Page 40 - FINAL CFA II SLIDES JUNE 2019 DAY 6

LOS 24.c: Explain conflicts that arise in agency
relationships, including manager–shareholder conflicts and READING 24: CORPORATE GOVERNANCE
director–shareholder conflicts.

Managers and shareholders. Shareholders want management to make decisions that maximize shareholder wealth, but managers, left on their own, may
well make decisions that maximize their own wealth.
• Using funds to expand the size of the firm. A larger firm may increase the managers’ job security, power, and compensation without benefiting the
shareholders.
• Granting excessive compensation and perquisites. Managers may give themselves high salaries and perquisites, such as corporate jets and lavish
apartments that are expensed as normal business expenses, forcing shareholders to bear the costs.
• Investing in risky ventures. This is one of the key criticisms leveled against the excessive use of executive stock options. By virtue of the nature of their
position, managers often stand to reap huge benefits if the risky venture succeeds, but do not share in losses if the venture fails.
• Not taking enough risk. Conversely, extremely risk-averse managers who have the bulk of their wealth tied to a firm’s stock may only invest in
conservative projects to protect that wealth and avoid potentially risky projects that would do a better job of maximizing value for shareholders.

Directors and shareholders. Conflict occurs when directors align more with management interests rather than those of shareholders:
• Lack of independence. Board members that are tied to the company or that may themselves be managers are less likely to identify with
shareholder concerns.
• Board members have personal relationships with management. Board members may be asked to join the board because of a friendship or family
ties with senior management.
• Board members have consulting or other business agreements with the firm. Business agreements may give the board member a dual
responsibility of answering to management as a consultant while also supervising management as a board member.
• Interlinked boards. Senior managers of Firm A may serve as directors in Firm B, while Firm B’s senior managers are on the board of Firm A.
• Directors are overcompensated. The goal of maintaining their excessive compensation may cause directors to accommodate management wishes
rather than protect the best interests of shareholders.