Finance Case - Corporate Finance

MBA Mod2011-12 Finance

Homework 1 : Agency problems, Ethics & Governance issues in Finance

Due : 10 April 2011 Midnight

Instructions: (1) Answer all questions. (2)Write your answers in the spaces provided and show your working where necessary.

Question 1

What assumptions need to hold if maximization of share prices is to be the sole objective in Corporate Finance?

Answer

Firstly, shareholders are residual owners in the business, thus after all other stakeholders were paid they receive what is left over in the business. Secondly, that management makes good decisions on behalf of the shareholders, because shareholders buy shares to gain financially, and thus a good decision from a shareholder point of view is something that increases the value of his shares. This maximisation of share value must be done in an ethical manner to ensure that other stakeholders and the environment are not jeopardised in the process.

Thirdly, that the board of directors ensure shareholder interest is protected by performing their duties of ensuring effective management and good corporate governance is adhered to by the management team. This is achieved through processes such as audits and sustainable remuneration packages for senior management that encourages that maximisation of shareholder value on a continues basis not just in the short term.

Question 2

Some have argued that maximizing share prices makes managers/investors focus on short and not long term results. Do you agree or disagree with this reasoning and why?

Answer

It has been seen in various organisations such as in the case of Enron that short term maximisation of the share price is driven to the detriment of longer term goals and social responsibility.

I do not necessarily agree that it will always lead to a focus on the short term results as this can be "controlled" by factors such as the way compensation packages are structured for executives to ensure longer term (sustainable) growth of share price is achieved, thus their personal targets are not only set on achieving short term gains for shareholders but also on future targets.

Question 3

Indicate what effect the following events will have on shareholder or management power - (1) increases management power; (2) increases shareholder power; or (3) no effect. Briefly explain why.

a. The firm decides to expand its board of directors from 10 members to 20 members and allows the CEO to pick