Financial Management, Corporate Social Responsibility & Rational Behavior

JWI 530 Financial Management I, Week1 Summary, 1/13/13

What a week it was ! The excellent quality of instruction, superb lecture, great organization in the text book, high level of engagement from classmates and the high quality of exchanges made this an extraordinary experience. I am grateful for this wonderful opportunity to learn from and with such bright minds.

I have found a new intellectual candy store through this class.
Takeaways below.
Dr DP

JWI 530 Financial Management I, Week1 Summary
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I. Week1 Lecture1
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Purpose of the course: How to make effective financial decisions as a business leader
(a) Financial management is all about making smart financial decisions.
- identify and execute opportunities that will maximize shareholder value
- achieve the best possible employee engagement
- deliver the best customer experience
(b) Learn the CFO language
- identify the best financial opportunities for your business
- fund the opportunities with right mix of financial options
- allocate profits that you make from those opportunities
(c) Learn accounting - principles of commerce
2. Financial crisis was caused by
- incorrect assumption that real estate prices will keep going up
- excessive debt
3. Annual Financial Reports 10K; Quarterly financial reports 10Q
Three sources to get to them:
Company -> About -> Investors -> Financials
Securities and Exchange Commission’s Edgar service www.sec.gov/edgar.shtml
Financial websites

II. Week1 DQ1 - Rethinking the Social Responsibility of Business
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A status quo model for business that works more often than not is presented by Friedman & Rodgers

(a) Perspective of Milton Friedman, Market Economist
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"Social responsibility of business is to increase its profits". By pursuing self interest, individuals promote society's interest more effectively. A bureaucratic system of pursuing public good does not work.

(b) Philosophy of TJ Rodgers, Cypress CEO
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Funds diverted for corporate philanthropy are better used through reinvestment in the business itself, thereby allowing shareholders to reap higher benefits with which they can decide how best to help society. Mackey's model will only work in good times and that "altruistic" companies like Whole Foods won't stand a chance during tough times.

A new and updated model for business in current times is presented by Mackey & IBM's institute for Business Value

(a) View of John Mackey Whole Foods CEO
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The purpose of corporations should not be just about maximizing profits. Corporations should measure success by how much value it creates for all of its constituents - customers, employees, investors, suppliers, community, environment. Corporations have responsibilities to each of these constituents that need to be balanced appropriately.

0% of profits donation to community is too little. 100% of profits donation would mean unsustainable business.
5% of profits donation is, though arbitrary, a reasonable number that is beneficial to corporation and the larger society.
Caring more broadly about constituents is good business.

(b) IBM's view of CSR evolved over 100 years of business experience
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Corporate Social Responsibility is no longer viewed as a cost center but as an integral part of corporate strategy to open new markets and achieve sustainable growth in a global marketplace.
http://www-935.ibm.com/services/us/gbs/bus/pdf/gbe03019-usen-02.pdf

III. Week1 DQ2 - Rational Behavior
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Field of finance is based on the assumption that people will behave rationally,  either in their own self interest or for the benefit of society. Learning from recent financial crisis include::
(1) Don't follow the crowd blindly. Question the assumptions. Never be afraid to check the fundamentals.
(2) Beware of conflict of interest between parties - especially those in positions of power.
Stay away from shady players even if they appear well dressed like Lehman Brothers.
(3) People can be short-sighted, self-interested, irresponsible, opportunistic, unethical.  But very seldom irrational (Dr Sasha's insight). 
Look for incentives for growth that lead to such behavior and see what can be done about changing those.
(4) Even rational behavior (eg. what people do in their self interest) built on faulty assumptions and models can also have undesirable or disastrous consequences at times.
Rational behavior does not mean it is smart behavior.
Quality of information, deadlines and risk tolerance play a role.
Reality check often and course correct.
(5) Enter only those businesses you understand (Warren Buffett's insight)
if returns seem to be too good to be true, there must be some risk you are not accounting for (Dr Sasha)

IV. Financial Management (Ehrhardt, Brigham, 2011, Chapter1 Highlights)
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(i) 3 types of business organization are proprietorship, partnership, corporation
(ii) primary objective of management is to maximize shareholder's wealth (achieve employee engagement, improve client experience)
(iii) Free cash flow (FCF): cash flows available for distribution to firm's investors, shareholders, creditors
(iv) Weighted Average Cost of Capital (WACC) - average return required by all of firm's investors; function of capital structure, interest rates, firm's risk and market's risk
(v) Value of the firm depends on FCF, timing of flows, risk
(vi) Capital transfers between borrowers and savers takes place through direct transfers, investment bouses and financial intermediaries
(vii) Cost of money is a function of production opportunities, time preferences for consumption, risk, inflation
(viii) Derivatives are claims on other financial securities. Securitization is the process by which new securities are created from claims on packages of other securities
(ix) Major financial institutions are: commercial banks, Saving & Loans Associations, Mutual Saving banks, credit unions, pension funds, life insurance companies, mutual funds, money market funds, hedge funds, private equity funds
(x) Spot market - involves on the spot sale and delivery; Futures market - has delivery at a future date
(xi) Money market - market for debt securities with maturity less than a year; Capital market - markets for longer term debt and capital stocks
(xii) Primary markets - markets in which corporations raise new capital; Secondary market - markets in which existing stocks are traded among investors
(xiii) Orders from buyers and sellers can be matches through open outcry auctions, dealers, Electronic Communication Networks (ECNs).
(xiv) Two types of markets - physical locations exchanges eg NYSE; computer/telephone networks eg Nasdaq