Explain why management may tend to pursue goals other than shareholder wealth maxinimiation.?

Question

Explain why management may tend to pursue goals other than shareholder wealth maxinimiation.?

Answer 1

Sounds like its right out of a textbook.  So here's what I would say:  The type of compensation received by management has a lot to do with their motivations.  If they receive most of their compensation in forms of stock, they tend to pay more attention to the stock price.  If they receive bonuses for certain yearly benchmarks, for example, they shoot for those benchmarks even if it doesn't do much for the stock.  Basically, you get what you reward.

Answer 2

'Maxinimiation', that's a good word and summarizes well the issue. To know if and why management would pursue goals that are not consistent with shareholders interest, you need to know first what are the motives and interests of each party.

The management works as an agent for a principle who are shareholders. As in many cases the two do not have the same goals and interests, they are even contradictory sometimes. This is why it is important for shareholders to motivate and align management interests to their own.

Shareholders want to receive dividends and increase in share price (even though even this goals is flawed if it is too focused on the short-term). Management on the otherside wants to get paid for the longest period, making less effort possible.

Companies usually pay management with their own stocks or with call options (right to buy stocks at a specific and lower price). So the management has an incentive to drive stock prices up in order to profit from their stocks. However, sometimes this does not work and seems to be deadly for the company. CEOs in this case have an incentive to 'cook' the books or engage in an unsustainable practice (such as distributing dividends that benefits themselves and shareholders in the short period of their tenure, but over the long run, the company's ability to generate future profits and make investments is hindered, and usually it is the subsequent management who is blamed when the problems finally become clear)