Source:-http://people.stern.nyu.edu/adamodar/pdfiles/cf2E/mgtobj.pdf of Damodaran.
Aswath Damodaran(Professor at Stern School at Business) is a famous authority on valuation and corporate finance. His website reflects the richness of his practical experience, command on theory and research expertise(he's one of the few academics who uses real world data exceptionally well as his valuations of Groupon/Linkedlin etc show on this blog). Anyways, enough on him, this post reproduces a few highlights of corporate finance, which are quite insightful.Earlier, I blogged on some other insights(http://financeandcapitalmarkets.blogspot.com/2012/02/corporate-finance-some-complied-loose.html) which readers may find useful
- The above 2 diagrams depict the contrast between the ideal world and the real world. Most Bschools focus on the ideal world but it is the diagram on right which we should care about. The above 3 diagrams themselves can summarize tomes of corporate governance books/laws.
- The need for debt covenants -stockholders maximize their wealth at the expense of bondholders
- • Increasing dividends significantly: When firms pay cash out as dividends,lenders to the firm are hurt and stockholders may be helped. This is because the firm becomes riskier without the cash.
- • Taking riskier projects than those agreed to at the outset: Lenders base interest rates on their perceptions of how risky a firm’s investments are. If stockholders then take on riskier investments, lenders will be hurt.
- • Borrowing more on the same assets: If lenders do not protect themselves,
a firm can borrow more money and make all existing lenders worse off
- Markets are not as shortsighted as they are claimed to be-There are hundreds of start-up and small firms, with no earnings expected in the near future, that raise money on financial markets
If the evidence suggests anything, it is that markets do not value current earnings and cashflows enough and value future earnings and cashflows too much.The market response to Investment Announcements of research and development and investment expenditure is generally positive
- Corporate cross holdings-alternate corporate governance in Germany, Japan, India-At their best, the most efficient firms in the group work at bringing the less efficient firms up to par. They provide a corporate welfare system that makes for a more stable corporate structure.At their worst, the least efficient and poorly run firms in the group pull down the most efficient and best run firms down. The nature of the cross holdings makes its very difficult for outsiders (including
investors in these firms) to figure out how well or badly the group is doing. In my personal view, this is a reason for conglomerate discount or premium depending on how the group does..