Free Essay About Separation Of Management And Ownership: Solution To The Problem

When there is separation between ownership and control there arises a conflict of interest between the principal-the owner(investors) and the agent those who control the activity directly (management) also known as principle-agent problem (Investopedia, 2012).. For example, let us say the interest of upper management is in perquisites rather than ensuring activities for profit making are taken to their logical end. In order to resolve them, principals may make contracts, which are in their interests without being monitored, and this makes force, the agents to take the respective actions. Hence, it can be said that incentive contracts are used. However, principles may substitute some monitoring activities like audits, analysts, etc. for financial incentives, when the cost of surveillance is not so costly.
Here the fundamental idea of the incentive contract is that, there would be less incentive for management to carry those activities that are in the interest of the firm but contrary to management's well-being given that the wages are high.
Hence, these kinds of problem and many others may arise due to separation of control and ownership. These types of problems need to be rectified as these things may eventually lead to collapse of the organization. These types of problems arise due to lack of focus on agency cost and governance mechanisms that can solve agency problems like here. Agency costs are the total costs of mechanisms such as structuring the sets of contracts among agents with conflicting interests, along with monitoring, and bonding them. Agency costs also contain the lost output value as the costs to enforce the contracts fully exceed the benefits (STEWARDS, AGENTS, AND THE FOUNDER DISCOUNT: EXECUTIVE COMPENSATION IN NEW VENTURES2015). It is important to control these agency problems in the decision process when the decision managers implement important decision, which are not the major residual claimants, and hence they do not carry a significant share of the wealth effects of their decisions. Without undertaking control procedures effectively, such decision managers are supposed to take actions that can deviate the actions from the interests of residual claimants. Here, the efficient system for decision control implies that the ratification and monitoring of decisions are to be separated from the management of decisions to some extent. The decision of the individual agents can influence the management in some of the decisions and the control of others, but by separation, it means that an individual agent are not allowed to exercise exclusive management and control rights (Anon, 2015).
In the given example, in order to overcome moral hazard that took place, the principal can make the commitment to a particular payment contingent on observing a desired outcome. However, they are not able to observe the actions taken by agent directly given that the example is a contract with a lower fixed salary (component) and a higher variable component that is an imperfect measure of the agent’s long-term actions like stock options. Bonus payments contingent upon some observed outcome can also be used as tactics in order to address shorter-term incentives.
The mechanism of corporate governance also should be used to solve the problem. Usually it is not examined how a large firm achieves efficient monitoring in agency relationship or say how do companies structure their corporate governance in order to control the agency problem created by the separation of ownership and control and this gives rise to the problem. The agency problem can be managed efficiently by establishing internal devices in response to competition from other firms. According to Fama (1980, p. 288), "individual managers within the company are controlled by the market's discipline and opportunities for their services both within and outside the firm". Accordingly, the companies segregate their decision management typically from the decision control rights at both top level and lower levels as like managers and workers in the hierarchy of the company.
The reason to separate decision management from decision control is to avoid situations when the agents who have no ownership of firm’s resources and who may look for their self-interest by making the decisions suboptimal to the principal (THE THEORETICAL FOUNDATIONS OF CORPORATE GOVERNANCE 2015). Hence, in order control the agency problem that are likely to arise with the senior managers including the CEO, the board of directors should be appointed by the owners as a corporate governance solution to the problem. The board have attorney in the decision control whereas the senior managers decision management rights. Hence, these types of mechanisms help to solve the problems that may arise in the agency problem.
In addition, the appointment of directors from outside controls the objectivity of other internal directors' decisions. It is expected that such incentive contracts will help to address the individual interests of directors and owners and contribute to mitigating agency problems. Similarly, market discipline also contributes to ensuring corporate governance fairness of the firm. For example, when boards fail to exercise their fiduciary duties and the firm fails, the company may be acquired or taken over by a competitor firm whose owners believe that they can reduce the agency costs of the ailing firm.
Hence, these are the solutions to the problems created due to separation between ownership and control.

References

Anon, (2015). [online] Available at: http://www.uiowa.edu/~lawjcl/articles/volume%2036-1/Sepe.pdf [Accessed 7 Mar. 2015].
Investopedia, (2012). The Agency Problem - Complete Guide To Corporate Finance | Investopedia. [online] Available at: http://www.investopedia.com/walkthrough/corporate-finance/1/agency-problem.aspx [Accessed 7 Mar. 2015].
“STEWARDS, AGENTS, AND THE FOUNDER DISCOUNT: EXECUTIVE COMPENSATION IN NEW VENTURES”. (2015). 1st ed
THE THEORETICAL FOUNDATIONS OF CORPORATE GOVERNANCE. (2015). 1st ed.
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