DISCUSSION POINTS

The Purpose of a Firm

What goal should firms set for themselves?

What goal should firms set for themselves?

Adam Smith (1776) and the Invisible Hand:

• What is the main argument presented by Adam Smith?
As a result of every individual pursuing their own interests, the interest of society will be
maximized/achieved

• What are the implications of his views on the way a business should be operated?
Businesses should operate without restrictions, pursuing their own interests of
profitability. As a result of this, society will be benefited.

• What is the main argument presented by Milton Friedman? (Capitalism and

Freedom, 1962)
Free markets and personal economic freedom are absolutely necessary for true political
freedom to exist

• What are the implications of his views for a firm’s stakeholders?

A firm’s responsibility is the increase the wealth of stakeholders. Economic freedom
should be paramount as stakeholders should be able to decide how their wealth gets spent

• How does Edward Freeman propose a firm reconcile its various responsibilities?
(Strategic Management: A Stakeholder Approach, 1984)
A firm’s only responsibility is to increase profits.

• What is the main argument presented by proponents of the stakeholder

perspective?
A business should consider the interests of all affected parties/stakeholders when
making decisions

• What are the implications of this view on how

a firm should be managed?
• A firm’s should create value for all stakeholders and not just shareholders.

• How would a firm that follows a value(s)-based management approach define its
goals?
The main goal of a value based management approach is to maximise value. The core
of the approach is that a company should maximise the value of their discounted cash
flows.

• What solution is proposed by Peter F. Drucker?

Drucker believed that managers should, above all else, be leaders. Rather than setting
strict hours and discouraging innovation, he opted for a more flexible, collaborative
approach
 • Should a firm attempt to maximise shareholder value or short-term interest of
stakeholders?
A firm should have a long term perspective where the firm aims to sustain and grow
profits over time.

Primary Goal of a Firm?

Consider the Academic Article:

• Identify the three main theories that were developed to identify a firm’s primary
goal

1. neoclassical model - indicates that the main purpose of an entity is to make profits and
therefore the focus is solely on the shareholders

2. conscious capitalism (CC) – focus turns from shareholders to all stakeholders and has
the business focusing on a higher purpose as opposed to profits. The viewpoint
emphasises a focus on all stakeholders of a business rather than just the owners and
thus brings triple bottom line (profits, plant and people) into consideration (Coates,
2013). CSR was therefore a strong focus in entities that follow the CC model. four
essential principles of CC, namely higher purpose, stakeholder orientation, conscious
leadership and conscious culture.

3. entity maximisation and sustainability (EMS), differs slightly to CC in that only part
of the focus is maximising entity wealth (which positively impacts all stakeholders),
the other part of the focus being sustaining the business in the long term

• What are the main differences between the theories?

Each theory has a different stakeholder focus. Neoclassical focuses on shareholders,
CC focuses on all stakeholders, and EMS focuses on maximising entity wealth (which
positively impacts all stakeholders), and sustainability of the business.

• Under which of these theories would a value(s)-based management approach be

classified?
Neoclassical

Conclusions
• What is the main objective of value-based management?
The main objective of value-based management is to maximise long term shareholder
value.

• What does the term “corporate social responsibility” mean?

Corporate social responsibility is the idea that a business has the obligation and
the responsibility to do good.

• What benefits can a firm achieve from a value(s)-based management

approach?
 A firm can grow with a sustainable growth pattern without relying on too much
debt.
Provide a foundation for the virtuous circle of csr i.e. sustainability
Doing well by doing good

• What should be the ultimate goal of a firm?

It is widely believed that the ultimate goal of a firm is to grow the wealth of its
shareholders.

Maximise long term value

The Elements of Value-Based Management (VBM)

Are management incentives aligned
with those of shareholders?
Measuring Wealth Creation
• How can we measure wealth creation?
Wealth creation can be measured by discounted cash flows
MVA main one we’re going to use in this course

• What would you consider as the fundamental paradigm of VBM?

The fundamental principle of VBM is represented by the involvement of decision
makers from all company panels in using the evaluations oriented to creating
value and aligning management objectives, techniques and processes towards
increasing the company performance.
MVA and EVA >0
Return on invested capital > Cost of capital

• Your opinion: How do some firms create so much value, while others end up
destroying it?

The Proper Design of a VSBM Program

• Explain what is referred to as the agency problem
The agency problem is a conflict of interest where one party, motivated by self-interest,
is expected to act in another's best interests.

• How can a firm employ VBM metrics to solve the agency problem?
VBM reduces agency conflicts and helps create shareholder value since it reveals value
increasing decisions to employees, allows for easier monitoring of managers decisions
and provides a method to tie compensation to outcomes that create shareholder value

• Identify the primary elements that are required to ensure an efficient VSBM
program
Creating value, managing for value, and measuring value
Alternative Valuation Paradigms
Accounting models:
o What is the main focus of accounting valuation approaches?
To assess a company’s assets and liabilities to provide information for financial
reports
o What are the main problems associated with these
approaches?
Not all financial reports and statements are consistent regarding their format.
Moreover, they do not provide information on ESG.
Focus on earnings plus markets valuation

Discounted cash-flow model:

o What are the main differences between DCF models and
accounting models?
The DCF requires forecasting
Incorporate expectations of cash flows
As well as the opportunity cost of capital

Conclusions
• What is often the underlying reason why management destroy value instead of
creating it?
The firms most likely to destroy value are those that fail to assign detailed
responsibilities and strict accountability to the teams in charge of researching,
planning, negotiating and implementing the acquisition
Agency problems

• When considering the design of value-based metrics: What drives value?

Sustainable growth over the long term
Future Cash flow
Cost of capital
VBM metrics are based on disc cash flow models

• Which VBM metric(s) should a firm focus on to ensure that it successfully create
value?
Sustainable growth rate, EVA, ROIC.
System required to build and support the sustainable cycle of value creation