Business Environment in the Light of the Current Financial Crisis - Assignment Example

The current business environment is characterized by the importance of the investor and the drive for shareholder value. Critically discuss this development in the light of the current financial crisis, prevailing research and course readings. 1. Introduction The survival of the firms in the modern market is related mostly with their potentials to stabilize their position towards their competitors. Moreover, it has been proved that the ability of firms to keep their shareholder value at high levels shows the prospects of these firms in the long term; in fact, in firms where the role of the investors is adequately appreciated and supported it can be expected that these firms will have more chances to survive in case of a strong financial crisis – compared to those firms that do not have similar strategic priorities. Current paper focuses on the importance of investors in modern firms; emphasis is given on the drive for shareholder value, which is considered as a strategic tool for the stabilization of business performance. It has been proved investors can have a key role in the survival of firms in current financial crisis; however, it is necessary that specific strategies be used so that the increase in shareholder value is continuous and standardized (or else, stable) in the long term. 2. The value of investor in the development of business in the context of the current recession The role of investor in modern businesses is likely to be differentiated in accordance with a series of criteria; normally, the business structure indicates the potential role of investors in the development of business activities; however, other criteria, like the position of the firm in the market – being related with the size of the firm – and the leadership style are likely to affect the role of investors within the particular organization. Different views have been developed in the literature regarding the power of the investors to intervene in the activities of modern businesses. In the study of Mikami et al. (2010) investors in modern firms are related with a specific target: the increase of business efficiency; in the above study a comparison was made between firms owned by investors and firms owned by workers; it has been proved that ‘the firm is efficient when it is owned by the input supplier (the investor or worker) who incurs large sunk costs of capital’ (Mikami et al., 2010, 77); on the other hand, it is assumed that firms that are owned by workers are less efficient – due to the lack of funds required for the cover of risks. From a similar point of view it has been proved that ‘ownership concentration has a negative impact on board independence, but no impact on audit committee independence while board independence enhances firm value’ (Setia, 2009, 694); the above findings can led to the assumption that the concentration of power in hands of specific investors offer to these investors the chance to have a decisive role in the development of business activities; however, in the above case the effectiveness of auditing in the particular organization is not expected to be decreased. At the same time it is proved that the control of the firm by a small number of investors (through the concentration of ownership in the specific organization) could lead to the limitation of the firm’s value. Under these conditions, investors that have to decide on the governance of their firm should choose independent directors – who would not expected to negatively affect the firm’s value. In periods of financial crises – like current one – firms tend to be particularly careful as of the protection of their investors; strategic measures are likely to be implemented for ensuring the protection of the investors’ interests during recession. However, the effectiveness of these measures is not guaranteed. Through the research of Rondi et al. (2009) it has been proved that ‘the stronger the investor protection the lower the fraction of equity that is owned by insiders’ (Rondi et al., 2009, 634); it has been also proved that ‘higher insider equity ownership is linked to larger risk premiums and higher costs of capital’ (Rondi et al., 2009, 634). However, the criteria used for deciding the measures taken for the protection of investors in modern firms cannot be standardized; especially in firms that business goals tend to be differentiated in accordance with the market trends and the firms’ performance the role of investors in the development of business activities can be interpreted using different parameters. The level at which the investors can affect the business performance is also likely to be depended on the market’s characteristics; towards this direction, it has been proved in the study of Chhabra et al. (2009) that ‘well-developed capital markets produce higher rates of economic growth and allocate capital more efficiently’ (Chhabra et al., 2009, 819). Moreover, a relationship seems to exist among the investors, the cost of capital and the level of a firm’s liquidity. When the specific issue was set under examination it was revealed that ‘lower levels of investor protection reduce share liquidity while simultaneously resulting in a higher cost of equity capital’ (Chhabra et al., 2009, 819). In accordance with the above, the measures taken towards the protection of investors within a specific organization should be based on the following criteria: a) the share liquidity of the firm would not be adversely affected – at least the limitation of the firm’s share liquidity should be kept at low levels, b) the cost of capital should not be increased and c) the balance between the benefits expected and the cost involved should be clear and reflecting the business performance the specific period of time; in other words, in periods of strong financial crisis the measures taken for the protection of investors should be carefully reviewed as of their effects on the organizational performance. The incorporation of credible disclosure in a specific firm is proposed as an effective method for increasing the firm’s profits – mostly by helping to the limitation of the agency costs (Stulz, 2009, 349). 