A fifth principle of finance relates to the fact that management objectives may diff er from owner objectives. Owners, or equity investors, want to maximize the returns on their investments but often hire professional managers to run their firms. However, managers may seek to emphasize the size of firm sales or assets, have company jets or helicopters available for their travel, and receive company-paid country club memberships. Owner returns may suffer as a result of manager objectives. To bring manager objectives in line with owner objectives, it often is necessary to tie manager compensation to measures of performance beneficial to owners.
Managers are often given a portion of the ownership positions in privately held firms and are provided stock options and bonuses tied to stock price performance in publicly traded firms. The possible conflict between managers and owners is sometimes called the principal-agent problem. We will explore this problem in greater detail and describe how owners provide incentives to managers to manage in the best interests of equity investors, or owners, The sixth principle of finance is, “Reputation matters!” An individual’s reputation reflects his or her ethical standards or behavior. Ethical behavior is how an individual or organization treats others legally, fairly, and honestly.
Of course, the ethical behavior of organizations reflects the ethical behaviors of their directors, officers, and managers. For institutions or businesses to be successful, they must have the trust and confidence of their customers, employees, and owners.