a) Managerial actions to maximize shareholders wealth.

Whereas Freeman (1984) defined shares as a unit of ownership interest in a

corporation or financial asset, he further defined Shareholders wealth as the
market capitalization of the public corporation. This market capitalization is
the number of equity shares outstanding multiplied by the share price at the
time of calculation. Market capitalization is an estimate, by capital markets,
of the net worth of the firm. The market capitalization reflects the firms
tangible assets plus the future expected residual revenue, which may be
distributed as dividends or kept as retained earnings.
Shareholder wealth maximization means maximizing the net present value of
a course of action to shareholders. Net present value or wealth of a course of
action is the difference between the present value of its benefits and the
present value of its cost. A financial action that has a positive net present
value creates wealth for shareholders and therefore is desirable. A financial
action resulting in negative NPV should be rejected since it would cause
financial lost to shareholders. Hence affecting Shareholder wealth. Between
mutually exclusive projects, the one with the highest NPVS should be
adopted. NPVS of a firms projects are additive in nature.
NPV (A) +NPV (B) =NPV (A+B)
The shareholder wealth maximization principle states that the immediate
operating goal and the ultimate purpose of a public corporation is and should
be to maximize return on equity capital. The shareholder wealth
maximization specification of what is often termed the corporate objective
makes operating goal and ultimate purpose the same: Managers and
investors should focus on shareholder wealth maximization.
Projecting earnings per share.

The management must consider the matter of total corporate profits versus
earnings per share (EPS). Management should be able to project the EPS
in order to maximize shareholders wealth. For example, suppose Okello had
300 million shares outstanding and earned 1,200 million, or 4 per share. If
you owned 100 shares of the stock, your share of the total profits would be
400. Now suppose Okello sold another 300 million shares and invested the
funds received in assets that produced 300 million of income. Total income
would rise to 1,500 million, but earnings per share would decline from 4 to
2.50, 1,500/600. Now your share of the firms earnings would be only 250,
down from 400. You (and other existing stockholders) would have suffered an
earnings dilution, even though total corporate profits had risen. Therefore,
other things held constant, if management is interested in the well-being of

its current stockholders, it should concentrate on earnings per share rather

than on total corporate profits.
Timing of the earnings stream.

Determination of maximization of expected earnings per share always

maximize stockholder welfare, other factors should be considered, Think
about the timing of the earnings. Suppose Okello had one project that would
cause earnings per share to rise by 0.20 per year for five years, or 1/= in
total, while another project would have no effect on earnings for four years
but would increase earnings by 1.25/= in the fifth year. Which project is
better in other words, is 0.20 per year for five years better than 1.25/= in
Year 5. The answer depends on which project adds the most to the value of
the stock, which in turn depends on the time value of money to investors.
Thus, timing is an important reason to concentrate on wealth as measured
by the price of the stock rather than on earnings alone.
Where the Time Value of Money: Present value (PV) of a lump-sum
amount (FV) to be received at the end of n periods when the per period
interest rate is i:
Riskiness of the projected earnings.

Another issue relates to risk. Suppose one project is expected to increase

earnings per share by 1/=, while another is expected to raise earnings by
1.20/= per share. The first project is not very risky if it is undertaken,
earnings will almost certainly rise by about 1/= per share. However, the
other project is quite risky, so, although our best guess is that earnings will
rise by 1.20/= per share, we must recognize the possibility that there might
be no increase whatsoever, or even a loss. Depending on how adverse
stockholders are to risk, the first project might be preferable to the second.
Use of debt

The riskiness inherent in projected earnings per share (EPS) also depends on
how the firm is financed. Many firms go bankrupt every year, and the greater
the use of debt, the greater the threat of bankruptcy. Consequently, while
the use of debt financing might increase projected EPS, debt also increases
the riskiness of projected future earnings. Concept of debt is represented by
the capital structure an appropriate capital structure is 70% equity and 30%
debt
Dividend policy decision.

