Today's business world shows a huge diversification in the shareholders of one company. In most countries, each investor only holds a very small fraction of issued shares by one corporation. This includes also the senior management.
Determining the objectives of the firm is not necessarily a straightforward task because the typical firm will have many types of participants. Among these participants are shareholders, creditors, managers, employees, customers, suppliers, governments and a variety of special interest groups. The objectives of these different types of participants are likely to be in conflict.
But the main focus and objective of every firm and its members should be maximizing value. But whose value should be maximized? It should be shareholders value. The main conflict comes when other members of the firm or other stakeholders try to maximize their own expected wealth. That objective could not be aligned with the main objective of the firm. For example, a manager that runs a not so profitable department will lobby for allocation of funds to his department, even if he knows that those funds could be better off in other department.
Shareholders and the board of directors (designated by shareholders) appoint the management team that will be in charge of managing the firm in the most efficient way and meeting with shareholder expectations and interests. From the perspective of shareholders, the managerial function is simply to maximize shareholder wealth, thus they are expected to act on behalf of the interests of shareholders.
Considering the separation between ownership and control, it is necessary to think about how shareholders can influence what happens in the corporation and how the corporation is managed. The problem arising is the principal-agent problem' including agency costs, which sometimes naturally follow.
The issue of a principal hiring an agent to...