Financial Strategy and Stakeholder Objectives
Strategy
Financial Strategy and Stakeholder Objectives
Syllabus tag: KASNEB CPA | Advanced Level | CA33 Advanced Financial Management | Topic 1 Financial Strategy and Stakeholder Objectives
Lesson objectives
By the end of this topic, you will be able to:
- State the objectives of financial management and the conflicts between them
- Explain the agency problem and the mechanisms that address it
- Identify stakeholder groups and their competing claims
- Explain the three forms of market efficiency and their implications
- Describe the objectives of not-for-profit and public sector entities
Why this matters
Every technique in this paper computes a number. This topic asks what the number is for — and whose interests it serves, which is not always the same question.
The primary objective
The conventional objective is the maximisation of shareholder wealth, measured by the value of the shares plus dividends received.
Why wealth rather than profit:
| Profit maximisation | Wealth maximisation |
|---|---|
| An accounting figure, open to policy choice | Based on cash flows |
| Ignores timing | Discounts for time |
| Ignores risk | Reflects risk in the discount rate |
| Can be raised short-term by cutting investment | Captures long-term consequences |
The decisive weakness of profit is the last row. Cutting research, maintenance and training raises this year's profit and destroys value — and only a wealth measure records that.
The agency problem
Shareholders own the company; directors run it. Their interests diverge:
- Directors may pursue growth and size, which raise status and pay, rather than value
- Directors bear personal risk from a failure and so may be excessively cautious, rejecting positive-NPV projects
- Directors have a shorter horizon than shareholders, particularly near retirement or a bonus date
- Directors enjoy perquisites paid for by shareholders
Mechanisms to align interests:
- Performance-related pay linked to share price or economic value added
- Share options, which give directors the shareholders' payoff
- Independent non-executive directors and board committees
- The market for corporate control — underperforming companies get taken over and the board replaced
- Disclosure and audit, which make performance visible
Note that each mechanism creates its own difficulty. Share options give a payoff that rises with volatility, which can encourage excessive risk; bonuses tied to annual profit encourage exactly the short-termism they were meant to cure. There is no incentive scheme without a distortion, and identifying the distortion is what an examiner rewards.
:::checkpoint A chief executive is paid a bonus on earnings per share growth. Identify two value-destroying actions this could encourage, and suggest a measure that would reduce the risk. :::
Stakeholders
| Stakeholder | Interest | Conflict with shareholders |
|---|---|---|
| Employees | Pay, security, conditions | Cost reduction, redundancy |
| Customers | Price, quality, service | Margin |
| Suppliers | Prompt payment, continuity | Working capital management |
| Lenders | Interest, security, covenants | Higher-risk projects, more gearing |
| Government | Tax, employment, compliance | Tax planning |
| Community | Environment, local employment | Cost of compliance and remediation |
The lender conflict is worth understanding. Once debt is in place, shareholders gain from riskier projects — they take the upside while lenders bear much of the downside. That is why loan agreements contain covenants restricting gearing, dividends and asset disposals. The covenant exists because the incentive is real.
Market efficiency
Weak form. Prices reflect all past price information. If it holds, technical analysis of price charts cannot produce abnormal returns.
Semi-strong form. Prices reflect all publicly available information. If it holds, fundamental analysis of published accounts cannot produce abnormal returns either — the information is already in the price.
Strong form. Prices reflect all information, public and private. If it held, even insiders could not profit — and the existence of insider dealing laws implies it does not.
What this means in practice:
- There is little point in cosmetic accounting: a semi-strong efficient market sees through a change of policy that alters reported profit without altering cash
- The timing of a share issue to catch a high price is not worth much effort, since the price is already fair
- What moves the price is new information, so the value of an announcement lies in its content, not its presentation
Emerging markets, including the Nairobi Securities Exchange, are generally found to be less efficient than developed ones — thinner trading, less analyst coverage, slower information flow. That weakens the practical conclusions above without overturning the framework.
Not-for-profit and public sector
Shareholder wealth has no meaning where there are no shareholders. The objective becomes value for money, examined through the three Es:
- Economy — obtaining resources at least cost
- Efficiency — output per unit of input
- Effectiveness — achieving the intended objectives
The difficulty is measurement. A hospital's output is health, which has no market price, so proxies are used and every proxy distorts. Measuring a hospital on waiting times will shorten waiting times, whether or not that improves health.
For public sector investment, cost-benefit analysis attempts to value social costs and benefits that never appear in a company's cash flows — travel time saved, lives preserved, environmental damage. The valuations are contestable, which is why the appraisals are contested.
:::checkpoint A county government appraises a road project. Identify two benefits that would appear in a cost-benefit analysis but in no commercial NPV, and explain why valuing them is difficult. :::