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4 - Financial Goals and Corporate Governance (Corporate Governance…
4 - Financial Goals and Corporate Governance
Types of ownership
Public enterprise
Government
Private enterprise
private or non-government entity
Public traded shares:
the firm becomes subject to many of the increased legal, regulatory, and reporting requirements related to the sale and trading of securities
separation of Ownership from Management
Principal agent problem or agency problem
separation raises possibility that the two entities may have different business and financial objectives
major strategy to align interests and objectives is through stock-based compensation
Goal of management
Maximize shareholder wealth but it has two challenges
it is not necessarily the accepted goal of management across countries to maximize the wealth of shareholders
it is extremely difficult to carry out
Shareholder Wealth Maximizing Model (SWM) | Anglo-American
Max. by the sum of capital gains and dividends for a given level of risk
assumes that the stock market if EFFICIENT - meaning that the share price is always correct because it captures all the expectations of return and risk as perceived by investors
Systematic risk cannot be eliminated through portfolio diversification and is risk that the share price will be a function of the stock market
LT (patient capitalism) vs ST (impatient capitalism)
ST caused companies like Enron , Parmalat, etc. to be incetivated to maximze growth in ST earnings and to meet inflated expectations by investors. These risky, deceptive, and sometimes dishonest practices for the recording of earnings and / or obfuscation of liabilities, ultimately let to their demise.
These strategy was motivated by the overly generous use of stock options to motivate top management
LT - investors like Warren Buffett, one of the best patient capitalist
Stakeholder Capitalism Model (SCM)
more constrained by powerful stakeholders. Labor unions are more powerful, and government interfere more in the marketplace to protect important stakeholder groups, such as local communities, the environment, and employment
does not assume that equity markets are either efficient or inefficient
assumes that total risk, that is, operating risk, does count
trying to meet the desires of multiple stakeholders leaves management without clear signal about the trade-offs
recent years, 2 trends have led to an increasing focus on SWM
1) as more of non-anglo market have increasingly privatized their industries, a shareholder is needed to attract international capital from outside investors
2) many analysts believe that shareholder-based MNEs are increasingly dominating their global industry segments.
Operational Goals for MNEs
Maximization of consolidated after-tax income
Minimization of the firm's effective global tax burden
Position the firm's income and cash by country and currency
Corporate Governance
Shareholders right
- owners of the firm, and their interest should take precedence over other stakeholders
Board Responsibilities
- recognized as the individual entity with final full legal responsibility for the firm, including proper oversight of management
Equitable Treatment of Shareholders
- specifically targeted toward domestic versus foreign residents as shareholders, as well as majority and minority interest
Stakeholder rights
- governance practices should formally acknowledge the interests of other stakeholders
Transparency and disclosure
- reporting of firm operating and financial results and parameters should be done in a timely manner, and should be made available to all interests equitably
Internal Forces
the officers of the corporation, and board of directors of the corporation are those directly responsible for determining both strategic direction and the execution of the company's future
External Forces
equity markets (stock exchanges) on which the company's shares are traded, the IB analyst who cover and critique the company shares, the creditors of the companies, the credit rating agencies, auditors and legal advisers, and the multitude of regulators who oversee the company's actions - all in an attempt to assure the validity of information presented to investors
Sarbanes-
Oxley Act
1) CEOs and CFOs of publicly traded firms must vouch for the veracity of the firm's financials
2) corporate boards must have audit and compensation committees drawn from independent directors
3) companies are prohibited from making loans to corporate officers and directors
4) companies must test their internal financial controls against fraud
Shareholder Dissatisfaction
Remain Quietly Disgruntled - The Past
Sell the Shares - Walk-away
Change Management - Shareholder Activism
Initiate a Takeover - Maximum Threat