The Role of Managerial Lecture Note 7

Matter of Fact (1 of 3) CEO Pay Around the World Both the amount that CEOs receive in compensation and the form their compensation takes vary greatly around the world. A 2016 report noted that median pay for CEOs in the United States was $14.9 million, nearly 3 times more than the median pay for CEOs from non-U.S. companies. British CEOs earned the second highest median pay at $10.5 million. On the European continent, German and French CEOs earned roughly half of what their British counterparts make, at $5.4 million and $4.0 million, respectively. Japanese CEOs received even less, with median pay at $1.5 million. Matter of Fact (2 of 3) Given these large differences in total compensation, the base salaries of CEOs were surprisingly similar. For instance, the median base salary for a U.S. CEO was $5.1 million, compared with $4.1 million for a German CEO. What, then, caused the variations in total CEO pay? These were driven mostly by differences in the use of equity-based compensation. As an example, the portion of CEO pay coming in the form of stock or stock options was 60% for U.S. and U.K. firms, but in Germany and France, the fraction paid in equity totaled less than 24%. Japan was an even more dramatic outlier, with equity-based compensation accounting for just 10% of total CEO pay. Matter of Fact (3 of 3) Recall that the U.S. and U.K. legal systems emphasize the duty of managers to shareholders, whereas legal systems elsewhere place more emphasis on stakeholders. Those differences are reflected in equity-based CEO compensation around the world. Source: “How CEO pay differs around the globe,” Equilar.com press release, August 17, 2016. 1.3 Organizational Forms, Taxation, and the Principal–Agent Relationship (13 of 13) • Corporate Governance – External Corporate Governance Mechanisms  Individual versus Institutional Investors – Activist Investors • Investors who specialize in influencing management  The Threat of Takeover – Government Regulation  Sarbanes-Oxley Act of 2002 – An act aimed at eliminating corporate disclosure and conflict of interest problems – Contains provisions concerning corporate financial disclosures and the relationships among corporations, analysts, auditors, attorneys, directors, officers, and shareholders 1.4 Developing Skills for Your Career • Critical Thinking • Communication and Collaboration • Financial Computing Skills Review of Learning Goals (1 of 8) • LG 1 – Define finance and the managerial finance function.  Finance is the science and art of how individuals and firms raise, allocate, and invest money. It affects virtually all aspects of business  Managerial finance is concerned with the duties of the financial manager working in a business. Financial managers administer the financial affairs of all types of businesses: private and public, large and small, profit seeking and not for profit  They perform such varied tasks as developing a financial plan or budget, extending credit to customers, evaluating proposed large expenditures, and raising money to fund the firm’s operations Review of Learning Goals (2 of 8) • LG 2 – Describe the goal of the firm, and explain why maximizing the value of the firm is an appropriate goal for a business.  The goal of the firm is to maximize its value and therefore the wealth of its shareholders. Maximizing the value of the firm means running the business in the interest of those who own it, the shareholders. Because shareholders are paid after other stakeholders, it is also generally necessary to satisfy the interests of other stakeholders to enrich shareholders. Review of Learning Goals (3 of 8) • LG 3 – Identify the primary activities of the financial manager.  Financial managers are primarily involved in three types of decisions. Investment decisions relate to how a company invests its capital to generate wealth for shareholders. Financing decisions relate to how a company raises the capital it needs to invest. Working capital decisions refer to the day-to-day management of a firm’s short-term resources such as cash, receivables, inventory, and payables. Review of Learning Goals (4 of 8) • LG 4 – Explain the key principles that financial managers use when making business decisions.  The time value of money means that money is more valuable today than in the future because of the opportunity to earn a return on money that is on hand now. Because a tradeoff exists between risk and return, managers have to consider both factors for any investment they make  Managers should also focus more on cash flow than on accounting profit. Furthermore, managers need to recognize that market prices reflect information gathered by many different investors, so the price of a company’s stock is an important signal of how the company is doing Review of Learning Goals (5 of 8) • LG 4 (Cont.) – Explain the key principles that financial managers use when making business decisions.  Finally, although managers should act in shareholders’ interest, they do not always do so, which requires various kinds of incentives to be in place so that the interests of managers and shareholders align to the greatest extent possible Review of Learning Goals (6 of 8) • LG 5 – Describe the legal forms of business organization.  These are the sole proprietorship, the partnership, and the corporation. The corporation is dominant in the sense that most large companies are corporations, and a corporation’s owners are its stockholders. Stockholders expect to earn a return by receiving dividends or by realizing gains through increases in share price Review of Learning Goals (7 of 8) • LG 6 – Describe the nature of the principal–agent relationship between the owners and managers of a corporation, and explain how various corporate governance mechanisms attempt to manage agency problems.  The separation of owners and managers in a corporation gives rise to the classic principal–agent relationship, in which shareholders are the principals and managers are the agents. This arrangement works well when the agent makes decisions in the principal’s best interest, but it can lead to agency problems when the interests of the principal and agent differ Review of Learning Goals (8 of 8) • LG 6 (Cont.) – Describe the nature of the principal–agent relationship between the owners and managers of a corporation, and explain how various corporate governance mechanisms attempt to manage agency problems.  A firm’s corporate governance structure is intended to help ensure that managers act in the best interests of the firm’s shareholders and other stakeholders, and it is usually influenced by both internal and external factors