SOSC 4043 Lecture Notes - Lecture 5: Stagflation, Takeover, Making Money
The Misapplication of Mr. Micheal Jensen: How agency theory brought down the
economy and why it might again
“tagflatio: Eoo is’t goig ad pies ae goig up
People tried to come up with new theories to fix the corporate world
This is hat is goig o ad this is ho e a fi it
Agency theorists diagnosed the eooi alaise of the ’s as the esult of eeutie
obsession with corporate stability over profitability - what is wrong with management?
Management tried to manage as they tried to increase entrepreneurialism and risk
taking, stock options, dediversification, debt financing, and outsider board members
But, they did not manage with moderating risk
• Executive equity holding
• Independent boards
Thus, in practise, the remedy heightened corporate risk taking without imposing
constraints
To date, regulators have proposed nothing to undo the perverse incentives of the new
shaeholde alue sste
“tagflatio i ’s a deade of lakluste stok aket pefoae, japaease
dominated the autootie idust ad high teholog had set Aeia’s fotue
opaies o a spiitual uest ’s
When it came to corporate governance and business strategy, agency theory offered a
diagnosis of the problem and a ready remedy
find more resources at oneclass.com
find more resources at oneclass.com
Neo liberals would say that min wage is wrong because there is surplus which causes
unemployment and now the government steps in to help
Efficiency wage theory: Firms would pay you an amount that is efficient enough for you
to do the work
Neo would tell you to save that money through tax cuts (the surplus) so the one who are
unemployed can get paid or government could employee the people themselves – no
absolutes, it is up to government to find a middle ground
Weaken unions and empower business owners so they can make enough profit to
employee the unemployed
Michael Jensen and William Meckling, in their journal of financial economics, the
theory challenged the way that firms were being run, suggesting that the interests
of shareholders and their agents were out of synch – (second lecture)
Executives were serving their own interests rather than those of their owners
They had been building large diversified empires that could shield them from
downturns in any industry which max corporate size rather than profit
Profit went to expand new businesses to expand the pyramid executives at the top
Agency theory rebuffs monitoring efforts that might bring their behaviour in line
ith shaeholde’s goals of a pofit doiatig the oads that ee haged
with overseeing them
Fortune 500 companies became unmanageable multi industries that did not live up
to their potential. Thus, the diagnosis
find more resources at oneclass.com
find more resources at oneclass.com
Agency theorists prescribed revolutionary changes in corporate governance and
strategy
Executives and shareholder were out of touch
Three changes were designed to increase corporate profit which focus management on
excelling in a single sector and improve bottom line
It would encourage entrepreneurial, risk taking strategies that promised great reward
• By changing incentives to managers,
o Using stock options to guarantee they would focus on
increasing the value of the firm
o Designing compensation to ensure they held equity in the firms
they ran
• Reinforcing industrial focus
o Focus on the management tea’s industry of expertise and
leave portfolio diversification to investors
o No incentive to focus on their own growth and let investors
diversify their risk
o Hostile takeover, discipline the executives, make sure money is
going out of ex. pocket and in their pocket, so the executives
would be forced to not failing
o Improve stock return and profit – dediiversify which decreases
efficiency and competition – intraindustry (within industry)
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
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