Question

"The goal of financial management is to take actions which maximize the value of a firm's stock. Those actions will eventually appear in the firm's financial statement, so a general understanding of financial statements is very important for the manager."

Given the recent failure of many financial institutions, do you believe business leaders really understand and use all of the concepts and principles we teach in accounting, finance, and economics?

In addition, do you believe financial managers are truly concerned about maximizing the value of a firm’s stock?

Why or why not?

Answer 1

The role of the financial manager, particularly in business, is changing in response to technological advances that have significantly reduced the amount of time it takes to produce financial reports. Financial managers’ main responsibility used to be monitoring a company’s finances, but they now do more data analysis and advise senior managers on ideas to maximize profits. Current failures in many financial institutions are generally caused by a wide variety of causes and most of the times ripple into failure of interlinked financial institutions.

Case 1: Failure of AIG

One of the most recent example was failure of Lehman Brothers and systemic collapse of global financial system which in turn reached the doors of AIG. AIG had written credit default swaps on over $500 billion in assets. In these transactions, the insurance seller (in this case, AIG) in some ways becomes the bond owner.

Over the course of those agreements, the worth of the underlying asset change and one party can pay the opposite cash, known as collateral, based that change; that collateral will flow back and forth between the 2 parties when the market moves. AIG’s credit default swaps didn't imply collateral to be paid fully because of market changes. Agreements were such that the collateral was owed only when market changes exceeded a particular value or if AIG’s credit rating fell below a particular level, the day all 3 major agencies downgraded AIG to a credit rating below AA-, calls for collateral on its credit default swaps rose to $32 billion AIG was accruing unpaid debts owed to its credit default swap partners and when AIG’s credit rating was lowered , those collateral provisions came up and AIG suddenly owed its counterparties an excellent deal of cash.

Therefore, it’ll be better to summarize that there a lot of parameters that cause the failure of financial entities and not just the proper concept utilization by financial managers.

Do you believe financial managers are truly concerned about maximizing the value of a firm’s stock? Why or why not?

A typical financial manager used to focus primarily on Profit maximization earlier which now has transformed to data analysis, advising senior management and employing technological changes to focus more on wealth maximization.

Maximizing the value of a firm’s stock is directly impacted by Wealth Maximization. This can be activated solely with the assistance of the profitable position of the financial entity. Wealth maximization taken up by financial managers focus more on cash flows rather than profits which is more apt from a long term scenario where a business which makes losses every year but there are cash profits because of heavy depreciation which suggests investment in fixed assets which in turn gives the true value of a firm’s wealth. So the goal of maximizing the worth of the stock avoids the issues or disadvantages related profit maximization i.e. a good financial decision increase the value of the owners’ equity and poor monetary selections decrease it. So a financial manager best serves the shareholders of the business by finding product and services that increase the value of the firm.