➡Title: The Impact of the Divorce of Ownership from Control on Firms' Conduct and Performance
🍃Introduction
The divorce of ownership from control refers to the separation of those who own a firm from those who manage and operate it. This phenomenon has become increasingly common as companies grow and owners delegate management responsibilities to professional executives. In this essay, we will discuss how this separation affects the conduct and performance of firms, touching on the principal-agent problem, the objectives pursued by firms, and the mechanisms in place to address these issues.
The Divorce of Ownership from Control
The traditional assumption in economics is that firms aim to maximize profits. However, as companies grow, owners often delegate the management of their firms to professional executives to focus on strategic decisions. This creates a situation where the owners (principals) and the managers (agents) may have different objectives, leading to a principal-agent problem. This divergence in objectives may impact both the conduct and performance of firms.
Impact on Conduct
The separation of ownership from control can lead managers to pursue objectives other than profit maximization, such as revenue maximization, sales growth maximization, and satisficing (achieving satisfactory performance rather than maximizing profits). This can occur when managers prioritize their own interests, such as career progression or personal recognition, over the owners' interests. The conduct of firms may also be influenced by a desire to maximize their own utility, which can include factors like job security, status, and other perks.
Impact on Performance
The pursuit of objectives other than profit maximization can have significant implications for the performance of firms. For example, firms may experience reduced efficiency, as resources are allocated to projects that do not maximize value for the owners. Additionally, the focus on objectives other than profit maximization can lead to diseconomies of scale, where the average cost of production increases as the firm grows. This may result in weaker financial performance indicators, such as lower profits or a reduced market share.
Comparisons Between Firm Types
Family firms, listed firms, and other types of organizations may experience the divorce of ownership from control to different extents. In family firms, the alignment of interests between owners and managers may be stronger due to familial ties, leading to a lower likelihood of principal-agent problems. In contrast, listed firms and large organizations with dispersed ownership may face more significant issues in aligning the objectives of owners and managers.
Addressing the Principal-Agent Problem
Owners can take several steps to address the principal-agent problem and better align the objectives of managers with their own. These include designing remuneration schemes that tie compensation to performance, such as payment in shares or performance-related pay. Additionally, many owners maintain some control over firms through seats on boards and voting on key decisions during annual general meetings.
👉Conclusion
The divorce of ownership from control can have significant implications for the conduct and performance of firms, often leading to the pursuit of objectives other than profit maximization and a divergence of interests between owners and managers. However, various mechanisms exist to mitigate these effects and better align the objectives of principals and agents. Overall, the impact of the separation of ownership from control on the conduct and performance of firms is significant, but it can be managed through proper governance and incentive structures.