Financial

Management
Function, Dividend
& Agency Theory,
Stakeholders
Analysis

Sitta Rosdaniah PhD

Introduction Me
– Personal
– Education
– Professional

Now You
– Background (Name, Home location)
– Life goals
– What do you want from this subject

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1.
Financial
Management
– refreshing
previous
lectures

3
10
Principles in
Financial “It is necessary to understand
Management these principles in order to
understand finance.”

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 We won’t take on additional risk unless
we expect to be compensated with
additional return.
Principle 1:
The Risk- Investment choices have different
Return amounts of risk and expected returns.
Trade-off The more risk an investment has, the
higher its expected return will be.

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 A dollar received today is worth more
than a dollar received in the future.
Because we can earn interest on money
Principle 2:
received today, it is better to receive
The Time
Value of money earlier rather than later.
Money

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 Cash Flow, not accounting profit, is used
as our measurement tool.
Principle 3: Cash flows, not profits, are actually can be
Cash— reinvested.
Not Profits—
Is King

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 The incremental cash flow is the
difference between the projected cash
Principle 4: flows if the project is selected, versus
Incremental what they will be, if the project is not
Cash Flows selected.

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 • It is hard to find exceptionally profitable
projects
• If an industry is generating large profits,
Principle 5: new entrants are usually attracted. The
The Curse of additional competition and added capacity
Competitive can result in profits being driven down to the
Markets required rate of return.
• Product Differentiation, Service and Quality
can separate products from competition

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Principle 6: • The markets are quick and the prices
Efficient
are right.
Capital
Markets • The values of all assets and securities
at any instant in time fully reflect all
available information.

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 • Managers won’t work for the owners
unless it is in their best interest
• A agency problem resulting from
Principle 7: conflicts of interest between the
The Agency manager/agent and the
Problem stockholder/owners.
• Managers may make decisions that
are not in line with the goal of
maximization of shareholder wealth.

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Principle 8:
Taxes Bias The cash flows we consider are the after-
Business tax incremental cash flows to the firm as
Decisions a whole.

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 • Some risk can be diversified
Principle 9: away, and some cannot
All Risk is • The process of diversification can
Not Equal reduce risk, and as a result,
measuring a project’s or an
asset’s risk is very difficult.

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Principle 10:
Ethical
Behavior is
Doing the
Right Thing, Each person has his or her own set of
and Ethical values, which forms the basis for
Dilemmas personal judgments about what is the
Are right thing
Everywhere
in Finance

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Goal Of
Financial ▪ What should be the goal of a corporation?
- Maximize profit?
Management
- Minimize costs?

- Maximize market share?

- Maximize the current value of the company’s

stock?
▪ Does this mean we should do anything and
everything to maximize owner wealth?

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 • Financial Planning
• Acquisition of funds
• Proper use of funds
• Financial decisions
• Improve profitability
Importance • Increase the value of the firm
of Financial
Management

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Decisions ▪ Investing Decision (Capital
under Budgeting)
Financial
Management ▪ Financing Decision (Capital
Structure)
▪ Asset Management Decisions
(Working Capital Management
Decisions)
▪ Dividend Decision
Investing Decision

▪ Investment in Short Term & Long Term Projects

▪ Short Term Projects

- Decisions relating to Working Capital Mgt.

-Inventory Management,

- Receivables Management, etc.

Long Term Decision

 Relates to Capital Budgeting Decisions

 Techniques:
(i) Traditional- Payback Period, Accounting Rate of Return
(ii) Modern- Net Present value Method,
Internal Rate of Return, Profitability Index, etc.
Financing Decision

▪ Decision relation to Funding of the Projects

▪ Sources
-Short Term (trade credit, bank overdraft,etc.)
-Long Term
(i) Owners Funds ( Equity, Retained Earnings)
(ii) External Funds( Long Term
Loans, etc.)
 Dividend Decision

This decision relates to How much of the Earnings to be

DISTRIBUTED AS DIVIDENDS?
AND
HOW MUCH TO BE KEPT
AS RETAINED EARNINGS?
 Asset Management Decisions

▪ How do we manage existing assets efficiently?

▪ How do we manage the day-to-day finances of the firm.
▪ Greater emphasis on current asset management than fixed asset
management.
Interrelationship of the decisions
made by a Financial Manager
 The engineer, who proposes a new plant, shapes
ALL the investment policy of the firm
MANAGERS
The marketing analyst provides inputs in the
ARE process of forecasting and planning
FINANCIAL
MANAGERS The purchase manager influences the level of
investment in inventories

The sales manager has a say in the determination

of the receivables policy

Departmental managers, in general, are important

links in the finance control system of the firm
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2.
AGENCY THEORY
& DIVIDENDS
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 The Modern Organization

Modern Organization

Shareholders Management
There exists a SEPARATION between owners and managers.
Role of
Management
Management acts as an agent for
the owners (shareholders) of the
firm.

▪ An agent is an individual authorized by

another person, called the principal, to
act in the latter’s behalf.
Agency Jensen and Meckling developed a
Theory theory of the firm based on agency
theory.
Principals must provide incentives
so that management acts in the
principals’ best interests and then
monitor results.

