CHƯƠNG 2:
The Objective in
Decision Making and
Corporate
Governance
Giảng viên: PGS.TS. Trần Thị Thùy Linh
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OUTLINE CHAPTER 2
2.1. Choosing the right objective.
2.2. The classical objective.
2.3. Maximize stock prices: The best- case Scenario.
2.4. Maximize stock prices: Real-world conflicts of interest
2.5 Alternatives to stock prices maximization.
2.6 Maximize stock prices: Salvaging a Flawed objective.
2.7 A Postscrip: Limits of Finance corporate
▰ Live Case study
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CHAPTER 2
▰ An objective specifies what a decision maker is trying to accomplish and by so
doing provides measures that can be used to choose between alternatives. In most
publicly traded firms, the managers of the firm, rather than the owners
(stockholders), make the decisions about where to invest or how to raise funds
for an investment.
▰ Thus, if stock price maximization is the objective, a manager choosing between
two alternatives will choose the one that increases stock price more. In most
cases, the objective is stated in terms of maximizing some function or variable,
such as profits or growth, or minimizing some function or variable, such as risk
or costs.
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CHAPTER 2
▰ Một mục tiêu xác định những gì mà người ra quyết định đang cố gắng đạt được và bằng
▰
cách đó cung cấp các biện pháp có thể được sử dụng để lựa chọn giữa các phương án.
Trong hầu hết các công ty giao dịch công khai, các nhà quản lý của công ty, chứ không
phải chủ sở hữu (cổ đông), đưa ra quyết định về nơi đầu tư hoặc cách gây quỹ cho một
khoản đầu tư.
Do đó, nếu tối đa hóa giá cổ phiếu là mục tiêu, một nhà quản lý lựa chọn giữa hai phương
án sẽ chọn phương án làm tăng giá cổ phiếu nhiều hơn. Trong hầu hết các trường hợp,
mục tiêu được nêu dưới dạng tối đa hóa một số chức năng hoặc biến số, chẳng hạn như lợi
nhuận hoặc tăng trưởng, hoặc giảm thiểu một số chức năng hoặc biến số, chẳng hạn như
rủi ro hoặc chi phí.
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CHAPTER 2
▰ Trong chương này sẽ xem xét mối quan hệ giữa các quyết
định tài chính và giá trị doanh nghiệp với điều hành công ty
cổ phần.
▰ Về lý thuyết, trong hầu hết các công ty giao dịch công khai,
các nhà quản lý của công ty, không phải chủ sở hữu (cổ
đông), đưa ra quyết định về đầu tư hoặc tài trợ cho một
khoản đầu tư. Do đó, nếu tối đa hóa giá cổ phiếu là mục tiêu,
một nhà quản lý lựa chọn giữa hai phương án sẽ chọn
phương án làm tăng giá cổ phiếu nhiều hơn.
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Corporate governance defined
▰ "Corporate governance is the system by which business corporations
are directed and controlled. The corporate governance structure
specifies the distribution of rights and responsibilities among different
participants in the corporation, such as, the board, managers,
shareholders and other stakeholders, and spells out the rules and
procedures for making decisions on corporate affairs. By doing this, it
also provides the structure through which the company objectives are
set, and the means of attaining those objectives and monitoring
performance," OECD April 1999.
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Decision-making objectives
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2.1. Choosing the right objective.
Corporate Finance relates three questions as:
1. What long-term investments should the firm choose?
2. How should the firm raise funds for the selected investments?
3. How should short-term assets be managed and financed?
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Firm objective
n The objective of the firm is to maximize the value of
the owners of the firm, which means maximizing
stock price.
n In order to determine whether management’s actions
are consistent with this objective, we need to
understand the corporate governance structure and
practices of the firm.
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The Goal of Financial Management
n What is the correct goal?
n Maximize profit?
n Minimize costs?
n Maximize market share?
n Maximize shareholder wealth?
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2.1. Choosing the right objective
13.1
There are a number of different objectives that a firm can
choose between when it comes to decision making. How
will we know whether the objective that we have chosen
is the right objective? A good objective should have the
following characteristics.
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2.1. Choosing the right objective
n
Studies have found that firms with better corporate governance characteristics tend
to perform better. Stock returns of firms with “good” corporate governance practices
are significantly greater than returns for firms with “bad” corporate governance
practices
n
n
n
Reduced expropriation of corporate resources by managers
Lenders and investors more willing to provide funds leading to lower costs of
capital.
