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Study Notes

Divorce between Ownership and Control


Last updated 22 Mar 2021

The so-called "divorce between ownership and control" happens when the owners of a business do not control the day-to-day decisions made in the business. For example, the majority of shareholders in public companies are not involved in any way with operational decision-making by the companies in which they have invested.

Ownership and Control of a Business

The owners of a company normally elect a Board of Directors to control the business's resources for them. Often in smaller firms, there is no difference between the Directors and the Shareholders - they are the same person or people.

However, when the share ownership of the business becomes more widespread (for example when shares are sold to external investors) the original owners of the business sacrifice some of their control.

Other shareholders can exercise their voting rights, and providers of loans often have some control (security) over the assets of the business.

This may lead to conflict between them as different shareholders can have varying objectives. This is known as the principal agent problem.

The Principal Agent Problem

How do the shareholders of a business know that managers charged with running the business are acting in their best interests by building shareholder value?

The principal agent problem revolves around how best to get your employees to act in your interests rather than their own?

Shareholders tend to want strong returns in the form of dividend payments and a rising share price.

However, managers may have objectives such as power, bonuses, prestige and status.

The problem is the many shareholders have no day-to-day control over managers.

Pension fund managers cannot dictate what CEOs and CFOs of businesses decide to do and senior executives may have little knowledge of what their managers are doing.

Many investors are 'passive'. The biggest investors in UK-listed companies tend to be large institutional shareholders such as pension funds and insurance companies.

What is in the best interest of the management is not necessarily the same as what is in the best interests of the shareholders.

Dealing with the Divorce between Ownership & Control

Strategies to deal with the potential conflict between shareholders and managers include:

  • Ensuring that financial rewards and incentives offered to managers are aligned with shareholder holder interests - e.g. based on the share price, dividends, profits achieved
  • Implementing suitable corporate governance procedures to ensure shareholders are protected as far as possible (e.g. through non-executive directors, management remuneration committees)
  • Company legislation ensuring that Directors are accountable for their actions to shareholders.

Activist Shareholders

Activist shareholders look to put pressure on existing management or force through changes to management boards.

Some insist on businesses using profits to buy-back shares to increase returns to existing shareholders.

An activist shareholder uses an equity stake to put pressure on existing management.

The goals of activist shareholders can range from financial (e.g. increase of shareholder value through changes in dividend decisions, plans for cost cutting or investment projects etc.) to non-financial (e.g. dis-investment from particular countries with a poor human rights record, or pressuring a business to speed up the adoption of environmentally friendly policies and build a better reputation for ethical behaviour, etc.)

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