-
Chapter 2
Financial Goals and
Corporate Governance
?
Questions
2-1.
Ownership of the Business.
How does ownership alter the goals and governance
of a business?
The return to a
shareholder in a publicly traded firm combines
current income in the form of
dividends
and capital gains from the appreciation of share
price:
Shareholder return
?
Dividend
Price
2
?
Price
1
?
Price
1
Pr
ice
1
where the
initial price,
P
1
, is equivalent
to the initial investment by the shareholder, and
P
2
is the
price of the share at the end of
period. The shareholder theoretically receives
income from both
components. For
example, over the past 50 or 60 years in the U.S.
marketplace, a diversified
investor may
have received a total average annual return of
14%, split roughly between dividends,
2%, and capital gains, 12%.
Management generally believes it has
the most direct influence over the first
component
—
the
dividend yield
. Management
makes strategic and operational decisions that
grow sales, generate
profits, and then
distributes those profits to ownership in the form
of dividends.
Capital
gains
—
the change in the
share price as traded in the equity
markets
—
is much more
complex, and reflects
many forces that
are not in the direct control of management.
Despite growing market share,
profits,
or any other traditional measure of business
success, the market may not reward these
actions directly with share price
appreciation.
A privately held firm
has a much simpler shareholder return objective
function: maximize current
and
sustainable income. The privately held firm does
not have a share price (it does have a value,
but this is not a definitive market-
determined value in the way in which we believe
markets work).
It therefore simply
focuses on generating current income, dividend
income, to generate the returns
to its
ownership. If the privately held ownership is a
family, the family may also place a great
emphasis on the ability to sustain
those earnings over time while maintaining a
slower rate of
growth which can be
managed by the family itself.
Separation of Ownership and
Management.
Why is this separation so
critical to the
understanding of how
businesses are structured and led?
The
field of
agency theory
is
the study of how shareholders can motivate
management to accept
the prescriptions
of the Shareholder Wealth Maximization (SWM)
model. For example, liberal
use of
stock options should encourage management to think
like shareholders. Whether these
inducements succeed is open to debate.
However, if management deviates too much from SWM
objectives of working to maximize the
returns to the
shareholders
—
the board of
directors should
replace them. In cases
where the board is too weak or ingrown to take
this action, the discipline of
the
equity markets could do it through a takeover.
This discipline is made possible by the
one-
share-one-vote rule that exists in
most Anglo-American markets.
2-2.
6
Eiteman/Stonehill/Moffett
?
Multinational
Business Finance,
Twelfth Edition
2-3.
Corporate
Goals: Shareholder Wealth Maximization.
Explain the assumptions and objectives
of the shareholder wealth maximization
model.
The Anglo-American markets are
characteri
zed by a philosophy that a
firm’s objective should be
to
maximize shareholder wealth
.
Anglo-American is defined to mean the United
States, United
Kingdom, Canada,
Australia, and New Zealand. This theory assumes
that the firm should strive to
maximize
the return to
shareholders
—
those
individuals owning equity shares in the firm, as
measured by the sum of capital gains
and dividends, for a given level of risk. This in
turn implies
that management should
always attempt to minimize the risk to
shareholders for a given rate of
return.
Corporate Goals:
Stakeholder Wealth Maximization.
Explain the assumptions and objectives
of the stakeholder wealth maximization
model.
Continental European and
Japanese markets are characterized by a philosophy
that all of a
c
orporation’s
stakeholders should be considered, and the
objective should be to
maximize
corporate
wealth
. Thus a
firm should treat shareholders on a par with other
corporate stakeholders, such as
management, labor, the local community,
suppliers, creditors, and even the government. The
goal
is to earn as much as possible in
the long run, but to retain enough to increase the
corporate wealth
for the benefit of
all. This model has also been labeled the
stakeholder capitalism
model
.
Corporate
Governance.
Define the following terms:
a.
Corporate
governance
Corporate
governance is the control of the firm. It is a
broad
operation concerned with choosing
the board of directors and with setting the long-
run
objectives of the firm. This means
managing the relationship between various
stakeholders in
the context of
determining and controlling the strategic
direction and performance of the
organization. Corporate governance is
the process of ensuring that managers make
decisions
in line with the stated
objectives of the firm.
