Business Ownership and Control Stakeholders and objectives Principle

Business Ownership and Control Stakeholders and objectives Principle agent problem tutor 2 u™

Stakeholders and aims ¢ tutor 2 u™ Stakeholders are groups who have an interest in the activity and performance outcomes of a business l Shareholders l Managers l Employees l Suppliers l Customers l Government and local communities.

Stakeholders and aims tutor 2 u™ ¢ Different stakeholders tend to have different objectives e. g. . owners want maximum profits, customers lower prices and workers higher wages. ¢ Stakeholder conflict can ensue. Eg in public limited companies, ownership and control are separate: owners seek maximum profits; managers may seek sales maximisation as these increase their bonuses.

Divorce between Ownership & Control tutor 2 u™ ¢ The majority of shareholders in a quoted company (plc) cannot exercise day-to-day control over the decisions of managers ¢ Managers employed by a business may have different motivations than owners ¢ Managers may want to maximise their own utility from being in charge of a business ¢ This may lead to decisions that are not consistent with profit maximisation / or maximising shareholder value over time

Ownership and control Principals: Shareholders OWNERSHIP Control Mechanisms: Pressures from the stock market Regular meetings with shareholders (AGM) Performance related pay (to provide incentives) Agents: Board of Directors Senior Management tutor 2 u™ CONTROL

Ownership, control & influence Principals: Shareholders OWNERSHIP Control Mechanisms: Pressures from the stock market Regular meetings with shareholders (AGM) Performance related pay Agents: Board of Directors Senior Management Other influences on business behaviour: Consumers – e. g. ethical retailing Industry regulators Government (taxation, trade policy etc) tutor 2 u™ CONTROL INFLUENCE

Behavioural Theorists: Managerial Discretion Models tutor 2 u™ ¢ Behavioural economists examine the decisions that are taken within complex business organisations ¢ Stakeholders are those with a vested interest in a business l Employees l Managers l Shareholders (owners) l Customers

Behavioural Theorists: Managerial Discretion Models tutor 2 u™ ¢ Managers often have discretionary powers in deciding on price and output and marketing in different segments of markets ¢ Much depends on the degree of autonomy (freedom) that the head office of a business gives to its managers e. g. people employed in individual sales outlets ¢ Maximising behaviour may be replaced by satisficing – I. e. setting minimum acceptable levels of achievement

Herbert Simon - The Satisficing Principle tutor 2 u™ ¢ Satisficing = Satisfy + Suffice ¢ No business can process all the factors affecting the marketing/pricing of a product, in the hope of maximising profit ¢ This theory is known as “bounded rationality” ¢ The complexity of decisionmaking may lead to managers following “rules of thumb” rather than seek optimal decisions all of the time

Herbert Simon - The Satisficing Principle tutor 2 u™ ¢ Agents (e. g. managers) face information costs in the present and uncertainty about the future ¢ This limits their decisionmaking ability and may force them to make decisions by seeking the first satisfactory solution rather than optimizing

The Principle Agent Problem ¢ ¢ The principal, hires an agent to perform tasks on his behalf but cannot ensure that the agent performs them in exactly the way the principal would like. l The efforts of the agent are expensive and timeconsuming to monitor l Incentives of the agent may differ from those of the principal leading to a conflict of objectives It is linked to the problem of asymmetric information l ¢ tutor 2 u™ Unequal information share between two parties It does not arise if a legal contract can be drawn up to specify all the duties of the agent

Coping with the Principle Agent Problem It boils down to having the right incentives! 1. Share-ownership schemes 2. Performance-related pay (a) Incentive pay schemes e. g. profit sharing (b) Wages related directly to productivity / profitability tutor 2 u™ 3. Long-term employment contracts for senior management – to give them a higher degree of loyalty to the business 4. Generous non-financial rewards but based on / contingent on assessments of performance 5. Regular performance reviews 6. Increasing role played by activist hedge funds