While it is important to understand the various objectives of firms, it is equally important also to note that some of these objectives may be inconsistent or incompatible with each other due to the principal-agent problem that normally exists between shareholders (owners of the firm) and managers (those who control the firm). This essay serves to analyse some managerial theories in light of the principal-agent problem and the conflict of interest between the shareholders and managers.
Table of Contents
1. Managerial theories and the principal agent problem
1.1 The conflict between managers’ and shareholders’ objectives
1.2 Neoclassical profit maximisation: short-run vs long-run
1.3 Sales maximisation and profit constraints
1.4 Managerial utility maximisation
1.5 Growth models and firm diversification
1.6 The behavioural model of the firm
1.7 Conclusion
Research Objectives and Themes
This work aims to examine the principal-agent problem within the context of managerial economics, specifically analyzing how diverging objectives between managers and shareholders manifest across various economic theories.
- Analysis of the principal-agent dilemma and its theoretical causes.
- Comparative review of neoclassical, Baumol, Williamson, and Maris growth models.
- Evaluation of manager versus shareholder utility functions.
- Exploration of behavioral theory in the context of firm decision-making.
- Investigation into profit maximisation versus sales and growth objectives.
Excerpt from the Book
Managerial theories and the principal agent problem: The conflict between managers’ and shareholders’ objectives.
According to Sloman (2006) the principal-agent problem occurs where people, as a result of lack of knowledge; cannot ensure that their best interests are served by their agents. Agents, according to Sloman (2006); may take advantage of this situation to the disadvantage of the principals. The principal-agent problem also refers to the conflicts of interest and moral hard issues that arise when a principal hires an agent to perform specific duties that are in the best interest of the principal.
Basically, this conflict emanates when shareholders (principals) contract a second party, the managers (agents) to perform some tasks on their behalf. The dilemma exists and is arguably inevitable because in most instances the agent is motivated to act his or her own best interests rather than those of the principal. The main reason for that is that the agent knows that they have some hidden information that puts them on a better position to engage in moral hazard. This is theoretically justified because the shareholders cannot possess all the information because of bounded rationality. Bounded rationality simply means that individuals cannot solve problems perfectly, costlessly and instantaneously.
Summary of Chapters
Managerial theories and the principal agent problem: This chapter introduces the core conflict of interest between agents and principals caused by asymmetric information and bounded rationality.
The conflict between managers’ and shareholders’ objectives: This section explores how differing time horizons regarding profit maximisation drive internal organizational conflict.
Neoclassical profit maximisation: short-run vs long-run: This part examines the tension between short-term manager-focused goals and long-term shareholder interests.
Sales maximisation and profit constraints: This section discusses the Baumol model, focusing on how managers prioritize sales performance over pure profit to secure personal salary benefits.
Managerial utility maximisation: This chapter analyzes Williamson’s model, explaining how managers prioritize personal benefits and prestige over shareholder dividend returns.
Growth models and firm diversification: This part investigates the Maris model, highlighting how managers utilize diversification to balance firm growth with job security.
The behavioural model of the firm: This section treats the firm as a coalition of conflicting interests, moving away from the single-objective utility function.
Conclusion: This final chapter synthesizes the various theories, asserting that the principal-agent problem remains a common denominator across all ideological frameworks.
Keywords
Principal-agent problem, Managerial economics, Shareholder objectives, Moral hazard, Bounded rationality, Profit maximisation, Sales maximisation, Utility maximisation, Job security, Diversification, Behavioural theory, Asymmetric information, Corporate governance, Firm growth, Conflict of interest.
Frequently Asked Questions
What is the fundamental focus of this publication?
The work focuses on the principal-agent problem within firms, specifically the conflict arising when managers and shareholders pursue different organizational goals.
What are the primary themes discussed?
The primary themes include profit vs. sales maximisation, the impact of asymmetric information, managerial utility, and the behavioral dynamics within a firm.
What is the core research question?
The research seeks to identify how managerial motivations diverge from shareholder interests and how various economic theories explain this persistent conflict.
Which scientific methods are employed?
The text employs a qualitative theoretical review, comparing foundational models such as neoclassical theory, Baumol's sales model, and Williamson's utility model.
What topics are covered in the main body?
The body covers the theoretical mechanisms of moral hazard, the shift between short-term and long-term profit goals, and the role of diversification in firm management.
Which keywords define this work?
Key terms include principal-agent problem, moral hazard, bounded rationality, utility maximisation, and corporate governance.
How does "bounded rationality" contribute to the principal-agent problem?
It explains why shareholders cannot possess all necessary information to control managers perfectly, thus allowing agents to act in their own best interest.
What differentiates the neoclassical model from the behavioural model?
While the neoclassical model seeks to reconcile objectives within a single utility function, the behavioural model views the firm as a complex coalition of conflicting individual interests.
- Quote paper
- Bsc (Honours) Economics Thabani Nyoni (Author), 2015, Managerial Theories and the Principal Agent Problem. The Conflict between Managers’ and Shareholders’ Objectives, Munich, GRIN Verlag, https://www.grin.com/document/302048
