FINANCIAL MANAGEMENT

UGBS 612

Dr Godfred Amewu (Department of Finance, University of

Ghana Business School)
2

Introduction and Overview of Financial

•Objectives
Management
•Financial Management and the Financial Manager
•Financial Management Decisions
•Forms of Business Organization
•The Goal of Financial Management
•The Agency Problem and Control of the Corporation
•Corporate Governance
 Financial Management

• Managing resources of a firm to maximize value.

– For the Individual it is personal finance.

– For the government it is public finance.
– For profit and non-profit organization it is called Corporate
or Business Finance.
 Financial Management
Issues
• Issues in Financial Management
– Long-term investment / capital budgeting decisions (lines of business, sorts of
buildings, machinery, and equipment) to invest in.
– Long-term finance/ capital structure decisions pay for your investment ( owner
ie equity or borrow ie debt
– Assets = Capital (Equity) + Liabilities (Debt)
– Everyday financial activities/ working capital management decisions (collection
from customers and paying suppliers)
– Distribution decision (dividends/stock repurchase).
 THE FINANCIAL MANAGER

• In large corporations owners (the stockholders) are usually

not directly involved in making business decisions, particularly
on a day-to-day basis.

• The corporation employs managers to represent the owners’

interests and make decisions on their behalf.

• In a large corporation, the financial manager would be in

charge of long-term investment, long-term financing and
managing everyday financial activities.
Sample Simplified Organizational Chart
 Functions of the Financial Manager

• Forecasting and Planning

• Financing Decision- capital Structure
• Investment Decision
• Dividend Decision
• Financial Negotiation
• Cash Management
• Dealing with Relevant parties in the
Financial Markets
 The Goal of the Financial Management /
Manager
• The primary goal of managing the finances of an organisation is
Maximize Shareholders Wealth.
Other goals may include
– Staff Welfare
– The good of the society at large
– Customers benefit
– Survive.
– Avoid financial distress and bankruptcy
– Maximize sales or market share.
– Minimize costs.
– Maximize profits.
– Maintain steady earnings growth.
Business Organizational Forms

Business Forms

Sole Partnerships
Corporations
Proprietorships
 Sole Proprietorship
• It is a business owned by a single individual that is entitled to
all the firm’s profits and is responsible for all the firm’s debt.

• There is no separation between the business and the owner

when it comes to debts or being sued.

• Sole proprietorships are generally financed by personal loans

from family and friends and business loans from banks.
• Advantages:
– Easy to start
– No need to consult others while making decisions
– Taxed at the personal tax rate

• Disadvantages:
– Personally liable for the business debts
– Ceases on the death of the propreitor
 Partnership
• A general partnership is an association of two or
more persons who come together as co-owners for
the purpose of operating a business for profit.

• There is no separation between the partnership and

the owners with respect to debts or being sued.
 Partnership (cont.)
• Advantages:
– Relatively easy to start
– Taxed at the personal tax rate
– Access to funds from multiple sources or partners

• Disadvantages:
– Partners jointly share unlimited liability
 Partnership (cont.)
• In limited partnerships, there are two classes of
partners: general and limited.
• The general partners runs the business and face
unlimited liability for the firm’s debts, while
• the limited partners are only liable on the amount
invested.
• One of the drawback of this form is that it is difficult to
transfer the ownership of the general partner.
 Corporation
• Corporation is “an artificial being, invisible,
intangible, and existing only in the contemplation of
the law.”

• Corporation can individually sue and be sued,

purchase, sell or own property, and its personnel are
subject to criminal punishment for crimes committed
in the name of the corporation.
 Corporation (cont.)
• Corporation is legally owned by its current
stockholders.

• The Board of directors are elected by the firm’s

shareholders. One responsibility of the board of
directors is to appoint the senior management of the
firm.
 Corporation (cont.)
• Advantages
– Liability of owners limited to invested funds
– Life of corporation is not tied to the owner
– Easier to transfer ownership
– Easier to raise Capital
• Disadvantages
– Greater regulation
– Double taxation of dividends
 The Agency Problem and Control of the Corporation

• large corporations, separation of ownership from control

gives rise to Agency Relationship.
– Owners / shareholders is the principal

– Control / Management is the Agent.

The Agency Relationship breeds Agency Problem.

– That is the possibility of conflict of interest between the
stockholders and management of a firm Goal Incongruence.
– The Agency problem is a result of separation of ownership from Control.
 Agency Problems
• Agency problems arise when there is conflict of interest between
the stockholders and the managers. Such problems are likely to
arise more when the managers have little or no ownership in the
firm.
• Examples:
– Not pursuing risky project for fear of losing jobs, stealing,
expensive perks.

