Managerial Behavior Essay

Custom Student Mr. Teacher ENG 1001-04 3 July 2016

Managerial Behavior

Manager is anyone who responsible for the work of other people. Stewart (1988) defines manager as those above a certain level in the hierarchy, usually those above foreman level on the works side and those above the first level of supervision in the offices. Managerial behaviour is the behaviour that can be reported, whether from observation by others or by self-reports. Managerial objective is the aim that a manager of a firm wants to achieve. In perfect markets a proper managerial objective is to maximize its firm’s market value.

The powers of the managerial behaviour are by no means unconstrained. On one hand they are constrained by the shareholder, involuntary takeover, and by the debt market through threat of capital starvation while on the other hand they are constrained by the ever present force of competition in product markets and its managerial labour market. While there are significant differences among countries, managerial constraints are ineffective and managerial objectives predominate.

The first constraint in managerial behaviour is coming from the share holders. The reason is that, dispersed ownership in large firms increases the principal-agent problem due to asymmetric information and managers are subjected to bounded rationality.

Because the contracts between managers and shareholders are unavoidably incomplete as future contingencies are hard to describe, shareholders must monitor managers. However, the cost of monitoring tends to be really expensive and when the equity is widely dispersed, shareholders do not have appropriate incentives to monitor managers since it is often that managers have better information and are more knowledgeable. The common solution is by appointing the Board of Director with the fiduciary obligation to look out for the best of their interest and monitor managers. Nevertheless, this is only partially successful since in most cases the Board of Directors is also in the management.

One way to align manager is by introducing Management Remuneration Schemes. This is not only to motivate managers to work harder or guarantee them a competitive salary, but a way of getting them to work in the interests of the owners. The remuneration scheme is the signal of owner expectations from management and can be divided to Cash-Based which includes performance-related and profit-related, and Share Ownership or Share-Value-Based. The argument for cash-based incentives is that it provides motivation for effort and cooperation to maximize results for the firm, and that it is good for morale if managers get more when profits are good. However, the disadvantage is that, it transfers part of the risks of a firm to the managers, who if they are risk-averse might prefer incomes which were smaller on average, but safer. Among the share-based systems, the most common are stock options. Stock options are long-term incentives, normally supplementing short-term schemes like performance- related pay. Nevertheless, when managers are subjected to stock options compensation, they are most likely to focus more on their stock returns.

The effect in shareholders control to manager is different among countries. For cooperative system in European countries, constraints on managers are not only coming from the owners, but also from other stakeholders such as employees, customers, suppliers and the local community. Therefore, managerial behaviour is highly constraint in this region. Unlike in the Europe, the concept of the stakeholder firm that emphasize cooperative labour relations was largely ignored by US and UK whereby shareholders are the only residual income claimants and risk bearers in a firm (Fitzroy 1998). In the UK and US, maximization of shareholder value is generally regarded as the only legitimate goal of the firm through stock-options or bonus payment which leads to high basic salary and other payments. Hence manager of a larger firm not would prefer to be risk-averse rather that achieving profit-maximizing and would intend to pursue operations that are subjected to lesser risk as they had already received high incomes (Fitzroy 1998). In addition, for a large company with dispersed ownership structure, shareholders have little incentive to discipline the management to act in their interest due to free-rider problem.

The second constraint that is being used by the owner for disciplining management and correcting managerial failure is the takeover mechanism which resulted in the downsizing of multi-sector conglomerates. Managers will wish to have certain amount of net profits to distribute as dividends in order to keep their shareholders satisfied with the firm’s performance. Unsatisfied shareholders may either replace the manager or attempt to sell their shares causing share devaluation and encouraging hostile take over bid (Moschandreas 2000).

Meanwhile, the manager wants to keep their jobs and will try to increase the costs of takeover to the potential bidder is decreasing in takeover costs which mean the higher the take over cost, the more unlikely the firm to be take over and therefore the managers will have higher job security.

Countries differ dramatically in the ease and frequency of takeovers which arises not only from differences in the regulatory framework underlying takeovers but also from cultural and historical attitudes towards takeovers. As for equity-based countries like US and UK, with dispersed ownership, take-over threat is higher caused by devaluation of shares as bidders are much feasible to raise large sums of money. Besides, there are also difficulties in manager entrenchment and higher liquidity in secondary markets which facilitates transfer of large blocks of voting shares has also made take over threat more feasible. On the other hand, in the bank-based countries, take over mechanism is unlikely to work because the cooperative society usually retains their majority of the shares. For example, in German and Japan are virtually unknown because of the concentrated ownership and long-term relationship investing by banks, the manager is entrenched and takeovers are ineffective in disciplining him.

