What are the causes of conflict of interest between managers and shareholders?

i. Incentives problem
Managers may have fixed salary and they may have no incentive to work hard and
maximize shareholders wealth. This is because irrespective of the profits they make, their reward is fixed. They will therefore maximize leisure and work less which is against the interest of shareholders.

ii. Consumption of “perquisites”
Prerequisites refer to the high salaries and generous fringe benefits which the directors might award them. This will constitute directors remuneration which will reduce the dividend paid to the ordinary shareholders. iii. Different risk profile Shareholders will usually prefer high risk high return investment since they are diversified managers on the other hand; will prefer low risk low return investment since they have a personal seat of losing their job if the project collapse. The difference in risk possible is a source of conflict of interest since shareholder will forego some profits which low return projects are undertaken.

iv. Different evaluation horizon
Managers might undertake projects which are profitable in short run shareholders on the other hand evaluate investments in long run horizon, which is consistent with the going concern aspect of the firm. Conflict occur when management pursue short term profitability while shareholders prefer long term profitability.

v. Management Buy Out (MBO)
The Board of Directors may attempt to acquire the business of the principal. This is equivalent to the agent buying the firm which belongs to the shareholders. This is inconsistently with the agency relationships and contract between shareholders and the managers.

vi. Pursuing power and self esteem goals
This is called “empire building” to enlarge the firm through mergers and acquisition hence increases in the rewards of managers.

vii. Creative accounting
This involves the use of accounting policies to report high profits, e.g. stock valuation methods, depreciation methods recognising profit immediately in long term construction contrast etc. Managers can be encouraged to act in the stockholders best interest through incentives, constraints and punishments. These methods however are effective only if shareholders can observe all of the actions taken by management. A moral hazard problem, whereby agents take unobservable actions in their own self interest, originates because it is infeasible for shareholders to monitor all managerial actions. To reduce the moral hazard problem, stockholders must incur agency costs.

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Judiesiz answered the question on August 16, 2018 at 20:19