CHAPTER 3 CORPORATE FINANCIAL OBJECTIVES SYNOPSIS. This chapter contains the empirical findings of this study,

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1 CHAPTER 3 CORPORATE FINANCIAL OBJECTIVES SYNOPSIS # Financial s of Business # Changing Obj'ectives # Management Group-wise s # Growth Group-wise s # R.QCE Group-wise s. This chapter contains the empirical findings of this study, : i *3 on the financial objectives the giant companies endeavor to achieve. The changes in objectives, if any, as well as influence of management group, growth rate and profitability on objectives were planned to study. : A3 FINANCIAL OBJECTIVES OF BUSINESS; The respondents were asked to rank the following objective statements in order of importance.to their company: 1. to maximize aggregate earnings, 2. to maximize return on investment in assets, 3. to maximize earning per share (EPS), 4. to Maximize ordinary share price, 5. to minimize business risk through diversification, 6. any other objective. The responses of the companies classified on the basis of management group, growth rate in gross block and average return on capital employed (ROCE). ' Were analysed and are presented here after. 115

2 The most lauded theoretical objective i.e. 'share-holders' wealth maximization' is still not popular. Only one respondent had assigned -first rank to 'maximize ordinary share price' as the objective. That was in addition to some other objective at the same rank. The 'return on investment in assets' is the most favoured first-rank objective. Forty percent of companies had chosen it over 'EPS'(287.) and 'aggregate earnings' (247.). Table 3.1 gives these details. Table 3.1 also contains a column of the ranking of objectives based on weighted average score of preference<#). In the overall ranking on the basis of weighted average score of preferences received from respondent companies, ROI stood first, followed by aggregate earnings and EPS in order. Table 3.1 Financial s of Giant of India First-Rank Frequency Distribution and Overall Weighted Ranking C Score of Preferences 1 First rank frequency distribution l age Overall Rank Haxiaize aggregate earnings 24 2 Haxiaize return on investeent in assets 40 1 Haxiaize earning per share 28 3 Haxiaize ordinary share price 4"'. 5 Hiniaize business risk through diversification 4 4 Any other - Total 100 (I) For this purpose the rank total for-each option Has obtained, and this Has divided by nuaber of responses to find the average rank for options. Based on these average ranks an overall rank Has obtained far each option. The least average rank Has ranked, highest (i.e. 1) and the largest average rank as the lonest. 116

3 Even the objective like minimizing business risk through diversif ication' was hailed marginally more important than maximizing ordinary share price', which came last in the ranking. The reason tor such priority was somewhat clear in one of the executives' statement. In his opinion, when environmental conditions offer nothing but uncertainties, the risk has to be diversified away_jby t-he way of diversification. This type of ranking indicates the futility of the theoretical objective in the country like India, where the confidence of investors is hard.l_y being reflected jproperly by the stock-exchange-determine'd prices^of equity shares. B3 CHANGING OBJECTIVES: The comparative information of objectives given in Table 3.2 below shows a definite change in the corporate objectives over a period. When compared the empirical findings of this study with that conducted by L.S.Porwal, about fifteen years back one would notice the change. More and more companies are moving towards Table 3.2 Coaparison of Financial s with other Indian and Aaerican Studies. [Figures indicate percentage to total responses! This study Porwal's study!1) Aaerican study(1) Haxiaize aggregate earnings ' Haxiaize return an investsent in assets Haxiaize earning per share Haxiaize ordinary share price Hiniaize business risk through diversification Any other Total (1) Porwal L.S. (1976)t Capital Budgeting in India', pp

4 better objective statements. Percentage of companies with 'aggregate earnings' as their objectives had declined. More companies now had chosen a better goal like EPS, and 4*/. even chose shareholders ' wealth maximization. The findings of this study is very much comparable with the American study given in Table 3.2. A rougih judgment can be made that Indian prac tices follow American practices with a lag of 15 to 20 years. A recent survey of U.K. companies also revealed almost the same ranking. U.K. companies ranked ROI as most important one and EPS gaga as next important objective. * Shareholders' wealth maximization came a poor fourth(2). C] MANAGEMENT GROUP-WISE OBJECTIVES; The management group-wise comparison of first-rank objectives and overall ranking based on weighted average score is given in Table 3.3. The Tata group of companies followed more appropriate financial objectives than Mafatial group of fable 3.3 Management Group-wise Financial s. First Rank Xage Overall Ranks Tata Mafatial Tata Mafatial Maximize aggregate earnings Haxiaize return on investaent in assets Haxiaize earning per share Haxiaize ordinary share price Hiniaize business risk through Diversification Any other - Total (2) Pike Richard and Fobins Richard (198b): 'Investment Decisions and Financial Strategy', p. 4.

