Professional Documents
Culture Documents
But there is a big problem that creates a potential misalignment of interests between shareholders and managers: The Separation of Ownership and Control!
For public corporations, shareholders are principals and managers are agents; an agency problem exists when agents have incentives to act in ways that are contrary to the interests of their principals.
Alignment Mechanism 1
Executive compensation
The average compensation of a Fortune 500 CEO in 2007 was 364 times that of the average worker. An Economic Policy Institute study found that between 1989 and 2007, CEO pay increased by 163 percent, compared with only 10 percent for the average worker (both adjusted for inflation). A number of studies have found that there is no correlation between executive compensation and firm performance, and recent work by Erickson, Hanlon, and Maydew (2003) found that executive compensation plans weighted more heavily toward stock compensation were related to the incidence of accounting fraud.
Alignment mechanism 1
Executive compensation (2)
There is evidence that (1) top managers have too much influence on setting their own pay and (2) boards have not done a good job of connecting executive compensation to performance (however performance is defined). Recent scandals involving insider trading have added to cynicism about business, and pay that is too high relative to performance may make the company a target of criticism.
Alignment mechanism 1
Executive compensation (3)
Good executive compensation plans take into account a variety of strategic and financial indicators and then reward for superior performance relative to industry peers, rather than absolute levels of stock performance. In the absence of good information about a corporations performance and strategies, shareholders and other stakeholders are unable to adequately evaluate top-manager performanceand over-compensation of top managers is a likely result.
Alignment mechanism 2
Boards of directors
Remember that shareholders are not in charge of the day-to-day operations of a corporation. Rather, they elect directors who then hire managers charged with formulating and implementing the companys strategy. However, shareholders have little control over who is nominated to the board of directors. Only under very limited circumstances can they even nominate a minority of the companys directors.
Alignment mechanism 2
Boards of directors (2)
As a result, members of a companys board of directors may feel more beholden to the CEO and the top management team than to the shareholders in whose interests they are supposed to be acting. Boards should be focused on evaluating the organizations (strategic and financial) performance and firing top managers when that performance is substandard and unlikely to improve.
Alignment mechanism 2
Boards of directors (3)
Boards should also have a respectful relationship with the top management team, think of themselves as independent from the CEO, and evaluate their own performance on a regular basis. Such boards do a better job of protecting shareholder value.
Alignment mechanism 3
The market for corporate control
When a company is perceived to be financially undervalued, there is the possibility that it can be taken over (often through a hostile takeover). When this happens, there is often a new management team and strategy put into place. Some observers propose that the threat of being taken over if the corporation is underperformingwhat is called the market for corporate controlprovides an additional means of aligning the interests of shareholders and managers.
A final comment. . .
Its pretty apparent that many boards have failed to do their jobs. That said, shareholders and non-shareholder stakeholders have a role to play in corporate governanceand part of the blame for recent corporate governance debacles rests with them. Shareholders should demand more of managers and boards.