In the case of a large company owned by many shareholders, managers are hired to make the daily executive decisions on the owners' behalf. However, they often have incentives to make decisions that are not in the shareholders' best interests. A firm's board of directors is supposed to oversee management and ensure that shareholder interests are being served. Still, the directors are merely human economic agents following incentives that may lead them to favor management over the shareholders, especially because of the director nomination and election process. Shareholders elect the directors, but there is usually only one slate nominated, by the board's nominating committee.
Shareholders can sue management and the board for breach of fiduciary duties.
In practice, though, it is so difficult a court to distinguish self-serving from incompetence and bad luck that lawsuits can guard against only the most flagrant abuses of management power. Shareholder activism has become the dominant disciplining mechanism in the last ten years. The more knowledge owners can acquire, the better they can oversee management, but the time and effort involved are monitoring costs that can only be recovered by a rise in the value of their shareholdings. A major limitation of the existing system of selecting outside directors is that it can be controlled by management. Even though these directors may have no other formal ties to the firm, candidates can still be screened to ensure friendliness to the CEO, and those who rock the boat can be omitted from nomination next time.