June 24, 2024


Business – Your Game

Owner Manager Conflict Within the Firm

Owner-manager conflict can result in loss of productivity, cause waste, and even make the firm go out of business. There are at least five sources of conflict that can arise between owners and managers

  • Choice of Effort. Additional effort by managers generally increases the value of the firm, but since the managers expend the effort, additional effort reduces their utility.
  • Perquisite Taking. It is in the interest of owners to pay sufficient salaries and bonuses to attract and retain competent mangers. However, owners do not want to overpay managers. In contrast, managers are likely to want not only higher salaries but also perquisites such as exclusive club memberships, lavish office furniture, luxurious automobiles, stimulating day care for children, and expensive French confections. Managers can be overpaid while the lower employees are underpaid thus resulting in a conflict between all involved which can cause loss of productivity and eventually even the result of the closing of the business.
  • Differential risk exposure. Managers typically have substantial levels of human capital and personal wealth invested in the firm. This large investment can make managers appear excessively risk-averse from the standpoint of the owners, who (at least in a large public corporation) typically invest only a small fraction of their wealth in any one firm. Hence, managers might forgo projects that they anticipate would be profitable simply because they do not want to bear the risk that the project might fail and lead to a reduction in their compensation. Managers will look after their own interests even if it means a loss to the owners or shareholders.
  • Differential horizons. Managers’ claims on the corporation generally are limited by their tenure with the firm. Therefore, managers have limited incentives to care about the cash flows that extend beyond their tenure. Owners, on the other hand, are interested in the value of the entire future stream of cash flows, since it determines the price at which they can sell their claims in the company. Again owners want their profits while managers only want to work and make enough to keep their pockets full.
  • Over investment. Managers can be reluctant to reduce the size of the firm, even if it has exhausted available profitable investment projects; they prefer to empire-build. Also, managers often are understandably reluctant to lay off colleagues and friends in divisions that are no longer profitable. Managers who fire their colleagues bear personal costs (disutility), whereas shareholders receive most of the benefits. Some managers become friends with their employees and their families therefore causing problems when they have to lay them off or let them go due to the business slowing down. The managers would rather the owners or shareholders lose profits than to letting their friends lose their jobs.

One example would be a company that drilled water wells. The owners had built up the business to be an honest and reputable business but after they retired and hired a manager to run the business for them the manager had different ideas of how to run the business. They weren’t as honest as the owners were and treated employees dishonestly by cheating them out of their pay. This caused much conflict between the owners and the manager as the company was losing customers but the manager continued to pay himself big wages.

Another example is a used car lot in Dade City that the original owners sold cars in an honest and reputable way building the business up and when he hired a manager to take over the business the manager started selling cars that were breaking down within weeks after the customers drove them off the lot. The manager would not help the customers with the fixing the cars like the owner did if he sold a car that caused his customers problems. The manager was making the sales and showing profits to the owner therefore making bigger profits for himself but at the same time he was ruining the reputation of the car lot. There was conflict with the owner and manager since the owner wanted the business ran one way and the manager ran it a different way.