Question

Assume you are an assistant financial analyst at an international corporation, Occulocorp, and you are interviewed by a radio broadcast journalist. You are asked to introduce and explain basic financial concepts to a local audience, for which you are given a set of questions. Please respond to the following questions: a. What is one of the primary goals for a firm with domestic or international operations? b. As a company grows, the separation of ownership and management will become a critical issue. What might be the reasons for this? Which theory is essential in this framework? c. Why does finance play such an important role in business? d. Are market prices generally right? e. Why do ethics, ethical behavior, and trust play an important role in financial decisions? f. Why is the time value of money important? g. Why are multinational corporations increasing?

Answer 1

You have asked a question with multiple sub parts, in the same post. I have addressed the first four. Please post the balance sub parts separately.

a. What is one of the primary goals for a firm with domestic or international operations?

The primary goal of an organization should be a permanent and long term and not transient or short term. It is therefore more important for a company to maximize shareholders wealth, rather than to maximize profits or have any other short term goals.

Shareholders'wealth maximization should be considered the main goal of the organization because:

• Shareholders'wealth maximization is a modern, wider approach and it leads to sustainable growth
• Shareholders'wealth maximization leads to long term, deeper and superior performance over the life of the company
• This goal is cash flows driven and present value i.e. time value of cash flows is considered
• Shareholders'wealth maximization is sustainable, efficient goal of an organization
• Such a goal leads to creation of a sustainable organization with long term focus, profit maximization leads to a very narrow approach by managers that may compromise the sustainability for near term profits.
• Profit maximization may lead the managers to undertake frauds and manipulations.
• And last but not the least, wealth maximization in a way automatically leads to profit maximization. You can't create wealth unless you create sustainable profits. The other way round is not true. Profits may not necessarily create wealth or value for the shareholders.

Hence, shareholders'wealth maximization therefore is a superior goal than profit maximization.

b. As a company grows, the separation of ownership and management will become a critical issue. What might be the reasons for this? Which theory is essential in this framework?

Shareholders own the company but they don’t manage it. They elect Board of Directors: Executive vs. non executive directors; independent directors. Board appoints top management and is supposed to ensure that managers act in the shareholders’ best interests.

Corporation is a permanent. Employees and managers are not. Even if managers quit or are dismissed and replaced, the corporation can survive. Existing shareholders can sell all their shares to new investors without disrupting the operations of the business.

At times, goals and the objectives of the shareholders and management can get misaligned. This gives rise to the famous AGENCY PROBLEM.

And the theory to solve this is Agency Theory.

c. Why does finance play such an important role in business?

Finance straightway impacts the cash flows or the cash of the company. The financial functions are therefore crucial. It can make or break the company. Finance controls the bread and butter of the organization. Hence, finance is an important role.

d. Are market prices generally right?

Market prices when determined by the theory of demand and supply are usually right. Many a times, the prices are distorted because of collusion, monopoly, oligopoly or market dominance. Predatory pricing is another reason to distort the prices. But if prices are determined by open forces of demand and hey are correct.