Creditors which are mostly banks are another type of constraint in managerial behaviour. By pooling the resources of many depositors and lending to many firms, creditor can hold a substantial piece of a firm’s debt giving banks incentives to monitor. In most cases, manager issues bank debt in order to raise capital. The controlling effect of debt is firstly that, as it is normally granted for a relatively short period, management must make a real effort to find productive ways of operating in order to amortize the loan, and secondly, if the company is unable to meet its debts, the creditors have the right to apply for bankruptcy and realise the loan guarantees.

The cost of monitoring by banks differs across economies as countries differ widely in regulatory regime applicable to the banking system. Japan and European systems are typically bank-based and owner concentrated, where as American ones rely on the stock market and dispersed ownership. The differences are due to legislation, the nature of financing and also partly to social attitudes. Since the creditor-depositor relationship is closer, banks in these Japan and European countries also have lower cost of bank monitoring. Therefore, manager in these region are much more constraint by their creditors. However, unstrict legal systems in concentrated ownership will offer a lot of discretion to the manager, allows him to make project choices which are in his best interests, for example the choices which accord him with larger private benefits.

On the other hand, US and UK have legal restrictions on corporate shareholding and are tends to have external relationship with the depositor which has lead to problem such as asymmetric information in the Principal-Agent relationship. The environment in US and UK is not conducive to bank monitoring are regarded as having a high cost of bank monitoring. However, in dispersed ownership, monitor through creditors is ineffective since manager will adhere to the bank debt only if his private benefits are much lesser than the benefits that he will get from commitment with the bank debt. In addition, they would rather prefer to be risk-averse than undertake any risky decisions.

The next constraint on managerial behaviour is due to product market competition. According to Leibenstein (1966), there may be a substantial amount of X-efficiency if output markets are perfectly competitive because manager would normally work harder and more effective. Contrarily, in situations where competitive pressure is light, manager will trade the disutility of greater effort, or search for the utility of feeling less pressure and of better interpersonal relations. In addition, Schmidt (1997) stated that, when the product market for managers is tough, an increase in competition is less likely to also increase in incentive schemes. He argues that increased competition reduces the firm’s profit, which induces the manager to work harder for a cost reduction in order to avoid liquidation.

Nevertheless, rising of product market power will also increased the managerial discretion because manager has more bargaining power and will takes this opportunity to pay more attention on increasing their incentives rather than committing themselves to maximize the firm’s profit. Plus, in order to retain its competitiveness, a company will invest in long-term product development, but managers are actually more concern on their own short-term-less-risk goals rather than long-term ones that would lead them to pursue their own objectives instead.

Product market competition is also different among countries. For instance, competition between individual is stronger in the US than in UK as in the US, the inefficient manager will be fired more readily. In the latter, incompetent but long-service managers in a large company used to be kicked upstairs and given jobs with a high-sounding title but which did not let them handicap the firm’s efficiency (Stewart 1985).

The fifth constraint in managerial behaviour can be classified as the managerial labour market. In managerial labour market, managers are preferred to be associated with good performance because this would allow them to earn a good reputation. Additionally, they have also found that executive cash compensation and top management turnover are strongly performance-sensitive. Top executive turnover is shown to serve as a disciplinary mechanism punishment for corporate underperformance whereas compensation rewards good performance and will provide strong managerial incentives to seek superior corporate performance in the subsequent periods.

This type of managerial constraint is somehow ineffective in controlling managerial behaviour since manager would not want to commit to any risky projects because their decision might disrupt their good labour market and therefore will affects their incentives.

Since all of the managerial constraints are ineffective in controlling the managers, they will tend to pursue their own objectives which would much benefit them later rather than aligning themselves to the owners’ interest. Managers may want to choose projects that give them a larger level of discretion and higher private benefits of control. According to Dicretionary Theory, Baumol (1959) argued that manager’s aim is to maximise their sales revenue while Williamson (1964) stated that managers would create discretionary funds for investment and spend excessively on emoluments and staff expenditure (Moschandreas 2000).

