The divorce of ownership from control as firms grow

As businesses expand, the people who own them often lose direct involvement in daily operations. This separation can create challenges because different groups within the firm may prioritise their own goals over the overall success of the business.

Reasons for the separation between owners and managers

In smaller businesses, the owner typically handles everyday management tasks themselves. However, as a firm grows, it may need more capital, which owners often raise by issuing shares. This brings in new part-owners (shareholders), but the firm is then managed by appointed directors who oversee operations on behalf of all owners.

This split is called the divorce of ownership from control, where the original or main owners no longer make the day-to-day decisions. Directors, who run the firm, might pursue aims that differ from those of the shareholders. Additionally, other groups connected to the firm, such as workers or suppliers, can influence decisions and have their own priorities.

Stakeholders and their influence

Stakeholders are any individuals or groups with a stake in the firm's activities, including staff, leaders, suppliers, buyers, and local communities.

The principal-agent problem and differing objectives

The separation of ownership and control can lead to conflicts where those managing the firm do not always act in the best interests of the owners. This issue highlights how personal goals can override the firm's broader aims.

The principal-agent problem

The principal-agent problem occurs when principals (such as shareholders) hire agents (like directors or managers) to act on their behalf, but the agents prioritise their own benefits instead. For instance, shareholders usually want the firm to focus on increasing profits to boost share values. However, if a director's rewards are tied to overall sales figures, they might aim to grow revenue rather than profits.

Directors could also seek to expand areas like market presence or total sales because leading a bigger organisation enhances their reputation or job prospects. Similarly, staff members, as agents, often focus on securing better salaries, perks, or job security rather than driving profits for the owners.

Objectives beyond profit maximisation

Traditional economic theory suggests firms always aim to maximise profits, but this is not always true, particularly in larger organisations where control is separated from ownership. Instead, leaders might target growth in sales or revenue. However, all firms must achieve at least normal profit over the long term to stay in business, even if pursuing other goals.

How owners retain control through accountability and incentives

Owners can address the challenges of separated control by ensuring managers remain answerable and motivated to align with the firm's goals. These approaches help bridge the gap between ownership and day-to-day running.

Methods to increase accountability

Accountability requires managers and directors to explain their past actions and outline future strategies to the owners. This transparency helps owners monitor performance. Shareholders have the power to vote out underperforming directors, though they may not always have full details to make informed choices. Strong accountability reduces the principal-agent problem by encouraging agents to act in the principals' interests.

Using incentives to align objectives

To encourage a focus on profit growth, owners can offer rewards that make this goal appealing to directors.

Examples include:

• Bonuses directly linked to the firm's profit levels.
• Company shares provided at no or low cost, giving directors a personal stake in the firm's success.

These incentives motivate agents to prioritise outcomes that benefit shareholders, such as higher profits.

The concept of satisficing as an alternative to maximisation

Not all firms push to achieve the highest possible profits or the lowest costs. Instead, they may adopt a more balanced approach to keep key groups content, especially when goals clash.

Understanding satisficing

Satisficing involves aiming for acceptable levels of performance that meet the needs of important stakeholders, rather than striving to maximise elements like profits or minimise expenses. It is often seen as a way to maintain a straightforward operation without excessive effort.

This approach is common when stakeholders have competing priorities. For example, directors might target just enough profit to keep shareholders satisfied, avoiding complaints, while offering wages sufficient to retain employees and prevent them from leaving or striking. This is another form of the principal-agent problem, where agents opt for ease over maximum gains.

When satisficing occurs