Another issue is the matter of paying dividends to stockholders versus

retaining earnings and reinvesting them in the firm, thereby causing the
earnings stream to grow over time. Stockholders like cash dividends, but
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they also like the growth in EPS that results from plowing earnings back into
the business. The financial manager must decide exactly how much of the
current earnings to pay out as dividends rather than to retain and reinvest,
this is called the dividend policy decision. The optimal dividend policy is
the one that maximizes the firms stock price.
Corporate Social Responsibility
Another issue that deserves consideration is social responsibility: Should
managers operate strictly in their stockholders best interests, or are firms
also responsible for the welfare of their employees, customers, and the
communities in which they operate? Certainly firms have an ethical
responsibility to provide a safe working environment, to avoid polluting the
air or water, and to produce safe products. However, socially responsible
actions have costs, and it is questionable whether businesses would incur
these costs voluntarily. If some firms do act in a socially responsible manner
while others do not, then the socially responsible firms will be at a
disadvantage in attracting funds.
Agency relationship
An agency relationship exists when one or more people (the principals) hire
another person (the agent) to perform a Service and then delegate decision
making authority to that agent. Important agency relationships exist (1)
between Stockholders and managers and (2) between stockholders and
creditors (debt holders).
A potential agency problem arises whenever the manager of a firm owns
less than 100% of the firms common stock. If a firm is a proprietorship
managed by the owner, the manager will presumably operate the business in
a fashion that will improve his or her own welfare, with welfare measured in
the form of increased personal wealth, more leisure. However, if the
manager incorporates and sells some of the firms stock to outsiders, a
potential conflict of interests immediately arises. For example, the manager
might now decide not to work as hard to maximize shareholder wealth
because less of this wealth will go to him or her, or decide to take a higher
salary or enjoy more bonuses because part of those costs will fall on the
outside stockholders. This potential conflict between two parties, the
principals (outside shareholders) and the agent (manager) is an agency
problem.
In general, if a conflict of interest exists, what can be done to ensure that
management treats the outside stockholders fairly? Several mechanisms are
used to motivate managers to act in the shareholders best interests. These
include (1) The threat of firing, (2) the threat of takeover and (3) managerial
compensation plans.
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1. The threat of firing. It wasnt long ago that the management teams of
large firms felt secure in their positions, because the chances of being
overthrown by stockholders were so remote that managers rarely felt their
jobs were in Jeopardy. This situation existed because ownership of most firms
was so widely distributed, and managements control over the proxy (voting)
mechanism was so strong, that it was almost impossible for dissident
stockholders to gain enough votes to overthrow the managers.
2. The threat of takeover. This is most likely to occur when a firms stock
is undervalued relative to its potential. In a hostile takeover, the managers of
the acquired firm generally are fired, and any who are able to stay on lose
the power they had prior to the acquisition. Thus, managers have a strong
incentive to take actions that maximize stock prices. In the words of one
company president, If you want to keep control, dont let your companys
stock sell at a bargain price. Actions to increase the firms stock price and to
keep it from being a bargain obviously are good from the standpoint of the
stockholders, but other tactics that managers can use to ward off a hostile
takeover might not be.
3. Managerial compensation plans. Increasingly, firms are binding
managers compensation to the companys performance, and this motivates
managers to operate in a manner consistent with stock price maximization.
In the 1950s and 1960s, most performance-based incentive plans involved
executive stock options, which allowed managers to purchase stock at
some future time at a given price. Because the value of the options was tied
directly to the price of the stock, it was assumed that granting options would
provide an incentive for managers to take actions that would maximize the
stocks price.
Golden Parachute: Substantial benefits given to a top executive in the
event that the company is taken over by another firm and the executive is
terminated as a result of the merger or takeover. Golden parachutes are
contracts given to key executives and can be used as a type of antitakeover
measure taken by a firm to discourage an unwanted takeover attempt.
Benefits include items such as stock options, cash bonuses, generous
severance pay or any combination of these benefits. Also known as "changein-control benefits."
A golden handshake: is a clause in an executive employment contract that
provides the executive with a significant severance package in the case that
the executive loses his or her job through firing, restructuring, or even
scheduled retirement. This can be in the form of cash, equity, and other
benefits, and is often accompanied by an accelerated vesting of stock
options. Golden handshake is similar to, but more generous than a golden
parachute because it not only provides monetary compensation and/or stock
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options at the termination of employment, it includes the same severance

packages executives would get at retirement.
Stockholders Versus Creditors
A second agency problem involves conflicts between stockholders and
creditors (debt holders). Creditors lend funds to the firm at rates that are
based on (1) the riskiness of the firms existing assets, (2) expectations
concerning the riskiness of future asset additions, (3) the firms existing
capital structure (that is, the amount of debt financing it uses), and (4)
expectations concerning future capital structure changes. These are the
factors that determine the riskiness of the firms debt, so creditors base the
interest rate they charge on expectations regarding these factors.
The External Environment
Although managerial actions affect the value of a firms stock, external
factors also influence stock prices. Included among these factors are legal
constraints, the general level of economic activity, the tax laws, and
conditions in the stock market. Working within the set of external constraints,
management makes a set of long-run strategic policy decisions that plan a
future course for the firm. These policy decisions, along with the general
level of economic activity and the level of corporate income taxes, influence
the firms expected profitability, the timing of its cash flows, and their
eventual transfer to stockholders.
CONCLUSION
The view that the corporate objective is and should be shareholder wealth
maximization (SWM) is a prescriptive, standard assumption in the economics
and finance literature. There are foundations for the principle in utilitarianism
and property rights. The strong form of the principle is arguably not
descriptively or instrumentally defensible. There is reason to think that
markets in which stock prices are set are seriously imperfect.
The principle does not correspond with the actual legal duties of officers and
directors. There are objections to strict Shareholder Wealth Maximization
from business ethics and corporation law, corporate social responsibility. The
corporate objective is better understood as constrained maximization in
principle, relaxed to constrained wealth seeking in practice (Jensen 2001).
Given compliance with these antecedent conditions, then management
should attempt to maximize the sustainable economic value of shareholders
investments over time. Time horizon is a matter of strategic judgment. The
shareholders must be concerned to minimize misappropriation of this
economic value by management acting as self-interested (i.e., opportunistic)
agents. And such agents may undermine efforts at meeting the prototype
conditions.
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b) Financing Current Assets