The first reason is because most managers want to achieve short term goals. In fact, any accounting based measure leads to short term thinking and may be counterproductive since managers often influence and control accounting practices. Most common stock-based managerial incentive plans are relatively liquid, such as stock options with stock appreciation rights or share-performance cash bonuses. Additionally, if they are going to negotiate for a certain matter they will also adopt to short termism actions. For example, the recent merger between Time and Warner company has raise doubts to the public since the entire merger was took place for only five months and all other aspects of the agreements came very easily. However, recent findings has proved that the one real deal-breaker was took place for the compensation benefits of the head of Time-Warner.

The second reason for predomination of managerial objective is because they want to maximize their own incomes i.e. private benefits, managerial ownership of the firm, expected cash flows to equity holders and salary. Manager will pursue their objective anytime when the private benefits are sufficiently large to offset the incremental value of his share of the higher cash flows as a result from his alignment.

In Europe and Japan, managerial salaries do not seem to grow faster than average pay and indeed CEO in these countries tend to earn lesser than their US counterparts today. In these regions, stock options are not widely being used and PRC are less important since it have no detrimental effects on firm performance (Fitzroy 1998). Contrarily, in UK, CEO compensation rose much faster than average pay throughout the 1980s and 1990s. More companies were introducing PRC, stock options and bonus schemes to align managerial incentives and shareholders’ interests and detailed studies had shown that this system to be tenuous at best.

According to Bureaucratic theory by Monsen and Downs (1965), the best established empirical fact about top manager’s pay is that total compensation is closely related to the firm’s size. Stewart (1985) argued that the manager of large companies would become more bureaucratic because of increasing in size and greater complexity. Therefore, in large firm, for the same level of positions, the managers are getting more pay compared to the smaller one. This has contributed to predomination of managerial objectives in large firm in maximizing their incomes.

The second reason for predomination of managerial objectives is because most managers are risk-averse because they expected to be blamed for failures but inadequately rewarded by the profits of success and pay depends on output will exposes employees to greater risk (Milgrom and Roberts 1992). Managers therefore prefer to diversify in their decision making between unrelated lines of business which would lead to devaluation of firm because of lack of economies of scope. Additionally, outside shareholders would like manager to maximize the value of the firm as this will lead to higher share prices but managers would try to offer shareholders steady capital gains and earnings increases, in contrast to possibly more fluctuating but on average more lucrative possibilities.

The third reason is because manager would always want to have a very high job security. Most managers don’t dare to jeopardise their jobs to achieve profit maximization by taking high risk decision. According to the Growth theory by Marris (1964), the various possible candidates for inclusion in a managerial objective function are collapsed into the single motive of desire for sustainable long-run growth in size. Managers have the power to pursue a long-term growth rate faster than the one which would be optimal for shareholders, but the further they go, the more they are in danger of depressing the market value of the firm to the point where there is a serious risk of involuntary takeover, the latter being feared because it means loss of job. Hence, manager may want to subject to unprofitable on average as this will increase both the size of the firm and also their own compensation (Fitzroy 1998).

The fourth reason is because managers may want to sustain their political reputation in the firm and would only run his objectives that will not disturb their political reputations. This would enable them to maintain supports from their staffs. In Japan, the preservation of individual status and prestige is much more important than in the US and UK. Promotion is largely by seniority at all levels (Stewart 1988). Some managers may want to pay their employees more than they deserve to maintain good relations with them and hence increase their political reputation and makes them more entrenched in the company.

As for conclusion, it is considerably clear that managerial behaviour is ineffective in controlling managers because they are more preferred to achieve short term goals, maximizing profits, being risk averse and securing their job security, which has lead to predomination of managerial objectives. The Growth Theory by Marris, Discretionary Theory by Baumol and Williamson, and Bureaucratic Theory by Monsen and Downs explain clearly the reasons for objectives predomination by managers. Besides, there are also different impacts of managerial constraints on managerial behaviour among bank-based and share-based system on different countries i.e. European, Japan, US and UK. Lastly, in any large firms regardless of the system of corporate governance, it is impossible to totally eliminate the predomination of managerial objectives. However, this problem can be reduced through development of management control systems and development and evaluation of remuneration schemes.

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