Corporate Goal of Maximizing Shareholder Value - Essay Example

Corporate Goal of Maximizing Shareholder Value Introduction: In this short essay, the author presents an argument on the corporate goal of maximizing shareholder value and any core objective apart from this. The author also presents how the agency theory constraints this objective. Finally, the author has presented few discussion points. Corporate goal – should it stretch beyond maximizing shareholder value? Historically, the fundamental corporate objective has remained focussed on maximizing share holder value with a notion that this fundamental objective can ensure existence & growth of the corporations. This has worked traditionally quite well but has a conflicting relationship with another fundamental corporate objective – the corporate governance. Enhancing shareholder value cannot be stretched beyond the limits that start breaching the fundamental requirements of corporate governance. Ireland (1996. pp289) established an empirical generalization that the legal existence of the company and the shareholders is entirely separate. Although acts like Sarbanes Oxley in United States have made the leadership of the organization (CEO or CFO!!) legally responsible for the accuracy in accounting statements, many countries around the world still lacks such acts. Moreover, the act does not make shareholders responsible always because in many companies the shareholders do not sign on accounting statements or manage the company operations. Sundaram and Inkpen (2004. pp353) argue that the shareholder value maximization should be considered after all the liabilities of the corporate has been fulfilled – including incentives of managers, contractual liabilities, payments of dividends, principal & interest payments to bond holders, supplier dues, wages, salaries, etc. The net value addition in shareholder wealth needs to be taken care of after all such liabilities have been fulfilled that can be effectively managed through corporate governance. The shareholder wealth maximization and effective corporate governance are conflicting objectives and hence need to be managed by different individuals to reduce the risk of conflict of interest. The non shareholding stakeholders should be engaged in corporate governance whereas the shareholders should be engaged in wealth maximization and the both parties should have a congenial environment to resolve conflicting situations. These roles should be normally fixed in support of the argument by Sundaram and Inkpen (2004. pp355) that the transition from non-shareholding stakeholders to shareholders is easy but vice versa is very difficult. Example, a CEO practicing effective corporate governance should be kept out of shareholding otherwise the conflict of interest scenarios will happen. Non shareholding CEOs will not indulge into high risk taking attitudes in the attempt to maximize shareholder wealth that may lead to the corporate failing miserably in meeting their obligations and the backfiring on shareholder wealth leading to complete crash. The meltdown of organizations like Lehman Brothers is an ideal example of failure of control procedures on risk taking attitudes. To what extent the objective of shareholder maximization is constrained by agency theory? Agency theory is an important aspect of corporate balancing acts given that individuals will divulge into those actions that maximize their personal utility. This forms an excellent baseline for creating a balance between shareholder wealth maximization and corporate governance. The current financial crisis that we are witnessing is the result of stretched risk appetite in the attempt to maximize shareholder wealth to the largest possible extent. Denis & Denis (1999. pp1072) presents the influence of agency theory on risk taking attitudes of corporate decision makers whereby they tend to take lesser risks by portfolio diversification at the cost of shareholder value destruction for personal factors like lower managerial overheads. However, if they themselves become owner of equities then they are less likely to take value reducing decisions thus reducing diversification of shareholder wealth. Overall the researchers could prove that increased personal interests of managers by equity holding increases their risk appetite towards maximizing value. From the author’s perspective, the agency theory can be applied in corporates to implement effective controls that may result in appropriate balance between extent of shareholder wealth maximization and risk taking attitudes thus risking the overall corporate governance. It may not be a good idea to provide shareholding options to corporate decision makers given that the risk management attitudes can dilute dangerously in the organization. At the end, if the controls fail no one will gain – neither the stakeholders nor the managers. In Croatia for example, the corporate governance framework is already in the process of adopting the International Standard of Auditing (ISA) guidelines accepted by the European Union and the UK. The new auditing standards automatically make the board charged with the accountability of corporate governance. The ISA 300 gives the right to auditors to withdraw from the assignment if conflicts in board related to corporate governance are evident. ISA 315 makes it mandatory for auditors to assess the internal risk management of misstatements in accounting statements and ISA 330 gives the auditors the right to test the effectiveness of internal risk management controls (published at www.frc.org.uk/APB/publications/isa.cfm). Discussion Points Supporting the controlling nature of agency theory presented by Denis & Denis (1999. pp1072) the author wishes to invoke a decision on whether agency theory can prevent from corporate scams or overvaluation of corporate assets. Is it really happening that giving shareholding options to key decision makers of the organization is causing imbalance in the equilibrium of controls on conflicts between corporate governance & shareholder wealth maximization? The second discussion proposed by the author is pertaining to effectiveness of regulations in controlling corporate governance thus reducing of chances of dilution of corporate governance. Are laws like Sarbanes Oxley effective in solving such conflicts or else they have provided more safe passage to shareholders that can make their top executives scapegoats amidst their own gesture to publish incorrect accounting statements? Fraja (1996. pp89-90) presented multiple modes of ownership shift of a firm. Firms may be either managed by owners or by employees. In some cases, the owners sell the firm to venture capitalist and take managerial positions in the executive management to manage the operations. In another cases, the managers buy out the shares in the firm to become shareholders and continue running the firm. There can be cases in which majority of the shares are sold to investors external to the firm such that the existing shareholders become minority shareholders but they continue to run the firm as managers. These are complex dynamics in which the personal entity of individuals changes drastically thus changing the equilibrium between shareholder value maximization & corporate governance. Looking into the agency theory, does the risk of investing in such companies vary with the shift in personal entities in the system? Example, should the AAA rating of a firm change because the Managers (critical decision makers) have decided to become shareholders or vice versa? Conclusion: The author of this short paper has presented the fundamental objectives of corporates as shareholder wealth maximization as well as effective corporate governance that are conflicting objectives. The author further presented the argument on how agency theory can be a controlling tool for managing such conflicts effectively. Table of Contents: Reference List: Denis, David J. and Denis, Diane K. et al. (1999). Agency Theory and the Influence of Equity Ownership Structure on Corporate Diversification Strategies. Strategic Management Journal. Vol. 20.No. 11. John Wiley & Sons. Retrieved on 2 April 2009. Available at http://www.jstor.org/stable/3094032 (Liverpool Library). pp1072. Fraja, Gianni. (1996). Entrepreneur or Manager – Who Runs the Firm?. The Journal of Industrial Economics. Vol. 44. No. 1. Blackwell Publishing. Retrieved on 2 April 2009. Available at http://www.jstor.org/stable/2950563 (Liverpool Library). pp89-90 Ireland, Paddy. (1996). Corporate Governance, Stake holding and the Company – Towards a less degenerate capitalism. Journal of Law and Society. Vol. 23. No.3. Blackwell publishing. Retrieved on 2 April 2009. Available at http://www.jstor.org/stable/1410714 (Liverpool Library). pp289. Sundaram, Anant K and Inkpen, Andrew C. (2004). The Corporate Objective Revisited. Organizational Science. Vol. 15. No. 3. INFORMS. Retrieved on 2 April 2009. Available at http://www.jstor.org/stable/30034738 (Liverpool Library). pp353, 355 Read More