Question

Case Study

Much production in the modern economy takes place within corporations. Like other firms, corporations buy inputs in mar-kets for the factors of production and sell their output in markets for goods and services. Also like other firms, they are guided in their decisions by the objective of profit maximization. But a large corporation has to deal with some issues that do not arise in, say, a small family-owned business. What is distinctive about a corporation? From a legal standpoint, a corporation is an organization that is granted a charter recognizing it as a separate legal entity, with its own rights and responsibilities distinct from those of its owners and employees. From an economic standpoint, the most important feature of the corporate form of organization is the separation of ownership and control. One group of people, called the shareholders, own the corporation and share in its profits. Another group of people, called the managers, are employed by the corporation to make decisions about how to deploy the corporation's resources. The separation of ownership and control creates a principal-agent problem. In this case, the shareholders are the principals, and the manageii are the agents. The chief executive officer and other managers, who are in the best position to know the available busi- ' ness opportunities, are charged with the task of maximizing profits for the shareholders. But ensuring that they carry out this task is not always easy. The managers may have goals of their own, such as taking life easy, having a plush office and a private jet, throwing lav-ish parties, or presiding over a large business empire. The managers' goals may not always coincide with the goal of profit maximization.

The corporation's board of directors is responsible for hiring and firing the top management. The board monitors the managers' performance, and it designs their compensation packages. These packages often include incentives aimed at aligning the interests of shareholders with the interests of management. Managers might be given bonuses based on performance or options to buy the com-pany's stock, which are more valuable if the company performs well. Note, however, that the directors are themselves agents of the shareholders. The existence of a board overseeing management only shifts the principal-agent problem. The issue then becomes how to ensure that the board of directors fulfills its own legal obligation of acting in the best interest of the shareholders. If the directors become too 'friendly with management, they may not provide the required oversight. The corporation's principal-agent problem became big news around 2005. The top managers of several prominent companies, such as Enron, Tyco, and WorldCorn, were found to be engaging in activities that enrichedthemselves at the expense of their sharehold- ers. In these cases, the actions were so extreme as to be criminal, and the corporate managers were not just fired but also sent to prison. Some shareholders sued directors for failing to monitor management sufficiently. Fortunately, criminal activity by corporate managers is rare. But in some ways, it is only the tip of the iceberg. Whenever ownership and control are separated, as they are in most large corporations, there is an inevitable tension between the interests of shareholders and the interests of management.

Please answer the following questions:

1. Why would management be willing to accept a certain profit that is lower than the expected value of an uncertain prospect that is insurable?

2. Discuss the following statement: "profit maximization make senses only if management is risk neutral.

3. "Managerial economics is at the core of the management of nonbusiness organizations like government agencies as well as the management of firms." Explain.

4. Although management economists generally assume that firms want to maximize profit, it is recognized that a principle-agent problem arises if managers pursue their own interests, even this decreases the profits of the owners. In case a principle-agent problem exists, how owners of firms try to minimize the risk of the problem?

5. Management is the core factor behind business performance and growth. In recent years, Bahrain has been making efforts to encourage private sector taking more active part in the economy. Converting the economy into a knowledge-based economy, as outlined in Vision 2030, will require strong managerial and entrepreneurial skills to make effective decisions and reduce the risk of failure. The question is this: What are the challenges and opportunities of doing business in Bahrain? Why there are very few multinational corporations currently doing business in the country?

Answer 1

1. Sometimes the managements goal may differ with the goals of the company. It is not necessary that the managers also share the goal of profit maximization, sometimes managers can take decisions that are contracting in nature to the goals of the company because they have more appropriate knowledge of the available business opportunities and sometimes dur to their own personal needs.

2. In a saturation where there are shareholders and managers their arises the problem of ."principle- agent problem". The agent needs to he risk neutral to effectively work for the corporation so as to maximize profitability. The principles agent problem suggests that there may be differences between the need of the shareholder and the managers.

3. Managerial economics is an amalgam of diverse subjects, the common core is the application of the fundamental principles of eco­nomics to analyse and to help solve problems faced by organizations in a modern mixed economy. In words of K.k seo & B.j winger "managerial economics is the in­tegration of economic theory and methodology with analytical tools for applications to decision making about the allocation of scarce resource in public and private institution.”

4. The corporation's board of directors is responsible for hiring and firing the top management. The board monitors the managers' performance, and it designs their compensation packages. These packages often include incentives aimed at aligning the interests of shareholders with the interests of management. Managers might be given bonuses based on performance or options to buy the com-pany's stock, which are more valuable if the company performs well. The idea behind this is to provide enough to the managers that they are willing to work as per the needs of the shareholders.

5. Bahrain opportunities-

Bahrain is constituted of 30 islands and has been the junction for major trade routes, because of its strategic location in the Arabian Gulf. The country enjoys a great location as it’s situated at the crossroads of trade routes, with Qatar to its north and the Kingdom of Saudi to its east

It’s a good idea to set up business in Bahrain and opt from the following most profitable business ideas or opportunities in Bahrain in the year 2020 like Finance and Banking , Construction Agency , Restaurants , Real Estate , Hospitality and Tourism ,Retailing , Financial Consultancies

Challenges-

1.Although foreign companies are not required to have local partners, local businessmen with strong government contacts can sometimes influence government decision-making.

2. Interpretation and application of the law sometimes varies by ministry and may depend on the stature and connections of an investor's local partner.

3.The "Bahrainization" of the labor force – a quota system requiring employers to employ a minimum percentage of Bahrainis – can sometimes lead to delays and confusion over work permit issuance and renewal.

4. Many of the largest infrastructure projects in Bahrain are funded by Bahrain’s wealthier GCC neighbors through the so-called GCC Stabilization Fund. Although those projects are tendered via the Bahrain Tender Board, final award decisions often are made by the country that funds the project, which may override the Tender Board’s recommendation.