Financial Management

MODULE : 1

INTRODUCTION TO FINANCIAL MANAGEMENT

Introduction:
In our present day economy, finance is defined as the provision of money at the time when
required. Every enterprise whether it is big or small, needs finance to carry on its activities
and to achieve its targets. Without adequate finance, no enterprise can possibly accomplish
its objectives.

The subject of finance has been traditionally classified into two :

1. Public Finance
2. Private Finance

Public finance deals with the requirements, receipts and disbursements of funds in the
government institutions.

Private finance is concerned with requirements, receipts and disbursements of funds in case
of an individual, a profit seeking business organization and a non-profit organization.
Thus, private finance can be classified into:
1. Personal finance
2. Business finance
3. Finance of non profit organizations

Personal finance deals with the analysis of principles and practices involved in managing
one’s own daily need of funds.
The principles and practices, procedures and problems concerning financial management of
profit making organizations engaged in the field of industry, trade and commerce is
undertaken under the discipline of business finance.
The finance of non-profit organization is concerned with the practices; procedures and
problem involved in financial management of charitable, religious, educational, social and
other similar organizations.

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CONCEPT OF BUSINESS FINANCE

The term business finance connotes financing of business activities. Thus, in order to
develop the meaning business finance explanations of the two terms are necessary. They
are business and finance.

Business : Business in the narrow sense means merchandising, the operation of some sort of
shop or store. But in the broader sense business means every human activity where by
man’s wants are satisfied. Usually these activities are activated with the profit motive.
Business can be categorized into : Commerce, Industry and Services
Commerce - concerned with the transfer of commodities through various channels from the
producer to the customer. Ex. Warehousing, Transporting, insurance of commodities etc.
Industry - concerned with sale of goods produced by the manufacturer. It is actually
concerned with manufacturing of commodities.
Services - rendering some services for making profit. Such activities are categorized under
the heading of services Ex. Services of lawyers, doctors, and lecturers

Finance : Finance may be defined as the provision for money at the time when it is
required. Finance refers to the management of flows of money through an organization.
However, there are three main approaches to finance:
1. According to traditional concept the finance is concerned with acquiring the funds
on reasonable terms and conditions to pay bills promptly.
2. The second approach holds that finance is concerned with cash
3. The third approach to finance looks on finance as being concerned with
procurement of funds and their utilization.

Business finance can further be classified in to three categories

a. Sole proprietary finance
b. Partnership firm finance, and
c. Corporate or company finance / financial management

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Definitions

“Business finance can broadly be defined as the activity concerned with planning, raising,
controlling and administering of funds used in the business” - Guttmann and Dougall.

“Financial management is the operational activity of a business that is responsible for

obtaining and effectively utilizing the funds necessary for efficient operation” – Joshph and
Massie.

“FM is the area of business management devoted to a judicious use of capital and a careful
selection of sources of capital in order to enable a business firm to move in the direction of
reaching its goals” – J.F.Bradlery.

“FM is application of the planning and control functions to finance function” – Archer and
Ambrosio.

“FM is a subject which deals with the tools and techniques through which a company’s
balance sheet is constructed”.

SCOPE OF FINANCIAL MANAGEMENT

The approach to the scope of financial management is divided in to 2 broad categories.

1. Traditional Approach
2. Modern Approach

I. Traditional Approach:
The traditional approach, which was popular in 1920’s, limited the role of the finance
manager to raise the funds and administering of the funds needed by the corporate
enterprise to meet their financial requirements.
It covered three aspects
1. Arrangement of funds from financial institutions.
2. Arrangement of funds through financial instruments from capital market.

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3. Looking after the legal and accounting relationship between the corporate and its
sources of funds.

The finance manager had a limited role to play. He was required to look into financial
problems of in incorporation, mergers, liquidation, reorganization etc. He was essentially
concerned with the long-term problems of financing.

Traditional Approach continued to dominate academic thinking during 1940’s and 1950’s.
However, in later fifties it started to be severally criticized

Criticisms of Traditional Approach:

 Outsider looking in approach
 Ignored routine problems
 Ignored non corporate enterprises
 Ignored working capital financing
 No emphasis on allocation of funds
The traditional approach out to live due to changed business situations since mid 1950’s.
Technical improvements, widened marketing operations, development of strong market
structure, keen and healthy business competitions etc. all are necessary for management to
make an optimum use of available resources for continuous survival of the business.

