Conflicts between Stockholders and Managers - dummies

Conflicts between Stockholders and Managers

By Kenneth Boyd, Lita Epstein, Mark P. Holtzman, Frimette Kass-Shraibman, Maire Loughran, Vijay S. Sampath, John A. Tracy, Tage C. Tracy, Jill Gilbert Welytok

Stockholders are primarily concerned with the profit performance of the business; the dividends they receive and the value of their stock shares depend on it. Managers’ jobs depend on living up to the business’s profit goals. But whereas stockholders and managers have the common goal of optimizing profit, they have certain inherent conflicts of interest:

  • Manager compensation: The more money that managers make in wages and benefits, the less stockholders see in bottom-line net income. Stockholders obviously want the best managers for the job, but they don’t want to pay any more than they have to.

    Most public business corporations establish a compensation committee consisting of outside directors that sets the salaries, incentive bonuses, and other forms of compensation of the top-level executives of the organization. An outside director is one who has no management position in the business and who, therefore, should be more objective and shouldn’t be beholden to the chief executive of the business.

    This scenario is good in theory, but it may not work out all that well in practice — particularly if the top-level executive of a large public business has the dominant voice in selecting the people to serve on its board of directors. Being a director of a large public corporation is a prestigious position, to say nothing of the annual fees that can be fairly substantial at many corporations.

  • Control over the business: The question of who should control the business — managers who are hired for their competence and are intimately familiar with the business, or stockholders who may have no experience relevant to running this business but whose money makes it tick — can be tough to answer.

  • Ideally, the two sides respect each other’s contributions to the business and use this tension constructively. Of course, the real world is far from ideal, and in some companies, managers control the board of directors rather than the other way around.

As an investor, be aware of these issues and how they affect the return on your investment in a business. If you don’t like the way your business is run, you can sell your shares and invest your money elsewhere. (However, if the business is privately owned, there may not be a ready market for its stock shares, which puts you between a rock and a hard place.)