Presentation on theme: "What is the Goal of the Company?"— Presentation transcript:
1 What is the Goal of the Company? Maximization of Shareholder Wealth!
2 CREATION OF VALUECompany’s objective is to create value for its shareholders;Value means market price of the company’s share;Value creation can be achieved by i. Investing ii. Financing and iii. Dividend/Share repurchase decisions.
3 Shortcomings of Alternative Perspectives Profit MaximizationMaximizing a firm’s earnings after taxes.ProblemsCould increase current profits while harming firm (e.g., defer maintenance, issue common stock to buy T-bills (govt. securities), etc.).Ignores changes in the risk level of the firm.
4 Shortcomings of Alternative Perspectives Earnings per Share MaximizationMaximizing earnings after taxes divided by shares outstanding.ProblemsDoes not specify timing or duration of expected returns.Ignores changes in the risk level of the firm.Calls for a zero payout dividend policy.
5 Strengths of Shareholder Wealth Maximization Takes account of: current and future profits and EPS; the timing, duration, and risk of profits and EPS; dividend policy; and all other relevant factors.Thus, share price serves as a barometer for business performance.
6 The Modern Corporation ShareholdersManagementThere exists a SEPARATION between owners and managers.
7 Management acts as an agent for the owners (shareholders) of the firm. Role of ManagementManagement acts as an agent for the owners (shareholders) of the firm.An agent is an individual authorized by another person, called the principal, to act in the latter’s behalf.
8 Agency TheoryJensen and Meckling developed a theory of the firm based on agency theory.Agency Theory is a branch of economics relating to the behavior of principals and their agents.
9 Agency TheoryPrincipals must provide incentives so that management acts in the principals’ best interests and then monitor results.Incentives include, stock options, perquisites, and bonuses.
10 Social Responsibility Wealth maximization does not preclude the firm from being socially responsible.Assume we view the firm as producing both private and social goods.Then shareholder wealth maximization remains the appropriate goal in governing the firm.
11 “An optimal combination of these three will create value” FUNCTIONS OF FINANCEInvestment DecisionsFinancing DecisionsDividend/Share repurchase Decisions“An optimal combination of these three will create value”
12 Investment DecisionMost important of the three decisions when it comes to the creation of value.Allocation of capital to future investment proposals (evaluated by expected return and Risk);Reallocation of capital when an asset no longer economically justifies the capital committed to it;Managing existing assets efficiently, especially current assets.
13 Financing DecisionDetermine how the assets (LHS of balance sheet) will be financed (RHS of balance sheet).What is the best type of financing (Debt or Equity)?What is the best financing mix (capital structure)?Implications of variation in capital structure on the valuation of firm.
14 Dividend/Share Repurchase Decision Excess cash to distribute to stockholders;Cash Dividends (directly) and Share repurchase (indirectly);Best Dividend policy (e.g. Dividend payout ratio)
15 Organization of the Financial Management Function Board of DirectorsPresident(Chief Executive Officer)VP ofFinanceVice PresidentOperationsVice PresidentMarketing
16 Organization of the Financial Management Function VP of FinanceTreasurerCapital BudgetingCash ManagementCredit ManagementDividend DisbursementFin Analysis/PlanningPension ManagementInsurance/Risk MngmtTax Analysis/PlanningControllerCost AccountingCost ManagementData ProcessingGeneral LedgerGovernment ReportingInternal ControlPreparing Fin StmtsPreparing BudgetsPreparing Forecasts
17 What is Financial Management? Financial Management endeavors to make optimal investment, financing, and dividend/share repurchase decisions.
18 Summary of Investing, Financing, & Dividend/Share repurchase decisions To acquire assets and invest in new products and services where expected return exceeds their cost; to finance with those instruments where expected return exceeds their cost, tax or otherwise, and to undertake a meaningful dividend policy for shareholders.