Managerial Actions to Maximize Shareholder Wealth
What types of actions can managers take to maximize shareholder wealth? To answer this question, we first need to ask, “What determines a firm’s value?” In a nutshell, it is a company’s ability to generate cash flows now and in the future. We address different aspects of this in detail throughout the book, but we can lay out three basic facts now: (1) Any financial asset, including a company’s stock, is valu- able only to the extent that it generates cash flows; (2) the timing of cash flows matters—cash received sooner is better; and (3) investors are averse to risk, so all else equal, they will pay more for a stock whose cash flows are relatively certain than for one whose cash flows are more risky. Because of these three facts, man- agers can enhance their firms’ value by increasing the size of the expected cash flows, by speeding up their receipt, and by reducing their risk. The cash flows that matter are called free cash flows (FCFs), not because they are costless, but because they are free in the sense that they are available for distri- bution to all of the company’s investors, including creditors and stockholders. As shown in Figure 1-1, the three primary determinants of free cash flows are (1) sales revenues, (2) operating costs and taxes, and (3) required new investments in operations. Sales revenues depend on the current level of unit sales, the price per unit, and expected future growth rates. Managers can increase unit sales, hence cash flows, by truly understanding their customers and then providing the goods and services that customers want. Some companies may luck into a situation that creates rapid sales growth, but the unfortunate reality is that market saturation and competi- tion, in the long term, will cause the unit sales growth rate to decline to a level that is limited by population growth. Companies may try to increase prices, but in a competitive economy such as ours, higher prices can be...
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