The management team is responsible for running the business and taking decisions as and when required but have almost negligible claim on profitability. In such organisations, separation of ownership and control is clearly visible. Many authors have described this relationship, between the shareholders and the management of the firm, as ‘pure agency relationship’. This concept will be further discussed in the essay with the help of ‘agency theory’.
The concept of separating ownership and control was aimed to assist the firms to achieve the sole motto of profit maximisation. This concept held the view that organisations should strike a balance between profit maximisation and development of society, which is corporate governance. In the later section, different theories associated with separation of ownership and control will be analysed to determine the cost of agencies.
The concept of separation of ownership and control was first introduced by Berle and Means in the year 1932. The agency theory explains that the owner (shareholders) of the firm is the principal and the one who take the responsibility of running and managing the business (management) is the agent. Both the principal and the agent think of their personal gains. The Principal tries to design the governance system for maximising his utility. In the same way, the agent tries to manage the firm for fulfilling his utility. If utility of both principal and the agent coincides, they both enjoy increment in their individual utility. However, often the utility of the agent differs from that of the principal, and the agent tries to maximise his utility at expense of the principal. To minimise such incidences, principal needs to introduce internal control, which results in an extra cost. Thus, the concept of separation in ownership and control is related to agency cost.