Chapter 26
VALUE : Value and corporate finance
- FINANCIAL ANALYSIS
- INVESTORS AND MARKETS
- VALUE
- CAPITAL STRUCTURE POLICIES
- FINANCIAL MANAGEMENT
From a financial point of view, a company’s aim is to create value, i.e. it should be able to make investments on which the rate of return is higher than the required rate of return, given the risk involved. If this condition is met, the share price or the value of the share will rise. If not, it will fall. The theory of markets in equilibrium teaches us that it is very difficult to create lasting value. Rates of return actually achieved tend, over the medium term, to meet required rates of return, given technological progress and deregulation, which reduce entry barriers and economic rents that all managers must strive to create and defend, even if sooner or later they will be eliminated. Similarly, diversification or debt cannot create value for the investor who can, at no cost on an individual level, diversify their portfolio or go into debt. Finally, there is no connection between the required return on any investment and the portfolio in which the investment is held — value can only be created by industrial synergies. Financial synergies do not exist.
It is important to understand that the creation of value is not just the outcome of a calcu- lation of returns. It has an economic basis, which is an economic rent that comes out of a strategy, the purpose of which is to “skew” market mechanisms. Accordingly, the conceptual framework of the theory of markets in equilibrium alone fails to explain corporate finance.
Signal and agency theory were developed to make up for the shortcomings of the theory of markets in equilibrium.
Signal theory is based on the assumption that information is not equally available to all par- ties at the same time, and that information asymmetry is the rule. This can have disastrous consequences and result in very low valuations or a suboptimal investment policy. Accord- ingly, certain financial decisions, known as signals, are taken to shake up this information asymmetry. These signals can, however, have a negative financial impact on the party who initiates them if they turn out to be unfounded.
Agency theory calls into question the claim that all of the stakeholders in the company (shareholders, managers, creditors) have a single goal – to create value. Agency theory shows how, on the contrary, their interests may differ and some decisions (related to borrowing, for example) or products (performance shares) come out of attempts at achieving convergence between the interests of managers and shareholders or at protecting creditors. Agency theory forms the intellectual basis of corporate governance.