Gompers, Ishii, and Metrick (2003), “Corporate Governance and Equity Prices”
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2.2 THE CLASSICAL OBJECTIVE
n Multiple Stakeholders and Conflicts of Interest: In the modern corporation,
stockholders hire managers to run the firm for them; these managers then borrow
from banks and bondholders to finance the firm’s operations. Investors in
financial markets respond to information about the firm revealed to them often by
the managers, and firms have to operate in the context of a larger society
n Potential Side Costs of Value Maximization: The objective in corporate
finance can be stated broadly as maximizing the value of the entire business,
more narrowly as maximizing the value of the equity stake in the business, or
even more narrowly as maximizing the stock price for a publicly traded firm
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THE CLASSICAL OBJECTIVE
▰ Nhiều bên liên quan và xung đột lợi ích : Trong công ty
hiện đại, các cổ đông thuê các nhà quản lý để điều hành công ty cho
họ; những người quản lý này sau đó vay từ các ngân hàng và trái chủ
để tài trợ cho hoạt động của công ty. Các nhà đầu tư trên thị trường
tài chính phản hồi thông tin về công ty thường được các nhà quản lý
tiết lộ cho họ và các công ty phải hoạt động trong mội trường xã hội
lớn hơn.
▰ Chi phí phụ tiềm ẩn của việc tối đa hóa giá trị : Mục
▰
tiêu trong tài chính doanh nghiệp có thể được hiểu rộng hơn là tối đa
hóa giá trị của toàn bộ doanh nghiệp, hẹp hơn là tối đa hóa giá trị vốn
cổ phần trong doanh nghiệp, hoặc thậm chí hẹp hơn là tối đa hóa giá
cổ phiếu cho một công ty giao dịch công cộng.
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THE CLASSICAL OBJECTIVE
n Multiple Stakeholders and Conflicts of Interest: In the modern corporation,
stockholders hire managers to run the firm for them; these managers then borrow
from banks and bondholders to finance the firm’s operations. Investors in
financial markets respond to information about the firm revealed to them often by
the managers, and firms have to operate in the context of a larger society
n Potential Side Costs of Value Maximization: The objective in corporate
finance can be stated broadly as maximizing the value of the entire business,
more narrowly as maximizing the value of the equity stake in the business, or
even more narrowly as maximizing the stock price for a publicly traded firm
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2.2 THE CLASSICAL OBJECTIVE
▰ Why Corporate Finance Focuses on Stock Price Maximization
▰ Much of corporate financial theory is centered on stock price maximization
as the sole objective when making decisions. This may seem surprising
given the potential side costs just discussed, but there are three reasons for
the focus on stock price maximization in traditional corporate finance.
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2.3. Maximize stock prices:
The best- case Scenario.
13.1
If corporate financial theory is based on the objective of
maximizing stock prices, it is worth asking when it is
reasonable to ask managers to focus on this objective to
the exclusion of all others.
There is a scenario in which managers can concentrate on
maximizing stock prices to the exclusion of all other
considerations and not worry about side costs.
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2.3. Maximize stock prices:
The best- case Scenario.
13.1
For this scenario to unfold, the following assumptions have to hold.
1. The managers of the firm put aside their own interests and focus on
maximizing stockholder wealth.
2. The lenders to the firm are fully protected from expropriation by
stockholders.
3. The managers of the firm do not attempt to mislead or lie to
4. There are no social costs or social benefits.
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The classical corporate governance framework
STOCKHOLDERS
Hire & fire
managers
- Board
- Annual Meeting
Lend Money
BONDHOLDERS
n .
