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FIN 385 Topic 2 Business and International Trade


BUSINESS AND INTERNATIONAL TRADE
Topic 2 FIN 385 Read Textbook, Chapter 2

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OVERVIEW OF THIS TOPIC
This topic makes one important argument: The financial goals of a firm impact on the way it is governed (corporate governance). Therefore, to understand international finance, first understand this relationship.

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AGENDA
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Ownership and management of the firm – in whose interest? Goals and structure of corporate governance.
Good corporate governance – what does it take? Aspects of reforms to corporate governance.
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For sure, the first goal of business is to make profits and reward its shareholders, but it must also be infused by a broader sense of civic duty and heed a broader spectrum of stakeholders—workers, suppliers, customers, the public at large, and the environment. It is fair to say that some strayed from this path in recent years. I am thinking in particular of the financial sector before the crisis, which pursued its own narrow gain at the cost of the greater good of society. By choosing reckless risk-taking, it sparked the greatest economic collapse since the Great Depression.

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Christine Legarde, Managing Director, International Monetary Fund. 2012

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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? 1.1 There is a range of ownership models.

1.2 The agency problem. 1.3 The goals of management – two models to understand: SWM, SCM.

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EXHIBIT 2.1 WHO OWNS THE BUSINESS?

[Insert Exhibit 2.1]

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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST?
The Agency Problem Starts from the separation of ownership and control/management. There are many types of stakeholders. Shareholders are one group. Governments (privatised utilities), institutions (banks), family, consortia(keiretsus in Japan).
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST?
Shareholder Wealth Maximisation (SWM) Model
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Applies in countries where ownership is dominated by shareholders. Goal of the firm is to maximise return to shareholder.

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Measured by dividends and capital gains.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST?
Shareholder Wealth Maximisation (SWM) Model
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How to do this? Incentivise management. Example – stock options. Back up with Board supervision. Plus market discipline imposed by investors, and by takeovers.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Shareholder Wealth Maximisation (SWM) Model But.. what timeframe should be used to measure value maximisation? ? The problem of short term performance versus long-term, sustainable performance.
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Most CEOs stay 3-5 years: the problem of impatient capitalism.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Shareholder Wealth Maximisation (SWM) Model ? There are differences in the meaning of SWM between private firms and publicly traded firms. ? For publicly traded firms – goal of management is to maximise current income (via dividends) and capital gain (from increase in the share price).

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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Shareholder Wealth Maximisation (SWM) Model ? In publicly traded firms, dividends come from growing the business revenue and profit, and paying part of the profits to shareholders.
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Capital gain is more complex for management to influence – many factors involved in determining shareholder perceptions.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Shareholder Wealth Maximisation (SWM) Model ? To try to satisfy shareholders, management needs to balance three objectives:
of consolidated after-tax income; ? minimization of the firm’s effective global tax burden; ? correct positioning of the firm’s income, cash flows, and available funds as to country and currency. These goals are frequently incompatible.
? maximization

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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Shareholder Wealth Maximisation (SWM) Model ? In a private firm, goal is to maximise current and future income for the private owners.
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There is no share price.

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AOL sells patents for $1.06b

The arrangement will give more than 800 patents and related applications to Microsoft, … AOL, whose revenue has dropped 29 percent since it was spun off from Time Warner Inc in late 2009, has faced pressure from shareholder Starboard Value LP to consider moves such as a patent deal.
AOL said it plans to return a "significant portion" of the sale proceeds to shareholders

Story – 13 April 2012.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST?

Stakeholder Capitalism Model (SCM) ? In some countries, such as in Europe, there are a wider range of powerful stakeholders.
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Governments, trade unions, communities. They also want a good, long term return, but they have other goals too, e.g., employment.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST?

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Stakeholder Capitalism Model In the SCM model, firms are not just run to maximise shareholder return.
For example – Governments regulate CO2 emissions. For example – trade unions want to stop job destruction.
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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Stakeholder Capitalism Model ? In the SCM, risk is seen in the long term survival of the firm.
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Therefore, product market risk may be more important than short term variations in earnings and capital gain.

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1. OWNERSHIP AND MANAGEMENTIN WHOSE INTEREST? Stakeholder Capitalism Model ? One big problem with the SCM is multiple goals.

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2. CORPORATE GOVERNANCE
2.1 Definition of corporate governance. 2.2 Goals of corporate governance. 2.3 Good governance – what does it take?

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2. CORPORATE GOVERNANCE
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Definition: The way a firm is managed and controlled to achieve its financial and other goals.

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Corporate governance is controlled by internal and external forces.
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2. CORPORATE GOVERNANCE
Goals of corporate governance OECD Principles of Corporate Governance (2004) ? Protect shareholder rights. ? Equitable treatment of all shareholders. ? Cooperation with stakeholders. ? Disclosure and transparency. ? Responsibility of the Board.
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2. CORPORATE GOVERNANCE
Structures of Corporate Governance
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Corporate governance is controlled by internal and external forces. The following ppts explain this in more detail.

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2. CORPORATE GOVERNANCE
Structures of Corporate Governance
The internal forces = the officers of the corporation and the board of directors are directly responsible for determining both the strategic direction and the execution of the

company’s future.
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2. CORPORATE GOVERNANCE
Structures of Corporate Governance The external forces include equity markets in which the shares are traded, the analysts who critique the company’s investment prospects and external regulators, among others.

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EXHIBIT 2.2 THE STRUCTURE OF CORPORATE GOVERNANCE

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3. GOOD GOVERNANCE – HOW?
3.1 Failures in corporate governance. 3.2 Country-related factors leading to good corporate governance.

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3. GOOD GOVERNANCE – HOW?
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Failures of corporate governance have been increasing.

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So, what is needed to have a good corporate governance system in a firm?

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3. GOOD GOVERNANCE – HOW?
General governance reputation of the country of residence. ? Accounting standards in the country.
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Reputations of board members. See Exhibits 2.4, 2.5, 2.6.

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3. GOOD GOVERNANCE – HOW?
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Good governance will have many positive effects -

- Profitability - Returns to shareholders - Cost of capital - Attracting investment.

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4. ASPECTS OF CORPORATE GOVERNANCE REFORM
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In recent years, there have been many calls for reform of Government control of corporate governance practice. Some of the reforms considered are: - supervision of financial statements - supervision of executive pay - fraud-testing of internal financial controls.
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POINTS TO LEARN
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Ownership and management of the firm – in whose interest? Goals and structure of corporate governance.
Good corporate governance – what does it take? Aspects of reforms to corporate governance.
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SOME KEY TERMS TO LEARN
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Stakeholder Agency

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Shareholder wealth maximisation
Stakeholder capital model Corporate governance
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END OF TOPIC 2
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