AGENCY THEORY
Berle & Means (1932) separation between ownership & control.
Managers’ opportunistic behavior.
Objective is control of resources through contracts which allocate decision rights and incentives.
Thus, return excess cash flow to investors rather than invest in projects with returns below the cost of capital.
Primary contractual devise is debt creation.
Suggests that managerial stock ownership helps align the interests of managers w/ those of other stockholders.
However, firms have many “management” constituencies: CEOs, T.M.T.s, etc.
To the extent that these constituencies having different orientations, can cause conflicts.
Ownership of equity in U.S. business firms has changes dramatically in recent years.
Federal legislation such as the employee retirement income security act and 401 (K).
Institutional owners now control over 55% of equity and 45% of debt.
Stock Ownership: the current problem with options. (Articles we have read. The problem is how they are used, not the idea itself.)
Debt: increasing debt introduces a stakeholder with a short-term orientation.
Survival requires a long-term orientation.
The theory is that if managers own too little stock, they will act in their own best interest, not that of the owners. That creates a ‘agency problem’. If they own too much stock, they become risk-averse. Both ways the firm suffers. What is ideal? No answer, thus compare to a better performing firm within same industry.
The current use of this term, agency problem, has one believing that any thing a manager does that is not in the best interest of stockholder represents an agency problem. Not so. There is a great deal of talk about corporate governance and ways to improve governance, but there is little more than talk because few agree on what governance is, or what performance is. Quite a mess, but not that unusual.
If you will hang with me I think by the end of the semester you will have a much better idea of what governance is (Enterprise Strategy) and how to control manager’s opportunistic behavior. For purposes of this class, ‘agency problem’ refers to behavior that can be linked to stock ownership.