Balancing Shareholders and Management in Microeconomics - dummies

Balancing Shareholders and Management in Microeconomics

By Peter Antonioni, Manzur Rashid

In reality, companies are often very complex entities. In microeconomics, the main difference is that large companies tend to be owned by one set of people — shareholders — and managed by another — the professional managers they hire.

Deciding how vital shareholders are to a company is an important question, and the answer isn’t as obvious as it may seem. The American Academy of Management, for instance, completely changed its view on the matter between the 1970s and 1980s (and has changed back again since).

In 1973, it announced that the company was at the centre of a set of relationships, between workers, owners, customers, and wider society. In 1980, though, following management fashion at the time, it said that only shareholders were important to the company, and only their interests should really matter!

Shareholders in a company typically have a stake in the ownership of the firm that entitles them to a share of its profits. The problem is that offering the share is management’s decision. That means that managers have to impress shareholders with their pitch for how much of the company’s profits — earnings in financial terms — they return to shareholders and in what form they do so.

Clearly, many trade-offs are required here. For instance, if a company retains too little of its profits for investment, shareholders may be called upon to stump up more cash in the future for investment purposes. They may not like that.

Retain too much of its profits, however, and shareholders wonder why you’re making unproductive investments. Make too much cash without a corresponding investment and investors — who want to make as much return on their capital as they can — can start demanding that you return some cash to them, either as dividends or by buying back some of their shares.

Therefore, although the economic model of a profit-maximising firm is a good modelling tool for general purposes, when you look specifically at how a company keeps all these people happy, you soon see that the problem becomes far more complex than you expected!