Conclusion

While the objective in corporate finance is to maximize firm value, in practice we often adopt the narrower objective of maximizing a firm's stock price. As a measurable and unambiguous measure of a firm's success, stock price offers a clear target for managers in the course of their decision-making.

Stock price maximization as the only objective can be problematic when the different players in the firm - stockholders, managers, lenders and society - all have different interests and work at cross purposes. These differences, which result in agency costs can result in managers who put their interests over those of the stockholders who hired them, stockholders who try to take advantage of lenders, firms that try to mislead financial markets and decisions that create large costs for society. In the presence of these agency problems, there are many who argue for an alternative to stock price maximization. While this path is alluring, each of the alternatives, including using a different system of corporate governance or a different objective, comes with its own share of limitations.

Given the limitations of the alternatives, stock price maximization is the best of a set of imperfect choices for two reasons. First, we can reduce the agency problems between the different groups substantially by trying the align the interests of stockholders, managers and lenders (using both rewards and punishment), and by punishing firms that lie to financial markets or create large social costs. Second, stock price maximization as an objective is self correcting. In other words, excesses by any one of the groups (whether it be managers or stockholders) lead to reactions by the other groups that reduce the likelihood of the behavior being repeated in future periods.

Problems and Questions

1. There is a conflict of interest between stockholders and managers. In theory, stockholders are expected to exercise control over managers through the annual meeting or the board of directors. In practice, why might these disciplinary mechanisms not work?

2. Stockholders can transfer wealth from bondholders through a variety of actions. How would the following actions by stockholders transfer wealth from bondholders?

(a) An increase in dividends

(b) A leveraged buyout

(c) Acquiring a risky business

How would bondholders protect themselves against these actions?

3. Stock prices are much too volatile for financial markets to be efficient. Comment.

4. Maximizing stock prices does not make sense because investors focus on short term results, and not on the long term consequences. Comment.

5. There are some corporate strategists who have suggested that firms focus on maximizing market share rather than market prices. When might this strategy work, and when might it fail?

6. Anti-takeover amendments can be in the best interests of stockholders. Under what conditions is this likely to be true?

7. Companies outside the United States often have two classes of stock outstanding. One class of shares is voting and is held by the incumbent managers of the firm. The other class is non-voting and represents the bulk of traded shares. What are the consequences for corporate governance?

8. In recent year, top managers have been given large packages of options, giving them the right to buy stock in the firm at a fixed price. Will these compensation schemes make managers more responsive to stockholders? Why or why not? Are lenders to the firm affected by these compensation schemes?

9. Reader's Digest has voting and non-voting shares. About 70% of the voting shares are held by charitable institutions, which are headed by the CEO of Reader's Digest. Assume that you are a large holder of the non-voting shares. Would you be concerned about this set-up? What are some of the actions you might push the firm to take to protect your interests?

10. In Germany, large banks are often large lenders and large equity investors in the same firm. For instance, Deutsche Bank is the largest stockholder in Daimler Chrysler, as well as its largest lender. What are some of the potential conflicts that you see in these dual holdings?

11. It is often argued that managers, when asked to maximize stock price, have to choose between being socially responsible and carrying out their fiduciary duty. Do you agree? Can you provide an example where social responsibility and firm value maximization go hand in hand?

12. Assume that you are advising a Turkish firm on corporate financial questions, and that you do not believe that the Turkish stock market is efficient. Would you recommend stock price maximization as the objective? If not, what would you recommend?

13. It has been argued by some that convertible bonds (i.e., bonds which are convertible into stock at the option of the bondholders) provide one form of protection against expropriation by stockholders. What is this argument based on?

14. Societies attempt to keep private interests in line by legislating against behavior that might create social costs (such as polluting the water). If the legislation is comprehensive enough, does the problem of social costs cease to exist? Why or why not?

15. One of the arguments made for having legislation restricting hostile takeovers is that unscrupulous speculators may take over well run firms and destroy them for personal gain. Allowing for the possibility that this could happen, do you think that this is sensible? If so, why? If not, why not?

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