Corporate Governance in Financial management

When valuing a business, in addition to assess the competitiveness of the business products and services, market shares and industry development, it is important to evaluate the management team as a whole as their interests may not always align with the stakeholders. Corporate governance has important impact on the future development of business and the value of the company.

Corporate Governance and Shareholder Value

Shareholders want companies to hire managers who are able and willing to take legal and ethical actions to maximize intrinsic stock prices.10 This obviously requires managers with technical competence, but it also requires managers who are willing to put forth the extra effort necessary to identify and implement value-adding activities. However, managers are people, and people have both personal and corporate goals. Logically, therefore, managers can be expected to act in their own self-interests, and if their self-interests are not aligned with those of stockholders, then corporate value will not be maximized.

Manager Behavior and Business Valuation

There are six ways in which a manager’s behavior might harm a firm’s intrinsic value.

Managers might not expend the time and effort required to maximize firm value. Rather than focusing on corporate tasks, they might spend too much time on external activities, such as serving on boards of other companies, or on nonproductive activities, such as golfing, lunching, and traveling

Managers might use corporate resources on activities that benefit themselves rather than shareholders. For example, they might spend company money on such perquisites as lavish offices, memberships at country clubs, museum-quality art for corporate apartments, large personal staffs, and corporate jets. Because these perks are not actually cash payments to the managers, they are called nonpecuniary benefits.

Managers might avoid making difficult but value-enhancing decisions that harm friends in the company. For example, a manager might not close a plant or terminate a project if the manager has personal relationships with those who are adversely affected by such decisions, even if termination is the economically sound action.

Managers might take on too much risk or they might not take on enough risk. For example, a company might have the opportunity to undertake a risky project with a positive NPV. If the project turns out badly, then the manager’s reputation will be harmed and the manager might even be fired. Thus, a manager might choose to avoid risky projects even if they are desirable from a shareholder’s point of view. On the other hand, a manager might take on projects with too much risk. Consider a project that is not living up to expectations. A manager might be tempted to invest even more money in the project rather than admit that the project is a failure. Or a manager might be willing to take on a second project with a negative NPV if it has even a slight chance of a very positive outcome, since hitting a home run with this second project might cover up the first project’s poor performance. In other words, the manager might throw good money after bad.

Managers might not release all the information that is desired by investors. Sometimes, they might withhold information to prevent competitors from gaining an advantage. At other times, they might try to avoid releasing bad news. For example, they might “massage” the data or “manage the earnings” so that the news doesn’t look so bad.