II. Modern Approach:

According to Modern Approach, “Financial Management is concerned with both acquiring
of funds as well as their allocation”. MA is an analytical way of looking at the financial
problems of a firm. The main content of the Approach are:

Main Contents
1. What is the total amount (volume) of funds an enterprise should commit?
2. What specific assets should an enterprise acquire?
3. How the required funds should be finance?
The above 3 questions relate to 3 broad decisions of finance.
1. Investment Decisions
2. Financing Decision and
3. Dividend decision

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FUNCTIONS OF FINANCE / DECISIONS IN FINANCIAL MANAGEMENT

1. Investment Decisions
2. Financing Decision and
3. Dividend decision

1. Investment Decisions : Investment decision refers to selection of assets in which the

funds will be invested by a firm. The assets which can be acquired falls under two
groups:
a. Long term Assets - which yield a return over a period of time in future
b. Short term Assets - those assets which in the course of business are convertible
into cash with in year.
Accordingly, the asset selection decision of a firm is of two types.
a. Capital Budgeting : (most critical decision of any firm)
 It relates to the selection of an asset or investment proposal whose benefits
are likely to be available in future over the time of a project.
 Long Term Assets can be old / new/ existing.

Important aspects of capital Budgeting

 Future benefits are difficult to measure and cannot be predicted with certainty,
because of uncertainty, capital budgeting involves risk, Investment proposals should
therefore be evaluated in terms of Risk and Return
 Other major aspect is the measurement of standard or hurdle rate against which the
expected return of a new investment can be compared.

b. Working Capital management (current asset management)

 Current asset management which affects the firm’s liquidity is yet another important
investment decision. Current assets should be managed effectively for safeguarding
the firm against the Danger of illiquidity and insolvency
 A conflict exists between profitability and liquidity while managing current assets. If
the sufficient funds are not invested in the current assets, it may become illiquidity.
But it would loose profitability, as idle current assets cannot earn anything. Thus the
proper trade off between Profitability and liquidity should be achieved.

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2. Financing Decision : It is the second important function to be performed by the

finance manager. Broadly speaking, he must decide when, where and how to
acquire the funds to meet the firm’s investment need. The main issue now is to
determine the proportion of the debt and equity. The mix of that debt and equity is
known as the firm’s capital structure. The finance manager must strive hard to obtain
the best financing mix or optimum capital structure. The firm’s capital structure is
concerned to be optimum when the market value of the share is maximized. Once
the finance manager is able to determine the best combination of debt and equity,
he must raise the appropriate funds through best available sources.

3. Dividend Decision : The third major decision of financial management is the decision
relating to the dividend policy. This dividend should be analysed in relation to the
financing decision of a firm. Two alternatives are available in dealing with the
profits.
a) They can be distributed among the shareholders in the form of dividend
b) They can be retained in the business.

If the dividends are paid, what portion of the profits must be paid as dividends to
the shareholders? The decision will depend upon the preferences of the shareholders
and investment opportunities available with in the firm.

The modern approach has broadened the scope of the financial management which
involves the solution of 3 major decisions namely investment, financing and
dividend. These are interrelated and should be jointly taken so that financial
decision making is optimal.

Apart from the above main functions, following are some of the subsidiary
functions, which the finance manger should perform
1. To ensure supply of funds to all parts of the organization.
2. Evaluation of financial performance.
3. To negotiate with bankers, financial institutions and other suppliers of credit.
4. To keep track record of stock exchanges quotations and stock market prices.

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GOALS / OBJECTIVES OF FINANCIAL MANAGEMENT

The objectives provide a framework for optimum decision-making. In other words, they
are concerned with designing a method of operating the internal investment and financing
of a firm.

There are two specific objectives

1. Profit Maximization : According to this approach, actions that increase profits should
be undertaken and those that decrease profits should be avoided. The PM criteria
imply that the investment, financing and dividend decision of the firm should be
oriented to the maximization of profit.

The rationale behind profitability maximization is

1. It provides yardstick by which economic performance can be judged.
2. It leads to efficient allocation resources
3. It ensures maximum social welfare.

Objections to Profit Maximisation

1. It assumes perfect competition and in the phase of imperfect modern markets, it
cannot be legitimate objective of the firm.
2. A PM criterion was developed in 19th century when the characteristic features of the
business were self-financing, private property and single enterprises were prevailing
and the main objective of these owners was to maximize the profit. But in the
modern times limited liability as come into being with business and a divorce
between management and owners. So profit maximization is regarded as unrealistic.
3. From the societies point of view PM may lead to inequality of income and wealth.

