Agency theory in practice!

In Topic 1 of the book, I introduce you to the subject of corporate finance by examining the relationship that exists between a company's senior managers and its shareholders. We see there that the goal of a company is usually stated to be the maximisation of shareholder value. In practice this is often simplified to be the maximisation of the company’s share price. In recent weeks there have been a number of excellent FT articles that have featured attempts by the larger shareholders to become more active in making sure that the company’s managers are acting in their interests. One issue that seems to be a source of their anger and concern is excessive executive pay. In the current economic climate investors do not want to see senior managers rewarding themselves with large pay rises at a time when share prices have been falling.

A good example from the FT was a recent article (May 4th) where David Blackwell highlighted the case of the recruitment group that owns Odgers, Ray & Berndtson, the headhunters known for their annual survey of FTSE 100 chief executives. Their share price has fallen from just under 500p to 39½p in two years which has reduced it to a market capitalisation of under £11m. The article points out that despite the company’s poor performance two of the company's executive directors were paid the maximum bonuses of £375,000 and £280,000, respectively, taking their total remuneration to £755,000 and £562,000 respectively. Such a situation can hardly please the shareholders who have seen a serious erosion in their net worth as a result of the slide in the share price.

These are excellent articles because they raise the whole issue of good corporate governance (see page 4, Key terms) and the role of activist shareholders (see page 9, Key terms). If you are a student about to be answering a question on this topic in an exam it would be good to refer to one of these recent articles to show how in touch you are with the latest financial news stories!