• All else equal, agency problems will reduce the firm value.
 Agency Cost

• Agency Costs refers to the costs of the conflict of

interest between stockholders and management.
These costs can be indirect or direct.
– An indirect agency cost is a lost opportunity, managers
refusing to undertake investment they consider risky to their
job security although such investment may lead to value
creation for shareholders.
 Agency Cost

• Direct agency costs is in two forms.

– The first type is a corporate expenditure that benefits
management but costs the stockholders. Such as the
purchase of a luxurious and unneeded corporate jet would
fall under this heading.

– The second type of direct agency cost is an expense that

arises from the need to monitor management actions.
Paying outside auditors to assess the accuracy of financial
statement.
 How to Deal with the
Agency Conflict
– Managerial Compensation (Examples: Performance based
bonus, salary, stock options, benefits)
– Direct Intervention by shareholders/ Monitoring (Examples:
Reports, Meetings, Auditors, board of directors, financial
markets, bankers, credit agencies)
• The Threat of Firing
• The Threat of Takeover
• Others Stock market, regulations such as SOX
(Sarbanes Oxley).
– Others are OECD principles of Corporate Governance, BOG
corporate Governance Directive (2018) among others
 Corporate Governance - The
Basics
• Large Corporations have shareholders who elect
directors who also employ management to manage
the affairs of the body corporate.
– These firms are typically in the form of stock corporations
that have equity stocks or shares outstanding.
– Stocks or shares are certificates of ownership that
frequently confer control rights, i.e. voting rights.
– Voting rights enable their holders, the shareholders, to
vote at the annual general shareholders’ meeting (AGM).
 The Basics (Continued)

• Voting shares confer the right to appoint the members

of the board of directors.
• The board of directors is the ultimate governing body
within the firm.
– Its role, in particular that of the non-executive directors, is to
look after the interests of all the shareholders.
– It may also look after the interests of other stakeholders
such as the employees and the firm’s creditors.
More precisely, it is the non-executives’ role to monitor the
firm’s top management, including its executives.
 Defining Corporate Governance
• Andrei Shleifer and Robert Vishny define corporate
governance as
– “the ways in which suppliers of finance assure themselves
of getting a return on their investment”.
– This definition assumes that the main objective of the firm
is to maximise shareholder value.
 Defining Corporate Governance
(Continued)
• In contrast, Marc Goergen and Luc Renneboog’s
definition allows for differences across countries in
terms of the main objective of the firm:
“A corporate governance system is the combination
of mechanisms which ensure that the management
of the firm runs the firm for the benefit of one or
several stakeholders.
– Such stakeholders may cover shareholders, creditors,
suppliers, clients, employees and other parties with whom
the firm conducts its business.”
 Corporate Governance - Definition

• The system by which business corporations are directed and controlled,

specifies the distribution of rights and responsibilities among different
participants in the corporation, such as the board, managers, shareholders
and other stakeholders spells out the rules and procedures for making
decisions on corporate affairs provides the structure through which the
company objectives are set, and the means of attaining those objectives and
monitoring performance.
(Source: OECD April 1999)
Organisation for Economic Co-operation and Development (OECD)
In 2004 OECD introduced the “OECD Principles of Corporate Governance”
http://www.oecd.org/corporate/ca/corporategovernanceprinciples/31557724.p
df
 OECD Corporate Governance

• The six OECD Principles are:

– Ensuring the basis of an effective corporate governance
framework.
– The rights of shareholders and key ownership functions.
– The equitable treatment of shareholders.
– The role of stakeholders in corporate governance.
– Disclosure and transparency.
– The responsibilities of the board.
 Bank of Ghana 2018
Definition
• Corporate Governance from a banking industry perspective, refers to the manner in
which the business and affairs of a bank, Specialised Deposit Taking Institutions (SDI)
or Financial Holding Company (FHC) are governed by its board and senior
management,.

