Separation of Ownership and Control in Business

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Table of Contents

Introduction
Potential conflicts of interests at the Walt Disney Company
Potential solutions
Reference List

Introduction

In most modern businesses, ownership and control are two distinct entities. This is because under certain circumstances, shareholders may be widely dispersed to an extent that it becomes hard for them to exert control over the management (Anechioco & Jacobs 1996). In order to ensure that the business is run in an efficient manner, it becomes important that the owners delegate authority to managers. Although there are a number of benefits that accrue from delegation of control to managers (Brickley & Van Horn 2002), on the other hand, conflicts of interest could also arise between the various stakeholders. A firm may be viewed at as a network of contracts among the various stakeholders including shareholders, employees, the society, and bondholders. The different stakeholders in a firm have different claims to the pay-off structure of the company. In addition, the alignment to the interests of the major stakeholders varies. As a result, potential conflicts arise. These incentive conflicts are collectively referred to as agency problems (Fama & Jensen 1983, p. 328; Pottier & Sommer 1997). Agency problems tend to disrupt the smooth operations of a company (Fama 1980). The paper explores the conflicts of interest that could arise among the various stakeholders at the Walt Disney Company. In addition, the paper also endeavors to examine potential solutions to the identified conflicts of interest.

Potential conflicts of interests at the Walt Disney Company

One of the potential conflicts of interest would be managerialism. This is a term used in reference to the self serving behavior that managers demonstrate. Modern corporations are widely diffused and the Walt Disney Company is not an exception. Consequently, numerous shareholders have a stake at the company. However, because ownership and control at the Walt Disney Company are two distinct entities, managers at the company are involved in the actual operations of the company. However, their stock ownership positions are minimal. This is a potential area for conflict of interest between the owners of the Walt Disney Company and the managers. The arising conflict could manifest itself in one or more dimensions. The conflict between the stockholders and the management may result in managerial propensity for empire building as a means of extending their span of control (Fama & Jensen 1983, p. 302). Of course, this comes at the expense of the owners. The conflict may lead to overly conservative investments as a way of seeking an inferior but safe project that would sustain the safety of not just their tenure, but their wage compensations as well.

Another form of conflict that could arise among the stakeholders at the Walt Disney Company is the debt agency. In this case, managers could be allowed to make sub-optimal financial and investment decisions on behalf of the equity holders because this is a stipulation of the debt contract. However, this is quite a departure from the value maximization principle. Such a scenario could occur if creditors and equity holders to the firm constitutes a disjointed group of investors (He & Sommer 2006). In such a case, maximizing equity value becomes the primary concern.

Another possible conflict of interest at the Walt Disney Company is one between the employees and the managers. Employees may be seeking better terms of employment, in the form of increased wages. On the other hand, the management could be on a mission to drastically reduce the operating costs of the company in an effort to boost the profit margins (He & Sommer 2006). As a result, a conflict of interest is bound to arise between the employees and the management. While employees may feel that they deserve higher wages in order to cushion for the rise in cost of living, on the other hand, the management is first and foremost answerable to the equity holders (owners) of the company who would want to realize a return for their investments. As such, the management may resist the urge to increase employees wages because it would eat into the profit margins of the company.

As with other firms, the shareholder-manager conflict can also affect the Walt Disney Company. This conflict also tends to take various shapes because the management and shareholders are likely to disagree over a lot of things. For example, managers could wish that they had the power to hold more cash, they may wish for their workload to reduce, they may wish to increase the job security of their employees by reducing the risk that the firm faces, and if they had the powers and means, managers would wish to increase employees wages (Pairote 2003). In addition, managers may also want to enjoy additional perks, such as a jet plane, or fancy offices. Shareholders and managers are therefore likely to disagree over all these things. The agency costs have been studied at length and documented for a long time now. Researchers argue that agency costs come about because managers are individuals too and as such they are inclined to serve their individual best interest even at the workplace.

Another disagreement that could happen between stakeholders at the Walt Disney Company is one between the shareholders and the bondholders. Such a disagreement could be occasioned by a number of things. Kose and Senbet (1997) opine that those firms that have a lot of debt to settle have a higher likelihood of foregoing business opportunities that promises positive growth simply because any accruing benefits would go to the bondholders, as opposed to the shareholders.

Another source of disagreement between the stockholders and bondholders at the Walt Disney Company could be on the issue of the amount of risk facing the company. For instance, assuming that the Walt Disney Company is a levered firm whose equity is equivalent to a call option, in this case, shareholders feel obliged to increase the amount of risk that the firm faces because there is an incentive involved (Pathranarakul 2005). In other words, the shareholders stand a chance to gain an unbounded payoff because of the higher likelihood of a large positive payoff (Pathranarakul 2005). On the other hand, the debt holders only enjoy a limited payoff, and hence the conflict of interest between these two parties.

