Objective Fuction

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The ObjectiveThe Objective

FunctionFunction



Why stock price maximisation?Why stock price maximisation?

Stock prices are the most observable, unless earnings orStock prices are the most observable, unless earnings orsalessales

Stock prices, in a market with rational investors(!!!),Stock prices, in a market with rational investors(!!!),reflect the long term effects (long term value) of thereflect the long term effects (long term value) of thefirm·s decisionsfirm·s decisions

Real measure of wealth. Stockholder can sell their stakeReal measure of wealth. Stockholder can sell their stake

and receive the price now.and receive the price now.



When is the stock price maximisation the onlyWhen is the stock price maximisation the only

objective a firm needs?objective a firm needs? ² ² Ideal WorldIdeal World

Managers put aside their own objectives and focus onManagers put aside their own objectives and focus onmaximising stockholder wealth.maximising stockholder wealth.

The lenders to the firm feel secure that their interestsThe lenders to the firm feel secure that their interestswill be protected.will be protected.

The managers do not attempt to mislead / lie toThe managers do not attempt to mislead / lie tofinancial markets and give sufficient informaiton to thefinancial markets and give sufficient informaiton to the

markets to make judgementsmarkets to make judgements There are no burdens for society.There are no burdens for society.





Stock price maximisation and agencyStock price maximisation and agency

costscosts The core problem is that stock holders,The core problem is that stock holders,

managers, bond holders and society havemanagers, bond holders and society have

different interests and incentives resulting indifferent interests and incentives resulting inconflict of interests which create costs for theconflict of interests which create costs for thefirm.firm.



Stockholders and ManagersStockholders and Managers

2mechanisms that gives power to stockholders2mechanisms that gives power to stockholders ² ² Annual Meeting and Board of Directors.Annual Meeting and Board of Directors.

Annual MeetingsAnnual Meetings ² ² small stockholderssmall stockholders -- costcost ² ² proxiesproxies

² ² large stockholderslarge stockholders ² ² sell off.sell off.

BoDBoD ² ² time spenttime spent ² ² lack of expertiselack of expertise ² ² not independentnot independent² ² CEOs in each other·s boardCEOs in each other·s board ² ² small shareholding small shareholding

(token size)(token size) Role of Large Institutional investorsRole of Large Institutional investors



Stockholders and BondholdersStockholders and Bondholders

How they view their investments in a business?How they view their investments in a business?

Conflict?Conflict?

Case of RJR NabiscoCase of RJR Nabisco ² ² 19881988 Bondholders· assumptionBondholders· assumption



The firm and financial marketsThe firm and financial markets

MeasurementMeasurement

Stock price as a measure of managerial successStock price as a measure of managerial success ² ² 2

barriers2

barriers ² ² the information problem andthe information problem andefficient markets.efficient markets.

Information problemInformation problem ² ² suppress / delay badsuppress / delay bad

news / misleading and fraudulent informationnews / misleading and fraudulent information ² ² larger firmslarger firms -- analystsanalysts ² ² penalties.penalties.



The firm and SocietyThe firm and Society

Ethics, moral, survivalEthics, moral, survival vsvs interest of society interest of society

Creating social costs without awarenessCreating social costs without awareness ² ² JohnsJohnsM

anville corporationM

anville corporation ² ² 50s50s





Stock price maximisation with lowerStock price maximisation with lower

agency costsagency costs Groups try to learn from mistakes and correct them inGroups try to learn from mistakes and correct them in

the future.the future.

Stockholder andManagersStockholder andManagers ² ² making managers think making managers think

more like shareholdersmore like shareholders ² ² equity stake in company equity stake in company

more effective BoDmore effective BoD ² ² smallersmaller ² ² few insidersfew insiders ² ² independent directorsindependent directors ² ² stock compensation.stock compensation.

Increasing shareholder powerIncreasing shareholder power ² ² demand informationdemand information ² ² large stockholder become part of managementlarge stockholder become part of management ² ² moremoreactivist institutional stakeholder.activist institutional stakeholder.



Stockholder and bondholderStockholder and bondholder ² ² bond covenantsbond covenants ² ² investmentinvestment ² ² dividenddividend ² ² leverageleverage ² ² security innovationssecurity innovations² ² protective putsprotective puts ² ² equity stakes.equity stakes.

Firms and financial marketsFirms and financial markets ² ² improving the quality of improving the quality of informationinformation ² ² analystsanalysts ² ² making markets more efficientmaking markets more efficient² ² decrease transaction costsdecrease transaction costs ² ² access to infoaccess to info ² ²

Firm and society Firm and society ² ² legal systemlegal system ² ² SROsSROs ² ² good citizengood citizen² ² ethics in doing business.ethics in doing business.

Stock price maximisation with lowerStock price maximisation with lower

agency costsagency costs



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Objective Fuction