Limitations of Profit Maximisation:

1. It is Vague (unreal)
2. Ignored time value of money
3. Ignores risk (quality of benefits is ignored)

To summarize the above discussion, the profit maximization criterion is inappropriate and
unsuitable as an operational objective of investment, financing and dividend decisions of
the firm. The alternative to the profit maximization is wealth maximization criteria.

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2. Wealth Maximization (Value Maximisation / NPW Maximisation) : This is known as

value maximization or net present worth maximization. In current literature the value
maximization is almost universally accepted as an appropriate operational decision criterion
for financial management decisions as it removes the technical limitations of the earlier
profit maximization criteria.

WM means maximizing the Net Present Value of a course of action. NPV of a course of
action is the difference between the Present Value of its benefits and the PV of its costs.
A financial action which has + NPV creates wealth and therefore is desirable. A financial
action which has – NPV should be rejected. Among the mutually exclusive projects –
project with highest NPV should be adopted.

The wealth maximization objective is also consistent with the objective of maximizing the
welfare of the shareholders of the company. From the shareholders point of view, the
wealth created by the company through its action is reflected in the market value of the
company’s shares. Therefore, the wealth maximization objective implies the fundamental
objective of the firm should be to maximize the market value of its shares.

Features:
1. The WM concept is based on the concept of cash flows generated by decision rather
than the accounting profit.
2. It considers both the quality and quantity of benefits. It incorporates time value of
money.

Advantages:
1. WM is a clear term
2. It considers the concept of time value of money.
3. Universally accepted.
4. It guides the management in framing consistent strong dividend policy to reach
maximum returns to equity shareholders.
5. Considers impact of risk.
6. WMO is consistent with the objective of maximizing the SHW.

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Criticisms of Wealth Maximisation:

1. The concept of wealth maximization is not descriptive.
2. The objective of WM is not necessarily socially desirable.
3. There is some controversy as to whether the objective is to maximize the stock
holders wealth or the wealth of the firm which includes other financial claim holders
4. The objective of WM may also face difficulties when ownership and management
are separated as is the case in most of the large scale corporate from of organization.

Differences between the two primary objectives of financial management

Profit Maximization Wealth Maximization

Large amount of profits Highest value to the firm and

Objective
highest market value of shares

 It is easy to calculate profits  It emphasizes on long term

returns and profits.
 It is easy to establish the
relationship between financial  It recognizes uncertainty and
decisions and profits risk
Advantages
 It recognizes the timing of
returns
 It considers shareholders’
returns

 It emphasizes on short-term  It offers no clear relationship

gains between financial decisions
and share prices.
Disadvantages  It ignores uncertainty and risk
 It can lead to management
 It ignores timing of returns
anxiety and frustration
 It requires immediate resources

The value of the stream of cash flows under wealth maximization criteria is calculated by
discounting it back to the present at a capitalization rate (discount rate).

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Capitalization Rate (Discount Rate)

It is the rate, which reflects the time and risk preference of the owners or suppliers of
capital. The capitalization rate as a measure of quality (risk) and timing is expressed in
decimals i.e. a discount rate of 20% is written as 0.20. The higher the risk the longer the
capitalization rate.

General Objectives of Financial Management

 Balanced Asset Structure.
 Liquidity.
 Judicious Planning of Funds (reducing the cost)
 Efficiency
 Financial Discipline.

“A”S OF FINANCIAL MANAGEMENT

 Anticipating Financial needs
 Acquiring financial resources
 Allocating funds in business
 Administering the allocation of funds
 Analyzing the performance of finance
 Accounting and reporting to management

“AIMS” of Financial Management

 Acquiring Adequate funds
 Proper Deployment of funds
 Escalating Profitability
 Maximising firms value

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ORGANISATION OF FINANCE FUNCTION

The organization structure of finance is as important as any other functional department.
Finance function is established directly under the control of BOD. The structure of finance
department differs from industry to industry.
 Small – Owners
 Big – independent Finance department
 Very big – an expert committee

Finance function is controlled by the top management. Survival and growth of the
company depends upon the finance function. Funds flow will be smooth because of sound
working of Finance function. Finance function can be divided into
a. Routine matters – Treasurer, b. Special finance functions – Controller.
Treasurer and Controller are governed by Finance Committee.

