Heather Warner
Dec.4, 2000
Economics 100 (02)
Professor Gabriel
The film Wall Street
is a movie that portrays the corruptness that can exist on
Wall Street. Bud Fox is trying to establish a name and a living
for himself, and thus he has the endless task of trying to increase
the number of clients that he represents. In the end he is taken
by the prospect of becoming rich, and it would seem that to do
this requires illegal actions, such as insider trading. It is
quite amazing how this can, almost overnight, lead to great riches
and power. Bud Fox was making an "honest" living; that
is until he finally is able to establish a relationship with Gordon
Gekko-a so-called financial wizard.
While this film deals primarily
with the concept of "Insider Trading" and how it affects
the stocks and their values, I would like to present in this paper
ideas and concepts that I learned in a previous class that extend
beyond just the ideas of insider trading and expand more broadly
to discuss the unethical problems that can occur within a corporation
in general (not just on wall street), when there is separation
of management and ownership. This is important to be aware of
in a capitalist society where many people work for other people,
and or are in charge of many other people as well. It constantly
causes people to question the systems in place and what can be
done to eliminate these potential problems and unethical actions.
The ultimate test of corporate
strategy is whether it creates economic value for shareholders.
Yet there are quite a few problems which can arise and interfere
with this agenda. The agency problem that arises from the separation
of ownership and management in the modern corporation can lead
to conflict between the objectives of owners and the objectives
of managers.
The manager's goal should
be, and in fact the manager's job is, to maximize shareholder
wealth. Managers work for the shareholders, since shareholders
are essentially partial owners of the corporation that they have
purchased stock in. Stockholders invest their money because they
hope that the value of their investment will grow. They want to
increase their wealth as much as possible. (Hickman 11)
Unfortunately, claimants (shareholders)
oftentimes have difficulty determining how well management is
actually doing because of the existence of information asymmetry-
in a sense lack of information. (Hickman 14) This presents an
unfair situation because it causes some people to be better off
than others. Stockholders can't review all the decisions made
by management, thus managers have much more information than others
who aren't involved with the day-to-day operations of the company.
In this case asymmetry exists because insiders and outsiders don't
have the same information. (14)
Information asymmetry can
never be fully eliminated, and it exists to some extent in all
corporations. But the degree to which information asymmetry exists
is relative to the size, organization, and complexity of the corporation.
(Hickman 15) The larger the corporation, the more sever the effects
of information asymmetry seem to be. In fact, in large corporations,
where there are thousands of investors, the "separation of
ownership (held by the common stockholders) and control (held
by managers)" often occurs. (15). This is because each stockholder
only accounts for a small portion of the corporation and they,
as an individual, don't have much voting power, nor can they maintain
constant, close scrutiny of the company. Managers often take advantage
of this situation in large corporations. In small corporations
managers must avoid the temptation of doing this because they
will probably be discovered.
Knowledge of the lack of scrutiny
gives managers many opportunities to exploit and take advantage
of their position in the company. Sometimes insider trading takes
place as a means of making quick and easy cash. However, it can
be a bit risky because if discovered, the outsiders (shareholders)
will lose faith in the fairness of trading the company's securities.
The company would then have a harder time raising capital because
people would be skeptical that they were paying too much. (Hickman
16) An even worse scenario is if managers, who do insider trading,
are found out then legal actions could be taken against them.
In fact, people can be prosecuted just for using inside information
to buy or sell a company's stock even if they don't work for the
company. (USA Today 1)
In the movie Wall Street,
Bud's father works for Blue Star airlines. Although Bud is a stockbroker
and not a manager of a company per se, he is responsible for people's
money and his goal should be to maximize their wealth-and thus,
the idea of insider trading also applies to him (and his job).
Bud learns information which he thinks will lead to and increase
in the stock's value. He turns out to be correct and earns a lot
of money. After getting involved with Gekko he continues to operate
this way because Gekko says to Bud, "The most valuable commodity
that I know of is information…Stop sending me information
(from analysis) and start getting me some…" The problem
with all of this is if the FCC finds out Bud will go to jail for
having committed a conspiracy and for having violated the "Insider's
Traders Act." In the end, this is what happens and Bud's
life is "ruined." He became obsessed by the riches;
the nice house, meals, and fun activities, but in the end one
must ask if it was all worth it for that short time, for he loses
everything, even other people's respect for him. Furthermore,
while Bud and his friends were earning nice sums of money, those
who they represented were probably not earning as much as they
were.
There are numerous example
of insider trading occurring in the "real world." An
actual example of insider trading and or lack of information concerns
the company "Compaq." In the March 2, 1999 issue of
the Wall Street Journal newspaper, there was an article titled,
"Compaq Is Criticized for How It Disclosed PC Troubles."
It explains how on February 25, 1999 only a "chosen few"
received news that Compaq Computer's sales for PCs in the first
quarter were running below "perceptions." Mr. William
J. Milton, computer analyst at Brown Brothers Harriman & Co.,
didn't find out about the slowdown until Friday morning (the 26th)
when Compaq's shares were already down 16%. Compaq's stocks went
down 55/8 and hit the rest of the technology sector as well. Mr.
Young was very annoyed and stated, "Next time I won't call
before downgrading them," since the company did not return
any of his phone calls prior to the decrease. (Pulliam C1)
This all illustrates how uneven
the playing field can be for stock investors. The uneven flow
of information is almost an "accepted" way of operation
on Wall Street. Mr. Levitt added that he was concerned with the
increase in this type of operation stating, "after the analysts
know the news, but before the public knows it-there is a great
deal of unusual trading." (Pulliam C4) Hearing such statements
should make any investor uneasy and more aware.
