It is important for the company to ensure that the investors get the maximum return in terms of profit and dividends. The investors besides the promoters are the shareholders. So it is the responsibility of the company to make conscious investment in the business and pay off good dividends. The strategic decisions and operations of the company influence the price value of the share. So what does a company comprise of? Who is in charge of taking the decisions that subsequently impacts the stock prices? What type of decisions are these?
A Company typically comprises of multiple resources that are put together to increase the top line figures of the income statement i.e. total income from operations. The ways these resources are used highly depend on the management of the Company. They have the responsiblity of converting shareholder’s money into profitable usage. Management is also responsible for taking strategic decisions and handling the operations of the firm. However, there is one problem prevalent in this type of system – the agency cost problem.
Typically, managers are only concerned to improve their incomes and incentives. While doing so, the shareholders’ profit gets impacted. Their income is generally linked to (on percentage basis) some aspect; for instance the turnover of the firm, cost reduction, etc. However, these objectives might not align with that of the shareholders interest area; where the latter’s interest is to only see better stock prices. It is important to resolve this conflict of interest between the management and the shareholders. This can be done only by linking the incentives of the managers to the stock price movements. In fact, the shareholders while selecting the managers can also bestow upon them the firm’s shares at discounted values or as incentives. Doing so, the interest of both the managers and shareholders align automatically.
For every firm, it is very essential to identify the extent to which the agency problem is prevalent. Based on this, a firm should act in accordance by trying to close this gap as much as possible. This would enhance the profits as perceived by the shareholders invariably. Thus, selection process of managers is very crucial for any firm. Moreover, the way incentives of a manager within a firm are bound to certain dependent parameters also serve as a driving force for the managers to improve the profits (as well as dividends) of the firm – by taking into consideration all the parameters.