Objectives of Financial Management

INTRODUCTION

It is often assumed that the single objective of commercial entities is:

To Maximise the Value of the Firm

Or

To Maximise the Wealth of the Shareholders

In reality, firms have multiple, and often conflicting, objectives and will seek to optimise among those.  The modern corporation is a complex entity which is responsible not only to shareholders but to all stakeholders.

The main stakeholders are:

  • Shareholders
  • Loan Creditors – seek security, repayment of loan interest and principal.
  • Employees – seek fair wages, promotional opportunities, welfare & social facilities => improved motivation.
  • Management – job security; fair reward; job satisfaction.
  • Trade Creditors – payment within credit terms.
  • The Community – sponsorship; charities; install environmental measures.
  • The Government – payment of taxes, rates, provide employment.
  • Customers – provision of service/goods at fair price; quality; on time etc.

The relative importance of the various groups may differ, possibly depending on company size and management style.

Management will be concerned with the value of the firm as it satisfies one of the important stakeholders (shareholders).  A low valuation may increase the possibility of an unwanted takeover bid.  Also, finance must be adequately rewarded and its market value maintained, so that further finance is obtainable when required.

 Non-financial objectives may conflict with financial objectives – e.g. provision of staff recreational facilities; modern, safe working environment etc.

AGENCY THEORY

The managers/directors act as agents for the shareholders (owners) in running the company.  This separation of ownership from control may lead to certain problems if managers are not monitored or constrained – e.g. management working inefficiently; adopting risk averse policies such as ‘safe’ short-term investments and low gearing; empire building for power/status; rewarding themselves with high salaries and fringe benefits; increased leisure time etc.

Managers’ and shareholders’ interests can be aligned by a number of measures – introducing profit-related remuneration for management; offering bonus shares; share option schemes; scrutiny of performance by the board of directors and banks who provide finance etc.  However, care must be taken to ensure that management does not take action to boost performance in the short-term to the detriment of the long-term wealth of the shareholders (‘short-termism’).

NATIONALISED INDUSTRIES/PUBLIC SECTOR

The objectives of nationalised industries are likely to be strongly influenced by the government and not primarily financial.  These organisations exist to provide a service and to ensure that social needs are satisfied and financial requirements may be seen as constraints and not objectives.  They are not usually profit maximising, although subsidiary objectives may be concerned with earning an acceptable return on capital employed.

 In the private sector the effects of investments (and associated financing and dividend decisions) on share price and shareholder wealth will be considered.  As there are no share prices in a nationalised industry and investor wealth maximisation is not the assumed objective, some private sector investment appraisal techniques will not be appropriate.  However, some private sector financial management techniques can be used in the public sector – e.g. discounted cash flow is often used.

CORPORATE SOCIAL RESPONSIBILITY (CSR)

Corporate Social Responsibility (CSR) is often used to describe the actions of a private, commercial organisation assuming a responsible view of its wider obligations to society.

Corporate Social Responsibility has been otherwise defined as:

“fulfilling a role wider than your strict economic role” or “acting as a good corporate citizen”.

The theory of business finance is that the prime objective of management of a listed company is to maximise the wealth of its ordinary shareholders.  Agency theory dictates that management, as agents of the company’s owners, must act in their best interests and, thus, strive to maximise shareholders wealth at all times. In their attempt to achieve this prime objective management will set financial objectives, including:

  • Profit levels
  • Sales and profit growth
  • Margin improvement
  • Cost releasing efficiency savings
  • EPS growth

Management will also set non-financial objectives, which should complement and support the financial objectives. These may include:

  • Brand awareness levels
  • Research & development successes
  • New product development
  • New markets entered
  • Customer satisfaction levels
  • Employee motivation levels

Such objectives may also include the following:

  • Providing for the welfare of employees and management Upholding responsibilities to customers and suppliers
  • Provision of a service.
  • Contributing to the welfare of society as a whole
  • Environmental protection
  • Which may be loosely described as acting in a socially responsible manner. This has led to the development of the concept of Corporate Social Responsibility (CSR).

Examples of acting in a socially responsible manner may include:

  • Such as KPMG International’s policy of purchasing over 90% of its electricity from renewable sources.
  • Junior Achievement Awards initiative.

Likewise, companies have been alleged to have acted in a less than socially responsible manner.  Examples include clothing and sports goods companies using sub-contractors who employ child labour practices.

The extent to which organisations subscribe to CSR varies greatly both ideologically and in practice.  Recent research has shown that 90% of companies believed that CSR should be part of a company’s DNA, yet only 30% thereof actually did anything about it.

Many organisations view CSR as a strategic investment and consider it necessary in order to achieve the reputation that is gaining importance in attracting and retaining key staff and to winning and retaining prestigious contracts and clients.  Many such companies have moved to operationalise CSR.  This has been achieved in many ways including:

  • Incorporating CSR in their mission statements
  • Appointing a ‘champion’ of CSR
  • Formally incorporating CSR objectives into its strategic planning process
  • Dissemination of CSR targets and reporting of key performance indicators
  • Retaining consultants to advise on existing performance and to recommend improvements
  • Appointment of committees to implement and reviews CSR related policies.

Whilst, some organisations see social responsibility as a passing trend and are content to get by with a bit of ‘lip service’ and tokenism, other organisations view CSR as the preserve of multinationals and government.  Part of the challenge in pursuing CSR related objectives lies in the relative novelty of the concept.  The critical debate is whether or not CSR detracts from the objective of maximising shareholder wealth.  As with all debates there are opposing views including:

Arguments in favour of CSR include that it:

  • Creates positive Public Relations for the organisation, or, as a minimum avoids bad P.R.
  • Helps attract new and repeat custom
  • Improves staff recruitment, motivation and retention
  • Helps keep the organisation within the law,

All of which may be considered to support the drive to maximise profits.

However, there are many writers who vigorously oppose the notion that private organisations should embrace social responsibility.  Some of the main arguments against CSR are:

  • Market capitalism is the most equitable form of society that has ever appeared
  • The ethics of doing business are not those of wider society
  • Governments are responsible for the well- being of society
  • An organisation’s maximum requirement is to remain within the law, no more than this is required.

Ultimately, they argue that business organisations are created and run in order to maximise returns for their owners and that CSR detracts from the profit maximisation

 Conclusion

The broad philosophical debate on the role of companies in society is still in its early days.  Depending on your viewpoint, CSR may be considered to support or detract from the objective of maximising shareholder wealth.  Neither viewpoint is definitive.

As the public debate on CSR and the changing role of business in society intensifies, companies will need to determine their own view on CSR and adopt their own stance on the subject.  Ultimately, they will have to make policy decisions that are in the best interests of the company and its owners, their shareholders.

  IMPACT OF GOVERNMENT ON ACTIVITIES

There are a number of areas where the Government plays a role in the financial arena:

  • Taxation – Corporate (Capital Allowances etc.) & Personal (Business Expansion Scheme, etc.)
  • Monetary Policy – Rates of Inflation, Interest Rates, Exchange Rates etc.
  • Investment Incentives Offered – Grants, etc.
  • Legislation – Monopolies, Competition, Environmental etc.
  • Wage Controls
  • Duties, Tariffs

COMPOSITION OF SHAREHOLDERS

Is there anything to be gained from a company knowing the composition of its shareholders.  Generally, it is useful as it may assist the company in framing its policy/approach in a number of areas e.g.

  • Dividend Policy
  • Attitude to Risk/Gearing
  • Unwelcome Bid – support critical
  • How Performance is Measured
  • Recent Shareholder Changes => Price Movements
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