“Financial Managers need only concentrate on meeting the needs of shareholders - no other group matters” Discuss the above statement using practical examples to support you answer.
Summary of Widgets Finical Ratios: Profitability6-8
A shareholder is someone that legally owns one or more share of stock in a company. The objective of the firm is to maximize shareholder value by increasing the value of the company’s stock. Although other potentials exist, such as survival, maximizing market share, maximizing profits and so on, these are co-insistent with maximizing shareholder value.
The responsibility of these objectives is held by Financial Managers. Financial Manger decisions can be divided into three general areas: investment decisions; financing decisions& dividend decisions. The investment principle determines where businesses invest their resources, the financing principle governs the mix of funding used to fund these investments, and the dividend principle answers the question of how much earnings should be reinvested back into the business and how much returned to the owners of the business. These decisions govern and guide everything that gets done and are interdependent with each other.
In practice corporate finance decision are not made solely by corporate financial management. Inside an integrated approach is taken by various directors. Directors that would be involved include finical directors, who oversee the finance function and will also consult with accountants, tax experts and legal counsel. Another director would be a corporate treasurer who keeps in contact with banks and other finical institutions regarding cash flow. Human resource directors help to dictate on ideal candidates for functional roles within the company. Production directors enable materials to be in stock so the company can sell to bring cash in. Selling and promotion of these products to attract a market is the responsibility of the marketing directors. And yet the primary objective of all these directors is to maximize the value of the company for its shareholders.
Within a company there are set corporate objectives to maximize its value. These objectives are based on the company’s mission or aims. The corporate objectives govern the targets for each department of the business. They provide a mechanism for ensuring that authority can be delegated without loss of co-ordination. Among the most common corporate objectives are: to ensure long term stable growth in real terms; to spread risk and achieve growth through diversification; to concentrate upon the firm’s core skills; to maximize market standing; to add value through continuous technological innovation; to achieve profit maximization in the short term to medium term; etc.
While management within a company should make decisions that meet the company objective of maximising shareholder wealth, this may not actually happen in practice, as the “agent is distracted by his own self interest”. This is a concept proposed by Jensen and Meckling (1976) known as Agency Theory.
Jensen and Meckling (1976) defined the agency relationship as a contract under which one party (the shareholder) engages another party (the agent) to perform some service on their behalf. As part of this arrangement, the principal will delegate some or all of the decision-making authority to the agent. In practice, shareholders from most companies delegate the decision-making authority to the board of directors. In turn, the board of directors delegates power to the chief executive officers. The agency problems arise because of the impossibility of perfectly contracting for every possible action of an agent whose...