a) What incentive conflicts exist in corporations?

In any corporation one will find conflicts between the managers and shareholders. A major reason behind this fact is that mangers often own very few shares in the company. According to Robert Vishny, who sampled 371 Fortune 500 companies, a firm’s performance is in fact weaker “at low levels of management ownership”. His article goes on to explain that when managers own 5 to 20 percent performance levels are higher when compared with firms where management ownership is only 0 to 5 percent.² Managers, especially those that own very little of the company’s stock, have different goals and motives from those of the shareholders. Manager’s engage in “self-interested behavior”, which is defined as “maximizing their own utility at the expense of corporate shareholders”.³ They very often take fewer risks than shareholders would like in an attempt to increase job security, or they feel they deserve special perks, such as company jets, free lunches, or gym memberships, to name a few. Managers may also shirk on the job instead of work hard and give it their all. While shareholders would like manager’s to maximize value of the firm, managers are more concerned with increasing the size of the firm to make themselves look better. Shareholders are concerned with performance of the company as a whole; mangers are concerned with their own individual performance. Incentives and compensation packages are ways to ease these conflicts, but again, managers and shareholders may not agree on what a fair compensation package is.

b) What mechanisms are used to address the incentive conflicts in corporations?

There are several techniques used in order to minimize incentive conflicts. Contracts are sometimes used to ease incentive conflicts by creating similar interests between shareholders and managers. These contracts