Solutions to Shareholders and Management Conflict of Interest
Conflicts between shareholders and management may be resolved as follows:
1. Pegging/attaching managerial compensation to performance
This will involve restructuring the remuneration scheme of the firm in order to enhance the alignments/harmonization of the interest of the shareholders with those of the management e.g. managers may be given commissions, bonus etc. for superior performance of the firm.
2. Threat of firing
This is where there is a possibility of firing the entire management team by the shareholders due to poor performance. Management of companies have been fired by the shareholders who have the right to hire and fire the top executive officers e.g the entire management team of Unga Group, IBM, G.M. have been fired by shareholders.
3. The Threat of Hostile Takeover
If the shares of the firm are undervalued due to poor performance and mismanagement. Shareholders can threatened to sell their shares to competitors. In this case the management team is fired and those who stay on can loose their control and influence in the new firm. This threat is adequate to give incentive to management to avoid conflict of interest.
4. Direct Intervention by the Shareholders
Shareholders may intervene as follows:
- Insist on a more independent board of directors.
- By sponsoring a proposal to be voted at the AGM
- Making recommendations to the management on how the firm should be run.
5. Managers should have voluntary code of practice, which would guide them in the performance of their duties.
6. Executive Share Options Plans
In a share option scheme, selected employees can be given a number of share options, each of which gives the holder the right after a certain date to subscribe for shares in the company at a fixed price.
The value of an option will increase if the company is successful and its share price goes up. The theory is that this will encourage managers to pursue high NPV strategies and investments, since they as shareholders will benefit personally from the increase in the share price that results from such investments.
However, although share option schemes can contribute to the achievement of goal congruence, there are a number of reasons why the benefits may not be as great as might be expected, as follows:
Managers are protected from the downside risk that is faced by shareholders. If the share price falls, they do not have to take up the shares and will still receive their standard remuneration, while shareholders will lose money.
Many other factors as well as the quality of the company’s performance influence share price movements. If the market is rising strongly, managers will still benefit from share options, even though the company may have been very successful. If the share price falls, there is a downward stock market adjustment and the managers will not be rewarded for their efforts in the way that was planned.
The scheme may encourage management to adopt ‘creative accounting’ methods that will distort the reported performance of the company in the service of the managers’ own ends.
The choice of an appropriate remuneration policy by a company will depend, among other things, on:
- Cost: the extent to which the package provides value for money
- Motivation: the extent to which the package motivates employees both to stay with the company and to work to their full potential.
- Fiscal effects: government tax incentives may promote different types of pay. At times of wage control and high taxation this can act as an incentive to make the ‘perks’ a more significant part of the package.
- Goal congruence: the extent to which the package encourages employees to work in such a way as to achieve the objectives of the firm – perhaps to maximize rather than to satisfy.
7. Incurring Agency Costs
Agency costs are incurred by the shareholders in order to monitor the activities of their agent. The agency costs are broadly classified into 4.
a) The contracting cost. These are costs incurred in devising the contract between the managers and shareholders.
The contract is drawn to ensure management act in the best interest of shareholders and the shareholders on the other hand undertake to compensate the management for their effort
Examples of the costs are:
- Negotiation fees
- The legal costs of drawing the contracts fees.
- The costs of setting the performance standard,
b) Monitoring Costs This is incurred to prevent undesirable managerial actions. They are meant to ensure that both parties live to the spirit of agency contract. They ensure that management utilize the financial resources of the shareholders without undue transfer to themselves.
- External audit fees
- Legal compliance expenses e.g. Preparation of
- Financial statement according to international accounting standards, company law, capital market authority requirement, stock exchange regulations etc.
- Financial reporting and disclosure expenses
- Investigation fees especially where the investigation is instituted by
- Cost of instituting a tight internal control system (ICS).
c) Opportunity Cost/Residual LossThis is the cost due to the failure of both parties to act optimally e.g.
- Lost opportunities due to inability to make fast decision due to tight internal control system
- Failure to undertake high risk high return projects by the manager leads to lost profits when they undertake low risk, low return projects.
d) Restructuring Costs – e.g. new I.C.S., business process reengineering etc.