Question

1. Why is maximizing current share price not equivalent to maximizing long- term value?
2. When managers and boards of directors evaluate firm performance, how might focusing exclusively on corporate earnings lead them astray?
3. Give examples of situations where shareholders’ and other stakeholders’ interests are complementary. Give examples of situations where these interests are not complementary. If interests conflict, what should management do?
4. What are some of the common feature of the 2008 stock market reach and previous market crashes? For example, Japan’s in the 1990s or the internet bubble around the turn of the millennium?

Answer 1

The current price of the share could be maximized by taking certain decisions such as announcing the dividends or buy back of shares which may provide a short term push for increase in share price. Such a decision may though lead to decrease in precious cash balance which may be deployed in projects aimed at long term growth. So an increase in share price may not correspond to long term value growth of the firm.

Too much focus on corporate earnings may lead to overstating revenues or taking more risks to increase revenues. Such an approach might be detrimental to actual long term growth of the firm.

An example of where interests of shareholders and other stakeholders align is where executive compensation consists of stock options. Thus increasing share price is advantageous for both. On the other hand increasing executive compensation may be detrimental to shareholders interest but good for employees.

The common feature of stock market crashes is the irrational exuberance and too much fund flowing into a particular sector. Also runway prices of financial assets without corresponding increase in value of physical assets was a fundamental cause.