Gerald Cracknell

Principles of Managerial Finance

Chapter 1 Case Study

To Do Questions:

a. What should the management of Sports Products, Inc., pursue as its overriding goal? Why?
Current theory asserts that the firms proper goal is to maximize shareholders
wealth, as measured by the market price of the firms stock. A firms stock price
reflects the timing, size and risk of cash flow that investors expect a firm to
generate over time. So financial managers should undertake only those actions that
they expect will increase the value of the firms future cash flow. Theorical and
empirical arguments support the assertion that managers should focus on
maximization shareholder wealth. Shareholders of a firm are sometimes called
residual claimants, meaning that they have claims only on any of the firms cash
flows that remain after employees, suppliers, creditors, governments and other
stakeholders are paid in full. As you see, shareholders stand at the end of this line
so if the firm cannot pay the stakeholders first, shareholders receive nothing.
Shareholders also bear most of the risk of running the firm. So if firms did not
manage to maximize shareholders wealth, investors would have little incentive to
accept the risks necessary for a business to succeed.
b. Does the firm appear to have an agency problem? Explain.
Yes, in this case the firms stock price had declined nearly $2 per share over the
past 9 months, and at the same time the firms profits had been rising. What the
shareholders receive are in the form of cash dividends, and this firm has never paid
dividends during its 20-year history. Basically shareholders wealth is reducing during
this period and it shows that there is an agency problem. In addition, managements
actions in case of pollution controls shows a profit maximization try, which means
they are trying to maximize their salary, rather than an attempt to maximize
shareholders wealth.
c. Evaluate the firms approach to pollution control. Does it seem to be ethical?
Why might the expense to control pollution be in the best interests of the
firms owners despite its negative effect on profits?
It possibly has two sides. We dont know whether their acts were planned or
accidental. It is clear that they are violating the law with dumping pollutants in the
adjacent stream and damaging the environment. Clearly, Sports Products not only
done things against the law but also established poor standards of conduct and
moral judgement. So at both situations, the companys manner does not seem to be
ethical. Incurring the expense to control pollution would be in the best interests of

the firms owners because it guarantees the firms long term profits in case of social
responsibility.
d. Does the firm appear to have an effective corporate governance structure?
Explain any shortcomings.
It seems to appear that the company does not have an effective corporate
governance structure. The most important shortcoming is the management team
who doesnt make good decisions for maximizing shareholders wealth.
e. On the basis of the information provided, what specific recommendations
would you offer the firm?
I would recommend the company comply with all laws as well as accepted
standards of conduct of moral judgement. I would also advise them to establish a
corporate ethics policy, to be read and signed by all employees. Finally I would
recommend designing a payment system that ties management team and
employees salary to share price or a performance based scale.