Untitled Document

Page 1 of 4

Go back to my homepage

Heather Warner
Dec.4, 2000
Economics 100 (02)
Professor Gabriel

Wall StreetFinancial Markets and Management in Corporations:

Examined
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)

http://www.mtholyoke.edu/~hkwarner/film7.html

13-Nov-2014

Untitled Document

Page 2 of 4

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 informationStop 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

http://www.mtholyoke.edu/~hkwarner/film7.html

13-Nov-2014

Untitled Document

Page 3 of 4

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,
A value given to an employee providing certain conditions
(tests) are met. The perquisite must be a requirement
or condition of employment; for the convenience of the
employer; and on the premises of the employer.
("HR Policy Manual" 1)
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

http://www.mtholyoke.edu/~hkwarner/film7.html

13-Nov-2014

Untitled Document

Page 4 of 4

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)

References
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.
Go back to my homepage

http://www.mtholyoke.edu/~hkwarner/film7.html

13-Nov-2014