Shareholder Value Creation: Corporate financial policy and strategy | Management Optional Notes for UPSC PDF Download

Introduction

• Corporate financial strategy involves utilizing financial mechanisms to assess the expected outcomes of projected business strategies and projects. It encompasses the evaluation of financial policies associated with raising and utilizing funds within a corporation. A company's financial policy represents its overall approach to managing financial decisions, which typically includes capital budgeting, financing, and dividend policy. While these areas are common to most corporations, each organization must consider unique factors before establishing its financial policies. In today's global financial market, managers are expected to deliver strategies that enhance shareholder value and attract investment.
• The primary objective of financial policies is to ensure a steady and adequate capital supply for the organization, taking into account both present and future business needs. However, capital should not only be sufficient but also judiciously utilized. Therefore, financial executives must carefully assess fixed and working capital requirements, determine the types of securities to issue, and identify appropriate funding sources. Contingencies should also be considered when formulating financial plans to avoid losses due to excess or inadequate funds.
• Additionally, minimizing the cost of raising capital is crucial, necessitating a balance between fixed cost-bearing securities (such as debentures and preference shares) and variable cost-bearing securities (like equity shares). Once funds are acquired, they should be effectively deployed, with liquidity, safety, and profitability being key considerations. Over the past decade, trends in corporate financial policies have evolved, with investors increasingly comfortable with leveraging debt to support business growth and seeking short-term gains over traditional long-term strategies.
• In today's business environment, corporate leaders utilize various financial strategies to actively enhance shareholder value, raise funds, attract venture capital, and promote corporate growth. Growth strategies may involve organic or inorganic business actions aimed at increasing revenue, staffing, and market share. However, factors such as human capital, intellectual property, change management, and investment funding can influence corporate value and growth. A company's operating business plan, informed by its financial strategy, guides its growth initiatives and efficiency improvements.
• The realm of corporate financial strategy integrates corporate finance and corporate strategy to complement and balance each other. In successful corporate finance strategy, these functions collaborate to create shareholder value. Despite historical divisions between finance and strategy decision-making, they are complementary functions that, when integrated, enhance corporate development and value creation.
• In the twenty-first century, multinational corporations share common characteristics such as business unit organization, dispersed business planning, and rapid technological innovation. However, their ability to integrate finance and strategy dimensions varies, impacting their competitiveness in the global market. Companies that effectively manage their finances gain competitive advantages, enabling them to increase shareholder returns, leverage resources for growth, and derive tax benefits through mergers and acquisitions.
• In summary, a robust financial strategy is essential for maintaining cash flow, sustaining business operations, and facilitating growth. Companies must consider various factors when formulating financial policies, including debt management, cash utilization, and shareholder returns. By leveraging financial strength, companies can achieve competitive advantages and enhance long-term success.

Numerous steps to develop effective Corporate Financial Strategy

Developing an effective Corporate Financial Strategy involves several key steps, best maintained internally and aligned with the company's operations. Here are the steps to develop fully integrated corporate financial strategies (Mallette, 2005):

• Establish a robust capital structure: The capital structure determines how a company finances itself, incorporating long-term debt, common stock, and retained earnings. Analyzing three key factors—downside cash flow scenario modeling, peer group analysis, and bond rating analysis—helps determine the optimal capital structure. Downside cash flow scenario modeling involves assessing various capital structures against potential downside scenarios. Peer group analysis compares the company's capital structure with those of peer businesses to glean operational insights. Bond rating analysis evaluates debt capacity within specific debt ratings.
• Determine accurate market valuation: Evaluating market valuation determines whether the company is undervalued or overvalued in the marketplace. Market valuation measures the company's worth in the market and involves reviewing financial metrics such as investor growth expectations, margins, and investments. Comparing investor expectations with management's expectations helps identify any discrepancies.
• Establish an optimal corporate financial strategy: Develop a strategy for value creation that ensures adequate funding, financial stability, and a growing cash reserve.

It's important to recognize that corporate financial strategy is tailored to each firm's unique circumstances, including available tools, resources, insights, goals, and objectives.

Applications

• In corporations, Chief Financial Officers (CFOs), managers, and planning teams design corporate financial strategies to enhance growth and shareholder value. These strategies are return-driven policies focused on creating, maintaining, and analyzing corporate strategies for long-term wealth development. In today’s business environment, managers bear more responsibility for creating shareholder value, monitoring business performance, and ensuring long-term success. Return-driven corporate financial strategies prioritize value-added outcomes, guiding businesses with a keen focus on return, value, and growth (Frigo, 2003).
• Common mechanisms employed in corporate financial strategies include value-based management, strategic planning, mergers and acquisitions, cost analysis, and capital budgets. CFOs, managers, and planning teams utilize these mechanisms to enhance shareholder value.

Corporate Strategies and Value-Based Management

• In the realm of corporate finance, Chief Financial Officers (CFOs), managers, and planning teams often opt to base their corporate financial strategy on the principles of value-based management. Value-Based Management (VBM) is a management philosophy centered on maximizing shareholder value. It encompasses strategies for creating, assessing, and overseeing value across various aspects of the business. VBM represents a comprehensive and integrated approach to business that influences corporate culture, communications, mission, strategy, organization, decision-making processes, and compensation structures.
• A commonly utilized mechanism in value-based management is the Economic Value Added (EVA) strategy. EVA is calculated as the net operating profit minus the opportunity cost of all capital invested in a project. Employing EVA analysis allows companies to assess unit performances based on cost-of-capital considerations, thereby adjusting for risks. Managers incentivized under a value-added system may receive compensation tied to EVA outcomes. Ultimately, the EVA approach serves as both a metric for economic performance and a strategy for enhancing shareholder wealth (Bhalla, 2004).
• In essence, the financial strategy of a corporation revolves around how it procures and allocates funds, aligning investor expectations with perceived risks. The overarching goal is to deliver value to shareholders, representing the primary financial objective of any company.