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Learning Objectives
Identify the key decision areas concerning a Financial Manager. Why Shareholders Wealth (SW) Maximisation is the primary financial objective. Why in practice Shareholders Wealth is achieved by maximising the companys share price. Constraints to maximising SW.
Introduction
Corporate finance is concerned with the efficient and effective management of the finances of an organisation. This involves :
Planning and controlling the provision of resources Allocation of resources Control of resources
NPV A
NPV B
NPV C
NPV D
1: NPV is additive 2: This link relies on market efficiency 3: Share price taken as surrogate of SHW
Share Price
3
SHWM
Shareholders need to ensure that their own wealth is maximised (Personal Aspiration).
Option 1: do nothing
Leaving managers to their own devices is problematic: Given human nature, managers will engage in suboptimal behaviour. Shareholders are satisficed rather than satisfied. No action is not really an option.
Option 2: monitoring
Problems associated with monitoring: Costly in terms of both time and money. Who will pay? Large shareholders? What about free-riding smaller investors? Some managerial actions are hard to follow. May drive bad managers underground.
Rewarding is more common than monitoring. Buttying rewards to profits may encourage short-termism and creative accounting.
Corporate governance
Monitor the activities of management Internal controls (financial reporting and accountability) The role of non-executive directors
Stakeholders Theory
Stakeholders power and influence as a external constraint to maximising SW. External constraints from:
Banks Trade suppliers Customers Government Society / community
Corporate Governance
Corporate governance is about promoting corporate fairness, transparency and accountability. It can be seen as an attempt to solve agency problem using externally imposed regulation.
In the UK, good corporate governance is encouraged through a self-regulatory code of best practice.
Revision Notes
Shareholders Wealth Key financial decisions Agency theory Stakeholders Theory Corporate Governance