2.2 Relationship between Shareholders and Company Management
3 min read•june 18, 2024
tackles the complex relationships between companies and their stakeholders. It's all about balancing the interests of shareholders, managers, and other groups affected by a company's actions.
At its core, governance deals with the principal-agent problem: how to ensure managers act in shareholders' best interests. Mechanisms like performance-based pay and board oversight aim to align these interests and drive better company performance.
Corporate Governance and Stakeholder Relationships
Principal-agent relationship in governance
Top images from around the web for Principal-agent relationship in governance
6.7: Conflict Management - Social Sci LibreTexts View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
6.7: Conflict Management - Social Sci LibreTexts View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
1 of 3
Top images from around the web for Principal-agent relationship in governance
6.7: Conflict Management - Social Sci LibreTexts View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
6.7: Conflict Management - Social Sci LibreTexts View original
Is this image relevant?
Summary of Principal—Agent Mechanism View original
Is this image relevant?
1 of 3
- Principals are shareholders who own the company and hire agents (managers) to run it on their behalf
- Potential conflicts of interest arise when managers prioritize their own interests over shareholders'
- Excessive compensation packages for managers
- by pursuing projects that increase manager's power but not shareholder value
- leading to missed opportunities for growth
- Mechanisms to align principal-agent interests
- Compensation packages tied to company performance (, bonuses)
- provides oversight and represents shareholder interests
- Threat of takeovers disciplines underperforming companies by replacing ineffective management
Stakeholders and corporate decision-making
- Shareholders are the owners of the company
- Elect the to represent their interests
- Approve major decisions (mergers, acquisitions, changes to bylaws)
- Exercise (voting, access to information, derivative lawsuits)
- Board of Directors is elected by shareholders
- Oversees management and company strategy
- Appoints and dismisses top executives (, CFO)
- Ensures management acts in the best interest of shareholders
- Management is hired by the board to run day-to-day operations
- Makes strategic and operational decisions (product development, pricing, marketing)
- Accountable to the board and shareholders for company performance
- Other stakeholders influence decision-making through various means
- Employees (unions negotiate wages and benefits)
- Customers (consumer advocacy groups lobby for product safety and quality)
- Suppliers (long-term contracts, partnerships)
- Creditors (, credit ratings)
- Communities (local regulations, public relations)
Management decisions vs company performance
- Capital allocation decisions impact shareholder value
- Investing in projects with positive net present value (NPV) increases value
- Poor investment decisions (overpriced acquisitions, unsuccessful R&D) destroy value
- Financing decisions affect the cost of capital and financial risk
- Optimal balances cost of debt (interest) and equity (dividends)
- Excessive debt increases financial risk and may lead to bankruptcy
- balances returning cash to shareholders vs reinvesting in growth
- Paying dividends provides immediate return to shareholders
- Retaining earnings allows for reinvestment in profitable projects
- Operational efficiency impacts profitability and cash flow
- Effective management of costs (lean manufacturing, supply chain optimization)
- Streamlined processes (automation, outsourcing non-core functions)
- Productive human resources (employee training, incentive systems)
- aligns management and shareholder interests
- Strong governance (independent board, transparent reporting) reduces
- Weak governance (insider boards, opaque financials) may lead to mismanagement and fraud
Corporate Responsibility and Stakeholder Management
- Corporate governance structures ensure ethical and effective management
- emphasizes considering all stakeholders' interests in decision-making
- policies aim to align management interests with shareholders
- initiatives address broader societal and environmental concerns
Key Terms to Review (38)
Agency Costs: Agency costs refer to the expenses and potential losses that arise from the inherent conflict of interest between a company's management (the agent) and its shareholders (the principal). These costs stem from the separation of ownership and control, where managers may make decisions that prioritize their own interests over those of the shareholders they are meant to serve.
Agency theory: Agency theory explains the relationship between principals (e.g., shareholders) and agents (e.g., corporate executives). It focuses on resolving conflicts that arise when agents do not align with the interests of principals.
Agency Theory: Agency theory is a framework that examines the relationship between a principal (such as a shareholder) and an agent (such as a company's management) in the context of decision-making and goal alignment. It explores the potential conflicts of interest that can arise when the agent is not fully incentivized to act in the best interests of the principal.
