Introduction

Founded in 2014 by Nick Molnar and Anthony Eisen, Afterpay rapidly emerged as a leader in the “buy now, pay later” (BNPL) sector, exemplifying how strategic financial management can drive substantial growth and shareholder wealth. By 2021, the company had expanded its services across multiple countries, including Australia, the United States, and the United Kingdom, amassing millions of users and merchants. This impressive trajectory culminated in a $39 billion acquisition by Block, Inc. (formerly Square) in January 2022. [footnote 1]

However, post-acquisition, Afterpay faced significant financial challenges. In the first half of fiscal year 2022, the company reported an after-tax loss of $345.5 million, a substantial increase from the $79.2 million loss in the previous corresponding period.

This downturn raised concerns about the sustainability of its business model and the effectiveness of its financial strategies.

These developments underscore the critical importance of robust financial management in achieving corporate objectives and creating shareholder value. They also highlight potential agency problems—conflicts of interest between management and shareholders—that can arise when strategic decisions do not align with shareholder interests. Effective corporate governance is essential in mitigating these issues, ensuring that management actions are transparent, accountable, and aligned with the long-term goals of the company.

In this chapter, we will explore the foundational principles of financial management, examine the nature of agency problems, and discuss the role of corporate governance in fostering ethical and effective decision-making. We will illustrate how these concepts interplay in real-world scenarios, providing insights into the complexities of managing a growing enterprise in today's dynamic financial landscape.

Learning Objective 1: The role of Financial Management

1.1. What is Business Finance?

Business finance, also known as corporate finance, is a field of study that focuses on various financial decisions that the financial manager makes to achieve the business objective. Business finance encompasses activities such as budgeting, forecasting, investment analysis, raising capital, managing costs, and ensuring effective allocation of resources to support both short-term operations and long-term growth. It plays a critical role in decision-making processes related to investments, risk management, and financial sustainability, helping businesses maintain solvency and profitability in a competitive market environment.

In modern organizations, the Chief Financial Officer (CFO) typically serves as the company’s top financial manager, overseeing all financial operations and strategic decision-making. Supporting the CFO are other key financial roles, such as the Treasurer, who manages the firm’s cash flow, investments, and financing activities, and the Controller, responsible for financial reporting, budgeting, and compliance. Together, these financial managers ensure the organization's financial health and align its operations with strategic goals.

1.2. What is a business?

While a very small business can be organized as a sole proprietorship or a partnership, most larger businesses are organized as a company. A company is a type of business organization that exists as a distinct legal entity, separate from its owners. It has its own rights and responsibilities, such as entering contracts, owning assets, and bearing liabilities.

Some defining features of a company include:

• it has limited liability
• it has an infinite life that is not dependent on the life of its owners
• ownership of the company is separate from is management
• ownership transfer is through selling/buying shares

1.3. Key financial decisions

Invesment decisions

Investment decisions, also referred to as capital budgeting decisions, are among the most critical and long-term choices a business makes. These decisions determine which investments or projects the company will undertake, shaping the organization's future and its ability to generate value. At its core, an investment decision involves selecting the types of assets a company wants to acquire or develop.

In fact, the very foundation of a business begins with an investment decision—an owner chooses to allocate resources to produce a specific product or service. This initial step influences subsequent actions, such as marketing, strategy, and growth planning. Moreover, businesses continuously invest in new ideas and products to remain competitive.

For instance, Facebook's acquisition of WhatsApp exemplifies an investment decision aimed at strengthening its messaging ecosystem. Similarly, Disney’s plan to develop a theme park in Rio de Janeiro reflects a strategic investment in expanding its global entertainment footprint. These decisions highlight the pivotal role of investments in driving innovation, growth, and sustainability in business.

Financing decisions

Financing decisions determine the source of funds a company uses to support its investment decisions, shaping its capital structure—the mix of debt and equity employed in funding operations and growth. These decisions involve choosing between two broad sources of financing: debt and equity, or a combination of both. Debt financing typically involves borrowing from banks or issuing bonds, while equity financing entails raising funds by selling shares to investors. The choice between these options significantly impacts a company’s financial leverage, cost of capital, and shareholder dynamics.

A recent example is Rio Tinto, a leading Australian mining corporation. In its pursuit to acquire Arcadium Lithium for nearly $10 billion, Rio Tinto considered issuing new shares to finance the deal. This equity-focused financing decision was aimed at increasing its Australian shareholder base, particularly given its primary listing on the London Stock Exchange. Issuing equity, rather than taking on debt, would adjust Rio Tinto’s capital structure by increasing the proportion of equity. This approach also aligned with strategic objectives, such as maintaining financial flexibility and navigating complex shareholder dynamics, including those involving Chinalco, a Chinese state-owned enterprise with a significant stake in Rio Tinto.