During the normal course of business operations, a company will usually
have ready access to certain sources for financing its current assets to some
extent. As these sources emerge in the normal course of business these are
referred to as 'spontaneous' sources. These include accrued expenses,
provisions and trade credit. As trade credit is one of the very important
sources of finance, it merits a detailed discussion in its own right. It is taken
up in the following section while the other two sources are considered below.
Accrued Expenses
These are basically liabilities covering expenses incurred on and prior to a
specified date, payable at some future date. Typical examples of accrued
expenses are accrued wages and salaries. In case, a company decides to
make payment of wages on a monthly basis instead of weekly basis
(assuming trade unions accept the policy change without demur) the amount
of accrued wages will increase and the drain on cash resources is deferred by
three weeks. It should be noted that 'accrued expenses' constitute a small
fraction of current liabilities and its usefulness as a source of financing
current assets is very much limited.
Provisions
These are basically charges for an estimated expense. Typical examples are
provision for dividends, provision for taxes and provision for payment of
bonus. Provisions also do not call for immediate cash drain. The drain on
cash resources occurs when the actual amount of liability is known and paid
for. The usefulness of 'provisions' as a source of financing current assets is
very much limited.
Trade Credit
Trade credit or accounts payables or sundry creditors are a very important
spontaneous source for financing current assets. On an average, trade credit
accounts for about 40 percent of current liabilities.

Trade credit has two important facets. The first one is to instill confidence in
suppliers by maintaining good relations supported by prompt payment. This
will enable a company to obtain trade credit. It may not be out of place here
to mention that some of the reputed companies tend to stretch payment to
their suppliers. In one instance involving an automobile manufacturing
company, one of the supplying companies stopped supplies because of
unduly delayed payments. This aspect needs a little elaboration. The second
facet of trade credit relates to the cost of trade credit when suppliers provide
an incentive in the form of cash discount for prompt payment. These two
aspects are briefly discussed below.
Short-Term Bank Finance
Traditionally, bank finance is an important source for financing the current
assets of a company. Bank finance is available in different forms. Bankers are
guided by the credit worthiness of the customer, the form of security offered
and the margin requirement on the assets provided as security. These
aspects will be discussed below.
Bank finance may be either direct or indirect. Under direct financing the bank
not only provides the finance but also bears the risk. Cash credit, overdraft,
note lending, purchase/discounting of bills belong to the category of direct
financing. When the bank opens a Letter of Credit in favour of a customer,
the bank assumes only the risk of default by the customer and the finance is
provided by a third party. Both direct and indirect forms of finance are briefly
outlined below.
Cash Credit
Under the cash credit arrangement, the customer is permitted to borrow up
to a pre-fixed limit called the cash credit limit. The customer is charged
interest only on the amount actually utilized, subject to some minimum
service charge or maintaining some minimum balance also known as
compensatory balance in the cash credit account. As per the banking
regulations, the margins are specified on different types of assets provided
as security. From the operational view point, the amount that can be
borrowed at any time is the minimum of the sanctioned limit and the
value/asset as reduced by the required margin. A simple illustration is given
below for better understanding.

