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The Structure of Corporations [Reading] [P2]

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York University
Administrative Studies
ADMS 1000
Eytan Lasry

The Structure of Corporations ADMS 1000 ReadingPart IISeparation of Ownership and ControlCorporate ownership and control are divided between two partiesstockholders and officerso The stockholders own the firm and officers or executives control the firmMost shareholders do not wish to take part in a firms business activitiesthese shareholders act like investors not owners o Ownersfocus on the business performance of the firm o Investorsfocus on the risk and return of their stock portfoliosThere is a problem with this separation of ownership and controlo It is not farfetched to imagine that managers may act in their personal interest if possible even at the expense of owners This is known as the principleagent problem or the agency problem y Consider the owner of a nightclub the principal who hires a bouncer the agent to check identification at the front door and to receive the cover charge from entering customers The bouncer may pocket some of the cash if he thinks no one is looking and try to maximize his own wealth at the expense of the owner If the owner cannot effectively monitor the transactions and the activities of the bouncer he or she should lose moneyTherefore monitoring is important to help overcome the agency problem The shareholders of the corporation are the principals and the managers who run the company are the agentso If shareholders cannot effectively monitor the managers behaviour then managers may be tempted to use the firms assets for their own ends such as improving their lifestyleso Executives may enjoy perks such as liberally charging the corporate expense account chartering the company jet ordering topgrade office furniture and so on all at the expense of shareholders Solutions to this problem tend to come in two categories incentives and monitoring o Incentivesto tie the wealth of the executive to the wealth of the shareholders so that executives and shareholders want the same thing This is called aligning executive incentives with shareholder desires
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