Separation of ownership from control and agency?

Question 1

Separation of ownership from control?

Answer 1

• Berle and Means
• likely to be goal divergence in a modern corporation
• owner controlled firms should be more profitable
• not much empirical support for this
• powerful mechanisms must mitigate against on the job consumption?
• we see large firms where security ownership is diverse from management, must tell us this type of organisation is efficient?
• Behavioural theory
• Baumol, Williamson, Penrose, Marris
• Jensen and Meckling – agency problems
• dealing w agency problems – reward structures – principle and agent
• other mechanisms to curb managerial discretion
• links to corporate gov systems

Question 2

March, Simon and Cyert

Answer 2

• focus on how a firm makes decisions
• firm max profits and actors united in aim – focus on comp in L market, market for final products and capital market
• firms are groups of participants w own obj
• each group inducements to make contributions (labour hours, ideas) inc non monetary benefits
• vector of inducements – responsibility, privilege working w peers

Question 3

The firm as a coalition of groups of participants?

Answer 3

• wide range of stakeholders – diff for managers to focus on just SWM (shareholder wealth max)
• goals developed through bargaining – power dep on how unique to contrib to coalition is
• goals in terms of aspiration levels

Question 4

Slack?

Answer 4

• diff between total resources and total payments needed to preserve the coalition
• LT exp aspiration levels of stakeholder groups to equal actual payments and alt available elsewhere, so no organisational slack
• But, theory shows due to imperfect markets and info problems, aspiration levels change slower so may always be slack

Question 5

Ramifications of behavioural theory?

Answer 5

• profit max may be diff to operationalise at sub level goals - conflict between sales and production – who takes responsibility
• firms don’t max obj function but make rough est of several consequences of a decision alt
• may satisfice – bounded rationality

Question 6

Perhaps managers have utility function of their own?

Answer 6

• Williamson
• managerial motives – financial reward, status, power, security
• encompassed in 3 policy variables
• MaxU = f(S,M,D)
• staff exp, emoluments, discretionary investment
• discretionary investment – amount of resources left at managers disposal spent on own discretion – above amount req for firm survival

Question 7

Growth as an objective - Penrose?

Answer 7

Limits for how much managers can push for growth

One of Penrose key insights is learning through experience causes managers to become more efficient at what they can do
Thus rising efficiency causes previously utilised managerial resources to become slack, although not idle, and these unused productive resources are, for the enterprising firm a challenge to innovate, an incentive to expand and source of competitive advantage
The capacities of the existing managerial personnel of the firm necessarily set a limit to expansion of the firm, a bottleneck, sometimes referred to as Penrose effect

Question 8

Penrose effect?

Answer 8

Current management resources -> inducement for company growth, means of expansion, but also limit on expansion

Managerial resources will grow at a rate some what faster than the growth of the firm - implications -> firm growth -> managerial intensity increases -> decreasing growth returns to managerial resources

Question 9

Penrose curves?

Answer 9

• curve X = managerial team increases, but firm grows at dim rate
• faster growth means more managerial talent needed to push growth beyond given level
• growth means more diff project needed – greater strains on managerial team
• But also, additions to managerial services from each new recruit decrease w rate of recruitment – services management can provide are a function of their training and their efficient integration – speed of integration partly a function of the time existing managers can spend training – declines faster the existing team tries to grow
• Curve Z – a neg relationship between growth of management team and growth of firm – managers spending time training less time to engage in projects
• Y = X+Z
• only until G1 does growth in management team lead to growth in firm – beyond, decreasing returns to managerial resources

Question 10

Marris 1964?

Answer 10

• management team U function
• managerial and shareholder goals not totally disparate
• how far can managers pursue own goals?
• obj function – balanced growth max
• to achieve, firm must – max rate of product demand growth whilst max rate of capital supply to finance

Question 11

Marris 1964 - demand constraint?

Answer 11

• function of growth rate of existing products and diversification rate Div
• G = X + K.Div
• K = f(P,A,RD,W,Div)
• W quality of product
• K = f(m,Div)
• m profit margin
• K and Div inversely related – faster Div means lower proportion successful
• K and m inversely – faster Div means prices down, RD up, quality increase
• Gd = f(Div,m)
• faster the firm tries to diversify at given profit margin, slower the increase in D
• faster diversification, greater burden on managerial team and R&D staffs
• no. products badly managed & poorly researched increases = fall in success rate
• also as div increases, could be competitor reaction so has to drop p and accept lower return

So -
Growth of product - demand initially increases with profit rate and G rate
More growth = more diversification = less profit

Question 12

Supply constraint - Marris?

