for a Google shareholder to become a Google employee?
Which one is more difficult, A or B?
A is more difficult
- The law fills the judicial void for stakeholders
Judicial void - stakeholders it is filled. Shareholders need to be taken care of
> Employment Law
Consumer Protection Law
Environment Protection Law
