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Lecture 2

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McMaster University
Dr.Richard Deeves

Commerce 2FA3: Lecture 02 3. Where do corporations fit in? Investors try to earn returns centage capital Return = Dividend yield + Percentage capital Gain Example: Return calculation • Capital gain = $1/$10 = 10% • Div. yield = 50 cents/$10 = 5% • return = 10% + 5% = 15% Goals of financial management • Primary goal of financial management should be: o To maximize shareholder wealth (value creation). • Advantage of stock price maximization is that both ST and LT earnings are considered. • But sometimes managers act differently… o If investors can be fooled maybe possible to take value-neutral action that appear to investors to be value-enhancing to push stock prices up temporarily. o This is called “catering.” Catering • Examples of catering: o Earnings management/manipulation o Dividend changes o Company name changes  Ex: during the internet boom some companies changes their name to and saw their share prices jump -> though some weren’t related to the internet, since there was an excitement for the internet But who benefits from catering? • Managers (and “aware” shareholders) who plan to “cut and run” • But not long-term shareholders (nor financial system) Separation of ownership and control Corporate governance and agency problem • Corporate governance is system whereby managers are controlled by shareholders. • Wise shareholders seek to align their interests with those of managers. o One method of doing this: performance-related rewards such as stock options o But these can encourage excessive risk-taking, earnings management and even fraud… Executive comp trends • GM in 1969 o CEO: $4m & average worker: $40k o Ratio: 100 • Wal-Mart in 2005 o CEO: $20m & average worker: $20k o Ratio: 1000 • Studies of other large firms indicate this example is not “cherry-picked” • And does extremely high-performance-related compensation enhance performance anyways o R
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