Ownership is the state or fact of being an owner which refers to the shareholders of the company. Control is the management process in which the actual performance of a company. The profit maximization may be unrealistic where ownership and control are in hands of different groups of people. In the first part of the essay, I will analyze the reason why the separation of ownership and control result in lower firm profits. Corporate control is shares of public firms are traded, and in large enough blocks this means control over corporations is traded. That puts some pressure on managers to perform well, otherwise their corporation can be taken over. In the second part of the essay, I will evaluate the effectiveness of corporate control in order to discipline managerial behavior.
The dispersion of the shareholdings in management-controlled firms leads to a lower profit. Management-controlled firms are those in which no single shareholder held more than 20 percent of shares, which 85 percent of US 200 largest firms were management controlled in 1963. In the US- or UK-style large public corporations, shares are usually highly dispersed with a lot of small shareholders. The shareholders typically have rights in the form of votes, but are too small and numerous to exercise control on a day-to-day basis. The dispersed shareholders have little incentive to monitor management because monitoring is a public good. If a shareholder's monitoring leads to improved company performance, all shareholders benefit. Given that monitoring is costly, each shareholder will free-ride in the hope that other shareholders will do the monitoring. Unfortunately, all shareholders think the same way and the result is that no monitoring will take place. Shareholders may have little incentive to launch a proxy fight since their vote is unlikely to make a difference. They have limited time to spend effort monitoring the administration of the company as they have relatively little invested. They are also hard to coordinate any action against the managers. The dispersed shareholders would not be able to exert control over the managers. They would not criticize the management when they are provided a moderate level of dividend.
The income nature of the Chief Executive Officer in the firm is another factor associated to a low incentive of generating maximum profit. If the income of the CEO is fixed or high income even when there is a loss in the company, they will not be motivated to seek maximum profit. The income of the CEOs should be related to the profit or the shares price in order to generate maximum profit. However, Jensen and Murphy (1990) stated that the CEOs in the US additional personal wealth arising from an increase in shareholder value of $1000 was only $3.25, which shown there was not sufficient to align CEOs’ interests with the shareholders. As under the legal requirement, the Chief Executive Officer could not take the form of a direct ownership stake in the firm as an income return. The corporation operates are usually limited to provide large scale payments to executives. Maximum profit thus is likely failed to achieve due to the weak working incentives of the Chief Executive Officers.
The behavior of the institutional shareholders such as pension funds, investment trusts, insurance companies, etc are another reason determine the manager in the firm. Although the institutional shareholders have great potential power to motivate the managers and are well informed about the activities of the firm they own, as they holds significant proportions of corporate equity. Nevertheless, they may still exhibit only minor concern about the managerial performance. The attempts to intervene in the running of companies they own such as hiring a manager to act on their behalf would be incurred a high cost and ineffective. When the financial institutions found the firm they invested is underperforming, they may just simply sell the shares out, instead of correcting the management.
The role of institutional shareholders in the market-based systems leads to lower profit. In the US and UK outsider systems, institutional shareholders play a limited role in monitoring and influencing the managers of the firm they own. They simply observe the share price and sell the shares of the firms they think are under-performing. They exert pressure by exit the company rather than voice in the management which have no benefit in improving the management to maximize the profit.
The ability of board of directors and managers are another factor associating lower profit. The board of directors consists of executive directors from the management team and non-executive directors. The executive directors could not monitor the whole firm themselves. The board members may not do a good job of monitoring managers. They may have poor information of the company if they are not good quality chief executive officers. As collecting the market information can be very costly which is in fact required for effective monitoring. Limitations on the information are therefore a failure of management. On the other hand, the non-executive directors may not do a very good job. Since they may not have a significant financial interest in the company, they may have only little gain from company performance. In addition, non-executive directors are busy as they may be chief executives and sit on many boards. They probably have little time to think about the company's affairs or to collect information about the company.
