2.4 Separation of Ownership and Control

The entity which owns the company (shareholders) is often not the one that controls the company’s resources (management).

◆Four advantages：

1. Professional managers would be expected to have specialized knowledge and therefore superior ability to run the business (theory of specialization).

2. To grow to an optimal size in terms of business efficiency, the financial resources of many households may have to be pooled.

3. In an uncertain economic environment owners will prefer to diversity their risks across many companies. Efficient diversification is difficult to achieve without separation of ownership and management.

4. The "learning curve"or"going concern"effect.

◆Four major downsides：

1. agency problem

2. free-riding problem※

3. increased costs of information gathering

4. information asymmetry

※free-riding problem（搭便车问题）：对于众多中小股东来说，由股东监控带来的经营业绩改善是一种公共物品。对致力于公司监控的任何一个股东来说，他要独自承担监控经营者所带来的成本，如收集信息、说服其他股东、重组企业所花费的成本，而监控公司所带来的收益却由全部股东享受，监控者只按他所持有的股票份额享受收益。这对于他本人来说得不偿失，因此股东们都想坐享其成，免费“搭便车”。

2.5 Agency Relationships

√ Shareholders( as owners) essentially give management the authority to represent them in dealing with others. 

√ This relationship is known as the principal-agent or agency relationship, which is an explicit or implicit arrangement where an agent acts on behalf of a principal. 

Managers (agents) are entrusted to look after the interests of shareholders(principals).

2.5.1 Agency problems

◆Examples

1. Managers may waste corporate cash and resources by engaging in negative net present value (NPV) acquisitions or investments to satisfy their desire to build an empire.

2. Less ominous, but no less costly, managers may squander corporate funds on excessively lavish corporate offices and jets.

3. More recently managers have been known to increase share prices (not value) by using “creative accounting”※, so as to exercise their stock options (e.g. Enron).

※ creative accounting 创造性会计

指在不违背会计准则和有关会计 法规的条件下, 为达到某种目的而有意识地选择会计处理方法的活动。创造性会计极易导致财务舞弊现象的发生，如安然事件（安然公司通过关联公司交易——包括层层控股，关联公司对倒交易以创造交易量，以财产出售所得充当营业利润等——进行财务舞弊，进而欺骗投资人）。

2.5.2 Agency costs

Agency costs are the total costs resulting from the agency problem. 

1. management takes actions that negatively influence the wealth of shareholders, or when.

2. the shareholders monitor the management’s actions to ensure compliance.

As defined by Jensen and Meckling (1976), agency costs comprise the following:

1. Bonding costs 

2. Monitoring costs

3. Residual costs

2.5.3 Practical solutions to the agency problem

——to ensure that managerial actions are consistent with shareholders' interests. 

1. Equity-based managerial compensation schemes

2. Election of independent outside members to the board of directors 

3. Threat of dismissal of management.

4. As a last resort, the threat of a hostile takeover.