Another area where investors must be careful is with the idea
of "proxy your vote." If a shareholder proxy's their
vote, they give even more authority to the manager. The manager
can use the proxy vote to add to "their side" (to add
to their favor). Thus, in the event that managers and shareholders
disagree in a meeting-the managers may be able to counteract any
ideas of the shareholders if they have enough votes (including
proxy votes) in their favor. (Downey 1) This hardly seems fair,
and it would seem to me that if they abuse this too much, shareholders
may just decide to sell their investments and invest in another
company.
Although managers are supposed
to act on behalf of shareholders and to satisfy the corporation's
fixed obligations, they also have their own self-interest in mind
and may act on behalf of their own well being. Agency costs are
often hidden, and tend to be viewed as production costs. (Tunstall
1) Yet one should not be fooled because agency costs often exist,
which is of course in direct conflict with the goal of maximizing
shareholder wealth.
Agency costs arise because of the separation of principles and
agents in large corporations. A "perquisite" is,
Perquisites can be cost
effective investments that can benefit managers directly and shareholders
indirectly, but they can also be taken too far. If they become
"excessive perquisites" they benefit the manager but
do not lead to an increase in shareholder wealth. (Hickman 17)
Another agency cost is "shirking." This often occurs
when a corporation's top managers are selected and highly compensated
by the company because it is felt that they, as managers, have
talent and will put forth great effort to find good, worthwhile,
value-creating investments. However, only managers themselves
really know just how much effort they put into their jobs. Thus,
if managers want they could reduce their efforts and still obtain
the same amount of money. However, at the same time of doing this,
shareholders won't be gaining any extra wealth-instead they would
actually be acquiring extra "costs" with no benefits.
(Hickman 17)
"Empire Building"
is yet another agency cost. There is incentive by managers to
expand the firm's size because they believe that they will then
receive a bigger paycheck. In doing this, however, they are not
necessarily taking into consideration the value that the expansion
will add to the shareholders' wealth; rather they are worrying
about how it looks in terms of pay, power, and prestige. (Hickman
17)
There is also always the chance
that managers are concerned only about short-term occurrences-in
that they will make any decisions so long as the results are seen
almost immediately. Unfortunately, what is good in the short run
is not always good or beneficial in the long run. But managers
will focus on the short-run so that they look good, and can perhaps
get a raise. They aren't concerned about the long-term effects
of their decisions because if they think that in the long-run
it won't be beneficial to the company they can always switch to
a different company before having to deal with the outcomes and
repercussions themselves. For example, in 1999 Hong Kong Telecommunications
lost its monopoly over the international long distance telephone
services. It had to come up with other ways to make up for the
revenue that was lost. They have diversified greatly. But is this
really the answer? They, for example, invested in "Video
On Demand" and property management. Video On Demand has not
had much success in Europe in the past, but it seems to be an
up and coming technology. Did management decide to invest in this
because they thought that it would bring in profits, or because
they thought that it looked good and would attract investors at
least in the short term? Property management is an area in which
they have no past or prior experiences with. It looks good to
be diversified, but will it work and be beneficial in the long
run? Diversifying is often risky because of numerous factors,
such as lack of knowledge and experience in a certain area.
Investors need to be aware
that such occurrences and events as the ones previously mentioned,
do happen within corporations and may even occur without one's
knowledge. The likelihood of the problems occurring are greatest
in large corporations where there is a higher degree of the separation
of ownership and management, and thus perhaps an occurrence of
a conflict of the goals of the managers and the goals of the shareholders.
One can attempt to reduce the chance of becoming an owner to a
corporation with these problems by carrying out careful research
of the company. This doesn't eliminate the fact that such things
still might occur in the future, but it is better not to get involved
with a company which has had to deal with such problems in the
past. Aside from doing research on the company itself, doing an
evaluation of stock can also prove to be useful. Knowing if stock
is overpriced, can tip you off, in that you then need to find
out why it is overpriced. For example, is the stock overpriced
because people (investors) sincerely believe that the stock is
good and has potential, or is the stock price high because insider
trading is occurring (such as was shown in the movie)? Knowing
the answer to such questions will help individuals as investors
make better and more informed decisions.
Managers need to reevaluate
their responsibilities to shareholders. They need to realize that
they should make decisions that benefit shareholders, not only
because it's their duty, but also because such behavior increases
the likelihood of promotion, pay raises, and bonuses, without
the hassle of having to worry about criminal charges. In a sense
then, a manager's self-interest depends on making decisions that
assure long-term profitability of the firm. (Hickman 63)
Downey, John. "EDITEK cancels meeting after proxy vote
ruling."
http://www.triadbusiness.com/editek64/html June 28,
1996. P.1.
Hickman, Kent A. Hunter, Hugh O. Byrd, John W. Foundations
of
Corporate Finance. New York: West Publishing Company,
1996. P. 11, 14-17, 63.
"HR Policy Manual-Benefits Section."
http://www.system.missouri.edu/hrs/manual/310.htm
July 21, 1998. P.1.
Pulliam, Susan. McWilliams, Gary. The Wall Street Journal.
"Compaq Is Criticized for How It Disclosed PC
Troubles."
Tuesday, March 2, 1999. P. C1, C4.
Tunstall, Tom. "Agency costs associated with outsourcing."
http://www.outsourcing-experts.com/outsourcing-board/messages/1769.html
Thursday, September 10, 1998. P. 1.
USA Today. "Court allows broader meaning of insider trading."
http://www.usatoday.com/news/court/nscot638.htm Associated
Press, 1997.
P. 1.