Corporate investment analysis and valuation methods

Financial Analysis

Over the past decade, increasing attention has been paid to the issue of corporate governance. As a result of multiple major scandals, new laws have been passed and the role of the SEC has been expanded. Sarbanes-Oxley introduced sweeping corporate governance reforms, and despite its high costs there are many tangible benefits. Many business advocates argue for lower regulatory standards, but there is a strong economic case to be made for higher regulatory standards.

The function of corporate governance is to protect the interests of shareholders. When a scandal occurs on the scale of Enron, billions of dollars of shareholder wealth are wiped out. The fallout from such governance failures has such a wide-ranging impact on the economy that the government must become involved, to preserve the overall health of the economy. The direct impacts of governance failure are on the shareholders. The wealth that they lose is taken out of the economy in a couple of ways. The shareholders are no longer able to spend that money. As well, they will need to increase their savings rate in order to attempt to make up for those losses.

Additionally, the impact on public confidence affects the economy. Without strong governance, investors are less likely to put faith in equity markets. This will make it more difficult in future for firms to raise capital. Either they will be unable to raise equity financing altogether, or they will need to offer more to investors to raise the funds. An increase in the cost of capital means that corporations will have less money to spend on capital projects, resulting in slower job growth in the economy. Additionally, the higher cost of capital will equate to a higher discount rate, which reduces the number of projects that management teams will be willing to undertake. This again results in slower job growth.

The Securities Exchange Commission is responsible for the enforcement SOX provisions and other governance issues. The government should maintain this role within any corporate governance framework, because the SEC has the teeth and the expertise to properly address the issue. Other government departments such as the Department of Justice do become involved occasionally, but their ability to manage the nation's capital markets is not as strong. One of the benefits of tighter governmental regulation is that investors are unlikely to a trust a corporate world that regulates itself. In the long run, companies that have poor governance issues can be expected to fail, or to have difficulty finding investors, but even today the average investors lacks perfect information. Therefore some provision must exist for government to intervene in the markets. Remember that strong rule of law is one of the prerequisites for private investment, and its absence will reduce the amount of investment capital in the economy. Having legislation in place and enforcement mechanisms run by an agency with the SEC's high level of experience will encourage investors, allowing them to inject new capital into the marketplace.