Corporate Finance

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'The history of corporate structure over the last one hundred and fifty years reflects that it fundamental purpose has been to maximize corporate profit with the view of increasing shareholder wealth.' (httpwww.band.edu.au/law/blr/vol10-/5-carfield.pdf) However , ethical considerations may be compromised with such financial modeling.

'The traditional view of the legal model of the company is a principal-agent model, the directors being the agents and the shareholders the principals. The shareholders, as sole owners and residual risk bearers, are entitled to assume that the company will be run in their interests exclusively' (Grinyer, 16)

The question of whether corporate management adopts strategies consistent with shareholder wealth maximisation is an ongoing issue in corporate finance. Agency problems may arise when management decisions or actions flow from non- value or trivial maximising strategies.

For example, management may seek to increase the size of the firm for the sole purpose of empire building, or they may seek to diversify the firms portfolio in order to increase their own job security. Further , 'the managerial entrenchment thesis suggests that the separation of ownership and control offers managers an array of discretionary behaviors, including shirking, and risk aversion or the taking

of fewer investment risks Each of these ultimately results in present value loss for the firm' (Taylor,000) and are important ethical considerations. These issues can apply to Project A for example, the NPV of the Project is positive, an indication that management should continue with the proposal. However, it is indicated the mines output is highly uncertain and the company is worried about cost overruns and delays due to requiring zoning changes and environmental approvals. Management may use their discretionary powers to avoid the project due to the risk involved, in order to increase their own job security.

This view is supported by Donaldson (184) who observed that managers did not seek to maximise shareholders wealth but sought instead to maximise corporate wealth.

Thus if the financial incentives of corporate managers are dependent on their performance, managers are more likely to adopt a set of strategies which are beneficial to themselves even if these strategies prove to be costly to shareholders. 'Alternatively, private as well as political forces may be the catalysts that drive managerial strategies rather than a goal of value maximisation.'( Taylor 000)

Further, it is 'sometimes argues that, left to themselves, managers would tend to maximize the amount of resources over which they have control over, or more

generally, corporate power or wealth. (Ross, Thompson, Christensen, Westerfield, Jordan 001)

In addressing why such ethical considerations arise, Taylor (000) states that,' of all the economic agents of a firm, corporate managers are the most likely targets for both internal and external pressure. Consequently, they tend to adopt strategies in response to these pressures to create shareholder value. Further, because contracts cannot fully specify the rights and obligations of the parties, opportunities exist for management to make decisions about the use of corporate resources that benefit them personally and at the firms costs. 'This kind of relationship raises agency costs because corporate management do not bear the wealth effects of their own decisions, and dispersed shareholders cannot efficiently monitor corporate management as they would like'. (http//www.allbrightlaw.com.cn/lubbs/wangq.htm)

In summary, management in reality do not attend exclusively to maximising returns for shareholders. 'Modern management frequently declares itself a trustee for employees, customers and stockholders and may even affirm, a social responsibility to a wide variety of societal segments which have a stake in the continued health of the corporation.' (Grinyer 16) Whether this is an attempt by management to

legitimise resource manipulation according to personal agendas, or a valid managerial concept, the issue remains an area of great controversy with significant ethical implications.

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