Chapter 1 Flashcards
Objective of maximizing TSR is justified how
The company which provides the highest returns for its investors will find it easiest to raise new finance and grow in the future. This should ensure optimal resource allocation within the economy and maximise the overall wealth of the nation.
Companies that achieve the highest returns for their investors will be those that are providing customers with what they require; this is again consistent with the nation’s economic health.
Companies that fail to provide adequate returns may become targets for hostile takeovers.
Directors have a legal duty to run the company on behalf of the shareholders. It is generally considered a reasonable assumption that the shareholders of listed companies (mainly institutional investors) seek to maximise wealth.
Criticism of maximizing shareholder wealth
It ignores market imperfections − it might not be in the public interest to allow monopolies to maximise returns as this may cause high prices for consumers.
It ignores social needs like health, education, police and so on.
Maximising TSR ignores the interests of other stakeholders
In the case of unlisted companies, even the shareholders may not require maximised returns (e.g. some closely held companies are run as “lifestyle” companies whose main objective is to create prestige for the owners).
Ways directors do not fulfill their fiduciary duties
use creative accounting, which can flatter the accounts (also known as window dressing);
use off balance sheet financing (e.g. keeping liabilities off the statement of financial position by using special purpose vehicles);
reject takeover offers, with the directors’ goal being to protect their own jobs rather than acting in the interests of their shareholders; and/or
disregard environmental issues, with directors allowing pollution emitting processes and product testing on animals.
Goal congruence
occurs when the objectives of agents acting within an organisation align with the objectives of the organisation
Methods of encouraging goal congruence with directors and shareholders
Performance-related pay − problems associated with relating pay or bonuses to the size of profit include short termism (e.g. not investing for future growth to maintain high profits in the short term).
Executive share option scheme − the evidence is mixed regarding the success of such schemes in motivating directors to improve performance (e.g. a company’s share price may rise due to a general rise in the stock market rather than the quality of its management).
Long-term incentive plans (LTIPs) − paying a bonus to directors if the company’s performance over several years is good when benchmarked against that of competitors.
Transparency in corporate reporting.
Increased shareholder activism (e.g. using voting rights).
Improved corporate governance (e.g. through the appointment of truly independent non-executive directors).
Corporate governance
the system by which companies are directed and controlled. The objective of corporate governance may be considered as the reduction of agency costs to a level acceptable to shareholders
Principles that underline corporate governance
Every company should be headed by an effective board which should lead and control the company.
There should be a clear division of responsibilities at the head of the company between running the board (chairman) and running the business (CEO); no single individual should dominate.
The board should have a balance of executive and independent non-executive directors.
All directors should be required to submit themselves for re-election on a regular basis.
Remuneration committees should be comprised of independent non-executive directors.
Remuneration committees should provide the packages needed to attract, retain and motivate executive directors and avoid paying more.
No director should be involved in setting his own remuneration.
The board should maintain a solid system of internal control to safeguard shareholders’ investment and the company’s assets.
How can EPS be increased
Undertaking a share consolidation
Increased through a share buyback scheme
Triple bottom line approach
A method of true cost accounting that considers the effect of production decisions in terms of environmental and social value
Internal stakeholders
Employees, directors
Connected stakeholders
Shareholders, customers, suppliers, competitors
External stakeholders
Government, local and national communities
Capital gain
The difference between the opening and closing share prices expressed as a percentage of the opening share price
