Multinational Business Finance
Financial Goals and Corporate
Governance
ESM Chapter 2
723g33
Lecturer Yinghong Chen Phd in
Economics
Ownership matters
• Most companies are created by entrepreneurs
who are either individuals or a small set of
partners. In either case, they can be members
of a family
• Over time, however, some firms may choose
to go public via an initial public offering or
IPO.
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Exhibit 2.1 Who Owns the Business?
[Insert Exhibit 2.1]
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Separation of Ownership and Control
• Controlling owners own less than 100% of the equity
typically, around 20%. An incentive problem emerges.
Controlling owners have their own interest which might
differ from other shareholders.
• The controlling owner is often a long term owner who
has financial strength.
• Conflict of interest between controlling and small
shareholders arises which leads to the so called investor
protection issues.
• Increased transparency is a way to solve this problem.
• This is the main governance model of continental
European firms.
Separation of Ownership and Control:
the Anglo-American model
• SOEs and widely held publicly traded
companies typically separate management
and ownership.
• The professional managers and the
shareholders have conflicts of interest.
• This raises the possibility that ownership and
management may not be perfectly aligned in
their business and financial objectives, the so
called agency problem arises.
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The Goal of Management
• Maximization of shareholders’ wealth is the
dominant goal of management in the AngloAmerican world.
• There are basic differences in corporate and
investor philosophies globally.
• Cultural influence has a bearing on MNEs
behavior.
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Shareholder Wealth Maximization
• In a Shareholder Wealth Maximization model
(SWM), a firm should strive to maximize the
return to shareholders
• Max (market capitalization + dividend
payment)
s. t. risk.
• Alternatively, the firm should minimize the
level of risk to shareholders for a given rate of
return.
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Shareholder Wealth Maximization
• The SWM model assumes that the stock
market is efficient.
• An equity share price is always correct
because it captures all the expectations of
return and risk as perceived by investors,
quickly incorporating new information into the
share price.
• Share prices are, in turn, the best allocators
of capital in the economy.
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Anglo-American model of corporate
governance
• Agency theory is the study of how to align the
interest between shareholders and
management.
Solutions to agency problem:
•
•
•
•
A big pay check, and other perks.
Stock options
Mobilize the manager
The market for takeover
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Stakeholder Value Maximization Model
• The SWM model emphasize the market
risk, not individual risk, since Individual
unique risk is diversifiable.
• The stakeholder model focuses on total
risk – i.e. operating and financial risk.
Typically have a long term goal.
• The managers in SWM focuses on the short
term result due to incentive pays that is
based on short term results.
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Operational Goals for MNEs
• The MNE has three common operational
financial objectives, but they might not be
compatible to one another
– Maximization of consolidated after-tax income;
– Minimization of the firm’s effective global tax
burden;
– correct positioning of the firm’s income, cash
flows and available funds as to country and
currency.
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Corporate Governance
• The governance structure of any company –
domestic, international, or multinational – is
fundamental and essential.
• Spectacular failures in corporate governance
have raised issues about the very ethics and
culture of business conducts. Case in point:
Enron scandal. (Sarbanes-Oxley Act (SOX) in
America is passed to ensure accountability of
accounting firms to investors)
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Good Corporate Governance
• The objective of corporate governance is the
optimization over time of the returns to
shareholders.
• The board of directors of the corporation
should focus their on developing and
implementing a strategy that ensures
corporate growth and improvement in the
value of the corporation’s equity.
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Good Corporate Governance
• Good corporate governance practices
should: (the so called OECD rule)
– protect shareholders rights.
– ensure the equitable treatment of all
shareholders.
– Stakeholders should be involved in corporate
governance. Local government, labor union, etc
– Disclosure and transparency is critical.
– The board of directors should be monitored and
held accountable.
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Exhibit 2.2 The Structure of Corporate Governance
Source: ESM 12th edition
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Structure of Corporate Governance
• The board of directors is the legal body that is
accountable for the governance of the
corporation.
• The CEO and his team are the implementing
body of the corporation’s strategic and
operational decisions.
• The Annual Shareholder Meeting reviews the
conduct of the management team and elect the
board of directors to represent shareholders.
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Exhibit 2.3 Comparative Corporate Governance
Regimes
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The Sarbanes-Oxley Act, 2002
• There are three major requirements:
– CEOs of publicly traded companies must vouch for
the truthfulness of published financial statements;
– corporate boards must have audit committees
drawn from independent directors;
– companies can no longer make loans to corporate
directors, and
– Companies must test their internal financial
controls against fraud
• Most of its terms are appropriate for the US situation,
but some terms do conflict with practices in other
countries. The Porsche case.
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Exhibit 2.4 Country Governance
Rankings 2008
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Mini-Case Questions: Governance
Failure at Enron
• Which parts of the corporate governance system,
internal and external, do you believe failed Enron the
most?
• How do you think each of the individual stakeholders
and components of the corporate governance system
should have either prevented the problems at Enron
or acted to resolve the problems before they reached
crisis proportions?
• If all publicly traded firms in the United States are
operating within the same basic corporate
governance system as Enron, why would some
people believe this was an isolated incident, and not
an example of many failures to come?
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Exhibit 1 Enron’s Actual Operating
Income
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Useful internet links
• www.corpgov.net Governance papers
• http://www.european-sarbanes-oxley.com/
The 8th European Company Law directive.
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