Answer 12

• profits of firms also link through to capacity growth
• Gs = alpha*p
• P rate of return on capital
• alpha amount of invest/finance raised per unit of profit earned
• Limits on alpha –
• to increase alpha – increase retentions (can affect share p), increasing debt ratio, decrease firm liq – dangerous

showing constraints holding managers back – don’t want to push growth rate too far

low g rate = poor capacity use - so g, profits and value can increase to g1, post g1 higher growth only at expense of dividends

Question 13

Agency - Jensen and Meckling 1976?

Answer 13

• How might ownership structure affect behaviour of managers in a firm

Question 14

Agency - non owners and on the job consumption?

Answer 14

• On the job consumption may be problem in owner managed firms and in cases where firms not managed by owners
• Persons may achieve U but only bear fraction of cost

Question 15

Positive theory of agency?

Answer 15

• Firm a nexus of contracts
• How do contracts affect behaviour
• Theory of PA – how should P design A reward structures to min problems of managers seeking overmuch growth/own U – can we min scope for opportunism

Question 16

Agency - appropriate rewards structures?

Answer 16

• Usual framework – higher until MRP=w
• But – salaries, piece rates, commission based packages, share options, non financial benefits, better conditions/other perks

Question 17

Agency - why so many different types of rewards?

Answer 17

• Labour inputs not a uniform commodity
• Need to reduce on the job consumption and shirking
• Be mindful of costs of eval and monitoring
• Key problem assessing effort under asymm info
• Sharecropper problem

Question 18

sharecropper problem?

Answer 18

Laws favouring landowners made it difficult or even illegal for sharecroppers to sell their crops to others besides their landlord, or prevented sharecroppers from moving if they were indebted to their landlord

Question 19

Agency - is profit sharing an answer?

Answer 19

• Consultant paid at opportunity rate – used for 50 hours
• D = firms input demand i.e. MRP connected to consultant services
• Supply curve elastic – hire until MRP=wage rate

look at slides for below
* Consultant paid at opportunity rate – used for 50 hours
* D = firms input demand i.e. MRP connected to consultant services
* Supply curve elastic – hire until MRP=wage rate

Question 20

Profit share - moral hazard?

Answer 20

• Unobservability
• Works up to 22 hours, then something else after
• Owner sees danger
• Withdraws profit sharing contract
• Net loss of EDC relative to 50 hour wage contract
• Solutions –
• Output quotas, benchmarking, close observation

Question 21

Agency - what happens if info symmetrical?

Answer 21

• P can see effort and knows about the environ, P selects reward structure
• Forcing contract – P promises to pay W0 if agent greater than E0, but nothing if effort less
• Either reward agent along n or forcing contract

Question 21

Agency payoff - best solution?

Answer 21

• Reward structure dep on extent of payoff, containing fixed element independent of payoff
• In west – many exec have performance incentives on top of normal pay – implies element of risk sharing
• M form structures may deal well w agency problems bc of close observability, comparability of executives; promotion and career ladders may mitigate problems
• Problems w bonus related system – not always flexible downwards
• Conc – reward systems help, unlikely to be complete solution

Question 21

Agency - what happens if info asymmetrical?

Answer 21

• Effort not observed
• Agents exp income U
• Agents exp payoff I
• Trade off between incentives and risk bearing in theory of P and A
• Payoff results from good weather and no effort or bad weather and high effort
• 2 extremes –
• Wage contract – agent bears no risk – lower level of effort
• Rent contract – agent bears all risk
• Assumes P risk neutral and A risk averse – best they share risk then – somewhere in the middle – V2 – R2 return to P

Question 22

Agency issues link through to corporate governance?

Answer 22

• Distrib or rights and responsibilities to diff participants inc owners employees, suppliers, society
• Spells out rules and procedure for making decisions, marking out structure through which company obj are set and means of monitoring progress towards obj

Question 23

Corporate governance - recent context?

Answer 23

* 1992 Cadbury report – high profile company collapses – protecting weak shareholders against self interested directors – focused on stopping corporate collapses * OECD 2009 – financial crisis revealed shortcoming in corporate gov

Question 24

Corporate governance - what does it cover?

