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next and how it would affect our business. My job is
stockbroking firms and we regularly visit company
largely concerned with analyzing economies and as-
management. In the evenings I study for the Chartered
sessing the prospects for bank business. There are
Financial Analyst exam. Since I did not study finance at
plenty of opportunities to work abroad and I hope to
college, this is quite challenging. I hope eventually to
spend some time in one of our Latin American offices,
move from a research role to become a portfolio man-
such as Argentina or Brazil.
ager.

Emma Kuletsky, Customer Service Representative,
Richard Gradley, Project Finance,
Regional Bank
Large Energy Company
My job is to help look after customers in a large branch.
After leaving college, I joined the finance department of
They seem to expect me to know about everything. I
a large energy company. I spent my first year helping to
help them with financial planning and with their applica-
analyze capital investment proposals. I then moved to
tions for loans. In a typical day, I may have to interview
the project finance group, which is responsible for ana-
a new customer who wants to open a new account with
lyzing independent power projects around the world.
the bank and calm an old one who thinks she has been
Recently, I have been involved in a proposal to set up a
overcharged for a wire transfer. I like dealing with peo-
company that would build and operate a large new
ple, and one day I hope to be manager of a branch like
electricity plant in southeast Asia. We built a spread-
this one.
sheet model of the project to make sure that it was vi-
able and we had to check that the contracts with the

The insurance industry is another large employer. Much of the insurance industry is
involved in designing and selling insurance policies on people™s lives and property, but
businesses are also major customers. So if you work for an insurance company or a
large insurance broker, you could find yourself arranging insurance on a Boeing 767 in
the United States or an oil rig in Kazakhstan.
A mutual fund collects money from individuals and invests in a portfolio of stocks
or bonds. A financial analyst in a mutual fund analyzes the prospects for the securities
and works with the investment manager to decide which should be bought and sold.
Many other financial institutions also contain investment management departments. For
example, you might work as a financial analyst in the investment department of an in-
surance company and help to invest the premiums. Or you could be a financial analyst
in the trust department of a bank which manages money for retirement funds, universi-
ties, and charitable bodies.

16
The Firm and the Financial Manager 17


TABLE 1.2
Career Annual Salary
Representative salaries for
senior jobs in finance Banking
President, medium-size bank $225,000
Vice president, foreign exchange trading 150,000
Controller 160,000
Corporate finance
Assistant treasurer 110,000
Corporate controller 165,000
Chief financial officer 250,000
Investment banking
Institutional brokers 200,000
Vice president, institutional sales 190,000 + bonus
Managing director 400,000 +
Department head 750,000 +
Money management
Portfolio manager 136,000
Department head 200,000
Insurance
Chief investment officer 191,000 + bonus
Chief financial officer 168,000 + bonus


Sources: http://careers.wsj.com; http://www.cob.ohio-state.edu/˜fin/osujobs.htm (April 1999).



Stockbroking firms and bond dealers help investment management companies and
private individuals to invest in securities. They employ sales staff and dealers who make
the trades. They also employ financial analysts to analyze the securities and help cus-
tomers to decide which to buy or sell. Many stockbroking firms are owned by invest-
ment banks, such as Merrill Lynch.
Investment banks and stockbroking firms are largely headquartered in New York, as
are many of the large commercial banks. Insurance companies and investment man-
agement companies tend to be more scattered. For example, some of the largest insur-
ance companies are headquartered in Hartford, Connecticut, and many investment man-
agement companies are located in Boston. Of course, many financial institutions have
large businesses outside the United States. Finance is a global business. So you may
spend some time working in a branch overseas or making the occasional trip to one of
the other major financial centers, such as London, Tokyo, Hong Kong, or Singapore.
Finance professionals tend to be well paid. Starting salaries for new graduates are in
the region of $30,000, rather more in a major New York investment bank and somewhat
less in a small regional bank. But let us look ahead a little: Table 1.2 gives you an idea
of the compensation that you can look forward to when you become a senior financial
manager. Table 1.3 directs you to some Internet sites that provide useful information
about careers in finance.


