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CORPORATE GOVERNANCE
Background
Shareholder Wealth Maximization defined (SWM): immediate operating goal and the ultimate purpose of a public corporation is and should be to maximize return on equity capital Investors and managers should narrowly focus on SWM Why? SWM is expected to yield the most socially efficient allocation of capital
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Ethical Issues
What is the social purpose of a corporation How are interests of shareholders, managers and society at large reconciled Can SWM and corporate social responsibility (CSR) be aligned? Can CSR trump SWM and be justified on the basis of ethics or the generation of social benefits beyond shareholders
History
First public corporations were joint stock companies formed in the 17th and 18th centuries relatively recent development Legal liability of shareholders limited to capital invested Private property rights are the foundation of market capitalism The stewards of private capital, the managers, are not to be liable except for gross negligence or willful misconduct. Shareholders are typically wide group with limited rights of control
History
SWM principle arises from agency theory separation of ownership and control SWM also justified by economic efficiency capital allocated to highest expected return. SWM principle also recognizes the public company as a nexus of contracts
Agents are in a position of trust Must safeguard assets SWM must consider both risk and return Agents/managers allowed discretion to exercise business judgment
Measures of SWM
Share Price - shareholder wealth defined as the market capitalization of a public company no. of outstanding shares multiplied by share price Market capitalization is just a market estimate
Higher EPS increases price per share Market cap reflects potential future earnings Can be used to justify additional investments
Market capitalization is an artificial construct of the subjective valuation by buyers and sellers
Artificial bubbles in valuation form Free cash flow vs. real cash flow can be manipulated Stock price may not fully reflect value of shares
Measure of SWM
Cash flow: Earnings per share EPS Profit (net income) can be accrued and subject to accounting manipulation Free cash flow shows real returns Negative cash flows could reflect investment in capital projects with future returns Economic Value Added (EVA): Is firm earning more than its cost of capital Deduct the opportunity cost of next best return i.e. risk free govt bond Economic profit only starts when capital cost is recovered
Evidence suggests that the relationship between CSR and financial performance is neutral or mildly positive.
Limited SCR is no likely to harm corporate earnings Social initiatives are not markedly unprofitable May enhance or protect corporate reputation Avoidance of harm assisted by engagement in good Wrongful conduct can clearly be very costly
Conclusions
Conclusions:
Management should attempt to maximize sustainable economic value for shareholders Shareholders must guard against management self interest Some purpose other than money may be a better strategy Broad stakeholder value may be strategically valuable Doing social good may be a good long term strategy.