Examples of Managerial Self-Interest

Adam Smith on the Divergence of Interests Between Managers and Shareholders

Aligning Manager and Shareholder Interests

The manager of a large corporation, who earns a fixed annual salary, approves a plan to acquire a smaller firm. This acquisition will substantially increase the size of the company and the manager's responsibilities. However, independent financial projections indicate that the acquisition is unlikely to increase the company's profits for several years. Which of the following statements best analyzes this situation from the viewpoint of the company's owners?

Evaluating a CEO's Strategic Decision

Analyzing Divergent Incentives in a Firm

Diverging Incentives in a Corporation

A manager of a publicly-traded company, whose compensation is a fixed salary with no performance-based bonuses or stock options, chooses to allocate a significant portion of the annual budget to a project that is projected to have very low financial returns. However, the project is expected to win several prestigious industry awards and greatly enhance the manager's professional reputation. Given this situation, the manager's decision is fully aligned with the primary financial interests of the company's owners.

A company's owners are primarily interested in maximizing profits. However, its managers, who are paid a fixed salary, may have different personal goals. Match each managerial action described below with the most likely underlying incentive driving it, which may not align with the owners' primary interest.

In a large corporation where ownership is separate from management, a conflict of interest often arises because the owners are the firm's __________, meaning they have the right to the net income that remains after all other costs are paid. This status gives them a strong incentive to maximize the firm's overall profitability.

A large corporation experiences a decline in profitability despite a growing market. An internal review reveals that the senior management team, who are on fixed salaries, have been heavily investing in expanding their departments and undertaking high-profile but low-return projects. Arrange the following statements to logically explain the sequence of events and underlying principles that led to this outcome, starting from the fundamental structure of the firm.

Evaluating a Corporate Governance Proposal

A corporation's owners want to ensure their hired manager makes decisions that maximize the firm's profitability. Which of the following compensation arrangements for the manager creates the most significant risk that the manager's personal goals will diverge from the owners' goals?