Maximize
stockholder
wealth
Managers
Protect
bondholder
Interests
Reveal
information
honestly and
on time
No Social Costs
SOCIETY
Costs can be
traced to firm
Markets are
efficient and
assess effect on
value
FINANCIAL MARKETS
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2.4 MAXIMIZE STOCK PRICES: REAL-WORLD
CONFLICTS OF INTEREST
n
n
n
n
n
Stockholders and Managers
The Annual Meeting
The Broad of Directors
Ownership Structure
The Consequences of Stockholder
Powerlessness (Hậu quả của sự bất lực của cổ
đông, không có quyền hành)
n
ILLUSTRATION 2.1 Assessing Disney’s Corporate Governance
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Mô hình quản trị, tổ chức kinh doanh và bộ máy
quản lý công ty FLC
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Hypothetical Organization Chart
Board of Directors
Chairman of the Board and
Chief Executive Officer (CEO)
President and Chief
Operating Officer (COO)
Vice President and
Chief Financial Officer (CFO)
Treasurer
Controller
Cash Manager
Credit Manager
Tax Manager
Cost Accounting
Capital Expenditures
Financial Planning
Financial Accounting
Data Processing
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A Comparison
Corporation
Partnership
Liquidity
Shares can be easily
exchanged
Subject to substantial
restrictions
Voting Rights
Usually each share gets
one vote
Taxation
Double
Reinvestment and
dividend payout
Broad latitude
General Partner is in
charge; limited partners
may have some voting
Partners
rights pay taxes on
distributions
All net cash flow is
distributed to partners
Liability
Limited liability
Continuity
Perpetual life
General partners may
have unlimited liability;
limited partners enjoy
limited
Limitedliability
life
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ILLUSTRATION 2.2 Corporate Governance at Vale: Voting and Nonvoting Shares &
Golden Shares Stockholders in Vale
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Stockholder vs. Management
Theory
n The stockholders have
significant control
over management.
n The mechanisms for
disciplining
management are the
annual meeting and
the board of directors.
Practice
n Most small stockholders do
not attend meetings
n Incumbent management
starts off with a clear
advantage when it comes
to the exercising of
proxies.
n For large stockholders,
sometimes, when
confronted by managers
that they do not like, is to
vote with their feet
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The problem with the board of directors
n
n
The board of directors is the body that oversees the management of a publicly traded firm.
The board of directors are supposed to represent the shareholders and discipline and guide
management if necessary. Historically, however,
n most directors in the past were hand-picked by CEOs
n
n
n
n
many have insufficient knowledge of the business
at times, management is too heavily represented on the board
there may be insufficient interest or motivation for the directors to take an active role
some boards are too large to be effective in administration
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Table 2.1 DISNEY’S BOARD OF DIRECTORS 1996
Insiders
Outsiders
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Visible managerial actions that provide no benefit to the
shareholders
n Greenmail: The (managers of ) target of a hostile takeover buy
n
n
n
n
out the potential acquirer's existing stake, at a price much
greater than the price paid by the raider, in return for the signing
of a 'standstill' agreement
Golden Parachutes: Provisions in employment contracts, that
allows for the payment of a lump-sum or cash flows over a
period, if managers covered by these contracts lose their jobs in
a takeover.
Poison Pills: A security, the rights or cashflows on which are
triggered by an outside event, generally a hostile takeover, is
called a poison pill.
Overpaying on takeovers. This transfers wealth from the
stockholders of the acquiring firm to those of the acquired firm.
How would we know? Look at market reactions to takeover bids.
Perks: Benefits provided to the CEO and management.
2.5 Alternatives to stock prices maximization.
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2.5 Alternatives to stock prices
maximization.
There are obvious problems associated with each of the linkages underlying wealth
maximization. Stockholders often have little power over managers, and
13.1
managers consequently put their interests above those of stockholders.
Lenders who do not protect their interests often end up paying a price when
decisions made by firms transfer wealth to stockholders. Information delivered
to financial markets is often erroneous, misleading, or delayed, and there are
significant differences between price and market value.
Finally, firms that maximize wealth may do so while creating large costs for society.
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Stockholder vs. Bondholder
Theory
n There is no conflict
of interest between
stockholders and
bondholders.
Practice
n Stockholders may maximize
their wealth at the expense of
bondholders by:
n Taking riskier projects than
those agreed to at the
outset.
n Borrowing more on the
same assets: If lenders do
not protect themselves, a
firm can borrow more
money and make all
existing lenders worse off.
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’tFigure
live in2.3
a Utopian
world
Stock Price
Maximization in the Real World
STOCKHOLDERS
Have little control
over firm
Put managerial interests
over stockholder interests
Lend Money
BONDHOLDERS
Managers
Large Social Costs
SOCIETY
Hurt by stockholder
actions
Cannot trace
Social Costs to firm
Delayed or missing
information
Markets that are volatile, shortterm, and make mistakes
FINANCIAL MARKETS
n
Agency costs refer to the conflict of interest that arise between the different
parties and thus make parties act in a manner that is inconsistent with stock price
maximization.
