The conflict between managers and shareholders.

• Author: Morck, Randall

The Conflict Between Managers and Shareholders

Randall Morck, Andrei Shleifer, and Robert W. Vishny

Economists since Adam Smith have been concerned that professional managers who own little equity in the companies they run have little incentive to serve their shareholders. This concern peaked during the Great Depression, rose again during the 1960s, and resurfaced in the 1980s with the advent of hostile takeovers. The recent concern has stimulated new empirical work asking whether managers indeed fail to serve their shareholders, and how financial markets discipline such managers. As a result of this work, we now know a lot more about the conflict between managers and shareholders than we did ten years ago.

Is Low Ownership by Managers Indeed a Problem?

Underlying the discussion of the conflict between managers and shareholders is the belief that managers who own few shares in firms they run do not maximize profits. But is this belief correct? Do the firms with lower management ownership indeed perform worse than firms with higher management ownership? For a sample of 371 Fortune 500 companies in 1980 we find that the answer is yes at low levels of management ownership.(1) Performance of firms with management ownership between 5 and 20 percent, as measured by profitability or by the ratio of market value to the replacement cost of assets, is indeed better than the performance of firms with management ownership between zero and 5 percent. This result is consistent with the standard view that ownership gives incentives for better performance.

However, we also find that performance deteriorates as management ownership rises beyond 20 percent. This result suggests that managers who own controlling blocks of shares do not care so much about becoming even richer than they already are and use their complete control to pursue personal objectives that might well be different from value maximization.

Managers of large public corporations typically own much less than 5 percent of their firms' total shares. The traditional concern that ownership levels are too low to guarantee top performance therefore is supported by the data.

What Do Managers Do That Hurts Shareholders?

Managers have many objectives that might lead them to make decisions that do not maximize value. Often they would like their firms to grow beyond what is profitable to provide opportunities for themselves and for other employees as well as to increase the scope of their control...