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Aligning Managers with Shareholder Interests

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What mechanisms should be put in place to better align managers with the interests of shareholders? Thanks.

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Solution Summary

This posting gives you a step-by-step explanation of how manager actions can be aligned with shareholder interests. The response also contains the sources used.

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Step 1

First let us understand the interests of the shareholders. When a shareholder makes an investment in a company the shareholder is interested in the profitability of his investment. For example, if the profitability of the company in which he has invested is 12% but the industry profitability is 18%, the shareholder feels that he has not made a good investment. The shareholders interests are reflected in the terms of dividends, profits, and capital growth. Each of these can lead to an increase in share prices. The shareholder looks at indicators such as earnings per share, price earnings ratio, intangible and tangible assets and dividend paid.

Step 2

There are mechanisms that align the interest of the managers with that of shareholders. Profit related pay is the first mechanism that aligns the interest of the managers with that of shareholders. The managers are paid in accordance with the profit earned. The managers then strive to achieve the targeted profits. For example, after six months the managers realize that the companies are 30% less than the target ...

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