Download - 0b5cbModule 1 Introduction Cntd
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Amity School of Business
Stock Holder Vs Bondholder
Theory PracticeThere is no conflict of interest
between stockholders and
bondholders
Stockholder may maximize
their wealth at the expense of
bondholders:
Taking riskier projects than
agreed.
Borrowing more on the same
assets.
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Firms and Financial Markets
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Theory PracticeFinancial markets are efficient. Managers suppress information.
Managers are honest and
convey full information to
financial markets.
Managers delay the releasing of
bad news.
Financial markets are reasoned
judgments of true value.
Managers sometimes reveal
fraudulent information.
Some argue that markets are
short sighted.
Analysts recommendations are
not always unbiased.
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Firms and Society
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Theory PracticeThere is no costs associated
with firms that can not be traced
and charged to the firms.
Financials decisions can create
social costs and benefits where;
A social costs or benefits is a
cost that accrues to society as a
whole not to a firm that is
making a decision.
These costs and benefits are
difficult to quantify.
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Amity School of Business
Given these agency problems, is stock price
maximization really the best objective?
Alternate objectives:
Maximize earnings.
Maximize market share.
Maximize firm size.
Do these serve us as a better objective?
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Maximize stock price subject to?
Maximization objective function is internal selfcorrection mechanism. Excess on any linkages lead, if
any unregulated counter actions which reduce or
eliminate these excesses.
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Response to Agency Problems
Bondholder Protection
Restrictive covenants.
New type of bond issue.
More hybrid bonds.
Financial Market response
Regulatory changes.
Increased importance of ethical behavior.
Increased availability of information and ease of trade.
Societal response
Catering more socially conscious clientele.
Growth of social responsible funds. 6
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Management compensation
andMeasurement of Performance
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Executive Compensation
Key elements: Salary.
Benefits.
Incentive Compensation.
Generated lot of debates among legislators, corporate observers,economists, journalists and management experts.
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Conflict of Interest
Agency theory has examined the problem from separation of
ownership from control in public co.
According to Lambert Larcker :
Principal sources of conflict: Excessive perquisites.
Differential interest attitudes.Varying with time horizons.
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Failure to promote value creation
Linkage between size and pay.
Emphasis on short term performance.
Reliance on accounting measures.
Alfred Rappaport Thedysfunctional consequences introduced bythe increased pay increased size philosophy and theoveremphasis on the short term results are exacerbated by the
universal use of accounting numbers for assessing both short
and long term performance.
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Objectives for Executive compensation
policyStephen OBryne identified 4 objectives:
Alignment Managers.Strategies, action, investments, actions that maximise shareholder
value.
LeverageWork harder, take risk, do unpleasant things.
Retention.Incentive sufficient to retain them.
Shareholder cost.Level where shareholder wealth is maximised. 11
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Designing an Incentive Compensation
Plan
A well conceived incentive compensation plan goes a long way in
aligning the interests of managers and shareholders.
Integrate the Incentive plan into the total compensation
Architecture.
Choose the Appropriate Level of Risk Posture and Time
Focus.
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Use Objective criteria
Select the right set of performance measures.
Reward relative measures.
Discourage parochial behavior.
Abandon attempts to measure what executives control.
Lengthen the Decision making Horizon of the Executives.
Employ Stock Options Judiciously.
Ensure tax Efficiency
= Post tax benefit to manager
Post tax cost to the company
Designing an Incentive Compensation Plan
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ESOP
EligibilityNot a promoter, not a director who holds more than 10% of
the outstanding Equity Shares.
Compensation committee consisting of a majority of
independent directors, for advice and supervision of the ESO
scheme.
No ESOS unless shareholders pass a special resolution.
Pricing
Lock in period and rights of the option holder.
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SEBI Guidelines for ESOS
Eligibility.
Compensation Committee.
Shareholder Approval.
Pricing.
Lock in period and rights of the option holder.
Accounting treatment.
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Performance Measurement
Robert W Hall:Performance measurement is the basis of every system in a
company:
Cost systems.
Planning systems.
Capital budgeting systems.
Personnel assignments.
Promotions.
Reorganisations. Budget allocations.
- the mechanisms built up over years by which everything runs.
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Rationale for business performance
measurement
Heightened competition.
Growing empowerment.
Quality awards.
Expanding organisational roles.
Greater external demands.
Power of information technology.
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Comprehensive value risk framework
Total shareholderreturn (TSR). Market valueadded (MVA). Discounted cashflows (DCF). Economic valueadded (EVA).
Economic Profit. Cash flow returnon investment(CFROI).Cash value added(CVA). Return on investedcapital (ROIC).
Return on Assets(ROA).Earnings beforeinterest taxesdepreciation andamortisation(EBITA).
Cash flow. Earning per share(EPS).
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Non Financial Measures
Customer Satisfaction Index
Customer Return
Market share
New product Introduction
On time Delivery
Manufacturing cycle time
Defects Percentage
Throughput
Employee Productivity Index
Patents Obtained
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S h d k N Fi i l M
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Strengths and weaknesses- Non Financial Measures
Strengths Directly traceable to key success factors: Customer satisfaction,
market leadership, manufacturing excellence, Quality etc.
Actionable.
Predict better picture of cashflows.
Weaknesses Difficult to assign rupee value to improvements in non financial
measures. Conflict with each other.
Managers may resort to gaming.
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