Management
of the firm
concerns implementation of the stated objectives
of the firm by
professional managers
employed by the firm. In theory managers are the
employees of the
shareholders and can
be hired or fired as the shareholders, acting
through their elected board,
may
decide.
Ownership
of the
firm is that group of individuals and institutions
that own
shares of stock and that
elected the board of directors.
b.
The market for corporate
control
The relationship
among stakeholders used to determine
and control the strategic direction and
performance of an organization is termed
corporate
governance
. The corporate
governance of the organization is therefore the
way in which order
and process is
established to ensure that decisions are made and
interests are
represented
—
for
all
stakeholders
—
properly.
c.
Agency theory
In countries and cultures in which the
ownership of the firm has continued
to
be an integral part of management, agency issues
and failures have been less a problem.
In countries like the United States, in
which ownership has become largely separated from
management (and widely dispersed),
aligning the goals of management and ownership is
much more difficult.
d.
Stakeholder capitalism
The philosophy that all of a
corporation’s stakeholders should be
considered, and the objective should be
to
maximize corporate
wealth
. Thus a firm should
treat shareholders on a par with other
corporate stakeholders, such as management, labor,
the
local community, suppliers,
creditors, and even the government. The goal is to
earn as much
as possible in the long
run, but to retain enough to increase the
corporate wealth for the benefit
of
all. This model has also been labeled the
stakeholder capitalism
model
.
2-4.
2-5.
Chapter 2
Financial Goals and Corporate
Governance
7
2-6.
Operational
Goals.
What should be the primary
operational goal of an MNE?
Financial
goals differ from strategic goals in that the
former focus on money and wealth (such as
the present value of expected future
cash flows). Strategic goals are more
qualitative
—
operating
objectives such as growth rates and/or
share-of-market goals.
Trident’s
strategic goals are the se
tting of such
objectives as degree of global scope and depth of
operations. In what countries should
the firm operate? What products should be made in
each
country? Should the firm integrate
its international operations or have each foreign
subsidiary
operate more or less on its
own? Should it manufacture abroad through wholly
owned subsidiaries,
through joint
ventures, or through licensing other companies to
make its products? Of course,
successful implementation of these
several strategic goals is undertaken as a means
to benefit
shareholders and/or other
stakeholders.
Trident’s financial goals
are to maximize shareholder wealth relative to a
risk constraint and in
consideration of
the long-term life of the firm and the long-term
wealth of shareholders. In other
words,
wealth maximization does not mean short-term
pushing up share prices so executives can
execute their options before the
company crashes
—
a
consideration that must be made in the light
of the Enron scandals.
Knowledge Assets.
“Knowledge assets” are a firm’s
intangible assets, the sources and uses of its
intellectual talent
—its
competitive advantage. What are some of the most
important “knowledge
assets” that
create shareholder value?
The definition of
corporate
wealth
is much broader than just
financial wealth. It includes the
firm’s technical, market, and human
resources. This means that an MNE that believes it
must
close a manufacturing
facility in Stuttgart, Germany, and shift its
operations to Penang, Malaysia,
may not
do so without considering the employment and other
social impacts on the Stuttgart
community.
As one study put
it, “[Corporate wealth] goes beyond the wealth
measured by
conventional financial
reports to include the firm’s market position as
well as the knowledge and
skill of its
employees in technology, manufacturing processes,
marketing and administration of
the
enterprise.”
Labor
Unions.
In Germany and Scandinavia,
among other countries, labor unions have
representation on boards of directors
or supervisory boards. How might such union
representation
be viewed under the
shareholder wealth maximization model compared to
the corporate wealth
maximization
model?
Labor union
representation required by statute is an example
of governmental direction toward the
corporate wealth maximization (CWM)
model, in that such a requirement is intended to
make the
board responsive to
stakeholders other than owners. Under the CWM
model, such a statute would
be viewed
favorably, while under the SWM model such a
statute would be viewed as undue
interference in the right of owners to
manage the assets into which they alone have
invested
money.
2-7.
2-8.