Board of directors: A Board of Directors is a group of individuals elected to represent shareholders and oversee the activities and direction of a company. They set broad policies, make significant decisions, and hire senior executives like the CEO.
Board of Directors: The board of directors is the governing body of a corporation, responsible for overseeing the company\'s management, setting strategic direction, and ensuring the organization\'s compliance with legal and ethical standards. It serves as the link between the company\'s shareholders and its day-to-day operations, balancing the interests of various stakeholders.
Capital structure: Capital structure is the mix of debt and equity that a firm uses to finance its operations and growth. It directly impacts the company's risk, cost of capital, and overall financial strategy.
Capital Structure: Capital structure refers to the mix of debt and equity financing that a company uses to fund its operations and investments. It represents the relative proportions of different sources of capital, such as short-term debt, long-term debt, and equity, that a company employs to finance its assets and activities. The capital structure of a company is a crucial aspect of corporate finance, as it directly impacts the company's financial risk, cost of capital, and ultimately, its overall value and performance.
CEO: The Chief Executive Officer (CEO) is the highest-ranking executive in a company, responsible for leading and managing the overall operations and strategic direction of the organization. The CEO is the primary decision-maker and serves as the primary link between the company's management and its board of directors.
Chief Financial Officer (CFO): The Chief Financial Officer (CFO) is the senior executive responsible for managing the financial actions of a company. The CFO's primary role is to oversee and direct the organization's financial planning, management, and reporting to ensure the company's financial health and stability, particularly in the context of the relationship between shareholders and company management.
Corporate governance: Corporate governance is the system of rules, practices, and processes by which a company is directed and controlled. It involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government, and the community.
Corporate Governance: Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It encompasses the relationships between a company's management, its board of directors, its shareholders, and other stakeholders, and provides the structure through which the company's objectives are set and the means of attaining those objectives are determined.
Corporate Social Responsibility: Corporate social responsibility (CSR) refers to the ethical and philanthropic obligations that businesses have towards their stakeholders, the community, and the environment. It encompasses a company's voluntary efforts to integrate social and environmental concerns into their operations and interactions with their stakeholders.
Cumulative Voting: Cumulative voting is an electoral system that allows shareholders to allocate their votes in proportion to their shareholdings, rather than being limited to one vote per share. This system aims to give minority shareholders a greater voice in the election of a company's board of directors.
Debt Covenants: Debt covenants are contractual agreements between a borrower and a lender that impose certain restrictions or requirements on the borrower. These covenants are designed to protect the lender's interests by ensuring the borrower maintains a certain level of financial health and adheres to specific operational guidelines. Debt covenants play a crucial role in the relationship between shareholders and company management, solvency ratios, and optimal capital structure.
Dividend Policy: Dividend policy refers to the strategy a company employs in deciding whether to distribute profits to shareholders in the form of dividends or to retain those earnings for reinvestment in the business. This policy directly impacts the relationship between shareholders and company management, as well as the market value ratios that investors use to evaluate a company's performance and prospects.
Earnings per Share: Earnings per share (EPS) is a key financial metric that represents the portion of a company's profit allocated to each outstanding share of common stock. It is a widely used indicator of a company's profitability and is an important consideration for investors when evaluating the performance and potential of a company's stock.
Empire Building: Empire building refers to the actions taken by company management to expand their control over resources and operations, often at the expense of shareholder interests. This can involve pursuing growth strategies that may not align with the best financial interests of shareholders, leading to conflicts between management objectives and shareholder value maximization. Such behavior can create agency problems where managers prioritize personal ambitions over the company's profitability and efficiency.
Executive Committee: The executive committee is a small group of high-ranking executives within a company who are responsible for overseeing the day-to-day operations and strategic decision-making of the organization. This committee typically includes the company's top-level managers, such as the CEO, CFO, and other C-suite executives, and serves as a key link between the board of directors and the company's management team.
Executive Compensation: Executive compensation refers to the financial rewards and incentives provided to top-level managers and leaders of a company, including the CEO, CFO, and other C-suite executives. It is a crucial aspect of the relationship between shareholders and company management, as well as a key factor in addressing agency issues that can arise between these two parties.