Overdraft
Overdraft arrangement is similar to the cash credit arrangement described
above. Under the overdraft arrangement, the customer is permitted to
overdraw upto a pre-fixed limit. Interest is charged on the amount(s)
overdrawn subject to some minimum charge as in the case of cash credit
arrangement. The drawing power is also determined as in the case of cash
credit arrangement. Difference between cash credit and OD is that cash
credit account operates against security of inventory and accounts
receivables in the form of hypothecation/pledge whereas overdraft account
operates against security in the form of pledge of shares and securities,
assignment of life insurance policies and sometimes even mortgage of fixed
assets.
Note Lending
Unlike cash credit/overdraft accounts which are running accounts, note
lending is for a specified period ranging from two to three months. The
customer takes a loan against a promissory note. Interest is charged on the
entire amount sanctioned as loan unlike cash credit/overdraft arrangement
where interest is not charged on the undrawn portion within the sanctioned
limit. This is not very much in vogue like cash credit / overdraft arrangement
which is quite popular as the liability of the loanee is unlimited.
Purchasing / Discounting of Bills
Under this arrangement, the bank provides finance to the customer either by
outright purchasing or discounting the bills arising out of sale of finished
goods. Obviously, the bank will not pay the full amount but provides credit
after deducting its charges. To be on the safe side the banker will scrutinize
the authenticity of the bill and the credit worthiness of the concerned
organization besides covering the amount under the cash credit/overdraft
limit.
Unlike open credit sale of goods which gives rise to accounts receivables, the
bill system specifies the date by which the purchaser of goods has to make
payment. Thus, the buyer is time-bound in his payment under this system
which did not find much favour with many buyers. This is the real reason
besides stamp duties etc., for the limited success of the bill market scheme.

Letter of Credit
Letter of credit is opened by a bank in favor of its customer undertaking the
responsibility to pay the supplier (or the supplier's bank) in case its customer
fails to make payment for the goods purchased from the supplier within the
stipulated time. Letter of credit arrangement is becoming more and more
popular both in the domestic and foreign markets. Unlike in other types of
finance where the arrangement is between the customer and bank and the
bank assumes the risk of non-payment and also provides finance, under the
letter of credit arrangement the bank assumes the risk while the supplier
provides the credit.
Security
As mentioned earlier, before taking a decision to provide financial assistance
to a company the bank will consider the credit worthiness of the company
and the nature of security offered. For providing accommodation towards
financing the current assets of a company, the bank will ask for security in
the form of hypothecation and/or pledge.
Hypothecation: By and large, security in the form of hypothecation is
limited to movable property like inventories. Under hypothecation
agreement, the goods hypothecated will be in the possession of the
borrower. The borrower is under obligation to prominently display that the
items are hypothecated to such and such a bank. In the case of limited
companies, the hypothecation charge is required to be registered with the
Registrar of Companies of the state where the registered office of the
company is located.
Pledge: Unlike in the case of hypothecation, in a pledge, the
goods/documents in the form of share certificates, book debts, insurance
policies, etc., which are provided as security will be in the possession of the
bank lending funds but not with the borrowing company. Thus possession of
items of security, distinguishes pledge from hypothecation. In the event of
default by the borrowing company either under hypothecation or pledge, the
lender can sue the company that has borrowed funds and sell the items of
security to realize the amount due.
Public Deposits for Financing Current Assets

Regulations imposed on the availability of bank finance have induced many

companies to explore alternative sources for financing their current assets.
Mobilization of funds from general public, especially from the middle and
upper middle class people, by offering reasonably attractive rates of interest
has become an important source. The deposits thus mobilized from public by
non-financial manufacturing companies are popularly known as 'Public
Deposits' or 'Fixed deposits'. These are governed by the regulations of public
deposits under the Companies (Acceptance of Deposits) Amendment Rules,
1978.
Commercial Paper
Commercial Papers (CPs) are short-term usance promissory notes with a
fixed maturity period, issued mostly by leading, reputed, well-established,
large corporations who have a very high credit rating. It can be issued by
body corporates whether financial companies or non-financial companies.
Hence, it is also referred to as Corporate Paper.
CPs are mostly used to finance current transactions of a company and to
meet its seasonal need for funds. They are rarely used to finance the fixed
assets or the permanent portion of working capital.
Factoring
Factoring is a "continuing" arrangement between a financial intermediary
called a "Factor" and a "Seller" (also called a client) of goods or services.
Based on the type of factoring, the factor performs the following services in
respect of the Accounts Receivables arising from the sale of such goods or
services.

Purchases all accounts receivables of the seller for immediate cash.

Administers the sales ledger of the seller.

Collects the accounts receivable.

Assumes the losses which may arise from bad debts.

Provides relevant advisory services to the seller.

Factors are usually subsidiaries of banks or private financial companies. It is
to be noted that factoring is a continuous arrangement and not related to a
specific transaction. This means that the factor handles all the receivables
arising out of the credit sales of the seller company and not just some
specific bills or invoices as is done in a bills discounting agreement.

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REFERENCES
1. IM PANDEY: Financial Management 10th Edition 2010 pg4
2. Masembe Kabali: Financial Management & Policy 3rd Edition 2013
3. Allen, F. E. Carletti, and R. Marquez. 2007. Stakeholder capitalism,
corporate governance and firm value.
4. Allen, W. T. 1992. Our schizophrenic conception of the business
corporation.

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