Goals of the Corporation
SHAREHOLDERS WANT MANAGERS TO MAXIMIZE
MARKET VALUE
For small firms, shareholders and management may be one and the same. But for large
companies, separation of ownership and management is a practical necessity. For ex-
18 SECTION ONE


TABLE 1.3
Site URL Comment
Internet sites for careers in
finance Wageweb www.wageweb.com Basic salary data.
Wall Street Journal careers.wsj.com Extensive salary information,
general advice, and industry
prospects.
Bureau of Labor Statistics www.bls.gov Government site with job and
qualification profiles, as well as
salary data. Go to “Publications and
Research Papers” and then
“Occupational Handbook.”
Wetfeet www.wetfeet.com A site for beginning job seekers,
with job tips and profiles of people
and jobs in the industry, as well as
information about industries and
specific firms.
Ohio State University www.cob.ohio-state. Extensive site with job descriptions,
edu/˜fin/osujobs.htm salary data, suggestions for further
reading, and many Web links.




ample, AT&T has over 2 million shareholders. There is no way that these shareholders
can be actively involved in management; it would be like trying to run New York City
by town meetings. Authority has to be delegated.
How can shareholders decide how to delegate decision making when they all have
different tastes, wealth, time horizons, and personal opportunities? Delegation can work
only if the shareholders have a common objective. Fortunately there is a natural finan-
cial objective on which almost all shareholders can agree. This is to maximize the cur-
rent value of their investment.
A smart and effective financial manager makes decisions which increase the current
value of the company™s shares and the wealth of its stockholders. That increased wealth
can then be put to whatever purposes the shareholders want. They can give their money
to charity or spend it in glitzy night clubs; they can save it or spend it now. Whatever
their personal tastes or objectives, they can all do more when their shares are worth
more.
Sometimes you hear managers speak as if the corporation has other goals. For ex-
ample, they may say that their job is to “maximize profits.” That sounds reasonable.
After all, don™t shareholders want their company to be profitable? But taken literally,
profit maximization is not a well-defined corporate objective. Here are three reasons:
1. “Maximizing profits” leaves open the question of “which year™s profits?” The com-
pany may be able to increase current profits by cutting back on maintenance or staff
training, but shareholders may not welcome this if profits are damaged in future
years.
2. A company may be able to increase future profits by cutting this year™s dividend and
investing the freed-up cash in the firm. That is not in the shareholders™ best interest
if the company earns only a very low rate of return on the extra investment.
3. Different accountants may calculate profits in different ways. So you may find that
a decision that improves profits using one set of accounting rules may reduce them
using another.
The Firm and the Financial Manager 19


In a free economy a firm is unlikely to survive if it pursues goals that reduce the
firm™s value. Suppose, for example, that a firm™s only goal is to increase its market
share. It aggressively reduces prices to capture new customers, even when the price dis-
counts cause continuing losses. What would happen to such a firm? As losses mount, it
will find it more and more difficult to borrow money, and it may not even have suffi-
cient profits to repay existing debts. Sooner or later, however, outside investors would
see an opportunity for easy money. They could offer to buy the firm from its current
shareholders and, once they have tossed out existing management, could increase the
firm™s value by changing its policies. They would profit by the difference between the
price paid for the firm and the higher value it would have under new management. Man-
agers who pursue goals that destroy value often land in early retirement.

We conclude that managers as a general rule will act to maximize the value of
the firm to its stockholders. Management teams that deviate too far from this
rule are likely to be replaced.


