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How can managerial motives differ from those of shareholders in a business?

Level:
A-Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 5 Feb 2023

Managerial motives and shareholder motives can sometimes differ in a business due to the different interests and goals that each group may have.

Some differences include:

  1. Time Horizon - Managers may focus on short-term goals and targets, while shareholders may be more concerned with long-term value creation.
  2. Risk Tolerance - Managers may be more risk-averse than shareholders, who may be more willing to take on risk in pursuit of higher returns.
  3. Personal Interests - Managers may have personal interests, such as job security, salaries, and bonuses, which may not align with those of the shareholders.
  4. Different Goals - Managers may prioritize growth and expansion, while shareholders may prioritize stability and profitability.
  5. Agency Problems - Managers may act in their own best interests, rather than those of the shareholders, leading to conflicts of interest.

These differences in motives can lead to a misalignment between the goals of managers and shareholders, which can impact the success of the business. Effective corporate governance and communication can help to align the interests of both groups and ensure that the business is focused on creating value for all stakeholders.

How can a business overcome the principal-agent problem?

The principal-agent problem refers to the conflict of interest that can arise between a business's owners (the principals) and its managers (the agents) when the managers act in their own self-interest instead of in the best interests of the company. To overcome this problem, companies can implement various mechanisms and strategies, including:

  1. Performance-based compensation - Tying managers' compensation to specific, measurable performance targets can align their interests with those of the shareholders.
  2. Shareholder involvement - Encouraging active shareholder participation, through mechanisms such as shareholder voting and shareholder engagement, can increase accountability and transparency in the decision-making process.
  3. Transparency - Providing regular, clear, and transparent communication about the company's performance and strategy can help to build trust and reduce the potential for conflicts of interest.

Here are a few real-world examples of companies that have implemented these strategies to overcome the principal-agent problem:

  1. Amazon - Amazon ties executive compensation to specific performance targets, such as revenue growth and operating income.
  2. Berkshire Hathaway - Berkshire Hathaway has a strong independent board of directors, led by Warren Buffett, who closely monitors the actions of its subsidiaries to ensure that they are acting in the best interests of the company.
  3. Procter & Gamble - Procter & Gamble has implemented a robust shareholder engagement program, which provides regular opportunities for shareholders to ask questions and provide feedback.

These are just a few examples of the many ways that businesses can overcome the principal-agent problem and align the interests of managers and shareholders. The specific strategies that a company implements will depend on its unique circumstances and objectives.

Why did Enron fail?

Enron, once a large energy and commodities company, failed due to a combination of financial reporting fraud and unethical business practices. The following are some of the key reasons that contributed to the failure of Enron:

  1. Accounting Fraud - Enron used various accounting techniques to mislead investors and inflate its earnings, such as hiding debt and inflating assets.
  2. Conflicts of Interest - Many Enron executives had conflicts of interest, including using their positions to benefit themselves and their friends at the expense of the company and its shareholders.
  3. Lack of Regulation - The regulatory framework in place at the time allowed Enron to engage in questionable practices without being held accountable.
  4. Pressure to Meet Earnings Targets - Enron faced pressure from Wall Street to meet earnings targets, which led to the company engaging in risky and unethical practices.
  5. Lack of Internal Controls - There was a lack of internal controls and oversight at Enron, which allowed the accounting fraud and unethical practices to go undetected for years.

These factors combined led to the collapse of Enron, one of the largest corporate failures in history. The Enron scandal brought to light the need for increased regulation and accountability in the financial reporting process, and helped to lead to the passage of the Sarbanes-Oxley Act in 2002.

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