The main aim of management may differ from those of the firm’s shareholders. In a large corporation, the stock may be so widely held that stockholders cannot even make known their objectives, much less control or influence management. Often ownership and control are separate, a situation that allows management to act in its own best interests rather than those of the stockholders.
We may think of management as agents of the owners. Stockholders, hoping that the agents will act in the stockholder’s best interests, delegate decision-making authority to them. Agency theory of the firm states the agent will make optimal decisions only if appropriate incentives are given and only if the agent is monitored. Incentives include stock options, bonuses, and perquisites, and they are directly related to how close management decisions come to the interests of stockholders.
Monitoring can be done by bonding the agent, systematically reviewing management perquisites, auditing financial statements, and explicitly limiting management decisions. The monitoring activities necessarily involve costs, an inevitable result of the separation of ownership and control of a corporation.
Agency problems also arise in creditors and shareholders’ having different objectives, thereby causing each party to want to monitor the others. Similarly, other stakeholders-employees, suppliers, customers, and communities- may have different agendas and may want to monitor the behavior of shareholders and management. Agency problems occur in investment, financing, and dividend decisions by a company.