Question

Among the many interesting topics related to businesses covered in this module, two of them probably need our further attention and discussion. One is about the goal of a firm, which is the maximization of the owners’ wealth. The other is about corporate governance issues resulted from the separation of ownership and management, which is another principle of finance. Choose one of them and discuss.

Answer 1

Separation of Ownership and management : Corporate Governance Issue

In public listed companies. The ownership doesn't lie with the management of the company. As the shares are distributed in public, so the ownership is also distributed. Now shareholders appoint a Board who decides the management of the company. This has led to Agent- Principal problem. Agent being the management here and principal is the shareholders. Management's compensation depends on the size of the company and also the share performance. So to increase the size of the company, management tend to go for mergers which are not strategically important for the company. At times managers try to opt projects that will reflect immediate profit, this helps to increase the share price in the short run. Managers stop thinking about the long term benefit of the shareholders.

So these all are corporate governance issues. Proper governance means where management will work for the benefit of the shareholders, there will be no information asymmetry between management and shareholders. Proper corporate governance plays an important part in public company.