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Remember me. Sign in Recover your password. It can be estimated but not measured precisely. At any given time, most stocks are reasonably close to their intrinsic values and thus are at or close to equilibrium. However, at times stock prices and equilibrium values are different, so stocks can be temporarily undervalued or overvalued. Investor optimism and pessimism, along with imperfect knowledge about the true intrinsic value, leads to deviations between the actual prices and intrinsic values.
Intrinsic values are strictly estimates, and different analysts with different data and different views of the future will form different estimates of the intrinsic value for any given stock. So, theoretically, it is better that the two be equal; however, intrinsic value is a long-run concept.
So, maximizing the intrinsic value will maximize the average price over the long run but not necessarily the current price at each point in time. However, the CEO would prefer that the market price be high— since it is the current price that he will receive when exercising his stock options. In addition, he will be retiring after exercising those options, so there will be no repercussions to him with respect to his job if the market price drops—unless he did something illegal during his tenure as CEO.
The compensation package should be sufficient to attract and retain the CEO but not go beyond what is needed. This means that options or direct stock awards should be phased in over a number of years so the CEO will have an incentive to keep the stock price high over time.
If the intrinsic value could be measured in an objective and verifiable manner, then performance pay could be based on changes in intrinsic value. However, it is easier to measure the growth rate in reported profits than the intrinsic value, although reported profits can be manipulated through aggressive accounting procedures and intrinsic value cannot be manipulated.
The advantages of the first two include the ease and low cost of formation. The advantages of corporations include limited liability, indefinite life, ease of ownership transfer, and access to capital markets. Limited liability companies and partnerships have limited liability like corporations. The disadvantages of a proprietorship are 1 difficulty in obtaining large sums of capital; 2 unlimited personal liability for business debts; and 3 limited life.
The disadvantages of a partnership are 1 unlimited liability, 2 limited life, 3 difficulty of transferring ownership, and 4 difficulty of raising large amounts of capital.
The disadvantages of a corporation are 1 double taxation of earnings and 2 setting up a corporation and filing required state and federal reports, which are complex and time-consuming. Among the disadvantages of limited liability corporations and partnerships are difficulty in raising capital and the complexity of setting them up. Companies, and consequently the stockholders, prosper by management making decisions that will produce long-term earnings increases.
There has been much criticism in recent years that U. A prime example is the U. The compensation package should be sufficient to attract and retain able managers but not go beyond what is needed. This means that options or direct stock awards should be phased in over a number of years so managers will have an incentive to keep the stock price high over time.
Stockholders can intervene directly with managers. First, they can talk with managers and make suggestions about how the business should be run. In effect, these institutional investors act as lobbyists for the body of stockholders. Although shareholder- sponsored proposals are non-binding, the results of such votes are clearly heard by top management.
Corporate philanthropy is always a sticky issue, but it can be justified in terms of helping to create a more attractive community that will make it easier to hire a productive work force. This corporate philanthropy could be received by stockholders negatively, especially those stockholders not living in its headquarters city.
Thus, stock price could decrease. Companies must make investments in the current period in order to generate future cash flows. Stockholders should be aware of this, and assuming a correct analysis has been performed, they should react positively to the decision. The Chinese plant is in this category.
Capital budgeting is covered in depth in Part 4 of the text. Assuming that the correct capital budgeting analysis has been made, the stock price should increase in the future.
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