What Inherent Characteristic Of Corporations Creates 188390

129 1 What Inherent Characteristic Of Corporations Creates The Need

What inherent characteristic of corporations creates the need for a system of checks on manager behavior? The corporation allows for the separation of management and ownership. Thus, those who control the operations of the corporation and how its money is spent are not the same who have invested in the corporation. This creates a clear conflict of interest and this conflict between the investors and managers creates the need for investors to devise a system of checks on managers—the system of corporate governance.

What are some examples of agency problems? Examples of agency problems are excessive perquisite consumption (more company jets/company jet travel than needed, nicer office than necessary, etc.), and value-destroying acquisitions that nonetheless increase the pecuniary or non-pecuniary benefits to the CEO on net.

What are the advantages and disadvantages of the corporate organizational structure? The corporate organizational form allows those who have the capital to fund an enterprise to be different from those who have the expertise to manage the enterprise. This critical separation allows a wide class of investors to share the risk of the enterprise. However, this separation comes at a cost—the managers will act in their own best interests, not in the best interests of the shareholders who own the firm.

Is it necessarily true that increasing managerial ownership stakes will improve firm performance? No. There are two counter-arguments. First, as Demsetz and Lehn (1985) argue, there is no reason to expect a simple relation between ownership and performance. The corporate governance system has many dimensions, and a one-size-fits-all approach is too simplistic; the right ownership level for one firm may not be suitable for another. Second, research shows a non-linear relationship—initial increases in ownership may improve performance, but within certain ranges, managers may entrench themselves, diminishing overall firm performance.

How can proxy contests be used to overcome a captured board? Proxy contests are contested elections for directors, where shareholders propose two or more slates of directors. If a board has become captured or unresponsive, shareholders can put forth a dissident slate. If the dissident slate wins, shareholders succeed in installing new directors, likely not beholden to the CEO, thus restoring oversight.

What is a say-on-pay vote? A say-on-pay vote is a non-binding shareholder vote on whether they approve an executive’s pay package.

What are a board’s options when confronted with dissident shareholders? A board can ignore the dissident, risking a proxy fight, or negotiate with the dissident shareholder to reach an agreement.

Paper For Above instruction

The inherent characteristic of corporations that necessitates a system of checks on manager behavior is the separation of ownership and management. In corporate structures, ownership—represented by shareholders—and management—run by executives—are distinct entities. This separation inherently creates agency problems, as managers may not always act in the best interests of shareholders. Shareholders invest capital but often lack direct control over daily operations, leading to potential conflicts of interest where managers might pursue personal benefits at the expense of shareholder value.

The primary concept underpinning the need for corporate governance mechanisms is the agency problem. Managers might indulge in excessive perks, such as private jets, luxurious offices, or engaging in acquisitions that benefit themselves financially or non-financially, but destroy shareholder value. These issues highlight the importance of formal checks and balances within the corporate structure.

The advantages of a corporate organizational structure include the facilitation of capital accumulation and risk-sharing among a wide pool of investors. Since managers can be different from investors, the corporation can leverage specialized managerial expertise, allowing investors to shoulder less managerial risk while funding operations. Nonetheless, this separation introduces disadvantages—namely, the risk of managerial shirking or self-interested behavior, which can undermine shareholder interests, leading to agency costs.

Research emphasizes that increasing managerial ownership stakes does not automatically translate into improved firm performance. As Demsetz and Lehn (1985) argue, ownership-performance relationships are complex, and an optimal ownership level varies among firms. Empirical studies indicate a nonlinear relationship, with moderate ownership enhancing performance, but excessive ownership possibly entrenching managers and reducing performance.

To counteract issues like a captured or unresponsive board, shareholders can utilize proxy contests—contested elections where shareholders propose and vote for different slates of directors. If successful, this process can replace ineffective boards and ensure managerial oversight aligns with shareholder interests.

The concept of a "say-on-pay" vote offers shareholders a non-binding but meaningful mechanism to express approval or disapproval of executive compensation arrangements, increasing managerial accountability.

When dealing with dissident shareholders, boards can either ignore them—risking a proxy fight—or engage in negotiations to reach mutually agreeable solutions. Both options reflect strategic responses to safeguard the company's governance integrity.

Overall, the characteristics linking corporation structure and the need for governance mechanisms highlight the complexity of aligning managerial incentives with investor interests. Effective systems—via voting rights, proxy contests, and transparency—are critical to mitigate agency problems and promote sustainable corporate performance.

References

• Demsetz, H., & Lehn, K. (1985). The Structure of Corporate Ownership: Causes and Consequences. Journal of Political Economy, 93(6), 1155-1177.
• Jensen, M.C., & Meckling, W.H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3(4), 305–360.
• Shleifer, A., & Vishny, R.W. (1997). A Survey of Corporate Governance. The Journal of Finance, 52(2), 737-783.
• Monks, R. A., & Minow, N. (2011). Corporate Governance. John Wiley & Sons.
• Fama, E.F., & Jensen, M.C. (1983). Separation of Ownership and Control. Journal of Law and Economics, 26(2), 301-325.
• Core, J.E., Holthausen, R.W., & Larcker, D.F. (1999). Corporate governance, executive compensation, and firm performance. Journal of Financial Economics, 51(3), 371-406.
• Gompers, P., Ishii, J., & Metrick, A. (2003). Corporate Governance and Equity Prices. The Quarterly Journal of Economics, 118(1), 107-155.
• Fama, E.F., & Jensen, M.C. (1983). Separation of Ownership and Control. Journal of Law and Economics, 26(2), 301-325.
• Cai, J., Garner, J., & Walkling, R. (2009). Electing Directors. The Journal of Finance, 64(5), 2389-2421.
• Bebchuk, L.A., & Fried, J.M. (2004). Pay without Performance: The Unfulfilled Promise of Executive Compensation. Harvard University Press.