Question

18.   This module discusses ways in which the interests of the owners of a firm and the managers who are not owners may differ. What are some of the common differences in such interests? What are the implications of these potentially differing interests on the overall competitive performance of the firm?

Answer 1

Some of the common differences between owners and managers who are not owners can be summarised as below:

(i) Managers are usually more willing to take more risks be it financing, operating or investing as their major part of compensation is in form of fixed salaries they have less to loose. On the other hand, owners desire maximised returns in the form of capital gains and dividend but are generally more risk averse.

(ii) Owners often views excess cash on company's balance sheet and agitate its return in form of cash dividends on the other hand, management may want to use this cash to make new investments or to add on its existing capacity

(iii) Managers may engage in self dealing, entering into transactions that benefit them over its owners. At times, managers may get involved in inflating financial figures to maximise their bonuses.

This difference in interest is more of a principal-agent problem as it involves difficulty in motivating one party (the agent-Manager) to act on behalf of another (the principal - owner). These two parties have different interests and assymetic information resulting in conflict resulting in Agency cost to the firm. It adversely affect the financial performance of the firm like Managers, in their own empire builing mode, may indulge in projects with low NPV thus affecting overall viability of the firm in the long run.