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Chapter 1 Case: Assessing the Goal of Sports Products, Inc.
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Loren Seguara and Dale Johnson both work for Sports Products, Inc., a major producer of boating equipment and accessories. Loren works as a clerical assistant in the Accounting Department, and Dale works as a packager in the Shipping Department. During their lunch break one day, they began talking about the company. Dale complained that he had always worked hard trying not to waste packing materials and efficiently and cost-effectively performing his job. In spite of his efforts and those of his co-workers in the department, the firm’s stock price had declined nearly $2 per share over the past 9 months. Loren indicated that she shared Dale’s frustration, particularly because the firm’s profits
had been rising. Neither could understand why the firm’s stock price was falling as profits rose. Loren indicated that she had seen documents describing the firm’s profitsharing plan under which all managers were partially compensated on the basis of the firm’s profits. She suggested that maybe it was profit that was important to management, because it directly affected their pay. Dale said, “That doesn’t make sense, because the stockholders own the firm. Shouldn’t management do what’s
best for stockholders? Something’s wrong!” Loren responded, “Well, maybe that explains why the company hasn’t concerned itself with the stock price. Look, the only profits that stockholders receive are in the form of cash dividends, and this firm has never paid dividends during its 20-year history. We as stockholders therefore don’t directly benefit from profits. The only way we benefit is for the stock price to rise.” Dale chimed in, “That probably explains why the firm is being sued by state and federal environmental officials for dumping pollutants in
the adjacent stream. Why spend money for pollution control? It increases costs,lowers profits, and therefore lowers management’s earnings!”
Loren and Dale realized that the lunch break had ended and they must
quickly return to work. Before leaving, they decided to meet the next day to continuetheir discussion.
a. What should the management of Sports Products, Inc., pursue as its overriding goal? Why?
b. Does the firm appear to have an agency problem? Explain.
c. Evaluate the firm’s approach to pollution control. Does it seem to be ethical? Why might incurring the expense to control pollution be in the best interests of the firm’s owners despite its negative effect on profits?
d. Does the firm appear to have an effective corporate governance structure? Explain any shortcomings.
e. On the basis of the information provided, what specific recommendations
would you offer the firm?
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Solution Preview
a. What should the management of Sports Products, Inc., pursue as its overriding goal? Why?
The overriding goal of management of Sports Products should be to maximize the wealth of the shareholder of the organization. The corporate objective function of maximizing shareholder wealth assumes that managers operate in the best interests of stockholders, not themselves, and do not attempt to expropriate wealth from lenders to benefit stockholders. Stockholder wealth maximization also assumes that managers do not take actions to deceive financial markets in order to boost the price of the firm’s stock. Another assumption is that managers act in a socially responsible manner and do not create unreasonable costs to society in pursuit of stockholder wealth maximization. Therefore, management of above mentioned organization should strike a balance in terms of maximizing shareholder wealth and at the same time, …
