PEARSONEDUCATIONLIMITED2005VANHORNEANDWACHOWICZFUNDAMENTALSOFFINANCIALMANAGEMENT,12E61THEROLEOFFINANCIALMANAGEMENTINCREASINGSHAREHOLDERVALUEOVERTIMEISTHEBOTTOMLINEOFEVERYMOVEWEMAKEROBERTGOIZUETAFORMERCEO,THECOCACOLACOMPANYPART1INTRODUCTIONTOFINANCIALMANAGEMENTCHAPTER1THEROLEOFFINANCIALMANAGEMENTPEARSONEDUCATIONLIMITED2005VANHORNEANDWACHOWICZFUNDAMENTALSOFFINANCIALMANAGEMENT,12E7_ANSWERSTOQUESTIONS_1WITHANOBJECTIVEOFMAXIMIZINGSHAREHOLDERWEALTH,CAPITALWILLTENDTOBEALLOCATEDTOTHEMOSTPRODUCTIVEINVESTMENTOPPORTUNITIESONARISKADJUSTEDRETURNBASISOTHERDECISIONSWILLALSOBEMADETOMAXIMIZEEFFICIENCYIFALLFIRMSDOTHIS,PRODUCTIVITYWILLBEHEIGHTENEDANDTHEECONOMYWILLREALIZEHIGHERREALGROWTHTHEREWILLBEAGREATERLEVELOFOVERALLECONOMICWANTSATISFACTIONPRESUMABLYPEOPLEOVERALLWILLBENEFIT,BUTTHISDEPENDSINPARTONTHEREDISTRIBUTIONOFINCOMEANDWEALTHVIATAXATIONANDSOCIALPROGRAMSINOTHERWORDS,THEECONOMICPIEWILLGROWLARGERANDEVERYBODYSHOULDBEBETTEROFFIFTHEREISNORESLICINGWITHRESLICING,ITISPOSSIBLESOMEPEOPLEWILLBEWORSEOFF,BUTTHATISTHERESULTOFAGOVERNMENTALCHANGEINREDISTRIBUTIONITISNOTDUETOTHEOBJECTIVEFUNCTIONOFCORPORATIONS2MAXIMIZINGEARNINGSISANONFUNCTIONALOBJECTIVEFORTHEFOLLOWINGREASONSAEARNINGSISATIMEVECTORUNLESSONETIMEVECTOROFEARNINGSCLEARLYDOMINATESALLOTHERTIMEVECTORS,ITISIMPOSSIBLETOSELECTTHEVECTORTHATWILLMAXIMIZEEARNINGSBEACHTIMEVECTOROFEARNINGPOSSESSESARISKCHARACTERISTICMAXIMIZINGEXPECTEDEARNINGSIGNORESTHERISKPARAMETERCHAPTER1THEROLEOFFINANCIALMANAGEMENTPEARSONEDUCATIONLIMITED2005VANHORNEANDWACHOWICZFUNDAMENTALSOFFINANCIALMANAGEMENT,12E8CEARNINGSCANBEINCREASEDBYSELLINGSTOCKANDBUYINGTREASURYBILLSEARNINGSWILLCONTINUETOINCREASESINCESTOCKDOESNOTREQUIREOUTOFPOCKETCOSTSDTHEIMPACTOFDIVIDENDPOLICIESISIGNOREDIFALLEARNINGSARERETAINED,FUTUREEARNINGSAREINCREASEDHOWEVER,STOCKPRICESMAYDECREASEASARESULTOFADVERSEREACTIONTOTHEABSENCEOFDIVIDENDSMAXIMIZINGWEALTHTAKESINTOACCOUNTEARNINGS,THETIMINGANDRISKOFTHESEEARNINGS,ANDTHEDIVIDENDPOLICYOFTHEFIRM3FINANCIALMANAGEMENTISCONCERNEDWITHTHEACQUISITION,FINANCING,ANDMANAGEMENTOFASSETSWITHSOMEOVERALLGOALINMINDTHUS,THEFUNCTIONOFFINANCIALMANAGEMENTCANBEBROKENDOWNINTOTHREEMAJORDECISIONAREASTHEINVESTMENT,FINANCING,ANDASSETMANAGEMENTDECISIONS4YES,ZEROACCOUNTINGPROFITWHILETHEFIRMESTABLISHESMARKETPOSITIONISCONSISTENTWITHTHEMAXIMIZATIONOFWEALTHOBJECTIVEOTHERINVESTMENTSWHERESHORTRUNPROFITSARESACRIFICEDFORTHELONGRUNALSOAREPOSSIBLE5THEGOALOFTHEFIRMGIVESTHEFINANCIALMANAGERANOBJECTIVEFUNCTIONTOMAXIMIZEHE/SHECANJUDGETHEVALUEEFFICIENCYOFANYFINANCIALDECISIONBYITSIMPACTONTHATGOALWITHOUTSUCHAGOAL,THEMANAGERWOULDBE“ATSEA“INTHATHE/SHEWOULDHAVENOOBJECTIVECRITERIONTOGUIDEHIS/HERACTIONSCHAPTER1THEROLEOFFINANCIALMANAGEMENTPEARSONEDUCATIONLIMITED2005VANHORNEANDWACHOWICZFUNDAMENTALSOFFINANCIALMANAGEMENT,12E96THEFINANCIALMANAGERISINVOLVEDINTHEACQUISITION,FINANCING,ANDMANAGEMENTOFASSETSTHESETHREEFUNCTIONALAREASAREALLINTERRELATEDEG,ADECISIONTOACQUIREANASSETNECESSITATESTHEFINANCINGANDMANAGEMENTOFTHATASSET,WHEREASFINANCINGANDMANAGEMENTCOSTSAFFECTTHEDECISIONTOINVEST7IFMANAGERSHAVESIZABLESTOCKPOSITIONSINTHECOMPANY,THEYWILLHAVEAGREATERUNDERSTANDINGFORTHEVALUATIONOFTHECOMPANYMOREOVER,THEYMAYHAVEAGREATERINCENTIVETOMAXIMIZESHAREHOLDERWEALTHTHANTHEYWOULDINTHEABSENCEOFSTOCKHOLDINGSHOWEVER,TOTHEEXTENTPERSONSHAVENOTONLYHUMANCAPITALBUTALSOMOSTOFTHEIRFINANCIALCAPITALTIEDUPINTHECOMPANY,THEYMAYBEMORERISKAVERSETHANISDESIRABLEIFTHECOMPANYDETERIORATESBECAUSEARISKYDECISIONPROVESBAD,THEYSTANDTOLOSENOTONLYTHEIRJOBSBUTHAVEADROPINTHEVALUEOFTHEIRASSETSEXCESSIVERISKAVERSIONCANWORKTOTHEDETRIMENTOFMAXIMIZINGSHAREHOLDERWEALTHASCANEXCESSIVERISKSEEKINGIFTHEMANAGERISPARTICULARLYRISKPRONE8REGULATIONSIMPOSEDBYTHEGOVERNMENTCONSTITUTECONSTRAINTSAGAINSTWHICHSHAREHOLDERWEALTHCANSTILLBEMAXIMIZEDITISIMPORTANTTHATWEALTHMAXIMIZATIONREMAINTHEPRINCIPALGOALOFFIRMSIFECONOMICEFFICIENCYISTOBEACHIEVEDINSOCIETYANDPEOPLEARETOHAVEINCREASINGREALSTANDARDSOFLIVINGTHEBENEFITSOFREGULATIONSTOSOCIETYMUSTBEEVALUATEDRELATIVETOTHECOSTSIMPOSEDONECONOMICEFFICIENCYWHEREBENEFITSARESMALLCHAPTER1THEROLEOFFINANCIALMANAGEMENTPEARSONEDUCATIONLIMITED2005VANHORNEANDWACHOWICZFUNDAMENTALSOFFINANCIALMANAGEMENT,12E10RELATIVETOTHECOSTS,BUSINESSESNEEDTOMAKETHISKNOWNTHROUGHTHEPOLITICALPROCESSSOTHATTHEREGULATIONSCANBEMODIFIEDPRESENTLYTHEREISCONSIDERABLEATTENTIONBEINGGIVENINWASHINGTONTODEREGULATIONSOMETHINGSHAVEBEENDONETOMAKEREGULATIONSLESSONEROUSANDTOALLOWCOMPETITIVEMARKETSTOWORK9ASINOTHERTHINGS,THEREISACOMPETITIVEMARKETFORGOODMANAGERSACOMPANYMUSTPAYTHEMTHEIROPPORTUNITYCOST,ANDINDEEDTHISISINTHEINTERESTOFSTOCKHOLDERSTOTHEEXTENTMANAGERSAREPAIDINEXCESSOFTHEIRECONOMICCONTRIBUTION,THERETURNSAVAILABLETOINVESTORSWILLBELESSHOWEVER,STOCKHOLDERSCANSELLTHEIRSTOCKANDINVESTELSEWHERETHEREFORE,THEREISABALANCINGFACTORTHATWORKSINTHEDIRECTIONOFEQUILIBRATINGMANAGERSPAYACROSSBUSINESSFIRMSFORAGIVENLEVELOFECONOMICCONTRIBUTION10INCOMPETITIVEANDEFFICIENTMARKETS,GREATERREWARDSCANBEOBTAINEDONLYWITHGREATERRISKTHEFINANCIALMANAGERISCONSTANTLYINVOLVEDINDECISIONSINVOLVINGATRADEOFFBETWEENTHETWOFORTHECOMPANY,ITISIMPORTANTTHATITDOWELLWHATITKNOWSBESTTHEREISLITTLEREA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