Current Business Environment Is Characterised by the Importance of the Investor - Coursework Example

27th February 2006 The current business environment is characterised by the importance of the investor and the drive for shareholder value (Summary: The debate on the managers' responsibilities towards its shareholders is an age-old one. In this paper we are trying to define the role of managers in terms of their responsibilities towards shareholders vis--vis other stakeholders. The debate on the importance of stakeholder's value upon shareholders values also analyzed. I have given a brief historical background of corporate governance. I have analyzed the different views proposed by various Management Gurus and the recent trend of thinking on the subject) (word count - 1860) Introduction The responsibilities of Managers in business environment are a matter of debate for long. When we talk about 'The current business environment is characterised by the importance of the investor and the drive for shareholder value' we will be talking in the perspective of Business and accounting managers. Henry Mitzberg, the Cleghorn professor of Management Studies, Mcgill University, started the debate by putting the blame on the students of Business Schools. He states that the 'Shareholder value is an antisocial dogma that has no place in a democratic societyIt breeds a society of exploitationsit is bad for business (Mitzberg, 2004, p 154). He alleges that the students of business schools get the impression that the organisations' share price is the only performance measure worth worrying about. Dr. Nick Tiratsoo of Nottingham University Business School has published a paper 'Mitzberg, shareholder value, and the business school: who has a case to answer' where he, tries to explore Mitzberg's argument about shareholder value and the business schools. He states, 'The conclusion offered that Mitzberg has substantially overstated his case, and thus clouded rather clarified a necessary debate about how business schools are to evolve in the future'. Before we go into the argument, first let's look at what is defined by a corporation/ company / firm, its shareholders, stakeholders and the roles of managers in the corporate set up. A corporation is essentially defined in terms of its legal status and the ownership of assets. Corporations are typically regarded as artificial persons in the eyes of the law. Corporations are notionally owned by shareholders. Managers and Directors have a fiduciary responsibility to protect the interests of the shareholders. It was Milton Freedman, who in his classic article 'The Social responsibility of business is to increase its profit vigorously' argued against the notion of social responsibilities of corporations. He professed that only the human beings have the moral responsibility for their actions. Its managers' responsibility to act solely in the interest of the shareholders. Social issues and problems are the proper province of the state rather than corporate managers. Freedman defines, 'A stakeholder in an organization is . Any group or individual who can affect or is affected by the achievements of the organizations' objectives.' Shareholder Value as defined by Value Based Management.net 'the definition of shareholder value is the value of the company minus the Future claims (debts). The value of the company can be calculated as the Net Present Value of all Future cash flows plus the value of the non operating assets of the company'. There is a great debate on the importance of Stakeholders Value over Shareholders Value. The Shareholder Value perspective emphasizes on Profitability over Responsibility. It relates the success of an organization by its share price, dividends and economic profit. The Stakeholders perspective on the other hand emphasizes on Responsibility over Profitability. It suggests that an organizations success should be measured by the satisfaction of its stakeholders i.e. customers, employees, society in general and also its shareholders. Sir Brian Pitman, senior Advisor, Morgan Stanley on his speech 'Corporate Governance - The Practitioner's view' at The Asian Banker Summit 2004, gives the following perspectives on the responsibilities of managers and the debate on shareholders and stakeholders - Is the board the agent of Shareholders or the trustee of stakeholders - Once a company calls on the market, its nature changes. The Anglo-American tenet has long-term shareholder value maximization as its main corollary. He emphasizes: 1 Our single purpose and governing objective is to maximize shareholder value. 2 Maximising shareholder value maximizes value for all the stakeholders, there is no conflict. 3 If world class means anything, it means world class in value creation. He also stresses - Over time maximizing shareholder value will produce the highest level of benefits for all stakeholders. Those companies with best track records of value creation are advantaged in attracting and utilizing resources - capital and human Those companies with the best track records of value creation are best at managing human resources and customer satisfaction. Wherever shareholders subsidize other stakeholders in a significant way, the financial health of the company is diminished, ultimately to the detriment of the stakeholders. Historical Background: After the Second World War, as the economic activity started picking up again, there was a spurt in the evolution of industrial and business entities. The leaders in this activity were the USA and some European countries like the UK. With decades of development of production capabilities, they started earning huge revenues. These entities generally followed the corporate governance principle called ' Retain and Reinvest ', in which major portions of the earnings are ploughed back as capital Investment and hence retained in the finances of the organization instead of distributing among the shareholders as profits. With a view to capture large market shares for their products, these entities followed a policy of expansion and diversification. The purpose of expansion was to enjoy the benefits of economies of scale and remain competitive. The purpose of diversification was to take advantage of factors such as risk reduction, earnings stability, synergy, growth, adapting to customer needs and better utilization of spare resources. Till the 1950's these corporations continued to grow into giant size enterprises, not only retaining their earnings for reinvestment, but also their people whom they employed, as complementary human resources, thus laying the financial foundations of corporate growth. They also employed mergers and acquisitions as tools of expansion. However, by the 1960's and 70' these corporations became very big, with several divisions handling diverse businesses. The central management was ineffective in controlling and monitoring the financial health of these divisions. This resulted in the gradual deterioration of the financial performance. Another