Potential solutions

One of the ways to control the conflict between managers and shareholders is to ensure that managers are watched over constantly (Trevino, Hartman & Brown 2000, p. 133). However, should this effort fall short of the shareholders expectations, the best options would be having the managers removed (Pottier & Sommer 1997). This strategy is more of a managerial labor market whereby the management feels constraints to yield to the demands of the shareholders. As such, they have no choice but to act in such a manner as to prioritize on the best interests of the shareholders, lest they are removed. However, it is important to note that watching over the managers is quite expansive to the shareholders, not to mention that success is not guaranteed (Rodwin, & Okamoto 2000, p. 345). This is because managers tend to be knowledgeable and better informed. The Board of Directors ensures that the best interests of the shareholders are taken care of and as such, the BOD is also charged with the responsibility of monitoring the management. Shareholders elects the BOD so that their best interest at the company can be taken care of. This method has also not been successful due to a number of reasons (for instance, by and large, the management is also represented on the BOD).

Perhaps a better alternative would be to add attractive incentives to the managements compensation contract. This is to avoid constant monitoring of the management by the shareholders. One way of achieving this goal is to award bonus to managers who please the shareholders (Trevino et al 2000, p. 134). In addition, bonus could also be given after a manager has met certain measures. Nonetheless, these strategies are prone to problems too. For instance, an accounting based measure could result in short-term thinking and in the long-run, may prove counterproductive because managers usually control and influence accounting principles. A more efficient strategy is one that utilizes market-based compensation (Raheja 2006, p. 288). This may be achieved either via Stock Appreciation Rights, stock options, or pure stock ownership. The last two decades have witnessed an explosion in the application of executive stock options. These long-term calls (options) often depend on high leverage alternatives as a way of integrating the stockholders interest with those of the management. The stock option strategy has been criticized but even so, managers appear to concentrate more stock return compared with the past decades.

To prevent a conflict between the shareholders of a firm and the bondholders, the latter may opt to cease lending money to the firm in question. Another strategy is to assume that the firms shareholder will deem it necessary to increase the companys riskiness so that bondholders may increase their interest rates (Andrews & David 1998).This way, the bondholders are actually price-protecting themselves. Alternatively, bondholders may decide to involve a third party in their negotiations with the shareholders. The third party should be neutral, and he/she would be charged with the responsibility of monitoring the firm on behalf of the bondholder. Another way of avoiding the conflict is to ensure that when drafting the lending contract, the terms are so restrictive as to limit s what the shareholders can actually do with the borrowed funds (Pairote 2000). By relying on the reputation of the shareholders, the bondholders may decide to reduce the shareholders opportunistic behavior. In other words, shareholders may be in need of extra funds in the future. Therefore, the most important thing for the bondholders is to make money available to the shareholders now so that in the days ahead, they can borrow again. Another viable alternative to reducing the shareholder-bondholder conflict is to agree to lend the funds in the form of convertible debt that is, the bondholder can always convert the money owed to them by the shareholders into equity. Alternatively, in case something bad occurs, the shareholders of the firm may decide to buy back the money owed to them (puttable debt).

Reference List

Andrews, K.R., & David, D. K., 1998. Ethics in Practice: Managing the Moral Corporation. Boston, Massachusetts: Harvard Business School Press.

Anechioco, F., & Jacobs, J. B., 1996. The Pursuit of Absolute Integrity. Chicago: University of Chicago.

Brickley, J. A., & Van Horn, R. V., 2002. Managerial incentives in nonprofit organizations: evidence from hospitals. Journal of Law and Economics, Vol. 45, pp. 227-249.

Fama, E. F., & Jensen, M. C., 1983. Agency Problems and Residual Claims. Journal of Law and Economics, 26, pp. 327-49.

Fama, E. F., & Jensen, M. C., 1983. Separation of Ownership and Control. Journal of Law and Economics, 26(2), pp. 301-325

Fama, E. F.., 1980. Agency Problems and the Theory of the Firm. Journal of Political Economy, 88(2), pp. 288-307

He, E., & Sommer, D. W., 2006. Separation of ownership and control: implications for board composition.

Kose, J., & Senbet, L. W., 1997. Corporate governance and board effectiveness.

Pairote, P., 2003. Conflict of Interest: Study on Public Sector Professional Groups.

Study Report Submit to the Civil Service Commission, Thailand. [online]. Web.

Pairote, P., 2000. Open System Evaluation: A Challenge to Good Governance. Thai Journal of Development Administration, 40(1), p. 1

Pathranarakul, P., 2005. Conflict of Interest: An Ethical Issue in Public and Private Management. Issue paper (Workshop D). 5th regional anti-corruption conference, Beijing, PR China.

Pottier, S. W., & Sommer, D. W., 1997. Agency Theory and Life Insurer Ownership Structure. Journal of Risk and Insurance, Vol, 64(3), pp. 529-543

Raheja, C. G., 2006. Determinants of Board Size and Composition: A Theory of Corporate Boards. Journal of Financial & Quantitative Analysis, Vol. 40(2), pp. 283-306.

Rodwin, M. A., & Okamoto, A. 2000. Conflicts of Interest, Journal of Health Politics, Policy & Law. Vol. 25(2), pp. 343-375.

Trevino, L. K., Hartman, L. P., & Brown, M. 2000. Moral Person and Moral Manager: How Executives Develop A Reputation for Ethical Leadership. California Management Review, Vol. 42(4), pp. 128-142.

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Separation of Ownership and Control in Business

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