Comparative Corporate Governance and Financial Goals
Chapter 1
Comparative Corporate Governance and Financial Goals
End-of-Chapter Questions
1. Corporate goals: shareholder wealth maximization. Explain the assumptions and objectives of the shareholder wealth maximization pmodel.
Answer: The Anglo-American markets have a philosophy that a firm’s objective should follow the shareholder wealth maximization (SWM) model. More specifically, the firm should strive to maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk. Alternatively, the firm should minimize the risk to shareholders for a given rate of return. The SWM model assumes as a universal truth that the stock market is efficient. This means that the share price is always correct because it captures all the expectations of return and risk as perceived by investors. It quickly incorporates new information into the share price. Share prices, in turn, are deemed the best allocators of capital in the macro economy. The SWM model also treats its definition of risk as a universal truth. Risk is defined as the added risk that the firm’s shares bring to a diversified portfolio. The total operational risk of the firm can be eliminated through portfolio diversification by the investors. Therefore, this unsystematic risk, the risk of the individual security, should not be a prime concern for management unless it increases the prospect of bankruptcy. Systematic risk, the risk of the market in general, cannot be eliminated. This reflects risk that the share price will be a function of the stock market.
2. Corporate goals: stakeholder capitalism. Explain the assumptions and objectives of the stakeholder capitalism model.
Answer: In the non-Anglo-American markets, controlling shareholders also strive to maximize long term returns to equity. However, they are more constrained by powerful other stakeholders. In particular, labor unions are more powerful than in the Anglo-American markets. Governments
Comparative Corporate Governance and Financial Goals
End-of-Chapter Questions
1. Corporate goals: shareholder wealth maximization. Explain the assumptions and objectives of the shareholder wealth maximization pmodel.
Answer: The Anglo-American markets have a philosophy that a firm’s objective should follow the shareholder wealth maximization (SWM) model. More specifically, the firm should strive to maximize the return to shareholders, as measured by the sum of capital gains and dividends, for a given level of risk. Alternatively, the firm should minimize the risk to shareholders for a given rate of return. The SWM model assumes as a universal truth that the stock market is efficient. This means that the share price is always correct because it captures all the expectations of return and risk as perceived by investors. It quickly incorporates new information into the share price. Share prices, in turn, are deemed the best allocators of capital in the macro economy. The SWM model also treats its definition of risk as a universal truth. Risk is defined as the added risk that the firm’s shares bring to a diversified portfolio. The total operational risk of the firm can be eliminated through portfolio diversification by the investors. Therefore, this unsystematic risk, the risk of the individual security, should not be a prime concern for management unless it increases the prospect of bankruptcy. Systematic risk, the risk of the market in general, cannot be eliminated. This reflects risk that the share price will be a function of the stock market.
2. Corporate goals: stakeholder capitalism. Explain the assumptions and objectives of the stakeholder capitalism model.
Answer: In the non-Anglo-American markets, controlling shareholders also strive to maximize long term returns to equity. However, they are more constrained by powerful other stakeholders. In particular, labor unions are more powerful than in the Anglo-American markets. Governments