“While Shareholders and Managers Will Have Different Objectives, the Extent to Which Managers Will Have Discretion to Pursue Actions That Are Not Consistent with Shareholder Wealth Maximization Is Severely Limited.”
Managers are hired to act on behalf of the shareholders of a firm. However, this is not always the case as both parties have different objectives. The difference in interests between shareholders and managers ‘derives from the separation of ownership and control in a corporation’ (Berk and DeMarzo, 2011: 921). Whereas shareholders are interested in maximising their own wealth, managers may have more personal interests which differ to that of the shareholders. Downs and Monsen (no date, cited in Chin, Cooley and Monsen, 1968:435) suggest that managers self-interest lies in maximising their life-time income and that ‘such self-interest will be congruent with profit maximisation for the firm only in special cases’. This conflict between both the shareholders and the managers is termed the agency problem. Alongside the agency problem comes agency costs, which is the costs incurred to prevent the managers from prioritising their interests over the shareholders. It can be argued that the extent to which managers will have discretion to pursue actions that are not consistent with shareholder wealth maximization is severely limited. However, this is not always the case.
Managers may have discretion to pursue their objectives before those of the shareholders as there is information asymmetry between the two parties. Berk and DeMarzo (2011:533) state that the managers’ ‘information about the firm and its future cash flows is likely to be superior to that of outside investors’. This statement is reinforced by Aboody and Lev (2000:2749) who assert that ‘managers can continually observe changes in investment productivity’. This is a consequence of the responsibilities of manager being to run the business on a day-to-day basis, meaning they will have access to management and financial accounting data. As a result, managers will be in a position to make investment decisions that will maximise their wealth, without detection by the shareholders. On the other hand, shareholders
Managers may have discretion to pursue their objectives before those of the shareholders as there is information asymmetry between the two parties. Berk and DeMarzo (2011:533) state that the managers’ ‘information about the firm and its future cash flows is likely to be superior to that of outside investors’. This statement is reinforced by Aboody and Lev (2000:2749) who assert that ‘managers can continually observe changes in investment productivity’. This is a consequence of the responsibilities of manager being to run the business on a day-to-day basis, meaning they will have access to management and financial accounting data. As a result, managers will be in a position to make investment decisions that will maximise their wealth, without detection by the shareholders. On the other hand, shareholders
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