Question Tag: Non-financial objectives

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  • 10 Marks

FM – Nov 2020 – L2 – Q1a – Introduction to Financial Management

Advise on non-financial objectives and risks associated with seabed mining.

Demo Gold is a Ghanaian mining company that has been operating on-land deep pit gold mining in Africa since its incorporation. Aiming at increasing the value of shareholders, the directors have signed an agreement with the governments of Tonga and Tuvalu to begin excavating an area of seabed in the Pacific Ocean for ores of copper, gold, and other valuable metals.

The idea of mining mineral deposits in the seabed has for many decades been considered unrealistic because of engineering challenges. However, the recent boom in offshore oil and gas operations has come with it the development of a few advanced deep sea technologies which can be used in mining mineral deposits in the seabed.

Required:

i) It appears that the sole objective of the seabed mining operation is to maximize the value of shareholders. Advise the directors on FOUR (4) non-financial objectives that Demo Gold should pursue to achieve a sustainable increase in shareholder value. (4 marks)

ii) Advise the directors of Demo Gold on THREE (3) likely sources of risk relating to the seabed mining operation. For each point, suggest a way through which the risk could be avoided or minimized. (6 marks)

i) Nonfinancial objectives

The following nonfinancial objectives can help Demo Gold to achieve a sustainable increase in shareholder value:

  • Customer satisfaction: The company should seek to provide minerals of the quality that customers expect for a fair price.
  • Employee satisfaction: The company should seek to maintain a safe working environment and provide job security to employees. Again, the company should seek to provide opportunities for employees to develop their professional knowledge and skills, and grow within the company.
  • Supplier satisfaction: The company should seek to remain loyal to its suppliers and continue to give them business. It should seek to pay them a reasonable price and ensure prompt payment.
  • Market leadership in research and development: The company should show a dominant position and leadership in research and development.
  • Diversification strategy: Seeking to expand and diversify business and product offerings to the market.
  • Market share growth: The company should seek to expand to increase its market share.
  • Reduction in negative environmental footprint: The company should seek to reduce environmental degradation and pollution. It should aim to protect marine life in the area it operates.

(4 nonfinancial objectives @ 1 mark each = 4 marks)

ii) Likely sources of risk relating to the seabed mining operation

Likely sources of conflicts relating to the operation of seabed mining include the following:

  • Potential reduction in shareholders’ value: The directors should manage the risk of the new business failing by hedging against mineral price, buying insurance to cover operational risks, and taking political risk insurance.
  • Exposure of employees to risk: The company should invest in safe machinery, disclose any safety issues to employees, train them on offshore mining, and maintain a compensation scheme for injuries.
  • Destruction to marine life: The company should invest in machinery that would not emit harmful gasses to marine life and carry out refinery operations onshore to avoid discharging untreated waste into the sea.
  • Loss of livelihoods of people living in the area: The company should provide compensation to displaced people and facilitate skill development in fish farming, providing seed capital for such activities.
  • Technology or system malfunction: Procure high-quality, well-tested equipment and systems with proper after-sales service and performance guarantees.
  • Political risk in the foreign environment: Take political risk insurance.
  • Economic risk: Proper economic forecasting and risk management in economic variables.
  • Currency risk: Use currency hedging tools to manage this risk.
  • 20 Marks

FM – NOV 2016 – L2 – Q1 – Introduction to Financial Management

Explains the agency problem in public companies, practical solutions, non-financial objectives, governance conflict solutions, and internal hedging methods.

a) Explain the term Agency problem in relation to a Public Limited Liability Company? (2 marks)

b) As a Finance expert, explain THREE practical steps to manage agency problem in public limited liability companies. (3 marks)

c) Profit maximization is the core objective of shareholders in Public limited Liability Companies. Identify and explain THREE other non-financial objectives that can be pursued by a Public limited liability Company. (3 marks)

d) Shareholders are risk-takers but Directors are risk-averse. Explain THREE approaches that corporate governance has identified for addressing conflict of interest between shareholders and Directors. Reference can be made to Companies Act 1963, (Act 179) (6 marks)

e) Explain THREE internal hedging methods that a company can use in order to minimize translation risk and transaction risk. (6 marks)

a) Agency problem occurs when managers or management take decisions that are not consistent with the objectives of shareholder value maximization. Contributors to this agency problem are: divergence of ownership and control, goals of managers differing from those of shareholders because of personal interest, and asymmetry of information between managers and shareholders. (2 marks)

b) The following can be used to manage or resolve the agency problem:

  • Use of performance-related reward scheme: Pay and bonuses based on satisfactory performance of managers in delivering shareholder value.
  • Executive share option scheme: Managers are allowed to buy shares of the company at a fixed price within a particular period. This encourages goal congruence between managers and shareholders.
  • Threat of firing or dismissal: Managers or directors can be forced out by the shareholders if they are unhappy with their performance.
  • Key Market participants like institutional investors such as fund managers,
    pension houses, insurance companies who have larger shareholdings can
    exercise that to push managers to perform or be voted out.
     Monitoring and control of managers performance through the use of external
    and internal auditors, Board committees and review consultants.

c) The following are other objectives:

  • Staff motivation
  • Top service to customers
  • Growth
  • Market leadership in research and development
  • Social responsibility
  • Environmental sustainability
  • Diversification purposes etc.

d) Managing conflict of interest:

  • Alignment of management goals with shareholder value maximization.
  • Corporate governance controls, like shareholder authority to replace directors.
  • Provide a framework for reviewing and modernizing existing policies. (6 marks)

e) Internal hedging methods include:

  • Matching assets and liabilities in the same currency to manage translation risk.
  • Invoicing in domestic currency to manage transaction risk.
  • Leading and lagging payments based on expected exchange rate movements. (6 marks)
  • 10 Marks

FM – Nov 2017 – L2 – Q1a – Introduction to Financial Management

Explain four non-financial objectives of private companies and their effect on financial objectives.

Directors usually want to focus on factual matters and concrete actions. They deal with rules, regulations, and compliance standards to ensure adherence to the law. They mostly measure company’s performance in financial terms with secondary consideration of other metrics.

i) Briefly explain and identify FOUR examples of non-financial objectives of private companies. (6 marks)
ii) Discuss and identify examples of the effect of these non-financial objectives on the achievement of the financial objectives of companies. (4 marks)

i) Non-financial objectives of private companies
The maximisation of long-term shareholder wealth should be the objective of all profit-seeking private companies. Often companies try to achieve this through a series of primary financial objectives. In addition to these primary financial targets, even profit-seeking private companies often have other secondary non-financial targets. Non-financial objectives could be aimed at:

  • The welfare of employees. Examples of this could be health and safety in the workplace, social and recreational services, the provision of accommodation or other services, and pay and perquisites beyond what might be deemed necessary to attract and hold the appropriate staff.
  • The welfare of management. Examples of this could be excessive pay and perquisites, “empire building” or increasing market share by either organic growth or through mergers and acquisition beyond what is in the best interests of shareholders for the benefit of management or not taking on risks that would be in the interests of shareholders but could jeopardise the survival of the firm and hence the welfare of the management.
  • The welfare of society. Examples of this could be acting in an environmentally sustainable way, not testing products on animals, respecting human rights, being a “good neighbour,” and contributing to the local economy/community.
  • The provision of a service. Examples of this could be providing a service that could not be justified on purely profit grounds such as assisting access to their products for the disabled or those in remote areas.

ii) The effect of non-financial objectives on the achievement of the financial objectives of companies can include:

  • By trying to improve health and safety in the workplace, social and recreational services, the provision of accommodation, or other services and pay and perquisites beyond what might be deemed necessary to attract and hold the appropriate staff will increase costs and hence could reduce profit and dividend growth. However, the contrary is not always advisable either. Not following acceptable health and safety standards or paying below minimum acceptable or legal standards either in the customers’ markets or even where the product/service is sourced in, for example, a third-world country can be advantageous in the short term. However, it is possible that this could lead to demotivated employees and angry customers. If the company’s reputation suffers, attracting and keeping customers will be more difficult. Thus in the longer term, this could hinder achieving the financial objectives of companies.
  • It would be hard to imagine how excessive pay and perquisites could be in the best interests of shareholders. Thus, this would be expected to reduce profit and dividend growth. Similarly, while management might argue that increasing market share or increasing the size of the company by either organic growth or through mergers and acquisition might be good for the shareholders, this is often not the case, (as often witnessed by the fall in the share price of a predator firm when it announces it intends to engage in the takeover of another firm). This can lead to earnings per share and dividends per share falls even though total profit and dividends may rise.
  • Not taking on risks would be expected to reduce profit and dividend growth and would not be in the interests of shareholders unless it was argued that financial distress costs are higher than is usually estimated in finance theory.
  • Most firms now accept that everyone has a part to play in ensuring sustainable development and reducing their impact on the environment. Also, many firms choose to help society in many other ways too such as contributing to the local economy/community, not engaging in illegal activities such as illegal pollution or bribing local and national officials. This could increase costs, particularly in the short term. Hence, it could reduce profit and dividend growth. However, it is possible that this could lead to increasing the reputation of the company. This could lead to better-motivated employees, and again attracting and keeping customers could be easier. Thus in the longer term, this could be good for achieving the financial objectives of companies.

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