This case highlights how financing decisions—whether to use debt, equity, or a mix—directly shape a company’s capital structure. Such decisions are integral to supporting investment initiatives, managing risks, and aligning financial strategies with long-term corporate goals and stakeholder interests.

Dividend Decisions

The dividend decision is a crucial aspect of financial management, representing a trade-off between retaining profits to reinvest in the business and paying dividends to shareholders. Companies must carefully evaluate how much of their profits should be distributed and how much should be retained, based on their investment needs and position in the business life cycle.

For instance, a company like Disney, which is considering a major capital investment such as building a theme park in Rio de Janeiro, may choose to retain a significant portion of its profits to fund this large-scale project. Similarly, a company like Facebook, after acquiring WhatsApp as part of its growth strategy, may prioritize retaining earnings to support future technological development or expansion.

In contrast, mature companies with stable cash flows and fewer growth opportunities may distribute a larger portion of their profits as dividends to reward shareholders. The dividend decision reflects a company’s financial strategy, balancing shareholder expectations with the need to fund growth and sustain long-term value creation.

In summary, the role of financial management is to make good decisions relating to investment, financing and dividends to achieve the corporate objectives.

Learning Objective 2: The business objective(s)

2.1. The traditional business objective

In the previous learning objective, we explored the three critical decisions a company must make. But what is the ultimate purpose of these decisions? Is it to:

• Maximise revenue
• Minimise costs
• Maximise profit
• Maximise share price

Let’s examine these options one by one:

Should the company maximise revenue?
Maximising revenue alone cannot be the firm’s objective because it does not account for the costs incurred in generating that revenue. High revenues without managing expenses may lead to financial losses.

Should the company minimise costs?
Minimising costs indiscriminately can also be detrimental. For example, cutting expenses by avoiding investments in assets like machinery or buildings could hinder growth and, in the long run, put the company at risk of going out of business.

Should the company maximise profit?
Maximising profit might seem logical, but when we talk about profit, we usually refer to accounting profit, which can be influenced by changes in accounting rules. For instance, Facebook’s earnings once increased by $934 million simply due to changes in how employee stock options were accounted for.[footnote 3] This highlights how accounting profit may not always reflect the true economic value of a company.

Should the company maximise share price?
The most widely accepted objective is to maximise the current share price, as this directly benefits the owners by increasing their wealth. The share price reflects the market's expectations about the company’s future performance and incorporates both current earnings and growth prospects. For firms that are not publicly listed, this objective aligns with maximising owners’ equity.

By focusing on maximising share price, a company prioritises sustainable growth, efficient resource allocation, and long-term value creation for its owners.

2.2. Revaluating the business objective in a changing world

Traditionally, since the days of Milton Friedman [footnote 4], the primary objective of a company has been to maximise share price, focusing on creating wealth for shareholders. However, the modern business landscape demands a broader perspective. Companies must now act responsibly to avoid further harm to society and the environment. Increasingly, regulators are introducing policies to ensure corporations engage in socially responsible behaviour. But do customers and investors genuinely care about these issues?

Yes, they do. Recent studies, such as the 2021 Global Consumer Insights Pulse Survey and Visual GPS research, reveal that 55% of customers actively choose sustainable products that help protect the environment. Customers value corporate responsibility and are more inclined to support companies that communicate their eco-friendly practices through advertising and outreach. Many consumers also report personal efforts to reduce their environmental impact, reflecting a growing awareness and demand for sustainability.

Who are these customers? Notably, consumers in the Asia-Pacific region, particularly in countries like the Philippines, Indonesia, Vietnam, Egypt, and the UAE, show heightened eco-consciousness. These environmentally aware individuals, often aged 23 to 32, represent a generation committed to driving sustainable practices.

This aligns with the United Nations' 17 Sustainable Development Goals (SDGs), a blueprint for a sustainable future. Corporations have the potential to contribute meaningfully to these goals, such as promoting good health and well-being, achieving gender equality, encouraging responsible consumption, and addressing climate change. By integrating these objectives into their strategies, businesses can support both societal progress and environmental preservation, preparing the world for future generations while maintaining their relevance in a changing market.

Image source: un.org

It may be time to reconsider the traditional objective of firms. A more holistic approach suggests that the overall goal of a firm should be to maximise welfare, encompassing social, environmental, and economic well-being. This broader objective aligns with and supports the financial goal of maximising share price. Firms that act responsibly toward society and the environment attract socially conscious investors, leading to increased investment and, ultimately, higher share prices over time. This perspective is backed by academic research, which demonstrates that socially responsible behaviour can enhance long-term financial performance while contributing positively to broader societal goals. [footnote 5]

Learning Objective 3: The agency problem

3.1. The agency problem - an example

The agency problem arises due to the separation of ownership and management in a company. It refers to a potential conflict of interest between a company's management (agents) and its shareholders (principals). Even when a manager is a major shareholder, personal actions can conflict with the company's best interests, exemplifying this issue.