The controller is concerned with management and control of the firm’s assets. His duties
include providing information for formulating the accounting and financial policies,
preparation of financial reports, direction to internal auditing, budgeting, internal control,
taxes etc. while the treasurer is mainly concerned with managing the firms funds, his duties
include forecasting the financial needs, administering the flow of cash, managing credit,
floating securities, maintaining relations with financial institutions and protecting funds and
securities.
Functions of the Treasurer and Controller

Treasurer Controller
 Obtaining finance  Financial Accounting
 Banking relationship  Internal Auditing
 Cash management  Taxation
 Credit Administration  Management Accounting
 Capital Budgeting  Control

Functions of Controller
 Formulation of the accounting and costing policies, standards and procedures.
 Preparation of financial statements.
 Preparation of interpretations of financial reports.
 Maintenance of books of accounts.
 Internal audit.

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 Preparation of budgets.
 Inventory control.
 Safeguarding company’s assets.
 Controlling cash receipts and payments.
 Preparation of payrolls.

Functions of a Treasurer
 Cash management Functions
o Opening accounts and depositing funds in the banks.
o Payment of company obligations through proper disbursements.
o Managing records of cash transactions.
o Management of petty cash and cash balances.
 Credit Management Functions
o Determination of customers credit standards.
o Orderly handling of collections from debtors.
o Cash discounts to encourage prompt payment from debtors.
o Determination of customers credit risk.
 Financial Planning Functions
o Reporting financial results to the top management.
o Forecasting future financial requirements.
o Forecasting cash receipts and cash payments.
o Planning the various avenues for investment of company’s surplus funds.
o Advice on dividend payments.
 Security Floatation Functions
o Taking the decisions on the type of securities a company has to float to raise
the funds from the public.
o Compliance with government regulations.
o Maintaining good relationships with the stock holders.
o Disbursement of dividends.
o Redemption of bonds.

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FINANCE MANAGER
 Finance Manager is a person who heads the department of finance.
 He forms activities in connection with general functions of management.
 His focus is on profitability of the firm.
 He plans and controls financial activities.
 Finance Manager takes key decisions on the allocation and use of money by various
departments.

FUNCTIONS OF FINANCE MANAGER

 Anticipate the finance requirement.
 Selection of right source
 Allocation of funds
 Analysis of the financial performance
 Administration of financial activities
 Protection of interest of investors and creditors

CHANGING ROLE OF FINANCE MANAGER

Traditional Role
 Primary market  Deployment of funds
 Secondary market  Capital budgeting
 Financial institutions  Working capital management
 Leverages  Dividend decisions
 Capital structure

New Role
 Mergers  Forex management
 tax planning  information technology
 Cost reduction strategies  Communication network
 access to foreign investment  Learning attitude etc.

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Functions of Financial Management or the role of Chief Financial Officer (CFO)

The functions of financial management or shortly called financial functions can be
summarized into Five A’s, viz.,
 Anticipation of Funds required for business (i.e., financial analysis and planning);
 Acquisition of required funds (i.e., Financing and Capital Structure Decisions);
 Allocation of acquired funds (i.e., Investment Decisions);
 Administration of allocated funds (like working capital management, risk
management, etc.,) And
 Accounting for the funds mobilized and utilized.

While the above mentioned functions are the standard functions to be performed by any
financial manager or CFO, in the recent times the role of a CFO has widened. In the
current business context, a CFO is supposed to perform the following functions in addition
to those stated above:
 Budgeting  Overseeing the IT function
 Forecasting  Overseeing the HR function
 Managing Mergers and Acquisitions  Strategic planning
 Profitability analysis  Corporate governance
 Pricing analysis  Regulatory compliance
 Decisions about outsourcing  Risk management etc.

FUNCTIONAL AREAS OF FINANCIAL MANAGEMENT

1. Estimation of financial requirement
2. Selection of the right sources of funds
3. Allocation of funds
4. Analysis and interpretation of financial performance
5. Analysis of cost volume profit
6. Capital budgeting
7. Working capital budgeting
8. Profit planning and control
9. Fair return to the investors
10. Maintaining liquidity and wealth maximization

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RELATIONSHIP BETWEEN FINANCIAL MANAGEMENT AND OTHER RELATED AREAS

Financial management is integral part of the overall management. FM is not totally
independent area. It is related to some of the disciplines namely Economics, Accounting,
Marketing and Production

1. Financial Management and Cost Accounting

Most of the large companies have a separate cost accounting department to monitor
expenditure in their operational areas. The cost information is regularly supplied to the
management for control purpose. The financial manager is concerned with the proper
utilization of funds and therefore he is rightly concerned with the operational costs of
the firm. The information supplied by cost accounting department is most important to
him and he makes suitable recommendations to keep costs under control.

