Control of the Corporation, Mergers and Acquisitions

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The Agency Problem and Control of the Corporation, Mergers and Acquisitions

The Agency Problem and Control of the Corporation

Corporate managers are the agents of shareholders. This relation creates a problem for shareholders who must find ways to induce managers to pursue shareholders interests. Financial managers do act in the best interest of the shareholders by taking action to increase the stock value. However, in large corporations ownership can be spread over a huge number of stockholders. It has been mentioned that this agency problem arises whenever a manager owns less than 100 percent of the firm’s shares. Because the manager bears only a fraction of the cost when his behavior reduces the firm value, he is unlikely to act in the shareholders’ best interest. Let’s just say that management and stockholder interests might differ, imagine that the firm is considering a new investment, and the investment is expected to favorably impact the share value, but is relatively a risky venture. Owners of the firm will then wish to take the investment because the stock will rise, but management may not with the fear of there jobs being lost. One obvious mechanism that can work to reduce the agency problem is increased manager insider shareholding. But, even where managerial wealth permits this is costly since it precludes efficient risk bearing. Other mechanisms are also available. More concentrated shareholdings by outsiders can induce increased monitoring by these outsiders and so improve performance by a firm’s own managers. Similarly, greater outside representation on corporate boards can result in more effective monitoring of managers, and the market for managers also can improve managerial performance by causing managers to become concerned with their reputation among prospective employers. The available theory and evidence are consistent with the view that stockholders control the firm and that stockholder wealth maximization is the relevant...
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