Chapter12FinancialManagementBrainstormingFinancialmanagementplaysmanyrolesinacompanybesidesthe“financialfunction”.Inyouropinion,howdoesfinancialmanagementaffectacorporation’soveralloperation?TextATheRoleofFinancialManagementTheRoleofFinancialManagerUntilaroundthefirsthalfofthe1900sfinancialmanagersprimarilyraisedfundsandmanagedtheirfirms’cashpositions.Inthe1950s,theincreasingacceptanceofpresentvalueconceptsencouragedfinancialmanagerstoexpandtheirresponsibilitiesandtobecomeconcernedwiththeselectionofcapitalinvestmentprojects.Today,externalfactorshaveanincreasingimpactonthefinancialmanager.WhatisFinancialManagement?InvestmentDecisionFinancingDecisionAssetManagementDecisionInvestmentDecisionThemostimportantofthefirm’sthreemajordecisionsDeterminationofthetotalamountofassetsneededtobeheldbythefirm.Assetsthatcannolongerbeeconomicallyjustifiedmayneedtobereduced,eliminated,orreplaced.FinancingDecisionThefinancialmanagerisconcernedwiththeliabilitiesandowners’equity.Dividendpolicymustbeviewedasanintegralpartofthefirm’sfinancingdecision.Thevalueofthedividendspaidtostockholdersmustbebalancedagainsttheopportunitycostofretainedearningslostasameansofequityfinancing.Themechanicsofgettingashort-termloan,enteringintoalong-termleasearrangement,ornegotiatingasaleofbondsorstockmustbeunderstood.AssetManagementDecisionOnceassetshavebeenacquiredandappropriatefinancingprovided,theseassetsmuststillbemanagedefficiently.Thefinancialmanagerischargedwithvaryingdegreesofoperatingresponsibilityoverexistingassets.Theseresponsibilitiesrequirethatthefinancialmanagerbemoreconcernedwiththemanagementofcurrentassetsthanwiththatoffixedassets.Alargeshareoftheresponsibilityforthemanagementoffixedassetswouldresidewiththeoperatingmanagerswhoemploytheseassets.TheGoaloftheFirmWeassumethatthegoalistomaximizethewealthofthefirm’spresentowners.Thesuccessofabusinessdecisionshouldbejudgedbytheeffectthatitultimatelyhasonshareprice.Frequently,profitmaximizationisofferedastheproperobjectiveofthefirm.Maximizingearningspershareisoftenadvocatedasanimprovedversionofprofitmaximization.However,Itdoesnotspecifythetimingordurationofexpectedreturns.Riskisnotconsidered.Doesnotallowfortheeffectofdividendpolicyonthemarketpriceofthestock.Maximizingearningspersharemaynotbethesameasmaximizingmarketpricepershare.Themarketpriceofafirm’sstockrepresentsthefocaljudgmentofallmarketparticipantsastothevalueoftheparticularfirm.TheGoaloftheFirm

ValueCreation

Managementisundercontinuousreview.Hareholderswhoaredissatisfiedwithmanagementperformancemayselltheirsharesandinvestinanothercompany.Thisaction,iftakenbyotherdissatisfiedshareholders,willputdownwardpressureonmarketpricepershare.Managementmustfocusoncreatingvalueforshare-holders.Thisrequiresmanagementtojudgealternativeinvestment,financing,andassetmanagementstrategiesintermsoftheireffectonshareholdervalue(shareprice).Managementshouldpursueproduct-marketstrategies.BuildingmarketshareIncreasingcustomersatisfactionTheGoaloftheFirm

ValueCreation

Thecausesofagencyproblems:TheseparationofownershipandcontrolinthemoderncorporationTheobjectivesofmanagementmaydifferfromthoseofthefirm’sshareholdersTheGoaloftheFirm

AgencyProblems

JensenandMecklingwerethefirsttodevelopacomprehensivetheoryofthefirmunderagencyarrangements。Theyshowedthattheprincipals,inourcasetheshareholders,canassurethemselvesthattheagents(management)willmakeoptimaldecisionsonlyifappropriateincentivesaregivenandonlyiftheagentsaremonitored.Incentivesincludestockoptions,bonuses,andperquisitesandthesemustbedirectlyrelatedtohowclosemanagementdecisionscometotheinterestsoftheshareholders.Monitoringisdonebybondingtheagent,systematicallyreviewingmanagementperquisites,auditingfinancialstatements,andlimitingmanagementdecisions.TheGoaloftheFirm

