How managers misappropriate funds

An extreme way managers divert funds from shareholders is through expropriation by engaging in pyramid schemes, for example.  A manager can also expropriate funds through transfer pricing by selling company output to themselves at below market prices.  The law in most developed countries has made such practices difficult, however, there are other areas in which management can divert funds to themselves.

Managers can pursue projects that benefit themselves rather than the shareholder. These can include low risk (low return) projects, pet projects and unnecessary expansion projects if compensation is tied to the size of the company.  Managers also have discretion over the use of luxurious items in their offices and benefits such as private jets.

To protect their job in the face of takeovers, managers can engage in strategies such as golden parachutes, poison pills and super-majority voting requirements.  Managers can also be rewarded excessive compensation.  These practices do not maximise shareholder wealth, in fact, they reduce it.

All of these practices are subject to the discretion of managers and the board. Knowing this information, shareholders are less likely to fund companies.  A framework of protection in the form of corporate governance is needed to induce shareholders to finance public companies in exchange for a return on investment.