Are Corporate Governance and Profit Maximization mutually exclusive?

Corporate Governance is the operative and efficient management of a company’s finances in order to achieve the established objectives. Considering the Anglo-American company viewpoint, this would primarily emphasize the effectiveness of shareholder wealth maximisation.

What is Shareholder Maximisation?

Shareholder Maximisation measures a company’s success by how successful it is in maximising profits for its shareholders. Generally, the aim of the game is to increase the company’s share price. If the stock price goes up, the value of the firm increases. Simple! Or is it?

Let’s consider the Enron Case:-

Enron Corporation

·         American Energy company based in Texas

·         USD$90.75 share price dropped to < USD$1 in a year

·         Largest corporate bankruptcy in US history

.·         Executives modified earnings and balance sheet to indicate positive    numbers

·         Executives hid the debt

The problem with Enron was primarily to do with the Executive team. Ken Lay was not only CEO, but president and chairman at the same time in 2001. What is the issue with this? If we were to follow corporate governance religiously, the CEO and chairman should be two separate individuals. The chairman’s role is to manage the board of directors. The board of directors’ role is to appoint and review the performance of the CEO. Can we see the conflict of interest here? We can argue that Enron's board of directors let the CEO take control for job security issues.

“The company’s management team were arrogant, overambitious and even sycophantic. Some even suggested that Kenneth Lay was like a cult leader with staff and employees fawning over his every word and following him slavishly” Solomon, Corporate Governance and Accountability (p.34). 

It is evident that Enron’s Corporate Governance was dysfunctional and the culture of the organisation became obsessed with short-term profits to maximize bonuses. The following conclusions can be said:

·         There is a huge issue between ownership & control (Berle and Means, 1932)

·         This case is an example of Agency Theory- the corporate governance dilemma.

·         Where Profit Maximization > Shareholder Wealth

What is Agency Theory?

Agency theory is the concerning relationship between principles (shareholders) and agents of shareholders (executives).

There are two issues with Agency theory:

1)      Principle cannot validate what the Agent is doing

2)      Different tolerance on risk

In Enron’s case, they had a complex business model that shareholders/analysts did not understand.

Agency theory suggests the problem of greedy managers, where their only concern was to make decisions based on their own personal wealth.

What could managers argue on Agency Theory?

·         They have a greater insight to the company and shareholders should not get involved.

·         Managers might truly believe that shareholders are not entitled to the largest piece of the surplus

·         Shareholder maximization is great as a score keeping measure but nothing to tell us how to survive. Business vision is key. So do managers know best?

As mentioned earlier, we have pointed out that as an Anglo-American company viewpoint; the primarily objective for any organisation is shareholder wealth maximisation.

Nevertheless, research has contradicted this “Anglo-American” theory. Loderer et al’s (2010) study highlights the content mentioned in companies mission statements- the heart of an organisations primarily aims and objectives. Within 1,800 listed Anglo-American companies, a measly 35% mention Shareholder wealth maximisation- ultimately questioning the feasibility of the Anglo-American model.

But at a theoretical point of view, Shareholder wealth maximisation is seen more valued to an investor than profit maximisation.

Why?

Profits can be manipulated (as we’ve seen within the Enron case). This is only good for short term aims and objectives but companies are likely to be worse off in the long term. If an investor sees a fluctuation in his/hers return, there is likelihood that the investor will sell their share/s. In short, steady income streams are highly valued by investors.

To conclude:

• Corporate Governance is key to achieve established objectives.
• Is shareholder maximisation just not implementable or feasible? Is that why the majority of Anglo-American organisations leave out “shareholder wealth maximization” within their mission statements?
• Investors admire a steady income stream where shareholder maximisation > Profit Maximisation
• Do we need more disclosure/ laws based on Agency theory to combat greedy managers?