Firms must provide the right incentives if they are to get managers to focus on long-run value maximization. conflicts exist between managers and stockholders and between stockholders (represented by managers) and debtholders. managers' personal goals may compete with shareholder wealth maximization. however, managers can be motivated to act in their stockholders' best interests through (1) reasonable compensation packages, (2) firing managers, and (3) the threat of hostile takeovers. if a firm's stock is undervalued, corporate raiders will see it as a bargain and will attempt to capture the firm in a hostile takeover.
bondholders generally receive fixed payments regardless of how the firm does, while stockholders earn higher returns when the firm's earnings are higher. investments in risky ventures, that have great payoffs to stockholders if successful but threaten bankruptcy if they fail, create conflicts. in addition, the use of additional debt increases stockholder/debtholder conflicts. consequently, bondholders attempt to protect themselves by including covenants in bond agreements that limit firms' use of additional debt and constrain managers' actions.