The Theory of Corporate Finance - Coursework Example

Introduction: This paper aims to apply the corporate finance theory to the real world problems by analysing and discussing a finance media article from Financial Times which has direct relevance to any of the Corporate Finance theories taught in the course. The corporate finance theory discussed under Chapters 1 to 5 (Tirole, 1996) in on Corporate Governance particularly on the debate between shareholder value and stakeholder society while the finance media article is about investing in China under the title: “Legal View: Employers face tougher rules.” by Lauffs (2007). Analysis and Discussion It is a given business and finance objective to maximize shareholder value. It appears that there are also non-financial objectives of business hence the debate on shareholder value and stakeholder society rages on. The application of corporate finance theory will therefore will dwell in determining how real is the debate in relation to investment decisions in China under the new draft of Chinese employment contract law? What is the debate on shareholder value and stakeholder society? Tirole, Jean (1996) dissected corporate governance on a debate between shareholder value and stakeholder society. He mentioned that corporate governance could be framed in terms of “shareholder value” using the economists assertion that “prices reflect the scarcity of resources that management should aim at maximizing shareholder wealth.” On the other hand, he narrated that stakeholder society would approximate the non-economist view of what may appear as “oblivious to redistributional issues” narrow-minded- or “out of touch with social realities” as consequences of limiting corporate governance to shareholders’ value maximization. To support the stakeholder society concept, he cited a prevalent view in politics and public opinion that “corporations should serve a larger purpose and “be responsible” that is they should reach out to other stakeholders not only to shareholders” (Tirole, 1996) (Paraphrasing made). In discussing therefore “The Corporate Social Responsibility View”, Tirole (1996) discussed ways under which an “economist would rephrase the position of the proponents of the stakeholder society” as could recommending “that management and directors internalize the externalities that their decision impose on various groups.” He thus cited examples of such externalities and concomitant duties toward stakeholders, according to the proponents of the stakeholder society. One is the duties toward employees where he argued that “firms should refrain from laying off workers when they make sizeable profits”. He also suggested that “firms should also protect minorities, provide generous training and recreational facilities and carefully monitor safety of the job.” Another externality is the duties towards communities where firms “should refrain from closing plants in distressed economic areas except when strictly necessary; in normal times, they should contribute to the public life of its communities.” (Tirole, 1996) As to how the apparent contrast between the two theories could be resolved as far as corporate governance is concerned Tirole (1996) the fact the economists have long been arguing “in favour of a paper internationalization of externalities.” Using Tirole’s observation that of the fact that the vast majority of these economist posed no objections to the goals advanced by the proponents of the stakeholder society, it thus an appropriate topic of debate how to strike a balance of achieving these goals. What are the objections to stakeholder society? There are however objections to stakeholder society. Tirole (1996) has advanced four different arguments that can be raised against a stakeholder-society governance structure. The first is that “giving control rights to non-investors may discourage financing in the first place. He cited an that if the employees are given control rights, the investors may have concerns that they will not be able to recoup their investments in the firm of they share control with the stakeholders on the reality that the employees may lack or unable to provide enough “pledgeable income” that stakeholders can credibly assure to pay back when they are part of governance structure. Thus he argued that “shareholder value may be the only way to obtain the required money.” The objection is that is “may generate inefficiencies in decision making” citing conflicting objectives which may not “may not converge to mutually agreeable policies” and hence ” deadlocks may result in sharing of control.” (Tirole,1996) (Paraphrasing made). Still another objection is that the “socially responsible manager faces a variety of missions, most of which are by nature immeasurable” as contrasted of share holder value which is usually measurable. (Tirole, 1996) Hence, managerial accountability under the stakeholder society may not be present. How shareholder values defend its position? Tirole (1996) stated that “proponents of maximization of shareholder value do not object to the goals of stakeholder society, rather they disagree on how these goals are to be reached.” He cited the implication of the shareholder value’s position is “the view that externalities are best handled through the contractual and legal apparatus, rather than through some discretionary action by firms officers and directors.” He thus suggested that “employees and unions should enter collective agreements with the firms specifying rules for on the job safety, severance pay, unemployment benefits.” (Tirole, 1996) (Paraphrasing made). Will expected changes in China’s employment contract law just make it only more difficult for investors or would be employers? Lauffs (2007) said that human resources managers in 2007 will face a new challenge with the expected exchanges in employment contract law due to the possibility of increased pressure to allow the establishment of unions in China companies under the new draft. She forecasted “that the arrival of unions is often accompanied by Communist party cells at the enterprise level” citing the move of government- sponsored All-China Federation of Trade Unions, the umbrella labour organisation, to push for more collective bargaining. She added that need of foreign-invested enterprises, which newly established business to establish as well supervisory board, expectedly having as members of these board elected by employees. She also foresaw foreign investors, to be focusing attention to the “draft employment contract law, which is likely to lead to major changes in employee rights and employer obligations.” (Lauffs, 2007) (Paraphrasing made). What are the highlights of new draft of China’s employment contract law? The first cited highlight to include “Fixed-term contracts.” This provision is used “because of the difficulty of terminating employees in China”, thus this new draft limits their use to two terms before an open-term contract must be signed, in addition to the