There is not one conflict between managers and shareholders. Various different underlying frictions create many manager-shareholder agency conflicts. Understanding the relevance of these various conflicts and how they vary across firms is crucial for designing incentive and governance structures that mitigate the impact of these conflicts on shareholder value and potentially the aggregate economy. For example, if a manager fails to make risky investments out of a reluctance to exert costly effort and a desire to pursue the “quiet life”, then shareholders might wish to increase the manager’s ownership stake to better align their interests and encourage risk taking. On the other hand, if the manager forgoes these investments because of risk aversion and the potential impact of failure on his or her income and wealth, then increasing the manager’s ownership stake in the firm will only worsen the agency conflict. Understanding the source of the agency conflict also has important implications for a firm’s optimal leverage and cash management policies.
Posted by Todd Gormley, Washington University in St. Louis, and David A. Matsa, Northwestern University, on Friday, January 13, 2017
Editor's Note: Todd Gormley is Associate Professor of Finance at Washington University in St. Louis Olin Business School; and David A. Matsa is Associate Professor of Finance at Northwestern University Kellogg School of Management. This post is based on their recent article. Related research from the Program on Corporate Governance includes The Costs of Entrenched Boards by Lucian Bebchuk and Alma Cohen; and How Do Staggered Boards Affect Shareholder Value? Evidence from a Natural Experiment by Alma Cohen and Charles C. Y. Wang.
