28 Corporate Finance
Exhibit 1.2 The balanced scorecard
Financial
ROC, Cash flow, etc.Customer Perspective
Customer satisfaction,
market share, etc.Internal Business
Perspective
Hours with customer on new
work, safety incident indexLearning and Growth
Staff attitude, revenue
per employee, etc.IMPEDIMENTS TO SHAREHOLDER WEALTH MAXIMIZATION
Shareholder wealth maximization rule is based on the assumption that other investor groups in the company
are unaffected by the latter’s decisions. There could be potential conflict of interest between shareholders
and bondholders, managers and shareholders, majority and minority shareholders. So, maximizing wealth
of one group could be achieved at the expense of other groups.
Shareholders vs Bondholders
Bondholders get a fixed, contractual payment (interest) during the term of the bond but have a prior claim on
the assets of the company; whereas equity investors have a residual claim on the cash flows of the company
as they are owners. Since bondholders get a fixed slice of the earnings pie, regardless of the size of the earn-
ings, they are more risk averse than shareholders who get to share the upside potential. Bondholders can
suffer opportunity wealth loss due to the company’s investment, financing and dividend decisions. A company
making losses may be tempted to borrow and take on business gambles, the benefits of which largely go to
shareholders. It’s a ‘heads-I-win, tails-you-lose’ strategy. If the project succeeds, shareholders enjoy the up-
side potential but bondholders get fixed interest payment; if the project fails, shareholders have nothing to
lose—it’s not their money anyway. Bondholders make an estimate of default risk at the time of lending and
the price is set assuming that no further debt will be issued. The bondholders’ claim gets diluted if additional
debt is issued with same or higher priority. The increase in default risk leads to a decrease in the price of the
bond. Potential conflicts can arise due to the firm’s dividend decision as well. Bondholders lend money as-
suming that their money will be invested in profitable venture and the cash flows from the project would be
used to service them. If the firm chooses to distribute that money to shareholders in the form of dividends,
the bondholders will be left with an empty shell.