ETHICS AND MANAGEMENT OBJECTIVES
We have suggested that managers should try to maximize market value. But some ide-
alists say that managers should not be obliged to act in the selfish interests of their
stockholders. Some realists argue that, regardless of what managers ought to do, they
in fact look after themselves rather than their shareholders.
Let us respond to the idealists first. Does a focus on value mean that managers must
act as greedy mercenaries riding roughshod over the weak and helpless? Most of this
book is devoted to financial policies that increase firm value. None of these policies re-
quire gallops over the weak and helpless. In most instances there is little conflict be-
tween doing well (maximizing value) and doing good.
The first step in doing well is doing good by your customers. Here is how Adam
Smith put the case in 1776:
It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our
dinner, but from their regard to their own interest. We address ourselves, not to their
humanity but to their self-love, and never talk to them of our own necessities but of their
advantages.10

By striving to enrich themselves and their shareholders, businesspeople have to provide
their customers with the products and services they truly desire.
Of course ethical issues do arise in business as in other walks of life. So when we
say that the objective of the firm is to maximize shareholder wealth, we do not mean
that anything goes.
In part, the law deters managers from blatantly illegal action. But when the stakes
are high, competition is intense, and a deadline is looming, it™s easy to blunder, and not
to inquire as deeply as they should about the legality or morality of their actions.
Written rules and laws can help only so much. In business, as in other day-to-day af-
fairs, there are also unwritten rules of behavior. These work because everyone knows
that such rules are in the general interest. But they are reinforced because good man-

10 Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (New York: Random House,
1937; first published 1776), p. 14.
20 SECTION ONE


agers know that their firm™s reputation is one of its most important assets and therefore
playing fair and keeping one™s word are simply good business practices. Thus huge fi-
nancial deals are regularly completed on a handshake and each side knows that the other
will not renege later if things turn sour.11
Reputation is particularly important in financial management. If you buy a well-
known brand in a store, you can be fairly sure what you are getting. But in financial
transactions the other party often has more information than you and it is less easy to
be sure of the quality of what you are buying. This opens up plenty of opportunities for
sharp practice and outright fraud, and, because the activities of rogues are more enter-
taining than those of honest people, bookshelves are packed with accounts of financial
fraudsters.
The reaction of honest financial firms is to build long-term relationships with their
customers and establish a name for fair dealing and financial integrity. Major banks and
securities firms know that their most valuable asset is their reputation and they empha-
size their long history and their responsible behavior when seeking new customers.
When something happens to undermine that reputation the costs can be enormous.
Consider the case of the Salomon Brothers bidding scandal in 1991.12 A Salomon
trader tried to evade rules limiting its participation in auctions of U.S. Treasury bonds
by submitting bids in the names of the company™s customers without the customers™
knowledge. When this was discovered, Salomon settled the case by paying almost $200
million in fines and establishing a $100 million fund for payments of claims from civil
lawsuits. Yet the value of Salomon Brothers stock fell by far more than $300 million. In
fact, the price dropped by about a third, representing a $1.5 billion decline in market
value.
Why did the value of the firm drop so dramatically? Largely because investors were
worried that Salomon would lose business from customers that now distrusted the com-
pany. The damage to Salomon™s reputation was far greater than the explicit costs of the
scandal, and hundreds or thousands of times as costly as the potential gains it could
have reaped from the illegal trades.
It is not always easy to know what is ethical behavior and there can be many gray
areas. For example, should the firm be prepared to do business with a corrupt or re-
pressive government? Should it employ child labor in countries where that is the norm?
The nearby box presents several simple situations that call for an ethically based deci-
SEE BOX
sion, along with survey responses to the proper course of action in each circumstance.
Compare your decisions with those of the general public.


Without knowing anything about the personal ethics of the owners, which company
Self-Test 5
would you better trust to keep its word in a business deal?
a. Harry™s Hardware has been in business for 50 years. Harry™s grandchildren, now al-
most adults, plan to take over and operate the business. Hardware stores require con-
siderable investment in customer relations to become established.
b. Victor™s Videos just opened for business. It rents a storefront in a strip mall and has
financed its inventory with a bank loan. Victor has little of his own money invested
in the business. Video shops usually command little customer loyalty.

11 For example, the motto of the London Stock Exchange is “My word is my bond.”
12 This discussion is based on Clifford W. Smith Jr., “Economics and Ethics: The Case of Salomon Brothers,”

Journal of Applied Corporate Finance 5 (Summer 1992), pp. 23“28.

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