2. Financial Management and Marketing

Marketing is one of the most important area on which the success or failure of the
company depends to a great extent. Determination of the appropriate price for the
firm’s products is of importance both for marketing and finance manager and therefore
should be a joint decision of both. The marketing manager provides information as to
how different prices will affect the demand for the company’s products in the market
and the firm’s competitive position while the financial manger can supply information
about costs, change in cost at different levels of production and the profit margin
required to carry on the business. Thus, the financial manager contributes substantially
towards formulation of the pricing policies of the firm.

The finance manager while formulating the credit and collection policies for the firm
must consult the marketing manager because these policies affect the magnitude of the
sales of the firm, weather to sell for credit, to what extent and on what terms are part
of the sales strategy of an enterprise. But they have financial implications too because
the funds which will be tied up in receivables must be made available and any change
in policies will tie up a large / smaller amount of receivables. Thus, this aspect of
business decision involves both finance and marketing.

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3. Financial Management and Personnel Management

The recruitment, training and placement of staff are the responsibility of the personnel
department. However, all this requires finance and therefore decisions regarding these
aspects cannot be taken by the personnel department alone. These decisions require
the help of finance department and therefore these decisions are taken in isolation of
both the departments.

4. Financial Management and Purchase & Production

Finance is closely related with purchase and production functions. The decisions to
determine the level of fixed assets and the different types of such assets for an
enterprise is the task of the production department. In the same way the types of
goods to be held in the inventory and the amount required for each are a basic part of
sales and purchase function.

As these assets and inventory involves risk and long-term funds, they require the special
attention of the finance manager. Since finance manager is primarily responsible for
supplying funds to finance inventory and fixed assets which must earn sufficient returns
to cover the cost involved in procuring funds. He is also directly responsible for the
decisions pertaining to acquisition and replacement of assets.

5. Financial Management and Economics

There are two broad areas of economics 1. Macro Economics 2. Micro Economics.
Macroeconomics is concerned with overall institutional environment in which the firm
operates. I.e. it looks economy as a whole.

Key macro-economic factors like the growth rate of the economy, the domestic savings
rate, the role of the government in economic affairs, tax environment, the nature of
external economic relationships, the availability of funds to the corporate sector, the
rate of inflation, the real rate of interest, and the terms on which the firm can raise the
funds define the environment in which the firm operates. Since the business firm
operate in the macro economic environment and the impact of the same on the firm.
Microeconomics deals with the economic decisions of individuals and organizations.
The theories of macroeconomics provide for effective operations of business firms.

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They are concerned with defining actions which will permit the firms to achieve
success.

The finance manager must be familiar with the theories of microeconomics such as
1. Demand and supply relationship and profit maximization strategies.
2. Issues related to the mix of productive factors, optimal sales level and product
pricing strategy.
3. Measurement of risk and determination of value.
4. The rational of depreciating assets.

To sum up, a basic knowledge of macroeconomics is necessary for understanding the

environment in which the firm operates and a good grasp of micro economic principles is
helpful in sharpening the tools of financial decision making.

6. Financial Management and Accounting

Finance Management and Accounting are quite distinct from each other. Financial
accounting is concerned with the recording, reporting and measuring of business
transactions. The information provided by financial accounting is used by the finance
manager to take decisions in order to achieve the objective of the business organization.
Financial accounting is the data collection process dealing with accurate recording and
reporting while financial management is a managerial decision making process. Financial
accounting is therefore concerned with the measurement of funds while financial
management is concerned with the management of funds.

The objective financial accounting is to keep a systematic record of the transactions of

the company profit and loss account and balance sheet and prepared by the financial
accountant in order to know the results of operations and financial state of affairs.

Financial management on the other hand, is primarily concerned with the task of
ensuring that the funds are produced at optimum cost and equally minimum financial
risk and it also ensures that the funds are made available at the right time.

