Chapter 1: Objectives
Learning Topics
1. Business and financial strategy
2. Stakeholders and their objectives
3. Sustainability and ESG
Learning Outcomes
1. Understand the role of business and financial strategy in guiding decision-making.
2. Identify stakeholders and their objectives, including potential conflicts.
3. Apply agency theory to real-world corporate scenarios.
4. Appreciate the importance of sustainability and ESG factors.
Lecture Note
Color Code for Notes
Very important and careful attention required
Normal attention required
Conceptual understanding needed
Commonly confused points
Standard reading required
1.1 What is strategy?
Strategy refers to the long-term direction and scope of an organisation, aimed at achieving competitive
advantage by configuring resources and responding to its external environment and stakeholders. Strategic
planning focuses on:
• Long-term objectives of the business
• Markets and products to compete in
• How objectives will be achieved.
1.2 Financial strategy
Financial strategy is a component of overall business strategy and focuses on the financial implications of
strategic decisions. Financial strategy covers decisions relating to:
• Allocation of financial resources
• Funding choices
• Managing financial risks
• Balancing stakeholder expectations (shareholders, lenders, regulators)
1.3 Types of Financial Decisions
Financial management involves making decisions that ensure the efficient acquisition, allocation, and control
of financial resources with the ultimate objective of maximizing shareholder wealth. Key types of financial
decisions include:
(i) Investment decisions: Investment decisions relate to how a firm commits its funds to assets or projects
that will generate future cash flows.
Examples:
• A manufacturing company investing in new automated machinery to reduce costs.
• A telecom company is investing in 5G infrastructure.
(ii) Financing decisions: Financing decisions concern with how a firm raises funds to finance its investments.
Such decisions require to decide the optimal mix of different sources of capital i.e. debt, equity, preferred
stock etc.
Examples:
• Issuing ordinary shares to finance expansion
• Taking a long-term bank loan to purchase equipment
(iii) Risk management decisions: Risk management decisions are concerned with how a business manages
risk in relation to investment decisions, financing decisions and liquidity, currency and credit decisions.
Examples:
• Using forward contracts to hedge foreign exchange exposure
• Switching from variable-rate to fixed-rate loans
(iv) Dividend decisions: Dividend decisions relate to how much profit should be distributed to shareholders
and how much should be retained for reinvestment.
Examples:
• Declaring a cash dividend annually
• Retaining profits to fund future expansion
• Issuing bonus shares (stock dividends) instead of cash
(v) Working capital management decisions: Working capital management decisions concern with the
management of short-term assets and liabilities to ensure smooth day-to-day operations.
Examples:
• Reducing inventory holding through just-in-time systems
• Offering early payment discounts to customers
• Negotiating longer credit periods with suppliers
1.4 Interrelationship of Investment, Financing, and Risk Management Decisions
Financial management decisions do not operate in isolation. Investment decisions, financing decisions, and
risk management decisions are closely interrelated. Investment decisions determine where funds are
committed and the level of business risk the firm undertakes. Financing decisions decide how these
investments are funded. Risk management decisions address the uncertainties arising from both
investments and financing, such as interest rate and exchange rate risks. The risk and return characteristics
of an investment influence the choice of financing, while investment and financing choices create additional
financial risks which are required to be managed through risk management decisions.
Following examples illustrate the interrelation among investment decisions, financing decisions, and risk
management decisions.
Type of Financial Example
Decision
Investment decision A retailer has decided to invest in new stores in overseas.
Financing decision Retailed has decided to raise necessary funds through a new issue of debt.
Risk management Overseas expansion and debt financing create foreign exchange and interest
decision rate risk which will be financed through exchange forward and interest rate
future.
2. Stakeholders and Their Objectives
2.1 Types of Stakeholders
A stakeholder is someone who has an interest in the performance of a firm or who is in a position to influence
decisions by the firm.
Stakeholder Discussion Primary Interests
Shareholders Shareholders are the owners of the Wealth maximization, profit, dividend
company income, capital gains etc.
Managers Managers are responsible for Job security, remuneration, reputation,
implementing strategy and making career growth etc.
day-to-day and long-term decisions.
Employees Employees contribute human capital Job stability, fair wages, good working
essential for operations and long- conditions, career development etc.
term success.
Lenders Lenders provide debt financing to the Timely repayment of principal, interest
company. security, financial stability of the company
etc.
Government Governments act as regulators and Regulatory compliance, timely payment of
tax collectors. taxes, contribution to economic growth etc.
Society / Society represents the broader Sustainable practices, ethical operations,
Community environment in which the firm social responsibility, environmental care etc.
operates.
2.2 Agency Theory, Agency Conflicts and Agency Cost
Agency theory explains the relationship between a principal and an agent who is employed to perform tasks
on the principal’s behalf. The agent is expected to act in the best interests of the principal, but their personal
objectives may differ, leading to potential conflicts. An agency conflict arises when the objectives of the
agent differ from the objectives of the principal. Costs incurred to manage agency conflicts are called
agency costs.
Different Categories of Agency Conflicts:
Type of Agency Conflict Description
Shareholders vs Managers Managers may prioritize personal objectives (job security,
reputation, bonuses) over maximizing shareholder wealth.
Majority vs Minority Majority shareholders may use control to extract personal benefits
Shareholders at the expense of minority shareholders.
Debtholders vs Shareholders and managers may take on excessive risk to increase
Shareholders/Managers returns, which increases the risk of default for debt holders.
Managers vs Other Managers may make decisions that benefit themselves but harm
Stakeholders other stakeholders (employees, customers, suppliers).