employers’ requirement “to pay severance to employees if fixed-term contracts expire.” (Lauffs, 2007) (Paraphrasing made). The second highlight is the use of “Training bonds.” This has the effect of preventing early resignation by employees after the companies “have spent time and money training by requiring minimum periods of service and repayment of all or part of training costs in the event of early resignation.” The new draft requires that enforceability, “there must be a minimum training time of one month and it must be full-time, off-the-job training.” This will limit employers not to “impose training bonds on distant learning courses or internal training.” (Lauffs, 2007) Another interesting part of the draft is on “Company rules/Codes of Conduct.” Under the new draft, company rules and codes of conduct, which are means in “maintaining discipline in the office and compliance with policies” will need consultation from unions or employee representatives must be consulted prior to implementation (Lauffs, 2007). Another is on “Mass lay-offs”, which under the new draft are “subject to consultations with the union or employee representatives” (Lauffs,2007). How would the new highlights fit into resolution of the issue on the debate? As could now be observed, it appears that the new draft will be less favourable to employers since this could limit their flexibility. The foreign investors are however not compelled to enter China assuming the new draft is enacted into law. The legal and contractual provisions arising from the new draft are ways of balancing the effects of globalization, which according to some have not really redounded to lesser inequality and the attain the objectives of stakeholder society (Tirole, 1996). Although they are legislations they could be avenues for employees and unions to factor in the same in making collective agreements with the firms. Conclusion The debate stays and we have seen how investing in China has exposed the decision maker to business realities. It would be hard to think only of shareholder value without social responsibility since the firms are just a part of the greater society where we live. Before corporations are societies. Corporations are therefore creations to attain the goals of society and there this corporation must help in attaining the said goals. Maximizing the shareholder value need not be contradictory with the larger goal of society. Investors must be rewarded with what they are due while they perform their roles in providing needs and wants and their customers while promoting the interest of the public. In order of things it is just normal that corporations need to sustain their operation by realization that decisions are optimal among a variety of variables for decision making while serving out their designed purpose. The author concluded that the new draft is friendlier than the current law, hence it could be inferred that it less friendly with investors since the new conditions under the new draft would limit flexibilities of management. The strengthening of rights of workers under the new draft may however be viewed as strengthening the requirements under which corporate responsibilities could be observed under the principle of corporate governance. Summary of Finance Media Article: Investing in China, Legal View: Employers face tougher rules by Andreas Lauffs Companies react if their companies face prospects of more restrictions in terms of new laws. Although it is still a draft of the China’s employment contract law, decision makers from companies particularly the human resources managers is facing a challenging year in 2007 with the possible effect under the new law that of “increased pressure to allow the establishment of unions in companies.” (Lauffs, 2007) Lauffs (2007) expressed concern that the arrival of unions is often accompanied by Communist party cells at the enterprise level. He cited that fact the “government- sponsored All-China Federation of Trade Unions, the umbrella labour organization, is pushing for more collective bargaining.” A federation is a group of union in a country and one could just imagine the nationwide effect of the influence of the federation. The same reaction of warning could be applicable to freshly put up foreign-invested enterprises as they also need to establish a supervisory board and they must be sure to include the in the members elected by employees, who would be at least one third of the total membership. Thus foreign investors must expect that under the employment contract law, major changes in employee rights and employer obligations could be factors that merit special attention (Lauffs, 2007) (Paraphrasing made). With so many comments received from the draft numbering 191,000 received from the public which include employees and unions, the new draft attracted the attention of foreign investors and chambers of commerce including attention of politicians in the US and Europe, new draft law which possessed noticeable highlights. The first cited highlight to include “Fixed-term contracts,” which is used “because of the difficulty of terminating employees in China”, thus this new draft limits their use to two terms before an open-term contract must be signed, in addition to the employers’ requirement “to pay severance to employees if fixed-term contracts expire.” Another highlight is the use of “Training bonds.” This has the effect of preventing early resignation by employees after the companies “have spent time and money training by requiring minimum periods of service and repayment of all or part of training costs in the event of early resignation.” The new draft requires that enforceability, “there must be a minimum training time of one month and it must be full-time, off-the-job training.” This will limit employers not to “impose training bonds on distant learning courses or internal training.” Another interesting part of the draft is on “Company rules/Codes of Conduct” which under the new draft will need consultation from unions or employee representatives must be consulted prior to implementation. Still another is on “Mass lay-offs,” which under the new draft will be “subject to consultations with the union or employee representatives.” (Lauffs, 2007) (Paraphrasing made). It was found that “the March 2006 draft offered a substantial increase in protection for employees and a greater role for unions than existing law” while “a draft completed in December 2006 scaled back protections for employees and sharply curtailed the role of unions.” The author found that “on balance, the new draft is more employee-friendly than current law.” (Lauffs, 2007) (Paraphrasing made). References: Lauffs, Andreas (2007), . Investing in China, “Legal View: Employers face tougher rules.”, Financial Times Limited {www document} URL http://www.ft.com/cms/s/7a8a1ae8-b074-11db-8a62-0000779e2340.html, Accessed February 23,2007. Tirole, Jean (1996) "The theory of Corporate Finance” Chapters 1-5, Princeton University Press Read More