1. IntroductionSince the introduction of the corporate business model, there has been a relationship that exists that inhibits a firm's ability to maximize its value. It is the structure of the corporation itself that brings about this problem; shareholders, who through their investment in the corporate entity own the firm, appoint a governance board that hires managers to run the operations of the company. On the surface, this arrangement seems like an efficient means by which a corporation may operate. Company owners, especially those with minimal interests in the firm, are already busy with their day-to-day affairs. They neither have the time nor the expertise to make substantive decisions about firm operations. As such, they appoint managers, or "insiders," who have the relevant experience and knowledge to make decisions that will be value-maximizing for the company.
The issue then becomes whether or not managers always make decisions that are best for the firm.
English: Shareholders Atradius 2010 Nederlands: Aa...
Shore Entertainment, Inc.
English: Payout diagram for shareholders of a firm...Managers operate the company with minimal interference from the shareholders. Company owners view only a fraction of the daily duties and decisions made by managers. The problem, then, stems from managers' ability to take actions that will benefit themselves more than the company itself. This is especially prevalent with management compensation issues, where a company official's bonus is based on meeting a certain financial accounting measure. As such, a company manager may make decisions that, while not optimal for the firm as a whole, will allow him or her to reach that measure to ensure their bonus is received. This issue is known as the "agency problem, and involves an "agent" (who is company management in this case) who is hired by a "principal" (company shareholders) to handle its affairs in the principal's best interests. The simple example illustrated above is just one of a...