Question

Learning Objective:

Identify the potential conflicts that arise within the firm between stockholders and managers and between stockholders and bondholders, and discuss the techniques that firms can use to mitigate these potential conflicts.

Topic:

A well-run company should align the management’s interest and with the owner’s interests.

What are some actions that stockholders can take to ensure that management’s and stockholders’ interests are aligned? Is this important? What are some of the risks/consequences if the management’s interests are not aligned with the owners?

Answer 1

Potential conflict that arises between stockholders and manager is when manager start to act in their own interest instead of acting in the interest of shareholder because managers are the agents of shareholder and their share agent principal relationship with the shareholder.

there are various conflicts between stockholders and bondholders as well because bond holders have priority of claim in case of liquidation of company and they also have debt covenant associated with them so there arises a conflict because they always want to control the operation of the company and interfere into the management of the equity shareholders

A company should align the managements interest with the owner's interest because it will help in maximization of the wealth of the overall company which will help the stakeholders of the company.

Some of the steps which can be taken by the stockholders to ensure that management and stockholders interest are aligned by better coordination and cooperation and a well-established channel of communication between principal and agent in order to have an effective management of business which will focus on the the profit maximization as well as share holders maximization of wealth so it will overall lead to to protection of the interest of stockholders in a company.

it can also be done through better compensation scheme, which will protect the interest of the management and restrict them through doing anything which are fraudulent in nature and always motivate them to do in the interest of shareholder.

Consequences if management interest are not aligned with the owners is that it it will lead to the dissatisfaction among principal and agent and it will lead to conflict because the management would always be looking for maximization of its own interest and undermining the interest of the shareholders.