Why and How Management Forecast Can Destroy Firm Value
Earnings are an important indicator of performance; therefore, from time to time, companies will make a forecast on projected earnings. CFOs narrates that the importance of preparing performance benchmarks is to create speculations on the stock price based on expected performance. The responses obtained from the CFOs private company indicate that the main reason of meeting the benchmark set is to build credibility with the capital market consequently it will translate to improved performance of the stock and extend the reputation of the management. Such objectives come at the expense of the need to convey future growth prospects to investors and ensuring that the stability of the business. The management view on the value of the firm is increasing market capitalization at the expense of other components of performance; in that view, the firm’s value is destroyed.
Why Managers Are Willing To Give Up the Options That Increase Firm Value
An entity’s value is the total of all stakeholders claims; in other words, a firm’s value is the economic value a business can fetch in the market. According to Graham et al., Shareholders are the real owners of the company who hire an administrator to manage the entity. The management team performance is evaluated based on earnings reported; hence, the finance officer will sacrifice the value of the firm in favor of meeting earnings expectations. CFOs perceive earnings as the best way of determining the firm’s value ahead of a more practical technique of valuation where the emphasis is on free cash flows generated from the business. Managers hold a short term view on business performance hence laying a higher weight on cash flows from operations.