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The
▪ Agency relationship
Agency - Principal hires an agent to represent
its interests
Problem - Stockholders (principals) hire
managers (agents) to run the
company
▪ Agency problem
- Conflict of interest between
principal and agent
▪ Management goals and agency costs
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 ▪ Managerial compensation
Managing - Incentives can be used to align

Managers management and stockholder

interests
- The incentives need to be

structured carefully to make

sure that they achieve their goal
▪ Corporate control
- The threat of a takeover may

result in better management

▪ Other stakeholders 30
Does ▪ Dividends matter – the value of the stock is
Dividend based on the present value of expected
Policy future dividends
Matter? ▪ Dividend policy may not matter
- Dividend policy is the decision to pay
dividends versus retaining funds to
reinvest in the firm
- In theory, if the firm reinvests capital
now, it will grow and can pay higher
dividends in the future
Cash ▪ Regular cash dividend – cash payments made
Dividends directly to stockholders, usually each quarter
▪ Extra cash dividend – indication that the
“extra” amount may not be repeated in the
future
▪ Special cash dividend – similar to extra
dividend, but definitely will not be repeated
▪ Liquidating dividend – some or all of the
business has been sold
 ▪ An agency conflict is defined as a conflict of interest
between corporate insiders (the agents) and outside
The shareholders (the principals) or in other words
between managers and shareholders. Managers may
Agency allocate resources to activities that benefit them, but that
are not in the shareholders' best interest. These activities
Theory of can range from lavish expenses on corporate jets to
unjustifiable acquisitions and expansions.
Dividends ▪ Agency costs are defined as the loss to shareholders
of controlling agency behavior, through measures
Policy taken by themselves and by managers as well as the
costs from any agency behavior that has not been
controlled
▪ Dividend payments are an important device in
reducing agency conflicts and therefore agency costs,
to take unnecessary cash from the firm is to increase
the level of dividend payouts .
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3.
Stakeholders
Management
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 What are Stakeholders?

▪ Stakeholders are groups of people who

have an interest in the activities of a
business
▪ They can be seen as being either external
to the organization,
or internal
▪ But some may be both!
An individual, group, or organization who may affect, be affected by,
or perceive itself to be affected by a decision, activity, or outcome of a
company
  Owners (I)
Types of  Shareholders (I)
Stakeholder
 Managers (I)
 Staff or employees (I)
 Customers (E)
 Suppliers (E)
 Community and/or  I = Internal
interest groups(E)
 Government (E )  E = External
 Rivals (E )
Internal and External Stakeholders

Internal stakeholders are those who are ‘members’ of the

business organisation

 Owners and shareholders

 Managers
 Staff and employees
 External stakeholders are not part
of the firm
But…..!

▪ Some groups can be both internal and

external stakeholders
▪ Such as staff or shareholders
who are also local community residents
▪ Can you think of any others?
Characteristics of Stakeholders

1. Owners and Shareholders

▪ The number of owners and the roles they carry out

differ according to the size of the firm
▪ In small businesses there may be only one owner
(sole trader) or perhaps a small number of partners
(partnership)
▪ In large firms there are often thousands
of shareholders, who each own a small part
of the business
Characteristics of Stakeholders
2. Managers:

▪ organize
▪ make decisions
▪ plan
▪ control
▪ are accountable to the owner(s)
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Characteristics of Stakeholders
3. Employees or Staff:

 A business needs staff or employees

to carry out its activities
 Employees agree to work a certain number
of hours in return for a wage or salary
 Pay levels vary with skills, qualifications,
age, location, types of work and industry
and other factors
Characteristics of Stakeholders
4. Customers:

 Customers buy the goods or services

produced by firms
 They may be individuals or other businesses
 Firms must understand and meet the needs
of their customers, otherwise they will fail
to make a profit or, indeed, survive
Characteristics of Stakeholders

5. Suppliers:

 Firms get the resources they need to produce

goods and services from suppliers
 Businesses should have effective relationships
with their suppliers in order to get quality
resources at reasonable prices
 This is a two-way process, as suppliers depend on
the firms they supply
Characteristics of Stakeholders

6. Community:

 Firms and the communities they exist in

are also in a two-way relationship
 The local community may often provide many of
the firm’s staff and customers
 The business often supplies goods
and services vital to the local area
 But at times the community can feel aggrieved by
some aspects of what a firm does
 Characteristics of Stakeholders
7. Government:
▪ Economic policies affect firms’ costs (through
taxation and interest rates)
▪ Legislation regulates what business can do
in areas such as the environment
and occupational safety and health
▪ Successful firms are good for governments
as they create wealth and employment
 Characteristics of Stakeholders

8. Rival firms: (last but not least)

▪ Innovation and product development from rival
companies can “set the agenda” for a business, e.g.
Apple watch influences Samsung product
development
▪ Competitors may try to use their market power to
exclude competition (price war)
▪ May not be important in all markets
 Managing Stakeholders

▪ Identify Stakeholders, Identify the stakeholders, analyze and document

information regarding their interests, involvementt, interdependencies, influence, and
potential impact on project success