Answer 24

* Accountability – management accountable to board, board to shareholders * Fairness – protecting shareholders rights, effective solutions for violations * Transparency – timely, accurate disclosure * Independence – structures to min conflicts of interest

Question 25

Monitoring - agency?

Answer 25

Key to overcoming agency issues Internal monitoring * By shareholders * 2 tier boards – exec v supervisory * Execs run company, supervisory advises External monitoring * By auditing firms/stock analysts/ debt holder/markets * Product market * Managerial labour market * Comp in stock market * Market for corporate control

Question 26

Agency - shareholder control?

Answer 26

* In theory, at least even atomised shareholders can come together at AGM and proxy systems can consolidate votes * BUT * Shareholder motives – value increase, but search costs for indiv shareholders likely to be high – how will shareholder know why company isn’t performing well * Dispersed ownership and getting adequate votes – incumbent directors often suggest they are given proxy votes at AGM * Dispersion encourages shirking and free riding – i.e. letting others bear search costs

Question 27

Market for corporate control?

Answer 27

ights to det management of corporate resources * Are markets efficient enough to pick up on signals * Problems relating to info asymm, bounded rationality and AS * BUT * Share p has to reflect actions and efficiency of managers * Mergers etc have to occur bc managers perform badly * But what about – mergers led by efficiency needs, synergies – mergers led by hubris etc. * Hubris relates to taking over a firm bc you think you can do it - overconfidence

Question 28

Overall bidders and targets - agency?

Answer 28

* Jensen 1988 overall substantial gains from process, gains to econ efficiency, not redistrib between various parties * Jarrell 1998 little empirical evidence that gains to shareholders due to losses from other shareholders

Question 28

Core problems - market for corporate control?

Answer 28

* Acquirers find it diff at low cost to examine whether poor performance down to exec problems of environ conditions * Free riding problems on search costs of others – market operates w poor info * Minority shareholders – will they sell or hold on to shares in exp of gains – holding up process * Inability of acquirers to cope w expansion * Defence mechanisms operated by incumbent management teams – poison pills making firm less attractive e.g., issuing new shares, taking on sig debt

Question 29

Markets for managers - agency?

Answer 29

* Managerial labour market can play part in disciplining managers – reputational * Firms comp for managerial services * Association w poor performing firm could affect future reward prospects * To enhance rep do managers restrain themselves from on the job consumption and shirking? * Are managers disciplined by other managers? Managers lower in hierarchy can gain by stepping over inefficient seniors

Question 30

The product market - agency?

Answer 30

* Does the tightness of the product market reduce managerial slack * Neo-C if costs not minimised, firm fails * Leibenstein X inefficiency * Management may be slack as monitors so that outputs from given inputs are not at max * Unit prod costs not min even in more comp markets

Question 31

Leibenstein's X inefficiency?

Answer 31

* Tighter market conditions -> more pressure on workers * Resulting in more effort and lower prod costs * Hart 1983 tends to be less managerial slack where profit max firms mixed w others

Question 32

What about bank's/stakeholders - agency?

Answer 32

* Could act as a check on on the job consumption * Can signal dissatisfaction to community * Banks foreclosure sends signal in market for managers * Perhaps better than shareholder at monitoring * Other groups – consumers, employees, TU, pressure groups often highlight salaries of execs

Question 33

Market orientated system - agency?

Answer 33

* Large efficient stock markets * Widely dispersed shareholdings * Strong legal protection for minority shareholders * Ownership and control separated * Few cases where institutions hold >10%

Question 34

Network orientated system - agency?

Answer 34

* Presence of block holders – few large shareholders may exist * Firms may or may not be listed * Large shareholders may be on board and they monitor managers and can displace them * Managers disciplined more by large shareholders not MCC * Japan and Europe * Large shareholders may have LT relationship w firm – may be a bank * Less scope for MCC in network system, less hostile takeover activity? * MCC – market for corporate control

Question 35

Different systems evolved - agency?

Answer 35

* Hofstede 2001 – social and political systems which indiv interests can prevails over the collective, may explain why market orientated systems more prevalent in Anglo American situations * Vast increase in cross border M&A * International financial reporting frameworks on disclosure * Harmonisation of security regulation, and mergers of stock exchanges

Question 36

Conclusions - agency?

Answer 36

organisation structures link to corporate governance structures Specific problems of agency may determine corporate governance structures and solutions Corporate governance structures likely to vary, and balance between internal and external monitoring systems may vary