2.2 Relationship between Shareholders and Company Management

Corporate governance tackles the complex relationships between companies and their stakeholders. It's all about balancing the interests of shareholders, managers, and other groups affected by a company's actions.

At its core, governance deals with the principal-agent problem: how to ensure managers act in shareholders' best interests. Mechanisms like performance-based pay and board oversight aim to align these interests and drive better company performance.

Corporate Governance and Stakeholder Relationships

Principal-agent relationship in governance

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• Principals are shareholders who own the company and hire agents (managers) to run it on their behalf
• Potential conflicts of interest arise when managers prioritize their own interests over shareholders'
  • Excessive compensation packages for managers
  • Empire building by pursuing projects that increase manager's power but not shareholder value
  • Risk aversion leading to missed opportunities for growth
• Mechanisms to align principal-agent interests
  • Compensation packages tied to company performance (stock options, bonuses)
  • Board of directors provides oversight and represents shareholder interests
  • Threat of takeovers disciplines underperforming companies by replacing ineffective management

Stakeholders and corporate decision-making

• Shareholders are the owners of the company
  • Elect the board of directors to represent their interests
  • Approve major decisions (mergers, acquisitions, changes to bylaws)
  • Exercise shareholder rights (voting, access to information, derivative lawsuits)
• Board of Directors is elected by shareholders
  • Oversees management and company strategy
  • Appoints and dismisses top executives (CEO, CFO)
  • Ensures management acts in the best interest of shareholders
• Management is hired by the board to run day-to-day operations
  • Makes strategic and operational decisions (product development, pricing, marketing)
  • Accountable to the board and shareholders for company performance
• Other stakeholders influence decision-making through various means
  • Employees (unions negotiate wages and benefits)
  • Customers (consumer advocacy groups lobby for product safety and quality)
  • Suppliers (long-term contracts, partnerships)
  • Creditors (debt covenants, credit ratings)
  • Communities (local regulations, public relations)

Management decisions vs company performance

• Capital allocation decisions impact shareholder value
  • Investing in projects with positive net present value (NPV) increases value
  • Poor investment decisions (overpriced acquisitions, unsuccessful R&D) destroy value
• Financing decisions affect the cost of capital and financial risk
  • Optimal capital structure balances cost of debt (interest) and equity (dividends)
  • Excessive debt increases financial risk and may lead to bankruptcy
• Dividend policy balances returning cash to shareholders vs reinvesting in growth
  • Paying dividends provides immediate return to shareholders
  • Retaining earnings allows for reinvestment in profitable projects
• Operational efficiency impacts profitability and cash flow
  • Effective management of costs (lean manufacturing, supply chain optimization)
  • Streamlined processes (automation, outsourcing non-core functions)
  • Productive human resources (employee training, incentive systems)
• Corporate governance aligns management and shareholder interests
  • Strong governance (independent board, transparent reporting) reduces agency costs
  • Weak governance (insider boards, opaque financials) may lead to mismanagement and fraud

Corporate Responsibility and Stakeholder Management

• Corporate governance structures ensure ethical and effective management
• Stakeholder theory emphasizes considering all stakeholders' interests in decision-making
• Executive compensation policies aim to align management interests with shareholders
• Corporate social responsibility initiatives address broader societal and environmental concerns