Cross-posted from System Viability and Corporate Governance blog
Standard investment advice is to diversify. Among other things, this
means that it's not a good idea to hold significant quantities of shares
in your own company, since you are doubly exposed if the company fails.
(Think Enron.)
Meanwhile, it is widely supposed that the company's interests are
served if the directors and employees have an investment stake in the
company as well as an employment stake. This is supposed to align the
personal interests of the directors and employees with the interests of
the company. There is personal commitment to the success of the
company, with an inflated cost of exit.
Furthermore, by having large personal shareholdings, company
directors demonstrate their confidence in the company's present state
and future prospects, and their belief that the share price undervalues
the true worth of the company.
There is therefore a structural conflict of interest between company
(external shareholders) and employees (especially directors). How is
this resolved?
Either the individual directors take an irrational stance in respect
of their personal investments, accepting an unbalanced portfolio with a
sub-optimal risk/reward ratio. However, we should not expect true
alignment between the interests of a director with an unbalanced
investment portfolio, and the majority of shareholders whose investments
are (of course) properly balanced and diversified.
Or the directors cheat. For example, holding derivatives that hedge
against the excess exposure to the failure of the company. For
example, manipulating information. And as a privileged class, the
directors hedge against failure by awarding themselves massive
termination payments. (While not illegal, this is a morally corrupt
practice.)
According to this argument, directors are driven by the system
towards either madness or badness. (Some manage both at once.) The
answer is not to recruit a new cadre of morally upright and selfless
leaders, but to change the system.
Click here for Trevor's reply
http://systemviabilityandcorporategovernance.blogspot.co.uk/2004/08/commitment-and-self-interest.html
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