To conclude, the dispersion of the shareholdings in management-controlled firms, the income nature of the Chief Executive Officer in the firm and the behavior of the institutional shareholders may put insufficient pressure to the managers to act for the interest of shareholders. The ability of board of directors and managers with inadequate market information are the factors influencing the separation of ownership and control failure to achieve maximum profit. The theoretical analysis gives evidence that managers do not serve the shareholders completely. However, the competitive market forces the manager to act in an aim of profit maximization to avoid bankruptcy. In order to survive in the managerial market, the managers would strike hard to work on profit maximization.
The market for corporate control is effective disciplining managerial behavior as the shareholders could use exit, selling shares in a firm if they believe it to be earning less profit then it could under poor management. It provides a source of pressure on managers through the working of share price. As share prices are determined by the amount of investor willing to pay that is equal to the present value of future profits. If the firm is making less than the maximum profit, the share prices will be undervalued than in the situation of profit maximization. A take-over threat will arise. Take-over exists when the one seek to buy up the undervalued shares, dispose of the incumbent management, in an objective to produce higher profits and rise in share price.
Under the risk of being taken over, the lazy managers may be disposed by new shareholder. Therefore, the managers of firms would be motivated to work hard to prevent loss of wealth or prestige under the corporate control. If the top managers’ job perspectives and salaries are dependent on their performance, they will work hard to avoid dismissal, takeovers and to gain a success in their management portfolio. They cannot get another job easily after poor performance.
For the limitations, the take-over will not take place in some situations. The firm is under-valued by the share market because of the information asymmetries. It may be facing other economic difficulties instead of managerial difficulties which the take-over raider will be feared and stop his action on the take-over. In another situation, the shareholders who know that the firm is worth more than its current value after take-over will not be willing to sell for less than the real worth. The raider will not buy those shares because of the high cost as the raider fail to make a big enough offer to persuade the shareholder to sell. There will be no profit for the raider to get control of the firm. Take-over thus is not an act as an effective disciplinary mechanism. In practice, the purchases of shares are big when there is an intention to take-over. The share prices would rise as a high cost for taking over.
Also, the managers of firms would use a variety of stratagems to defend the take-over threat. Supermajority amendments appears when they may persuade their shareholders to change the company constitution, thus most of the votes are needed for the approval of mergers or changes in the board of director. They might issue shares that carry the right to dividends but no voting rights. A poison pill is the existing shareholders are given the right to sell their shares to the company at high prices after a change of ownership, giving the incumbent an impossible burden if the take-over succeeds. The shareholders will have the right to buy more shares at a discount, if one shareholder buys a certain percentage of the company's shares. It imposes significant costs on the bidder with his equity holdings and his voting rights. The green mail is a practice of purchasing enough shares in a firm to threaten a takeover and thereby forcing the target firm to buy those shares back at a premium in order to suspend the takeover. The raider is offered a high price for the shares it has already purchased in return for abandoning the bid. The greenmailer ends up sell his share back to the company to end the threat but at a substantial premium to the fair market stock price. The golden parachute is an agreement between a company and the managers specifying that the managers will receive certain benefits if employment is terminated. The take-over m Those benefits may include severance pay, cash bonuses, stock options, or other benefits which must be paid in the take-over, adding the cost of take-over. However, the managers may sell the company in low price in order to get the extra payments following the take-over. It helps an executive to remain his business objective during the takeover process. The takeover attempts will have an increasing burden by the cost of golden parachute.
In conclusion, the corporate control is effective in a certain extent. The corporate control is an important mechanism in a market economy. It gives incentives to the managers to work for profit maximization from the threat of being taken over which is related to their job being dismissed. They manage company efficiently to gain the interest of their salaries and reputation, alongside the shareholders get the dividend distributed from the profit. Yet, the shareholders would in revenge use the defensive tactics such as the supermajority clauses, poison pills, greenmail, golden parachute, etc to prevent from taken over by a potential big shareholder to become a new management board. Those would hinder an effective market for corporate control.