▪ Plan Stakeholders management, develop management strategies to

effectively engage stakeholders

▪ Manage Stakeholders Engagement, communicate and work with

stakeholders to meet their needs and expectations, address issues as they occur, and foster
appropriate engagement in corporate activities

▪ Control Stakehoders Engagement, monitor overall stakeholder

relationships and adjust strategies and plans for engaging stakeholders
Identify
stakeholders

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 Business Responsibility to Stakeholders:
Shareholders
Stakeholder Interest
 Annual dividends comparable
to similar firms
 Share price rising over time
 Security of investment
 Ability to sell shares when
required
Business Responsibility to
Stakeholder
 Incorporated businesses
should be operated in
accordance with the law
 Annual accounts presented to
shareholders (financial
statements)
 Strategies taken to increase
shareholder's value over time
 Business Responsibility to Stakeholders:
Managers
Stakeholder Interest
 Employment security
 Salary and benefits that
compare with similar posts of
responsibility in other
businesses
 Responsibilities offered and
status of the post
 Opportunity for profit sharing
Business Responsibility to
Stakeholder
 Job security
 Competitive salary and other
benefits
 Opportunities for
responsibility and career
advancement
 Business Responsibility to Stakeholders:
Employees
Stakeholder Interest
 Employment security
 Wage levels and benefits that
compare well with similar jobs
in other businesses
 Good working conditions
(health and safety)
 Some participation in decision
making within the business
Business Responsibility to
Stakeholder
 Adhere to country's laws that
outline treatment of workers
 Provide training, job security,
more than minimum wage,
good working conditions, staff
involvement with some
business decisions
 Business Responsibility to Stakeholders:
Customers
Stakeholder Interest
 Value for money
 Product quality and safety
 Guarantees
 Service levels
 Long-term rewards for loyalty
Business Responsibility to
Stakeholders
 Not to break the laws on
consumer protections and
accurate advertising
 Not taking advantage of
vulnerable customers (young
or the elderly)
 Not using high pressure sales
tactics
 Assurances about quality,
delivery dates, and service
Business Responsibility to Stakeholders:
Suppliers
Stakeholder Interest
 Speed of payment
 Level and regular orders
 Fairness of treatment (not
being exploited by a large
customer base)
Business Responsibility to
Stakeholders
 Two-way relationship that are
a benefit to each other
 Avoid excessive pressure on
small or weaker suppliers to
cut price
 Pay fair prices and pay
invoices promptly
 Business Responsibility to Stakeholders:
Governments
Stakeholder Interest
 Creation of jobs and incomes
that boost the economy
 Taxes paid for employees
and on profit
 Value of output produced
adds to the GDP
 Impact on wider society (is
production environmentally
sustainable)
Business Responsibility to
Stakeholders
 Pay taxes
 Keep accurate accounting
records so true profit can be
shown
 Provide information that the
government requests
 Keep within the legal limits
 Business Responsibility to Stakeholders:
Banks and creditors

Stakeholder Interest Business Responsibility to

Stakeholders

 Security of their loans and the  Pay interest

ability of the business to  Pay back capital owed
repay them
 Prompt payment of interest
and capital owed by the
business
 Business Responsibility to Stakeholders:
Community and/or special interest group

Stakeholder Interest Business Responsibility to

 Pressure groups –
campaigning to achieve a
change in business
decisions/activities
 Local community –
encouraging business to act
in the community's best
interest and to avoid harmful
production methods
Stakeholders
 Pressure groups – recognize
genuine concern over
business activity; business
may respond by changing
decisions or operations
 Local community – avoid
pollution and other damaging
operations; support for local
groups
 Business Responsibility to Stakeholders:
Rivals/Competitors
Stakeholder Interest
 Fairness of competitive
practices
 Strategic plans of the
business
Business Responsibility to
Stakeholders
 To compete fairly and within
the law
 It is NOT a responsibility of
business to provide details of
its strategic plans to
competitors
 CASE STUDY --Consumer Stakeholders:
Product and Service Issues
Sam Walton, founder of Walmart –
• “There is only one boss. The customer. And he can fire everybody in the
company …, simply by spending his money somewhere else.”

Toyota, which enjoyed a sterling reputation for quality, saw it evaporate

with its gas pedal acceleration case:
• First, there was the problem itself; people died. And 8 million of its cars
would have to be recalled.
• Second, there was Toyota’s slow response. Despite knowing about the
problem in Europe since 2008, and installing new pedals there, nothing was
done in the U.S. Then in 2010, the company faced a U.S. recall of 2.3 million
cars. The company had dragged its feet.

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 Two Central Issues -
The Issue of Quality -

• Product quality means different things to different people.

• Service quality usually means that the service was performed as expected
and on time.

• Interest is driven by an increase in family income and intense global

competition.

The Issue of Safety -

• Nearly all consumer products or services entail some small degree of risk.

• Interest about safety is driven by the public’s concern with safety and risk-
free products– and business’ responsibility to address this concern.

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Business’ Response to Consumers

At first, casual and

ineffective

Formal interactions with

consumer stakeholders
have become more
institutionalized
Now, toll-free hot lines,
user-friendly web sites,
and customer service
programs 60