Other contributing factors leading to the agency problem includes

• Asymmetric Information: Managers often have more information about the company than shareholders, leading to decisions that may not align with shareholder interests.
• Risk Preferences: Shareholders may favour higher-risk projects to maximize returns, whereas managers often prefer lower-risk strategies to safeguard their positions.

In October 2024, Richard White, founder and then-CEO of WiseTech Global, resigned amid allegations of personal misconduct, including offering business advice in exchange for personal favours and involvement in legal disputes over luxury assets. These controversies led to a significant decline in WiseTech's share value, eroding shareholder wealth. [footnote 6]

Despite being a major shareholder, White's actions prioritized personal interests over corporate welfare, highlighting the agency problem. His resignation, though intended to protect the company, underscores the complexities when personal conduct of key executives adversely affects shareholder value.

This case illustrates that even when management holds substantial ownership, personal misconduct can lead to conflicts of interest, necessitating robust corporate governance to align management actions with shareholder interests and uphold corporate integrity.

3.2. Consequences of the agency problem

The agency problem can have significant negative implications for a company, affecting its financial performance, reputation, and relationships with stakeholders as detailed below.

• Decreased Shareholder Value: When management prioritizes personal goals over shareholder interests, it can result in suboptimal decisions that reduce profits and depress share prices. For example, excessive executive perks or wasteful spending may erode company value.
• Increased Monitoring Cost: To mitigate the agency problem, companies may implement costly oversight mechanisms such as audits, performance-based compensation, and corporate governance frameworks, which increase operational expenses.
• Misdirection of Resources: Management may pursue projects or investments that serve personal interests but do not align with the company’s strategic goals, leading to inefficient resource allocation and reduced competitiveness.
• Conflicts Between Shareholders and Bondholder: Shareholders might favour high-risk investments to maximize returns, whereas bondholders prioritize stability and debt repayment. This conflict can increase borrowing costs or impose restrictive covenants on the company.
• Reputational Damage: Misaligned decisions or unethical behaviour can harm the company’s reputation, making it less attractive to investors, customers, and employees.
• Reduced Investor Confidence: Agency problems can create uncertainty about the company's governance and financial health, discouraging investment and potentially increasing the cost of capital.
• Increased Risk of Corporate Failures: If agency problems are left unchecked, they can lead to financial mismanagement or ethical scandals, potentially resulting in legal penalties, loss of market share, or even bankruptcy.

Addressing the agency problem requires a combination of transparent corporate governance, incentive alignment, and effective oversight mechanisms to ensure that management acts in the best interests of shareholders and other stakeholders. This is the focus of our next learning objective.

 

Learning Objective 4: Governance

Governance or Corporate governance refers to the system of rules, practices, and processes by which a company is directed and controlled. It establishes the framework for achieving accountability, transparency, and fairness in a company’s relationship with its stakeholders, including shareholders, management, customers, and employees. Effective corporate governance ensures that decisions are made in the best interests of the company and its shareholders, balancing short-term objectives with long-term sustainability.

While there are numerous corporate governance mechanisms to ensure the alignment of managers' interest to that of shareholders, two of the most common mechanisms are the board of directors and executive remuneration.

4.1 Board of directors

The board of directors is a governing body elected by a company’s shareholders to represent their interests and oversee the organization’s management. All publicly listed companies are legally required to have a board of directors. Many non-profits and private companies also choose to have a board of directors although they are not by laws required to do so.

The board is typically headed by a chairperson and comprises individuals with diverse skills, experience, and expertise that allow it to oversee the company's strategic direction and monitor management's performance.

To enhance efficiency and ensure focused oversight, the board of directors often establishes sub-committees with specific responsibilities. Common sub-committees include:

• Audit Committee: This committee ensures the accuracy and integrity of the company’s financial reporting, monitors compliance with legal and regulatory requirements, and oversees both internal and external audit processes.
• Risk Management Committee: Responsible for identifying, assessing, and mitigating risks, this committee ensures the company’s strategy and operations are resilient to financial, operational, and strategic threats.
• Nomination and Remuneration Committee: This committee identifies qualified candidates for board and executive positions and designs remuneration policies that align executive incentives with the company’s long-term performance and shareholder interests.
• Sustainability Committee: Focused on the company’s environmental, social, and governance (ESG) initiatives, this committee ensures the company operates sustainably, addresses climate-related risks, and meets stakeholder expectations regarding corporate responsibility.