• The responsibility of the Board and Senior Management are

1. set the regulated financial institution, strategy and objectives;
2. determine the regulated financial institution’s risk tolerance/appetite;
3. operate the regulated financial institution’s business on a day-to-day basis;
4. protect the interests of depositors,
5. meet shareholder obligations, and
6. take into account the interests of other recognised stakeholders; and align corporate
activities and behaviour

The expectation is that the regulated financial institution will operate in a safe and sound
manner, with integrity and in compliance with applicable laws and regulations.
 BoG Corporate Governance Objectives

• Objectives
a) to require regulated financial institution to adopt sound corporate
governance principles and best practices to enable them to
perform their role in enhancing economic growth in Ghana;

b) to promote and maintain public trust and confidence in regulated

financial institution by prescribing sound corporate governance
standards which are critical to the proper functioning of the banking
sector and the economy as a whole; and

c) Minimise the possibility of regulated financial institution failures

that are usually rooted in poor corporate governance practices.
 Corporate Governance
• Corporate governance is therefore about what the
board of a company do and how it sets the values of
the company,

– This must be distinguished from the day-to-day

operational management of the company by full-time
executives.
 Corporate Governance
Why is it important?
1. Proliferation of financial scandals and crisis
2. Loss of trust of investors
3. Globalization leads to increasing cross-border
investment opportunities but investors may not have
knowledge about the regulatory framework of
overseas investees
 Functions of Corporate
Governance
1. Promote the efficient use of scarce resources
2. Promote the trust of investors
3. Good corporate governance has a positive link to
economic development and good corporate
performance
4. Funds will flow to entities which are seen to have
internationally accepted standards of corporate
governance
 Corporate Governance- Why is it
Important
1. Investors are not willing to invest in countries/companies
that are corrupt, prone to fraud, poorly managed and lacking
sufficient protection for investors’ rights
2. Securities and company law protection may help, but not
enough
3. Corporate Governance supplements the legal framework
4. Corporate Governance also plays an important role in
maintaining corporate integrity and managing the risk of
corporate fraud, combating against management
misconduct and corruption.
 Corporate Governance
• Theory
Conflict of interests that may exist between an agent
and the agent’s principal.
• Michael Jensen and William Meckling formalised
these conflicts of interests in their principal–agent
theory.
 Corporate Governance
• The agent may ratherTheory
prefer to act in his own
interest. Economists call this moral hazard.
• Moral hazard is not just an issue in corporate
governance, but it is also a major issue for insurance
companies.
• One way of addressing principal–agent problems is
via so called complete contracts.
 Corporate Governance
• Complete contractsTheory
are contracts which specify
exactly what
– the managers must do in each future contingency of the
world; and
– what the distribution of profits will be in each contingency.
• In practice, contracts are unlikely to be complete as
– it is impossible to predict all future contingencies of the
world;
– such contracts would be too complex to write; and
– they would be difficult or even impossible to monitor and
reinforce by outsiders such as a court of law.
 Corporate Governance
Theory
• A necessary condition for moral hazard to exist and for
complete contracts to be impossible is the existence of
asymmetric information.
– Asymmetric information refers to situations where one party,
typically the agent, has more information than the other
party, the principal.
• There is no moral hazard problem if information is
equal among all parties at all times.
 Corporate Governance
Theory
• Moral hazard exists because the principal cannot keep
track of the agent’s actions at all times.
• Even ex post, it is sometimes difficult for the principal to
judge whether failure is due to the agent or external
circumstances.
• Jensen and Meckling’s principal-agent model also
assumes that there is a separation of ownership and
control.
 Agency Problems

• The two main types of agency problems are

– perquisites and
– empire building.
• Perquisites or perks consist of on-the-job consumption by the
managers.
• While the benefits from the perks accrue to the managers,
their costs are borne by the shareholders.
– Examples of perks are CEO mansions financed by the firm and
personal usage of corporate jets.
 Agency Problems
(Continued)
The former CEO of Tyco International had his
company fund his wife’s 40th birthday party in Sardinia
at a cost of US$1 million.
“Former Merrill CEO John Thain spent $1.2 million
to renovate his offices, including installation of a
$35,000 toilet.”
Source: The Gazette, 28 March 2009, p. B1.
 Agency Problems
(Continued)
• While perks can cause public outrage,
especially when they are combined with
lacklustre performance, they tend to be
modest compared to empire building.
• Empire building consists of managers
pursuing growth rather than shareholder-
value maximisation.
• While there is a link between the two, growth
does not necessarily generate shareholder
value and vice-versa.
– Empire building is also referred to as Jensen’s free
cash flow problem.
Agency Problems (Continued)
• The free cash flow problem consists of
managers investing beyond the point where
investment projects earn an adequate
return given their risk.
• So why would managers be tempted by
empire building?
– Managers derive benefits from increasing the size
of their firm.
– Such benefits include increased power and social
status.
– Managerial remuneration has also been shown to
depend on firm size.
END