CIMA BA1 Syllabus B. Microeconomic And Organisational Context Of Business - Resolving the principal/agent problem - Notes ^{13 / 13}

We have just seen that the primary objective of a company is the maximisation of shareholder wealth.

However, there is an alternative known as the stakeholder view.

This means balancing shareholder wealth with the objectives of other stakeholders.

Let’s have a look at some stakeholders and their objectives:

Clearly meeting all stakeholders objectives entirely is impossible.

Often they are in conflict with each other. Therefore a degree of compromise is reached.

For example, Performance related pay for example is a means of satisfying both staff and shareholders.

So how can the owners ensure that the agents are working for the owners objectives and not just their own?

1. Fixed wages

   Not always the optimal way to organise relationships between principals and agents. 

   A fixed wage might create an incentive for the agent to shirk since his compensation will be the same regardless of the quality of his work or his effort level.

2. Performance related Pay

   When agents have incentive to shirk, it is often more efficient to replace fixed wages with compensation based on the profits of the firm,  since it makes their compensation dependent on their performance. 

   However this can lead to individuals not working for the team as a whole by inflating budgets required etc. 

   Output may also be encouraged rather than quality. It disregards job satisfaction also

3. Share options

   Seems like a great idea as if the share price goes up then both the managers and the owners benefit. 

   However often shares go up and down in line with market movements regardless of how well the managers have performed so many managers would not like to be measured and paid solely this way. 

   Some element of share options within their pay though would be a good thing and acceptable by all

The principal/agent problem can be addressed by monitoring the actions of management (corporate governance) or by the use of incentive schemes.

Corporate Governance

The systems by which companies are directed and controlled.

(CIMA Official Terminology)

Here are some of the main requirements for effective corporate governance