The Australian Securities Exchange (ASX) Corporate Governance Principles and Recommendations [footnote 7] provide a framework for listed companies to promote transparency, accountability, and long-term value creation. In relation to the board of directors, key principles include:

1. Board Composition and Structure:
   • The board should consist of a majority of independent directors to ensure impartial decision-making.
   • The chairperson should ideally be independent and not the CEO, providing a clear separation of roles.
2. Skills and Diversity:
   • The board should have an appropriate mix of skills, experience, and diversity to effectively oversee the company’s operations and strategy.
   • Companies are encouraged to disclose a board skills matrix to ensure that the board’s capabilities align with the organization’s needs.
3. Responsibilities and Accountability:
   • The board is responsible for overseeing the company’s strategic direction, risk management, and financial performance.
   • Directors should act in the best interests of the company and its shareholders, ensuring ethical and transparent decision-making.
4. Nomination and Appointment:
   • A Nomination Committee should be established to identify and recommend qualified candidates for board positions, ensuring the board remains effective and aligned with the company’s strategic goals.
5. Evaluation and Performance:
   • Regular evaluations of board and individual director performance should be conducted to ensure accountability and continuous improvement.
   • Companies should disclose their board evaluation processes in their annual governance statements.
6. Risk Oversight and Sustainability:
   • The board should actively oversee the company’s risk management framework and ensure the integration of sustainability and Environmental, Social, and Governance (ESG) considerations into strategic decision-making.
7. Remuneration:
   • The board should ensure that director and executive remuneration is fair, reasonable, and aligned with shareholder interests, with a clear link to the company’s performance.

4.2 Executive Remuneration

Executive remuneration is a critical tool for promoting good corporate governance by aligning the interests of executives with those of shareholders. It typically comprises four key components:

1. Fixed Salary: Provides a stable income for executives, reflecting their experience and responsibilities, while ensuring they remain focused on their roles.
2. Short-Term Incentives (STIs): Often tied to annual performance metrics, such as revenue growth or profitability, these bonuses reward executives for achieving specific short-term goals.
3. Long-Term Incentives (LTIs): These include equity-based rewards such as stock options or performance shares, which are directly tied to the company’s long-term success. LTIs encourage executives to focus on sustainable growth and align their interests with shareholders by linking compensation to share price performance.
4. Other Benefits: These may include perks such as retirement contributions, health insurance, company-provided vehicles, or housing allowances. While not directly tied to performance, these benefits help attract and retain top talent and provide additional support to executives.

By combining these components and linking them to well-defined performance criteria, companies can incentivize ethical decision-making, foster accountability, and ensure executives prioritize the company’s long-term success over short-term gains. Transparent and fair remuneration policies also build trust among stakeholders, reinforcing good governance practices.

Key concepts in this topic

• Role of Financial Management:
  Financial management focuses on planning, obtaining, and utilizing financial resources to achieve the company’s strategic goals. It involves making critical decisions about investments, financing, and dividend policies to maximize the company's value and ensure financial stability.
• Objective of a Company:
  Traditionally, the primary objective of a company is to maximize shareholder wealth, often reflected in the share price. However, modern perspectives emphasize balancing this goal with broader responsibilities, such as promoting sustainability and addressing societal and environmental impacts.
• The Agency Problem:
  The agency problem arises from conflicts of interest between management (agents) and shareholders (principals), or between shareholders and bondholders. Misaligned incentives can lead to decisions that prioritize personal gain over the company’s success, requiring mechanisms like performance-based compensation and governance frameworks to mitigate these issues.
• Corporate Governance:
  Corporate governance refers to the system of rules and practices that guide a company’s operations and decision-making. It ensures accountability, transparency, and fairness, with mechanisms such as the board of directors and sub-committees (e.g., audit, risk management, nomination, and sustainability) to align management actions with the company’s objectives and stakeholders’ interests.

Footnote

1. For more detail see Investors Block
2. For more detail see Small Caps
3. For more detail see Accounting Change Boosts Facebook’s Earnings | CFO.com
4. For more detail see Milton Friedman - Wikipedia
5. For more detail see Where Friedman Was Wrong - ProMarket
6. For more detail see The Australian
7. For more detail see Corporate governance principles and recommendations

References

• Peirson, G., Brown, R., Easton, S. A., Howard, P., & Pinder, S. (2015). Business finance (Twelfth edition). McGraw-Hill Education.
• Ross, S. A., Trayler, R., Hambusch, G., Koh, C., Glover, K., Westerfield, R., & Jordan, B. (2021). Fundamentals of corporate finance (Eighth edition.). McGraw-Hill Education (Australia) Pty Limited.
• Parrino, R., Au Yong, H. H., Dempsey, M. J., Ekanayake, S., Kidwell, D. S., Kofoed, J., Morkel-Kingsbury, N., & Murray, J. (2014). Fundamentals of corporate finance (Second edition.). John Wiley and Sons Australia, Ltd.