3. Shareholder value as a strategic tool for the development of businesses in current financial crisis The development of strategic decisions in a particular organization is commonly based on the needs of the organization but also the similar practices of competitors; at the next level, different organizational activities are likely to be promoted under specific market conditions. In current financial crisis the identification of the business priorities is of crucial importance allowing the firms to develop strategic plans that will ensure the stabilization of organizational performance in the long term. Shareholder value has been proved to be a key strategic tool for the development of business activities even under extremely adverse market conditions – current recession is an indicative example. However, because the power of shareholders in a specific organization is not the same – being depended on the number of shares hold by each investor – it is expected that the impact of shareholders on the development of business activities can be different – as a consequence different measures should be taken by the firms that would seek to keep their shareholder value at high levels. This fact is not related with the cost of the strategy promoted neither with the initial criteria on which the relevant scheme is based. In the study of Aggarwal et al. (2009, 3131) it has been proved that ‘minority shareholders benefit from governance improvements and do so partly at the expense of controlling shareholders’ (Aggarwal et al., 2009, 3131). In other words, measures taken for the protection of shareholder majority could also benefit the shareholder minority – the targets set by specific strategic plans could lead to additional benefits if these plans are appropriately designed and monitored. Because of its importance, the shareholder value may be set as a criterion for the positioning of a firm in its market; a relevant rule exists in the US legislation; under certain conditions the limitation of firm’s shareholder basis can lead to the decrease of this firm valuation – usually within a specific period of time. In this context, it is noted by King et al. (2009) that ‘cross-listed firms with a single class of shares enjoy a permanent increase in valuation if they attract and maintain investor recognition over time’ (King et al., 2009, 2393). This is a rule applied on firms operating in the Canadian market; similar rules can be identified in other markets internationally. On the other hand, the research of Mansoor et al. (2009) led to the conclusion that there is ‘a link between investor and consumer confidence’ (Mansoor et al., 2009, 1). The above assumption is possibly based on the fact that the limitation of risk in firms with extended shareholder base can lead to the increase of confidence in the public – as a result of the limitation of chances for the collapse of the particular organization. In many cases, the measures taken by firms for the increase of shareholder value fail to achieve the targets set; this failure has been related with the lack of understanding of the firms’ needs in the long term; for this reason, it has been proved that ‘the singular, monistic and short-term oriented shareholder perspective fails to capture the dynamics of value management from the standpoint of all stakeholders, not just shareholders’ (Ullah et al., 2010, 153). In this context, it is made clear that the shareholder value cannot be considered as just a concept reflecting the level of equity of a specific organization; it is rather an indicator of the organization’s power to balance the risks related with all organizational activities – the equity provided by the investors should be considered not only as part of the organizational capital but also as a tool for guaranteeing the potential of a firm to overcome a recession – for this reason the increase of shareholder value in period of financial crisis shows the ability of the firm to survive during this crisis. In practice, the use of shareholder value for developing business activities – especially in periods of financial crisis – can be a challenging task; an indicative example is provided by Goutas et al. (2009) who studied the role of shareholder value in German firms and found that the methods used for the introduction of shareholder value in the German market have been differentiated – more specifically, it is noted that ‘divergences are identified both at the discursive level and at the level of organisational structures and practices of corporate governance’ (Goutas et al., 2009, 327). It can be assumed that the methods used for the increase of shareholder value in a specific market depend on the characteristics of the above market. 4. Conclusion In periods of recession, firms are likely to set different priorities aiming to secure their position in the market; emphasis is usually given on the protection of investors’ rights and interests. In the literature, the specific strategy has been justified; investors have been found to have a crucial role in the development of business activities – especially during a financial crisis where risks in various organizational activities can be high. However, in practice, the effectiveness of plans developed for the increase of shareholder value is limited – at least compared to the targets set by the firms’ strategic managers. This phenomenon can be explained by referring to the structure and the trends of modern market: the limitation of cost of business activities is set as a priority when organizational plans are developed; at the same time, the monitoring of strategic plans in modern firms is not appropriate. The failure to understand the organizational needs can result to the failure to propose measures that can sufficiently protect the rights of investors within a specific organization. References Aggarwal, R., Erel, I., Stulz, R., 2009. Differences in Governance Practices between U.S. and Foreign Firms: Measurement, Causes, and Consequences. Review of Financial Studies, Volume 22, Number 8, pp. 3131-3169 Chhabra, M., Ferris, S., 2009. Investor protection effects on corporate liquidity and the cost of capital. Applied Economic Letters, Volume 16, Number 8, pp. 819-826 Gerzema, J., Lebar, E., 2009. Measuring the Contributions of Brand to Shareholder Value (and How to Maintain or Increase Them). Journal of Applied Corporate Finance, Volume 21, Number 4, pp. 79-88 Goutas, L., Lane, C., 2009. The Translation of Shareholder Value in the German Business System: A Comparative Study of DaimlerChrysler and Volkswagen AG. Competition and Change, Volume 13, Number 4, pp. 327-346 King, M., Segal, D., 2009. The Long-Term Effects of Cross-Listing, Investor Recognition, and Ownership Structure on Valuation. Review of Financial Studies, Volume 22, Number 6, pp. 2393-2421 Mansoor, D., Masson, P., 2009, Measures Of Investor And Consumer Confidence And Policy Actions In The Current Crisis, Research Working Papers, pp. 1-28 Mikami, K., Tanaka, S., 2010. Sunk costs of capital and the form of enterprise: investor-owned firms and worker-owned firms. Annals of Public and Cooperative Economics. Volume 81, Number 1, pp. 77-104 OECD, 2009. Getting back to sustainable growth path is the key policy challenge. OECD Economic Surveys Volume 2009, Number 3, pp. 27-63(37) Rondi, L., Elston, J., 2009. Corporate governance and capital accumulation: firm-level evidence from Italy. Scottish Journal of Political Economy, Volume 56, Number 5, pp. 634-661 Setia, L., 2009. Governance Mechanisms and Firm Value: The Impact of Ownership Concentration and Dividends. Corporate Governance, Volume 17, Number 6, pp. 694-709 Stulz, R., 2009. Securities Laws, Disclosure, and National Capital Markets in the Age of Financial Globalization. Journal of Accounting Research, Volume 47, Number 2, pp. 349-390 Ullah, Q., Kane, V., 2010. Value cycle model: managing value through stakeholder management. International Journal of Value Chain Management. Volume 4, Numbers 1-2, pp. 153-169(17) Read More