Business Ownership and Control Stakeholders and objectives Principle agent problem

Stakeholders and aims Stakeholders are groups who have an interest in the activity and performance outcomes of a business Shareholders Managers Employees Suppliers Customers Government and local communities.

Stakeholders and aims Different stakeholders tend to have different objectives e.g.. owners want maximum profits, customers lower prices and workers higher wages. Stakeholder conflict can ensue. Eg in public limited companies, ownership and control are separate: owners seek maximum profits; managers may seek sales maximisation as these increase their bonuses.

Divorce between Ownership & Control The majority of shareholders in a quoted company (plc) cannot exercise day-to-day control over the decisions of managers Managers employed by a business may have different motivations than owners Managers may want to maximise their own utility from being in charge of a business This may lead to decisions that are not consistent with profit maximisation / or maximising shareholder value over time Ownership refers to individuals or organisations that own a firm. In small firms, owners are directly involved in management. Large public limited companies are controlled by directors elected every year by the shareholders at an annual general meeting (AGM). Directors oversee managers. Managers are responsible for making decisions about objectives & strategies, and the best use of resources & organisational structure of the firm to meet those objectives. Directors & managers control plcs owned by many shareholders who take no part in management

Ownership and control Principals: Shareholders Agents: Control Mechanisms: Pressures from the stock market Regular meetings with shareholders (AGM) Performance related pay (to provide incentives) CONTROL Agents: Board of Directors Senior Management

Ownership, control & influence Principals: Shareholders OWNERSHIP Control Mechanisms: Pressures from the stock market Regular meetings with shareholders (AGM) Performance related pay CONTROL Agents: Board of Directors Senior Management INFLUENCE Other influences on business behaviour: Consumers – e.g. ethical retailing Industry regulators Government (taxation, trade policy etc)

Behavioural Theorists: Managerial Discretion Models Behavioural economists examine the decisions that are taken within complex business organisations Stakeholders are those with a vested interest in a business Employees Managers Shareholders (owners) Customers

Behavioural Theorists: Managerial Discretion Models Managers often have discretionary powers in deciding on price and output and marketing in different segments of markets Much depends on the degree of autonomy (freedom) that the head office of a business gives to its managers e.g. people employed in individual sales outlets Maximising behaviour may be replaced by satisficing – I.e. setting minimum acceptable levels of achievement

Herbert Simon - The Satisficing Principle Satisficing = Satisfy + Suffice No business can process all the factors affecting the marketing/pricing of a product, in the hope of maximising profit This theory is known as “bounded rationality” The complexity of decision-making may lead to managers following “rules of thumb” rather than seek optimal decisions all of the time

Herbert Simon - The Satisficing Principle Agents (e.g. managers) face information costs in the present and uncertainty about the future This limits their decision-making ability and may force them to make decisions by seeking the first satisfactory solution rather than optimizing Satisficing: no one objective is maximised. The minimum aims of several stakeholders are met eg lower profits & staff bonuses

The Principle Agent Problem The principal, hires an agent to perform tasks on his behalf but cannot ensure that the agent performs them in exactly the way the principal would like. The efforts of the agent are expensive and time-consuming to monitor Incentives of the agent may differ from those of the principal leading to a conflict of objectives It is linked to the problem of asymmetric information Unequal information share between two parties It does not arise if a legal contract can be drawn up to specify all the duties of the agent

Coping with the Principle Agent Problem It boils down to having the right incentives! Share-ownership schemes Performance-related pay (a) Incentive pay schemes e.g. profit sharing (b) Wages related directly to productivity / profitability Long-term employment contracts for senior management – to give them a higher degree of loyalty to the business Generous non-financial rewards but based on / contingent on assessments of performance Regular performance reviews Increasing role played by activist hedge funds