AgencyProblems

Somepeoplesuggestthattheprimarymonitoringofmanagerscomesnotfromtheownersbutfromthemanageriallabormarket.Efficientcapitalmarketsprovidesignalsaboutthevalueofacompany’ssecuritiesandabouttheperformanceofitsmanagers.Managerswithgoodperformancerecordsshouldhaveaneasiertimefindingotheremploymentthanmanagerswithpoorperformancerecords.TheGoaloftheFirm

AgencyProblems

MaximizingshareholderwealthdoesnotmeanthatmanagementshouldignoresocialresponsibilityProtectingtheconsumerPayingfairwagestoemployeesMaintainingfairhiringpracticesSafeworkingconditionsSupportingeducationBecominginvolvedinsuchenvironmentalissuesascleanairandwaterTheGoaloftheFirm

SocialResponsibility

Managementshouldconsidertheinterestsofstakeholdersotherthanshareholders,includeCreditorsEmployeesCustomersSuppliersCommunitiesinwhichacompanyoperatesWhensocietyestablishestherulesgoverningthetrade-offbetweensocialgoalsandeconomicefficiency,thetaskforthecorporationisclearer.Wecanthenviewthecompanyasproducingbothprivateandsocialgoods,andthemaximizationofshareholderwealthremainsaviablecorporateobjective.TheGoaloftheFirm

SocialResponsibility

JamesC.VanHorneisProfessorofFinance,Emeritus,havingcometoStanfordin1965.HeisthepastpresidentoftheAmericanFinanceAssociationandoftheWesternFinanceAssociation,andhasbeenanactivememberoftheFinancialEconomistsRoundtable.HealsohasservedasAssociateEditorofseveralleadingfinancejournals.NotesJohnMartinWachowicz,isProfessorofFinance,Emeritus,atTheUniversityofTennessee,Knoxville.Hehasreceivedsixteenteaching,researchandserviceawards,includingthreeMBAOutstandingFacultyAwards,theL.R.HeslerAwardforExcellenceinTeachingandService,andtwoAlumniOutstandingTeacherAwards.NotesCapitalstructure

theory:

Asystematicapproachtofinancingbusinessactivitiesthroughacombinationofequitiesandliabilitiesinfinancialmanagement.Closelyrelatedtothefirm’scostofcapital.TherewillbeamixofdifferentsecuritiesinthecapitalstructureatwhichWACCwillbetheleast.Thedecisionregardingthecapitalstructureisbasedontheobjectiveofachievingthemaximizationofshareholderswealth.RelatedTheoriesTheEfficientMarketHypothesis(EMH):Aninvestmenttheorywherebysharepricesreflectallinformationandconsistentalphagenerationisimpossible.AccordingtoEMH,stocksalwaystradeattheirfairvalueonstockexchanges,makingitimpossibleforinvestorstoeitherpurchaseundervaluedstocksorsellstocksforinflatedprices.RelatedTheoriesAgencytheory:

Examinesthedutiesandconflictsthatoccurbetweenpartieswhohaveanagencyrelationship.Agencyrelationshipsoccurwhenoneparty,theprincipal,employsanotherparty,calledtheagent,toperformataskontheirbehalf.RelatedTheoriesAsymmetricinformationtheory:Developedinthe1970sand1980sasaplausibleexplanationforcommonphenomenathatmainstreamgeneralequilibriumeconomicscouldn’texplainAnimbalanceofinformationbetweenbuyersandsellerscanleadtoinefficientoutcomesincertainmarkets.TheCapitalAssetPricingModel(CAPM):Describestherelationshipbetweensystematicriskandexpectedreturnforassets,particularlystocks.CAPMiswidelyusedthroughoutfinanceforpricingriskysecuritiesandgeneratingexpectedreturnsforassetsgiventheriskofthoseassetsandcostofcapital.RelatedTheoriesOptionpricingtheory:Usesvariables(stockprice,exerciseprice,volatility,interestrate,timetoexpiration)totheoreticallyvalueanoptionProvidesanestimationofanoption'sfairvaluewhichtradersincorporateintotheirstrategiestomaximizeprofits..RelatedTheoriesTextBFinancialManagementofJohnsonandJohnson(JNJ)What’stheprimaryreasonanorganizationspendsagooddealofitsavailablefundsoninventoryandcapitalexpenditures?Onethingyoucaneverhavetoomuchofis