Mechanisms to Manage Agency Conflicts:
Mechanism How It Works / Discussion Example
Performance-based Managers’ rewards are tied to measurable - Share options granted to directors
incentives performance metrics aligned with shareholder - Annual profit-sharing bonuses
objectives. By linking pay to company results, - Long-term incentive plans (LTIPs)
managers are motivated to act in ways that tied to share price growth
increase shareholder wealth rather than pursue
personal interests.
Monitoring and Internal and external oversight reduces - Internal audit of operations and
supervision information asymmetry and ensures that agents controls
act in line with principals’ goals. - External audit of financial
statements
Corporate Formal structures and policies establish - Independent audit and
governance accountability and regulate managerial remuneration committees
behavior. Governance frameworks ensure - Mandatory disclosure and
transparent decision-making, protect minority reporting requirements
shareholders, and limit self-serving managerial - Shareholder voting on major
discretion. decisions
Debt contracts and Borrowing agreements often include restrictions - Loan agreements with debt-to-
covenants on managerial behavior to protect lenders. equity ratio limits
Covenants limit excessive risk-taking, require - Requirement for collateral on long-
collateral, or restrict additional borrowing. term borrowings
- Restrictions on dividend payouts
when debt levels are high
3. Sustainability and ESG
3.1 Sustainability
Sustainability refers to the ability to meet the needs of the present without compromising the ability of future
generations to meet their own needs.
3.2 ESG
Environmental, social and governance (ESG) is a set of criteria used to measure and report sustainability.
3.3 ESG Objectives
While wealth maximization remains a key goal, businesses are increasingly expected to consider
environmental, social, and governance (ESG) objectives alongside financial performance, since these
factors influence long-term value, risk, and returns. These dimensions or factors of ESG include:
Dimension Focus Areas
Environmental (E) Environmental dimension focus on how a Use of fossil fuels, waste
company impacts the natural environment. management, greenhouse gas
The aim is to improve environmental emissions, biodiversity,
performance and sustainability. deforestation, etc.
Social (S) Social dimension focus on how a company Employee welfare, diversity and
interacts with stakeholders, employees, and inclusion, safe working
society. conditions, supply chain ethics,
local community support etc.
Governance (G) Governance dimension focus on how a Board structure, executive
company is managed and controlled. monitoring, shareholder rights,
ethics, fraud prevention,
compensation policies etc.
3.4 ESG Reporting Areas
Businesses are increasingly expected to report on environmental, social, and governance (ESG) factors,
as these affect both financial performance and long-term sustainability. Standardized reporting, such as
IFRS S1 (general sustainability disclosures) and IFRS S2 (climate-related disclosures), ensures
transparency and comparability for investors. Global initiatives like the US SEC rules, UK regulations, and
TCFD recommendations are driving harmonization of ESG standards. Effective ESG reporting builds
credibility, informs investment decisions, and supports long-term value creation.
A sustainability report should include:
Area Particulars
Environmental Use of materials, energy, water, emissions, waste, and mechanisms for
environmental complaints.
Health and safety, product responsibility, employment practices, labor rights,
Social
and supplier assessments.
Governance Systems for managing economic, environmental, and social performance.
Climate-related Compliance with current and potential future regulations.
Disclosures
Policies, Practices & Description and data on ESG activities, showing results against targets.
Performance
Targets Forward-looking goals for each ESG factor in the next year.
3.5 Measuring ESG Performance
A business may measure its performance using key performance indicators (KPIs). However, in practice, it
can often be difficult or impossible to quantify ESG performance for the following reasons:
• The choice of KPIs often involves a certain degree of subjectivity.
• Qualitative effects can be difficult to measure (i.e. employee satisfaction).
• KPIs that are not sufficiently specific may be hard to measure (i.e. reducing environmental
damage).
Self-test Questions
Self-test Question # 1
‘Financial managers need only concentrate on meeting the needs of shareholders by maximizing earning
per share – no other group matters.’
Requirement: Discuss.
Self-test Question # 3
Assume you are Finance Director of a large multinational company, listed on a number of international stock
markets. The company is reviewing its corporate plan. At present, the company focuses on maximizing
shareholder wealth as its major goal. The Managing Director thinks this single goal is inappropriate and
asks his co-directors for their views on giving greater emphasis to the following:
o Cash flow generation
o Profitability as measured by profits after tax and return on investment
o Risk-adjusted returns to shareholders
o Performance improvement in a number of areas such as concern for the environment, employees’
remuneration and quality of working conditions and customer satisfaction
Requirement:
Provide the Managing Director with a report for presentation at the next board meeting which:
(i) discusses the argument that maximization of shareholder wealth should be the only true objective of a
firm; and
(ii) discusses the advantages and disadvantages of the MD’s suggestions about alternative goals.
Previous Year Questions
March - April 2025
The following statement appears in the objectives of a well-known listed companies in Bangladesh:
"We never confuse why we exist - to create the maximum possible returns to our stakeholders." The
managing director of the company believes that the best external measure of shareholder wealth
maximization is growth in earnings per share (EPS).
Critically evaluate this belief. Suggest three value drivers on which a business can focus, and why their
management will increase shareholder wealth.
March - April 2025
AD is a globally recognized German based sportswear company that sells branded sportswear mainly
cloths and footwear throughout the world. Many of its brands are promoted by well-known sports stars, who
appear in company's advertisement and wear its product while competing in events.
The company designs its product in Germany but outsource their manufacture to partners mostly in
Bangladesh due to its cheap labor cost. Recently, it has come to the attention of the sportswear company's
board of directors that one of the manufacturing companies employs children at its factories. These children
are paid very low wages and work long hours, so they are unable to attend school.
Discuss the factors the board of AD should consider when deciding whether to continue to work with this
manufacturing partner.