Fiduciary Duty: Fiduciary duty is a legal obligation for an individual or organization to act in the best interest of another party. It is a fundamental principle that governs the relationship between those who manage or control assets on behalf of others, such as shareholders, clients, or beneficiaries.
Golden Parachute: A golden parachute is a severance agreement that provides significant benefits to top-level executives if they are terminated or demoted following a change in the company's ownership or control. It is a contractual arrangement designed to protect executives' financial interests in the event of a major corporate transition.
Hostile Takeover: A hostile takeover is a corporate action in which an investor or group of investors acquire a controlling stake in a company without the consent or cooperation of the company's management. This is in contrast to a friendly takeover, where the target company's management supports the acquisition.
Institutional Investors: Institutional investors are large organizations that pool money to invest in securities, real estate, and other assets on behalf of their clients. They play a significant role in the financial markets and have a substantial impact on the relationship between shareholders and company management, as well as the overall efficiency of the market.
Minority Shareholders: Minority shareholders are investors who own a small portion of a company's stock, typically less than 50% of the total shares outstanding. As minority owners, they have limited influence over the company's decision-making and operations compared to majority shareholders or controlling stakeholders.
Poison Pill: A poison pill is a defensive tactic used by a company's management to make the company less attractive to a potential acquirer, typically in the context of a hostile takeover attempt. It is a strategy designed to discourage such takeovers by making them prohibitively expensive or difficult to execute.
Principal-Agent Relationship: The principal-agent relationship refers to the dynamic between a principal, who delegates work or decision-making authority to an agent, who then performs that work on the principal's behalf. This relationship is central to understanding the relationship between shareholders and company management.
Proxy Voting: Proxy voting is the process by which shareholders of a company authorize someone else, typically the company's management or a third-party, to vote on their behalf at shareholder meetings. This allows shareholders who are unable to attend the meeting in person to still have a voice in the company's decision-making process.
Return on equity: Return on Equity (ROE) measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested. It is calculated as Net Income divided by Shareholders' Equity.
Risk Aversion: Risk aversion is a fundamental concept in finance and economics that describes an individual's or entity's preference for avoiding or minimizing potential losses, even if it means forgoing potential gains. It is a crucial factor in decision-making processes related to investments, portfolio management, and broader economic behaviors.
Sarbanes-Oxley Act: The Sarbanes-Oxley Act (SOX) is a federal law enacted in 2002 that established new standards for public company boards, management, and public accounting firms. It was implemented to improve corporate governance and restore public trust in the wake of high-profile accounting scandals.
Sarbanes-Oxley Act (SOX): The Sarbanes-Oxley Act (SOX) is a U.S. federal law enacted in 2002 to protect investors from fraudulent financial reporting by corporations. It established strict requirements for financial disclosures and imposed severe penalties for corporate misconduct.
Shareholder Activism: Shareholder activism refers to the actions taken by shareholders to influence the decisions and policies of a company in which they hold shares. It involves shareholders actively engaging with the management and board of directors to promote changes that they believe will enhance the company's performance and maximize shareholder value.
Shareholder Primacy: Shareholder primacy is the principle that the primary goal of a corporation should be to maximize shareholder wealth and returns. It holds that the interests of a company's shareholders should be the central consideration in corporate decision-making.
Shareholder Rights: Shareholder rights refer to the legal and contractual privileges granted to individuals or entities that own shares in a publicly traded company. These rights dictate the level of control, participation, and protections afforded to shareholders in the governance and decision-making processes of the corporation.
Stakeholder: A stakeholder is any individual or group that has an interest in the success and functioning of a company. This includes shareholders, employees, customers, suppliers, and the broader community.
Stakeholder Theory: Stakeholder theory is a framework that emphasizes the importance of considering the interests and well-being of all parties affected by a company's actions, not just the shareholders. It suggests that a company's decision-making should balance the needs and concerns of various stakeholders, including employees, customers, suppliers, communities, and the environment, in addition to shareholders.
Stock Options: Stock options are financial instruments that give the holder the right, but not the obligation, to buy or sell a company's stock at a predetermined price within a specific time period. They are an important tool in the relationship between shareholders and company management, as they can be used to align the interests of executives with those of the shareholders.
Subscriber: A subscriber is an individual or entity that commits to purchasing shares in a corporation, usually during its initial offering. Subscribers become shareholders once the shares are issued and paid for.