Academic journal article Canadian Social Science

Other People's Money: How CEOs Create Value for Shareholders during Good Times or Bad

Academic journal article Canadian Social Science

Other People's Money: How CEOs Create Value for Shareholders during Good Times or Bad

Article excerpt

Abstract

The chief executive officer (CEO) of any enterprise has a tremendous role to play in determining the direction of the organization. His choice of funding pattern for the business could determine the level of profitability and robustness of the enterprise. Whether the business should be funded with debt (i.e., other people's money) or equity is a decision the CEO has to repeatedly make in the course of piloting the ship of the organization. This paper looks at the various ways the CEO can create value for the shareholders in good times or bad, and what risks he must confront squarely in order to ensure that his efforts yield the desired results. The paper takes a critical look at funding with debts in the light of the Modigliani & Miller Theory, and concludes that the CEO does constantly explore ways by which to increase the profitability of the business, and employs other people's money to maximize wealth for the shareholders. His key approaches include constant improvement of the annual returns and taking appropriate risks aimed at attaining the enterprise's set growth goals. This paper will be beneficial to corporate finance managers and entrepreneurs who repeatedly face decision-making on what financial portfolios to engage in order to attain maximum wealth for the shareholders.

Key words: Chief Executive Officer; Shareholders; CEO's role

INTRODUCTION

The value of a business depends on a number of positive factors such as the quality of its major product or service, the kind of leadership and the type of funding it is exposed to (Bridge, 2006; Branson, 2008; Lechter, 2005). These factors are in themselves easily affected by the beliefs and personal creativity of the CEO. This accounts partially for why two CEOs operating in the same market with similar capital base may end up with different performance indices. The purpose of going into business is to make a profit. Sometimes, certain factors prevail to detract from this, but every CEO must galvanize efforts in positive ways to ensure that his enterprise does not only make a profit from year to year, but must do so in an increasing manner that assures recovery of inflationary gaps and taxation and still leave the investors' wealth at the best level. This is to say that the performance level of the business must be consistently way above the breakeven point. Break-even point is the level of operation where the company is making neither a profit, nor a loss. In progressive environments, even the not-for-profit establishments expect something better than a mere breakeven. The CEO's scanner is often drawn to the average cost of capital. A performance level that does not produce better than the average cost of capital is unacceptable since it would mean that the business is spending more to achieve less. The day to day business of the CEO is to find the right marriage between Debt and Equity funding levels that would produce the lowest average cost of capital and hence most maximum return on the investors' assets (Abiodun, 2010).

Following the 2008 financial crisis which exposed largely the weaknesses of the regulatory and supervisory frameworks, part of the CEO's drive is to achieve risk reduction by (i) finding how to assess systemic risk; (ii) improving transparency; (iii) asking how, and (iv) putting effective control measures in place (Sacasa, 2008).

The CEO as a Change Agent

Creativity is the key to the success or otherwise of a CEO in the bid to maximize shareholders' wealth (Bridge, 2006). This involves the CEO taking timely decisions to fund operations that would bring in substantial returns per unit of capital engaged. In this way, the CEO acts as change agent by adopting a proactive engagement in visioning the direction of the business and analyzing his environment in such a manner that he is able to foresee in advance business opportunities that, when funded adequately, will bring about growth and expansion to the business (Arnold, 2006). …

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