Management Versus Stockholders

The objectives of management may differ from those of the firm's stockholders. In a large corporation, the stock may be so widely held that stockholders cannot even make known their objectives, much less control or influence management. Often ownership and control are separate, a situation that allows management to act in its own best interests rather than those of the stockholders.

We may think of management as agents of the owners. Stockholders, hoping that the agents will act in the stockholders' best interests, delegate decision making authority to them. Jensen and Meckling have developed a comprehensive theory of the firm under agency arrangement They show that the principals, in our case the stockholders, can assure themselves that the agent (management) will make optimal decisions only if appropriate incentives are given and only if the agent is monitored. Incentives include stock options, bonuses, and perquisites, and they are directly related to how close management decisions come to the interests of stockholders. Monitoring can be done by bonding the agent, systematically reviewing management perquisites, auditing financial statements, and explicitly limiting management decisions. These monitoring activities necessarily involve costs, an inevitable result of the separation of ownership and control of a corporation. The less the ownership percentage of the managers, the less the likelihood that they will behave in a manner consistent with maximizing stockholder wealth, and the greater the need for outside stockholders to monitor their activities.

Fama suggests that the primary monitoring of managers comes not from the owners but from the managerial labor market.' He argues that management control of a large corporation is completely separate from its security ownership. Efficient capital markets provide signals about the value of a company's securities and, hence, about the performance of its managers. If the managerial labor market is competitive both within and outside the firm, it will tend to discipline the manager. In that situation, the signals given by changes in the total market value of the firm's securities become very important.