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Though financial accounting and financial management are quite distinct from each
other both have a role to play, which is complementary to the other. This would be
clear from the following:
a. P&L account discloses the profit made by the company over a period of time.
Earning per share is the concept, which is of the vital interest of the financial
manager, which in turn depends on profit. Thus both FA and FM are concerned
with the ascertainment of true profit.
b. Determination of dividend policy is generally a function of a finance manager, the
figures of profits earned by the enterprise play an important part in determining
the amount of dividend.
c. Decisions regarding the expenditure on assets are taken by the finance manager
through the technique of capital budgeting. However, it is the accounts
department, which feeds the finance manager with the necessary data.
d. One of the important functions of the finance manager is to maintain proper
working capital management. For this purpose, cash budget is prepared, inventory
level is decided and credit policy of the company is determined. The information
required for taking with regard to above is provided by the accounting
department.

Thus, although accounting and financial management differ from each other in many
respects, yet both of them are a must for every organization as they perform
complementary functions to each other.

Factors influencing the financial decisions

There are number of factors that influence the financial decision. The list of important
external as well as internal factors influencing the decisions are

External Factors
 State of the economy  Government policy
 Structure of capital and money markets  Taxation policy
 Requirements of investors  Lending policy of financial institutions

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Internal Factors
 Nature and size of business  Age of the firm
 Expected return, cost and risk  Liquidity position
 Composition of assets  Working capital requirements
 Structure of ownership  Conditions of debt agreement
 Trend of earnings

THE AGENCY PROBLEM

An agency relationship occurs when a principal hires an agent to perform some duty. A
conflict, known as an "agency problem," arises when there is a conflict of interest between
the needs of the principal and the needs of the agent.

In corporate finance, the agency problem usually refers to a conflict of interest between a
company's management and the company's stockholders. The manager, acting as the agent
for the shareholders, or principals, is supposed to make decisions that will maximize
shareholder wealth. However, it is in the manager's own best interest to maximize his own
wealth. While it is not possible to eliminate the agency problem completely, the manager
can be motivated to act in the shareholders' best interests through incentives such as
performance-based compensation, direct influence by shareholders, the threat of firing and
the threat of takeovers.

In finance, there are two primary agency relationships:

 Managers and stockholders
 Managers and creditors
1. Stockholders versus Managers
 If the manager owns less than 100% of the firm's common stock, a potential agency
problem between mangers and stockholders exists.
 Managers may make decisions that conflict with the best interests of the
shareholders. For example, managers may grow their firms to escape a takeover
attempt to increase their own job security. However, a takeover may be in the
shareholders' best interest.

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2. Stockholders versus Creditors

 Creditors decide to loan money to a corporation based on the riskiness of the
company, its capital structure and its potential capital structure. All of these factors
will affect the company's potential cash flow, which is a creditors' main concern.
 Stockholders, however, have control of such decisions through the managers.
 Since stockholders will make decisions based on their best interests, a potential
agency problem exists between the stockholders and creditors. For example,
managers could borrow money to repurchase shares to lower the corporation's
share base and increase shareholder return. Stockholders will benefit; however,
creditors will be concerned given the increase in debt that would affect future cash
flows.

Motivating Managers to Act in Shareholders' Best Interests

There are four primary mechanisms for motivating managers to act in stockholders' best
interests:
1. Managerial compensation
2. Direct intervention by stockholders
3. Threat of firing
4. Threat of takeovers

1. Managerial Compensation - Managerial compensation should be constructed not only

to retain competent managers, but to align managers' interests with those of
stockholders as much as possible. This is typically done with an annual salary plus
performance bonuses and company shares. Company shares are typically distributed to
managers either as:
 Performance shares, where managers will receive a certain number shares based on
the company's performance
 Executive stock options, which allow the manager to purchase shares at a future date
and price. With the use of stock options, managers are aligned closer to the interest
of the stockholders as they themselves will be stockholders.

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2. Direct Intervention by Stockholders - Today, the majority of a company's stock is

owned by large institutional investors, such as mutual funds and pensions. As such, these
large institutional stockholders can exert influence on mangers and, as a result, the firm's
operations.
3. Threat of Firing - If stockholders are unhappy with current management, they can
encourage the existing board of directors to change the existing management, or
stockholders may re-elect a new board of directors that will accomplish the task.
4. Threat of Takeovers - If a stock price deteriorates because of management's inability to
run the company effectively, competitors or stockholders may take a controlling interest
in the company and bring in their own managers.

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