Principal-Agent framework
- shareholders are the principals
- managers are the agents
Agency Problem A conflict of interest inherent in any relationship where one party is expected to act in another’s best interests.
Agency costs reduce firm value due to agency problems:
- value lost because managers do not make value-maximising decisions
- Costs of monitoring managers
Stockholders want three things:
- maximise current wealth
- transform wealth into most desirable time pattern of consumption
- manage risk
Auditors issue reports (unqualified, qualified, adverse) opinions through the GAAP (generally accepted auditing principles).
Lenders (banks, shareholders) monitor assets, activities and profitability.
Shareholder Capitalism (Milton Friedman)
- the government regulations will protect stakeholders (social responsibility) and manage externalities through laws and taxes
- firms should maximise profits within rules
Materiality asks whether markets react to your decisions
ESV (Enlightened Shareholder Value)
- stakeholders are a means to an end
- invest in them (via bonus, salary) if it is NPV
- but increasing shareholder value is still the final goal.
Stakeholder Capitalism (Genossenschaft)
- justified when friedman’s assumptions fail
- freedom as manager to take decisions without caring about NPV calculation
- but comes as a cost, no clear replacement of NPV (no decision rule)
- accountability to everyone means accountability to none
- Weighting shareholders vs stakeholders (how much shareholder value shall be “sacrificed”)
- How to measure stakeholder value (salary, happiness, etc…)
Responsible Businesses
- create shareholder value via society
- mixture of shareholder and stakeholder capitalism
- create value for society by the business itself.
- more value creation vs. value extraction
What principles can a responsible business use to make decisions? Incorporate negative externalities into the investment decisions.
ESG (Environmental, social and governance)
- CEO pay linked to ESG targets (principal agenct problem - hit metric not actually care)
- ESG ratings for a company (like credit-worthiness)
- These ratings are inconsistent (correlation of 0.38-0.71 between rating companies)
Multiplication Principle: asks whether markets approve of firms decision