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Chapter 01

Chapter 01. Comparative Corporate Governance and Financial Goals. Comparative Corporate Governance and Financial Goals. Multinational Enterprise (MNE) Multinational Business Finance Goal of Management Shareholder Wealth Maximization Stakeholder Capitalism Model

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Chapter 01

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  1. Chapter 01 Comparative Corporate Governance and Financial Goals

  2. Comparative Corporate Governance and Financial Goals • Multinational Enterprise (MNE) • Multinational Business Finance • Goal of Management • Shareholder Wealth Maximization • Stakeholder Capitalism Model • Comparative Corporate Governance • Currency Terminology

  3. The Multinational Enterprise (MNE) • A multinational enterprise (MNE) is defined as one that has operating subsidiaries, branches or affiliates located in foreign countries. • The ownership of some MNEs is so dispersed internationally that they are known as transnational corporations. • The transnationals are usually managed from a global perspective rather than from the perspective of any single country.

  4. Multinational Business Finance • While multinational business finance emphasizes MNEs, purely domestic firms also often have significant international activities: • Import & export of products, components and services • Licensing of foreign firms to conduct their foreign business • Exposure to foreign competition in the domestic market • Indirect exposure to international risks through relationships with customers and suppliers

  5. Global Financial Management • There are significant differences between international and domestic financial management: • Cultural issues • Corporate governance issues • Foreign exchange risks • Political Risk • Modification of domestic finance theories • Modification of domestic financial instruments

  6. The Goal of Management • Maximization of shareholders’ wealth is the dominant goal of management in the Anglo-American world. • In the rest of the world, this perspective still holds true (although to a lesser extent in some countries). • In Anglo-American markets, this goal is realistic; in many other countries it is not. • There are basic differences in corporate and investor philosophies globally. • In this context, the universal truths of finance become culturally determined norms.

  7. Shareholder Wealth Maximization • In a Shareholder Wealth Maximization model (SWM), a firm should strive to maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk. • Alternatively, the firm should minimize the level of risk to shareholders for a given rate of return. • Assumptions of SWM: • The SWM model assumes as a universal truth that the stock market is efficient. • An equity share price is always correct because it captures all the expectations of return and risk as perceived by investors, quickly incorporating new information into the share price. • Share prices are, in turn, the best allocators of capital in the macro economy.

  8. Shareholder Wealth Maximization – Continued • Assumptions of SWM – Continued: • The SWM model also treats its definition of risk as a universal truth. • Risk is defined as the added risk that a firm’s shares bring to a diversified portfolio. • Therefore the unsystematic, or operational risk, should not be of concern to investors (unless bankruptcy becomes a concern) because it can be diversified. • Systematic, or market, risk cannot however be eliminated.

  9. Shareholder Wealth Maximization – Continued • Agency theory is the study of how shareholders can motivate management to accept the prescriptions of the SWM model. • Liberal use of stock options should encourage management to think more like shareholders. • If management deviates too extensively from SWM objectives, the board of directors should replace them. • If the board of directors is too weak (or not at “arms-length”) the discipline of the capital markets could effect the same outcome through a takeover. • This outcome is made more possible in Anglo-American markets due to the one-share one-vote rule.

  10. Shareholder Wealth Maximization – Continued • Long-term versus short-term value maximization • Long-term value maximization can conflict with short-term value maximization as a result of compensation systems focused on quarterly or near-term results. • Short-term actions taken by management that are destructive over the long-term have been labeled impatient capitalism. • This point of debate is often referred to a firm’s investment horizon (how long it takes for a firm’s actions, investments and operations to result in earnings). • In contrast to impatient capitalism is patient capitalism. • This focuses on long-term SWM. • Many investors, such as Warren Buffet, have focused on mainstream firms that grow slowly and steadily, rather than latching on to high-growth but risky sectors.

  11. Stakeholder Capitalism Model • In this context, a firm should treat shareholders on a par with other corporate interest groups, such as management, labor, the local community, suppliers, creditors and even the government. • This model, also called the stakeholder capitalism model focuses on earning as much as possible in the long-run while retaining enough to increase the corporate wealth for the benefit of all interest groups. • Assumptions of SCM: • The SCM model does not assume that equity markets are either efficient or inefficient. • In fact, market efficiency does not matter as the firm’s financial goals are not exclusively shareholder-oriented. • This model assumes that long-term “loyal” shareholders should influence corporate strategy, not transient investors. • The SCM model assumes that total risk, operating and financial risk, does count.