5 companies. None of the two groups selected shareholders' wealth as the first choice. Overall ranking-wise also both groups assigned last rank to it. Thirty eight percent of Tata group of companies kept EPS as the target against nil of Mafatlal group of companies. The ranking based on weighted average score also proves this point. Tata group of companies had assigned second rank to *EPST and only third rank to 'aggregate earning'. Mafatlal group of companies considered 'aggregate earnings' as better goal than 'EPS'. Therefore, it can be broadly concluded that the companies in a particular management group follow almost common direction even in terms of financial goal of business<#). D3 GROWTH GROUP-WISE OBJECTIVES; High and low growth companies in terms of growth rate of gross block also help derive interesting hypothesis. Table 3.4 gives such comparison of high and low growth companies. Low growth companies largely assigned weight to the aggregate earnings. Very few low growth companies were found to be following ROI or EPS as the corporate financial objective. ROI was favoured at second and third rank by almost all low growth companies, which made it possible to have assigned first rank to ROI, marginally over aggregate earnings'. High growth companies were more professional in this respect. Two-third of. them followed ROI as the objective, and the remaining were equally (t) The study of objectives followed by other uanage*ent-group canpanies was not possible because there were no sufficient nueber of responses to sake such analysis. The study could have been sore interesting for observations across the eanageaent group, had the responses been available accordingly. 119

6 Table 3.4. Financial s Followed By High and Low Growth First Rank l age Overall Ranks High Growth Low Growth High Growth Low Growth i Maximize aggregate earnings Haxiaize return on investment in assets Haxiaize earning per share Haxiaize ordinary share price Hiniaize business risk through Diversification Any other Total divided for aggregate earnings ; and EPS. There is a clear indication from rank-column that trying to achieve the goal like ROI or EPS helps grow faster. One company among the low growth group is found to have been following 'shareholders' wealth maximization' as well as EPS_ maximization' as its primary objectives. This company did not show any attractive growth rate in gross block because it was ai new company and had yet to stabilize the operations. Its strategy of growth was to invest in subsidiaries until the existing new plant itself needed modernization. It can : easily be hypothesized that high growing companies can grow fast because they follow better financial objectives than its counterparts in the group of low- growth companies. However, there exists a chicken-egg syndrom. E3 ROCE GROUP-WISE OBJECTIVES; Since return on investment was much favoured goal so far, it 7 had been thought appropriate to distinguish the practices of high ROCE companies from low ROCE companies. The companies in the 120

7 upper quartile of ROCE were largely different from those which appeared in upper quartile of growth-rate. So is the case for companies in lower quartile also. Table 3.5 gives first-rank analysis as well as overall ranking of objective statements, as selected by high and low RQCE companies. The companies which follow theoretically sounder objectives, are more likely to gear up the policies to achieve higher return on capital employed'. Table 3.5 Financial s Fallowed by High and Low ROCE coapanies First Rank l age Overall Ranks High ROCE Loir ROCE High ROCE Low ROCE Haxiaize aggregate earnings Haxiaize return on investaent in assets Haxiaize earning per share Haxiaize ordinary share price Hiniaize business risk through Diversification Any other - Total 100 too Observation of first rank assigned by the companies, as well as that of overall ranking prove this point. The companies which still follow the primitive goals are the ones which have landed up with low return on capital employed. The difference is quite noticeable. Concern for profit was very obvious from answers to the question on depreciation method used by companies. Not less than half of low ROCE companies were folloing written down value method of depreciation for plant and equipment against only 16 percent of high ROCE group of companies. Selection of the 121

8 corporate objective statement has a de-finite influence on the growth-rate in gross block and/or ROCE of a company. _ - ' " '''rs -- '"-- w* F3 AN OVERVIEWS Though shareholders' wealth maximization' was still enjoying last position, the statement of -financial objective of companies has undergone a good change over a period. The companies now use better and more appropriate objective statements, all related to profitability. On comparison with other Indian and foreign researches in the field, it is observed that statement of objective as used by Indian companies have a time lag of about 15 to 20 years from that of its American counterparts. High growth companies were found to have set objectives with better expression than low growth companies. It can be concluded that success of the company and objective statement followed by the company have a definite correlation. 122