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Separation of Ownership and Management in Large Corporations

1. Introduction
A small group of investors can directly manage a firm they own when it is initially
established. As the firm grows, new shares need to be issued to raise more capital,
eventually its shares may be able to be traded in public markets. A large public
corporation can have hundreds of shareholders who are all the owners of the
corporation. It is not realistic that all of them can directly manage the company.
Therefore, the separation of ownership and management always exists in large
corporations.
This separation benefits the corporation, at the same time, it causes some tough
problems as well. In this study, the main implications of the separation of
ownership and management are discussed. And also, various options available to
shareholders in dealing with the negative issues are evaluated.
The reminder of the essay contains following contents: Section 2 describes the
implications of the separation of ownership and management. Section 3 presents
the evaluation of different options available to shareholders. Section 4 concludes.

2. Implications of Separation of Ownership and Management

2.1 Positive Implications
First of all, the separation of ownership and control makes corporations
sustainable or permanent (Brealey et al., 2011). The ownership can be easily
transferred to another shareholder without disturbing the operation. The
corporation also can continue even if managers quit or be replaced.
Secondly, the corporation can be managed by a team of professionals. When a
corporation grows, the owners may not have all the necessary skills to manage the
company. Employing professional managers can diverse skills to make sure that
the corporation is on tis right way.
Thirdly, capital utilization can be maximized. Every shareholder has own
preference on investments. It is managers' job to find the optimal investment.
Managers should be able to find ways in which business assets are managed to
gain the highest profit for all shareholders.

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Finally, managers act as balances between shareholders. They may have to

eliminate the negative impact on the corporation due to some of the shareholders.
They should be able to lessen losses of other shareholders as a result of the actions
of another shareholder.
2.2 Negative Implications
The main negative implication of the separation of ownership and control is the
principle agency problem.
All the advantages brought by the separation of ownership and control are based
on one expectation. It is that the managers act on the behalf of shareholders'
interests. Because it is the shareholders who have ultimate control of the company
and who have the power to choose the management of the company. Managers
should pursue the goal of maximizing shareholders' wealth. However, in reality,
the situation is not like this.
Because of the separation of ownership and management, shareholders cannot
control what managers do except indirectly through the board of directors.
Managers may make decisions that can benefit themselves instead of the
shareholders. For example, managers may want to maximise short-term profits in
order to earn bonuses while the shareholders may focus on the long-term
development of the corporation. The imperfect and asymmetric information
causes conflicts. The conflicts between shareholders and managers refer to
principle agency problems. When managers do not attempt to maximize firm
value and shareholders incur costs to monitor the managers, agency costs incurred
(Brealey et al., 2011). The agency costs are not good things for shareholders. Even
worse is that agency problems can sometimes lead to astonishing scandals that
adversely affect the corporation and the shareholders.
Agency problems widely exist in large corporations. A commonly accepted theory
suggests that managers will shirk their responsibilities and use their position for
their interests at shareholders' expenses when given opportunity. A study done by
Kroll, Wright and Theerathorn in 1993 provide additional evidence shows that
managers will be more likely to absorb selfish benefits when they have

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discretionary control over the corporation. Even though some managers do better
in controlling costs and maximizing shareholders' profit they may still lavish some
savings on themselves.
Furthermore, agency problems also have a negative impact on the society. There is
an argument says that the separation of ownership and management occurred with
diffusion of stock ownership in large corporations. The power to some extent
shifted from shareholders to managers. The firm may not be fully subjected to the
requirements of economic efficiency and wealth maximization (Kroll et al., 1993).
The consequence for advanced societies with such organizations tends to be
economic decline (Burnham, 1962; Parsons, 1971 in Kroll et al., 1993).

3. Ways Available for Shareholders in Addressing the Issue

3.1 Legal and Regulatory Requirements
There are laws and regulations to constrain the behavior of managers. For
example, the U.S Securities and Exchange Commission sets accounting standards
for public corporations to ensure transparency (Brealey et al., 2011). And
Sarbanes-Oxley Act 2002 requires chief executive officers and chief financial
officers to certify in the financial statements related to the accuracy of the
statements. And the labor contract of the managers could be more detailed and
strict in order to reduce managers' opportunity of shirking responsibilities or
taking perks.
3.2 Compensation Plans
Offering incentive payment and stock options to top managers. Linking their
interests tightly with the shareholders' interests. Or making the managers become
shareholders. Managers who have company shares in hand will work hard to
increase the value of the shares, if they fail to do so, the shares will become
valueless to them. The more the increase in share price, the more the managers
will gain.
3.3 Board of Directors
Board of directors is elected by the shareholders to represent their interests. Board
of directors should monitor the managers. Their day-to-day impact is difficult to
observe. But when things go wrong, they can become the center of attention. For
example, Enron (Adams et al., 2010). The makeup of boards affects what they do.

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After the Enron scandals exploded, Sarbanes-Oxley Act requires public companies
place more independent directors who are not involved in the management on the
board (Brealey et al. 2011). This to some extend prevents directors from being
influenced by the management. Another problem is that some outside directors
may serve on several boards at the same time. The research done by Fich and
Shivdasani in 2006 indicates that boards relying heavily on busy outside directors
are likely to have a low-quality corporate governance.
While despite board of directors, managers are monitored by other parties such as
security analysts and banks.
3.4 Threats of Takeovers and Labor Market
Falling share price indicates the poor performance of the company. This increase
the threat of takeovers. Then managers may lose jobs. And the poor performance
gives the labor market an adverse signal and the ability of the manager could be
questioned. If managers do not try to maximize firm value, they may eventually
lose reputation.
3.5 Shareholder Pressure
Shareholders have the ultimate control over the corporation. If shareholders are
not satisfied with the performance, they can change the top managers or the board
of directors. But in this situation, shareholders should be very strong and rational.

4. Conclusion
It is difficult to get rid of agency problems. However, there are several ways to
mitigate those issues. Each method has its limitations. The shareholders can
combine different methods in order to get a better result.
The performances of large public corporations have an important influence on the
society and the economy. Stricter laws and regulations can be enacted to constrain
people with strong power.

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References
Brealey, R., Myers, S. and Allen, F. (2011). Principles of corporate finance. New
York: McGraw-Hill/Irwin.
Kroll, M., Wright, P. and Theerathorn, P. (1993). Whose interests do hired top
managers pursue? An examination of select mutual and stock life insurers. Journal of
Business Research, 26(2), pp.133-148
Adams, R. B., Hermalin, B. E., and Weisbach M. S. (2010) The Role of Boards of
Directors in Corporate Governance: A Conceptual Framework and Survey, Journal of
Economic Literature, 48(1), pp. 58107.
FICH, E. and SHIVDASANI, A. (2006). Are Busy Boards Effective Monitors?
Journal of Finance, 61(2), pp.689-724.
James, R. (2014). The Advantages of the Separation of Ownership & Management
(online)

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