  12. Stakeholder Capitalism Model – Continued • Although the SCM model avoids the impatient capitalism as seen in the SWM, it has its own flaw in that management is tasked with meeting the demands of multiple stakeholders. • This leaves management without a clear signal about the tradeoffs, which management tries to influence through written and oral disclosures and complex compensation systems. • While both forms of wealth maximization have their strengths and weaknesses, two trends in recent years have led to a focus on the SWM model. • As non Anglo-American markets privatize their industries the SWM model becomes more important in the overall effort to attract foreign capital • Many analysts believe that shareholder-based MNEs are increasingly dominating their global industry segments

  13. Corporate Governance • The single overriding objective of corporate governance is the optimization over time of the returns to shareholders. • In order to achieve this goal, good governance practices should focus the attention of the board of directors of the corporation by developing and implementing a strategy that ensures corporate growth and improvement in the value of the corporation’s equity. • The most widely accepted statement of good corporate governance practices are established by the OECD: • The corporate governance framework should protect shareholders rights. • The corporate governance framework should ensure the equitable treatment of all shareholders. • Stakeholders should be involved in corporate governance. • Disclosure and transparency is critical. • The board of directors should be monitored and held accountable for what guidance it gives.

  14. Comparative Corporate Governance • These regimes are a function of: • Financial market developments • Degree of separation between managers and owners • Disclosure and transparency • Historical development of the legal system

  15. Failures in Corporate Governance • Failures in corporate governance have become increasingly visible in recent years. • In each case, prestigious auditing firms missed the violations or minimized them, presumably because of lucrative consulting relationships or other conflicts of interest. • In addition, security analysts urged investors to buy the shares of firms they knew to be highly risky (or even close to bankruptcy). • Top executives themselves were responsible for mismanagement and still received overly generous compensation while destroying their firms.

  16. Corporate Governance Reform • Within the United States and the United Kingdom, the main corporate governance problem is the one treated by agency theory: with widespread share ownership, how can a firm align management’s interest with that of the shareholders? • Because individual shareholders do not have the resources or the power to monitor management, the U.S. and U.K. markets rely on regulators to assist in the agency theory monitoring task. • Outside the U.S. and U.K., large, controlling shareholders are in the majority – these entities are able to monitor management in some ways better than the regulators can.

  17. The Sarbanes-Oxley Act • This act was passed by the US Congress during 2002 and has three major requirements: • CEOs of publicly traded companies must vouch for the veracity of published financial statements; • Corporate boards must have audit committees drawn from independent directors; • Companies can no longer make loans to corporate directors, and • Companies must test their internal financial controls against fraud • Penalties have been spelled out for various levels of failure. • Most of its terms are appropriate for the US situation, but some terms do conflict with practices in other countries.

  18. Currency Terminology • Foreign currency exchange rate or exchange rate is the price of one country’s currency in units of another currency or commodity (gold or silver). • If a government determines the exchange rate for its currency then exchange rate system is called fixed or managed exchange rate system • The rate at which the currency is fixed or pegged called is called par value • If government does not interfere then the system is called flexible or floating • Spot exchange rate is the quoted price for foreign exchange to be delivered at once, or in two days for interbank transactions. • How can you interpret $1.2670/€?

  19. Currency Terminology – Continued • Devaluation of a currency refers to a drop in foreign exchange value of a currency that is pegged to gold or another currency. • The opposite is revaluation • Weakening, deterioration, or depreciation of a currency refers to a drop in the foreign exchange value of a floating currency. • The opposite is strengthening or appreciation • Soft or weak describes a currency that is expected to devalue or depreciate relative to major currencies. • Hard or strong describes a currency that is expected to revalue or appreciate relative to major trading currencies. • Eurocurrencies are domestic currencies of one country on deposit in a bank in a second country. • Eurodollar – dollar deposits overseas • Euroyen – yen deposits outside Japan

  20. Currency Terminology – Continued • Foreign Exchange Rates & Quotations – Direct and Indirect Quotes • A direct quote is a home currency price of a unit of a foreign currency • Sfr1.6000/$ is a direct quote in Switzerland • An indirect quote is a foreign currency price of a unit of the home currency • Sfr1.6000/$ is an indirect quote in the US, • $0.6250/Sfr is a direct quote in the US and an indirect quote in Switzerland

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