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’tFigure
live in2.4
a Utopian
world
Stock Price
Maximization with Corrective Loop
STOCKHOLDERS
Have little control
over managers
Managers put their interests
above stockholders
Lend Money
BONDHOLDERS
Managers
Bondholders can
get ripped off
Delay bad news or provide
Misleading information
Significant Social Costs
SOCIETY
Some costs cannot be
traced to firm
Markets make mistakes and
can over react
FINANCIAL MARKETS
n
Agency costs refer to the conflict of interest that arise between the
different parties and thus make parties act in a manner that is
inconsistent with stock price maximization.
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2.5 Alternatives to stock
prices maximization.
13.1
Choosing an Alternative Objective
1. Maximize Market Share .
2. Profit Maximization Objectives
3. Size/Revenue Objectives
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2.6 Maximize stock prices:
Salvaging a Flawed objective.
In this section, we consider the case for salvaging value maximization as an
objective but consider ways we can reduce some of the problems
highlighted in the earlier section. In particular, we consider ways we can
reduce the conflicts of interest between stockholders, bondholders, and
managers and the potential for market failures. We also present an
argument for market-based mechanisms based on the market’s capacity to
correct systematic mistakes quickly and effectively.
Conflict Resolution: Reducing Agency Problems
Stockholders and Managers
13.1
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Firms and Financial Markets
Practice
Theory
n Financial markets
are efficient.
n Managers convey
information honestly
and truthfully to
financial markets
n Financial markets
make reasoned
judgments of 'true
value'.
n
Management suppress
information
n
Management delay the
releasing of bad news
n
Management sometimes
reveal fraudulent
information
n
Some argue that markets
are short-sighted
n
Analyst recommendations
are not always unbiased
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Firms and Society
Theory
n There are no costs
associated with the
firm that cannot be
traced to the firm and
charged to it.
Practice
n
Financial decisions can create
social costs and benefits where,
n
n
A social cost or benefit is a
cost or benefit that accrues
to society as a whole and
NOT to the firm making the
decision.
These costs/benefits tend to be
difficult to quantify
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Counter-reaction to agency costs..
STOCKHOLDERS
1. More active
investors
2. Changing Listing
Requirements
Managers of poorly
run firms are put
on notice.
Protect themselves
Managers
BONDHOLDERS
1. Covenants
2. New Types
Firms are
punished
for misleading
markets
Corporate Good Citizen Constraints
SOCIETY
1. More laws
2. Investor/Customer Backlash
Investors and
analysts become
more skeptical
FINANCIAL MARKETS
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Traditional
corporate financial theory
breaks
n The interests/objectives
of the
decision
down when ...
makers in the firm conflict with the interests of
stockholders.
n Bondholders (Lenders) are not protected
against expropriation by stockholders.
n Financial markets do not operate efficiently,
and stock prices do not reflect the underlying
value of the firm.
n Significant social costs can be created as a byproduct of stock price maximization.
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2.7 A Postscrip: Limits of
Finance corporate
13.1
Corporate finance has come in for more than its fair share of criticism in the
past decade or so.
There are many who argue that the failures of corporate America can be
traced to its dependence on financial markets. Some of the criticism is
justified and based on the limitations of a single-minded pursuit of stock
price maximization. Some of it, however, is based on a misunderstanding
of what corporate finance is about.
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The Goal of Financial Management
n
The strength of the stock price maximization objective function is its
internal self correction mechanism. Excesses on any of the linkages lead,
if unregulated, to counter actions which reduce or eliminate these
excesses.
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Text, Ch. 2
CFA Reading
LIVE CASE STUDY
▰ Objective:
To assess the company’s corporate governance structure and examine the
relationships between different stakeholders in the business (society, bondholders, and financial
markets)
1.Examine whether there is a separation between the management of a business and its owners. If so, also
assess how much power owners have in monitoring management and influencing decisions.
2. If the firm has borrowed money, either in the form banks or in the form of bonds, evaluate the potential
for conflicts of interest between the equity investors and lenders and how it is managed.
3. If the firm is publicly traded, examine how markets get information about the firm and investor reactions
and assessments of the stock.
4. Evaluate the company’s standing as a corporate citizen, by looking at its reputation (good or bad) in
society.
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