Question

Please read the Graham et al. and discuss why and how management forecast can destroy firm value.

QUESTION

1. Why are managers willing to give up the options that increase firm value?

Answer 1

Owing to lack of integrity in financial markets where investors tend to reward and punish the managers for achieving or failing to achieve the budgeted figures, managers tend to devalue the firm. In particular, the stock price of the company gets hammered when the reported EPS is away from the analyst consensus forecasts by as little as a penny. Managers destroy firm value by making budgets at lower end to sooth the market predictions

As per the survery of CFOs and Managers, market is heavily influenced by earnings rather than cash flows. This has lead to the sutation where under delivering could lead to heavy toll on current valuations. This is why Managers sacrifice long term economic value projects to meet current earning expectations of market.