Size & Types of Firms

Economics: Edexcel A A Level, topic 5.1.1

Divorce of Ownership from Control

Managers run companies. Shareholders partly own companies. These mean that there's a divorce of ownership from control.

This can lead to the principal-agent problem.
The interests of the manager may not be in the interest of the shareholder but shareholders are not able to very easily monitor the behaviour of managers.
The manager may benefit more from revenue maximisation than profit maximisation, and so the manager may not act in the shareholders best interest.

Shareholders can regain control from managers.
This can be done by holding them accountable for the firms performance, adding pressure for them to perform in the shareholder's interest.
Managers could also have their pay linked to the share price over a number of years, for example.
This realigns the goals of managers and shareholders.

Sometimes business owners choose to keep a business small. However, sometimes, businesses are unable to expand.

Sometimes the size of a company's market is not large enough for a firm to grow anymore. If a company sells Chilli-flavoured ice cream, there may not be enough demand outside of very niche ice cream shops. This can limit growth because the firm is in a 'niche market'.
Research by CB Insights found that 42% of startups failed because the market didn't need their product and 9% failed because of a failed geographic expansion.

If a business cannot access capital, then it is unable to spend anything other than profits to grow. When companies are small, often they don't make huge profits because they have to cover both their fixed and variable costs, but don't have many customers to spread their fixed costs over.
After the 2008 financial crisis, many businesses reported that banks would not lend to them.
CB Insights research finds that 29% of failed startups failed because they ran out of cash.
If a company cannot issue equity or borrow from banks, then it has bad access to capital.

Some business owners or founders may decide that they don't want to grow.
Growing and hiring more employees increases the amount of legal, accounting and bureaucratic burden for a firm.
Owners may be risk-averse and just want to run a 'lifestyle business' that can fund their own desired income.
For example, a software developer setting up a company to sell his services may not want to hire other developers and grow, preferring to focus on funding his own income.

Not for profit firms may only hope to improve one social issue in one area - e.g. homelessness in Leeds. They may have no incentive to grow, even if they could.
Firms or departments in the public sector may have no incentive to grow. The UK Department for Education has no funds allocated and no desire to expand internationally.

What is the term for when a firm's owner doesn't control the day to day actions of the firm?
The principal-agent problem describes the potential conflict of interest between which parties?
Which of these might a company choose to address the danger of the principal-agent problem?
If a business cannot access capital, what does it spend to grow?