Commerce 2FA3: Lecture 02
3. Where do corporations fit in?
Investors try to earn returns centage capital
Return = Dividend yield + Percentage capital
• 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.”
• 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
xxx.com 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
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