Chapter 2 • A framework for financial decision making
Wetherspoon, typical of most businesses, paid very substantial bonuses to directors,
based on the level of returns to shareholders – an indication that directors’ attention
was being focused clearly on the welfare of shareholders.
Many businesses, nearly all larger ones, grant ‘share options’ to their directors and
senior managers. This is an arrangement where shares offered at the current market
price can be taken up and paid for at some future time. This means that the directors
can benefit directly, and without risk, from any increases in the business’s share price.
If the share price goes up, they exercise their option and can immediately sell the
shares at the higher price. If the price does not go up, the directors are not required to
take up the shares.
We can probably summarise the evidence provided by looking at what individual
businesses say and do, as follows. Many businesses state their objective to be share-
holder wealth maximisation, though not all do so. Nearly all larger UK businesses pay
sizeable bonuses to their directors. These bonuses are almost always linked closely to
returns to shareholders. On top of this, most larger businesses grant substantial share
options to directors. In this way directors have a strong incentive to benefit the share-
holders. Bonuses and share option benefits can easily exceed basic salaries of many
directors. So, while some businesses do not state shareholder wealth maximisation as
their goal, their actions, including the incentives given to senior managers, strongly
imply that the economic welfare of shareholders is a major issue.2.3 Conflicts of interests: shareholders versus managers
– the ‘agency’ problem
The problem
Although the shareholders control the business in theory, in practice the managers
control it on a day-to-day basis. It has been suggested that some businesses might
pursue policies that are likely to maximise the welfare of their managers, at the same
time giving the shareholders sufficient rewards to stop them from becoming too dis-
satisfied and causing discomfort to the managers, rather than maximising shareholders’
wealth. The ways in which managers might seek to maximise their welfare include:l paying themselves good levels of salary and ‘perks’, but not too much to alert
shareholders to whom, by law, directors’ salaries must be disclosed;
l providing themselves with larger empires, through merger and internal expansion,
thus increasing their opportunities for promotion and social status; and
l reducing risk through diversification, which, as we shall see in Chapter 7, may not
benefit the shareholders, but may well improve the managers’ security.
We saw in Chapter 1 that the Combined Code on corporate governance seeks to
avoid the more extravagant divergences between the welfare of the shareholders and
that of the directors. No amount of regulation is likely to eliminate this problem com-
pletely, however.
There is no reason to believe that managers consider only their own interests at the
expense of the shareholders. However, it is likely that some, possibly most, managers
would consider their own welfare when making decisions about the business. This, no
doubt, can cause decisions to be made that are sub-optimal from the shareholders’