For Better Corporate Governance, Shareholder Value Review
By: Jessica • Essay • 4,701 Words • May 28, 2010 • 2,666 Views
For Better Corporate Governance, Shareholder Value Review
“For Better Corporate Governance, Shareholder Value Review”
1. INTRODUCTION
This article seeks to address the issue of corporate governance and how effective corporate governance can be enhanced by conducting a periodic Shareholder Value Review (SVR). It focuses on explaining how shareholder value is maximised, its current status as a corporate objective, how it is effected by the corporate competitive life cycle, and a proposal on how to conduct an effective SVR and its benefits.
1.1. Corporate governance: This is concerned with the duties and responsibilities of a company’s board of directors in managing the company, and their relationships with the shareholders and other stakeholder groups. Corporate governance guidelines are a set of rules or practices that firms can adopt to reduce agency costs. The guidelines are generally lists of practices that demonstrate how the board of directors will oversee the management of the firm and carry out its responsibilities. In the aftermath of high-profile business failures such as Enron Corp. and WorldCom, Inc., public confidence in corporate governance structures has decreased to very low levels. In 2002, President Bush signed into law the Sarbanes-Oxley Act which incorporates many reforms intended to protect investors by improving the accuracy and reliability of corporate disclosures.
1.2. Shareholders’ Wealth: The main objective of management should be to maximise the wealth of the company’s shareholders. Other factors such as profit maximisation and social responsibility should be of secondary importance. Shareholders’ wealth is maximised through company management making sound investment, financing and dividend decisions. These decisions should take account of expected company cashflows, their timing and associated risk, as these are the key variables driving shareholders’ wealth.
Maximising shareholder value literally means to maximise the company’s share price since shareholders wealth is the number of shares held multiplied by the share price. Major internal factors that effect share value include the level of R&D in firms, its capital structure, dividend policy, strategy and management quality.
The following example, taken from Dragon Oil’s website, shows their views on shareholder value:
Dragon Oil, Investor Relations (Extract from http://www.dragonoil.com/:)
�Dragon Oil’s corporate objective is to increase earnings and create maximum shareholder value. Through our Investor Relations programme, we aim to keep our shareholders and the broader financial community informed about financial results, operational activities and the company’s strategy. The Investor Relations pages provide financial information, reports and presentations, and share information. Please note that we are aiming to develop our Investor Relations function and we would appreciate all suggestions for improvement.’
2. THEORIES & STRATEGY:
2.1. AGENCY THEORY
The shareholder and the manager are on the same side but may have different goals. The shareholder puts capital into the company and expects a decent return for his investment. However, the manager may be driven by promotion prospects, more power and bigger earnings. Three factors that contribute to the agency problem in public limited companies are:
1. When an agent (management) is appointed to run the company on behalf of the owners (shareholders), there is a separation of ownership and control.
2. The goals of management may differ from those of the owners (shareholders).
3. Management have access to the day-to-day data and financial reports while
the shareholders only receive annual reports which may be subject to manipulation by management.
When managers act in their own interests leading to a negative impact on the shareholder this is known as an agency cost. The shareholder ultimately bears the burden of these costs as it reduces their wealth. For example, a manager who has a luxury car paid for by the company when a cheaper car would do. Such agency costs are difficult to control.
Jensen and Meckling (1976) suggested that there are two ways of seeking to encourage �goal congruence’ between shareholders and managers. First is for the shareholders to monitor the actions of management. This would include additional reporting requirements and use of external analysts. The second would be to offer incentives