Chapter 1 The world of financial management LEARNING OUTCOMES You should be able to: Identify and discuss possible objectives for a business and explain the advantages of the shareholder wealth maximisation objective Discuss the role of the finance function within a business Describe the agency problem and explain how it may be managed Explain how risk, ethical considerations and the needs of other stakeholders influence the pursuit of shareholder wealth maximisation

Operations management The role of managers Strategic management Risk management Operations management

The task of the finance function Investment project appraisal Financial planning Financing and capital market operations Financial control

Primary objective To achieve wealth maximisation the needs of other stakeholders must be considered Not the same as profit maximisation The primary objective of a business is shareholder wealth maximisation: High ethical standards may be needed to maximise shareholder wealth

Shareholder wealth maximisation Shareholders: Have a residual claim and bear the risk Are incentivised to increase their residual claim through entrepreneurial activity Are the effective owners However, pursuit of this objective: May undermine the status of other stakeholders May encourage excessive cost cutting May encourage unethical behaviour

Profit maximisation problems Profit is influenced by accounting policy choices Different measures of profit are available May encourage short-term thinking

Stakeholder approach – problems Does not offer clear-cut objectives Increases problems of accountability Raises difficult questions concerning who the stakeholders are and how they should be treated

Relationship between risk and return

Principles underpinning a framework of rules Disclosure Accountability Fairness Source: P. Atrill and E. McLaney, Financial Accounting for Decision Makers, 6th edn, Financial Times Prentice Hall, 2010, p. 392.

The UK Corporate Governance Code Aims to ensure that: Powers and responsibilities of directors are clearly delineated Appropriate checks and balances are in place

The UK Corporate Governance Code (Continued) Every listed company should have a board of directors There should be a clear division of responsibilities between the chairman and the chief executive officer There should be a balance of skills, experience, independence and knowledge Appointments to the board should be the subject of rigorous, formal and transparent procedures The board should receive timely information

The UK Corporate Governance Code (Continued) Remuneration levels should be sufficient to attract, retain and motivate directors of the appropriate quality There should be formal and transparent procedures for developing policy on directors’ remuneration The board should present a balanced and understandable assessment of the company’s position and prospects The board should try to ensure that a satisfactory dialogue with shareholders occurs All directors should submit themselves to re-election at regular intervals

The UK Corporate Governance Code (Continued) Formal and transparent arrangements for financial reporting and internal control should be in place The board should define the company’s risk appetite and tolerance and maintain a sound risk management system The board should formally and rigorously examine its own performance each year Boards should use the annual general meeting to communicate with investors

Ownership of UK listed shares, end of 2008 Private non-financial companies Insurance companies 5 20 15 40 % Other financial institutions Pension funds Individuals Unit trusts Investment trusts Public sector Banks Charities 10 25 35 30 Rest of the world Source: Financial Statistics, Share Ownership Survey 2008, Office for National Statistics, p. 1. Copyright © 2010 Crown Copyright. Crown copyright material is reproduced with the permission of the Controller of HMSO.

The main forms of shareholder activism Exercising voting rights Meeting with directors Direct intervention in business affairs

UK Stewardship Code Financial institutions should: Publicly disclose how they discharge their stewardship responsibilities Have a robust policy on managing conflicts of interest in relation to stewardship which is publicly disclosed Monitor their investee companies Be willing to act collectively with other investors where appropriate Establish clear guidelines on when and how activities will escalate in order to protect and enhance shareholder value Report periodically on their stewardship and voting activities Have a clear policy on voting and disclosure of voting activity