factor, which badly affected these corporations, was the rise of international competition especially from Japan and some European countries. The Japanese developed mass production capabilities with innovations in the development of integrated skill bases. The Japanese philosophy of integrating their skill base right from the top management to the shop-floor level, and also with their supplier network, clearly gave them a huge advantage over their American competitors, whose 'hourly' production workers could not exercise any control over the conditions of work and pay. The American policy of favouring suppliers with lowest current costs, eventually neglecting the long-term advantages of supplier integration. With the theory of 'Retain and reinvest' no longer productive, a principle of ' Downsize and distribute ' evolved .The 1980's saw a change in the line of thinking regarding control over allocation of corporate resources and returns. A view developed that the managers of these corporations who were supposed to be the agents of their principals, that are the shareholders, may not be operating towards their interests, which is maximization of the value of shares. Theorists called this as ' agency theory '. They argued that there was a need of a take-over market, which would function as a market control to force the managers to take corrective steps, whose units were performing badly. ROR on Capital stock and maximization of shareholder value became the most important factors of evaluating the performance of these corporations. By the 1990's this view was fully entrenched in the minds of most of the theorists. This aspect is discussed in detail further. Current trends: In current trend let's define some related terminologies. Wikipedia gives this definition of Corporate Governance; 'CG is the set of processes, customs, policies laws and institutions affecting the way a corporation is directed, administered or controlled. Corporate Governance also includes the many players involved (the stakeholders) and the goals for which the corporation is governed)' Corporate Governance also defined as 'the system by which the owners of the corporation ensures that it pursues, does not deviate from and only allocates to its defined purpose'. (LSE and RSM Robson Rohodes, 2004). Value based Management: CIMA defines VBM as 'a managerial process which effectively links strategy, measurement and operational processes to the end of creating shareholder value'. The three key elements of Value based Management are: Creating value, i.e. ways to actually increase or generate maximum future value. Measuring Value Managing for Value i.e. governance, management, organization, culture, communication. A related issue has been the focus on auditing practices and the integrity of financial statements. Recent accounting fraud by Enron and WorldCom has given another angle to the shareholders value, i.e. accounting ethics. There is a debate about the role of auditors. In post-Enron era a number of initiative has been undertakes to arrest this malpractices. The recent failure of companies like Mangham, Dearlove, Mitroff, Swanson, Enron has created a debate about the role and responsibilities of managers. Most companies subscribe to the theory of 'in the business of maximizing value for their shareholders'. However managers often lack understanding of the difference between decisions that lead to higher profits and those that create value. Managers' responsibility should lie on creating value addition to the corporation i.e. its' assets. We have seen how in case of Enron, accounting scandal destroyed the value for both of their shareholders and stakeholders. There are other companies, which failed not due to fraud but for strategic errors. In its technical report 'Maximizing Shareholder Value - Achieving clarity in decision-making' of CIMA, it is stated '78% of companies interviewed for a University of Washington study (Graham, 2004) admitted to artificially smoothing earnings and sacrificing shareholders value in order to meet, or beat Wall Street expectations. 55% also said that they would avoid initiating a project with a very positive net present value (NPV) if it meant failing short of the current quarter's consensus on earnings. It is quite commonly observed that some companies forget their principal responsibility of maximizing value for share holders in an attempt to maintain steady earnings stream, that are believed to be preferred by equity analysts and investors. Lucia Dore, on her article 'How to pursuit of shareholder value can achieve sustainable economic growth states,'pursuing shareholder value philosophy requires total management commitment and a deep understanding of how an organization creates value at every business unit. Shareholder value is the only way to identify value destroying businesses and allocate resources efficiently.' She points out that there is no conflict between shareholders value and stakeholder value once the parameters of business operation is drawn and adhered to. Conclusions: In conclusion I will go with the old fashioned integrity and honesty and a genuine focus on alignment of interests between owners and managers, remembering that the boards are given the stewardship of other people's money. The managers have the responsibility towards their shareholders and it's their duty to maximize the shareholders value. But in doing so the managers have to keep the basic tenets of business ethics in their mind. It will be more appropriate to say that to maximize the shareholders profit, it is very much necessary to look after the stakeholders' interests. Without proper contribution from all the stakeholders like employees, suppliers of goods and services, customers, no company will survive in the long run. The managements' concern should be on value addition, the priority should be on value addition of the company rather than the share price. References Corporate Governance, Wikipedia http://en.wikipedia.org/wiki/Corporate_Governance Dobbs Ian, Managerial Economics, 2000, Oxford University Press, New York, Dore, Lucia, How the pursuit of shareholder value can achieve sustainable economic growth. http://www.powerful-communication.com/shareholder-value-essay.pdf Maximising Shareholder Value, Achieving clarity in decision-making, CIMA http://www.valuebasedmanagement.net/articles_cima_maximizing_shareholder_value.pdf Perman Roger and Scouller John, Business Economics, (P222-229), 1999, Oxford University Press, New York Pitman, Sir Brian, Corporate Governance the practitioners view, The Asian Banker Summit 2004. http://www.theasianbanker.com/A556C5/DwdPresentation.nsf/3F97012E97C9BA3348256E8D00269AB2/$File/BrianPitman.pdf Tiratsoo, Dr. Nick, Mintzberg, shareholder value, and the business schools: who has a case to answer http://www.ebkresearch.org/downloads/ebk2004_2tiratsoo.doc What is a shareholder Value - definition, Value based Management.net http://www.valuebasedmanagement.net/faq_shareholder_value.html Read More