KR editions 89 to 92

KR-89 (Management refresher V)

The story till now: Whizkid wants to expand his business and for this he needs to raise money. He has an idea to get this money from sources other than financial institutions. He wants to make people pour in some of their savings. But he has a problem.

• What can he give back to people who contribute money? He could announce "I'll give everyone Rs. 1200 at the end of the year". 
• But this assumes that he'll be able to generate an income a lot of income (over a crore) within a year to repay everyone. And certainly no one will trust him. Repaying back (like what a bank does), wouldn't be possible for our whizkid. 
• The only other option left is to tell the people that every contributor will have a stake in the company; 
• What do we mean by a stake in the company? It means that each contributor will have some basic rights/authority over the company, rights over the decisions taken in the company, right to question the company, right to get money in case the company earns profits etc. 
• But there has to be some way of telling each contributor that he is a stakeholder in the company. An official letter stating this might suffice. So everyone who contributes money will be issued a letter stating how much they've contributed. This letter is basically what we call a "stock". 
• Our whizkid can go public by announcing that he is selling (say 10,000) stocks and each stock has a price of Rs.1000. People interested would buy the stocks (an individual can buy more than one stock). When the 1000 stocks are sold, our whizkid would have raised Rs. 1 crore for the corporation. 
• There are a lot more legal formalities involved in the formation of a corporation when compared to a solo/partnership business (and these rules may vary from government to government).

to be continued.....

KR-90 (Management refresher VI)

We've successfully touched the 90s!.
The story thus far: Our whizkid has decided to sell stocks to the public so that he can raise funds for expanding the company.....

• The people who hold stocks of whizkid's company are called "stockholders". 
• The question arises; of what real use is a stock (after all, finally there has to be some monetary benefit to the stockholder; because otherwise he/she might as well have deposited the Rs. 1000 in a bank and earned some interest on it)? 
• There are 2 benefits:- one which is direct and one indirect. 
• 1.) Dividends (these are direct): Let's say our whizkid's company earned huge profits the year after going public (say profits of Rs. 2.5 crores). Remember that in a partnership, the partners would divide the profit equally amongst themselves. Now in a corporation, all the stockholders have a right over the company. So depending on the percentage of shares each one holds, they should be entitled to that much percentage of the profit. If someone has 5000 stocks (out of a total of 10,000) then that person should get Rs. 1.25 crores (this amount is the dividend). But a corporation can't simply give away all the money because they would need to retain some of the profits for future use (like buying more land etc). So out of the Rs. 2.5 crores profit, the corporation might decide that they will give away Rs. 1 crore as dividends to the stockholders while they would retain Rs. 1.5 crores for development of the business. 
• 2.) Capital Gains (the indirect means): When you buy something and sell it for more money you are said to have gained capital. For example: if we were to buy a piece of land for Rs.1.5 lakhs and sell it for Rs. 2 lakhs then our capital gain is 0.5 lakhs. A stock is also similar to other commodities. We buy it at some price and then we could sell it (the selling price would depend on how much someone is willing to pay to buy the stock). 

We'll take a closer look at this in the next edition.
That's all for this week...Have a great weekend (suggestions, comments, KRs welcome)...

KR-91 (Management refresher VII)

We saw that owning a stock can lead to financial benefit in 2 ways: through the dividends and through capital gain.

• Let's explore the capital gain issue; this is actually based on one of the main principles of economics: demand, supply and price relationship. 
• When demand for a commodity is high and supply is low then the commodity price will be high (people are willing to pay since they really want the commodity). 
• For example: the way the movie ticket black market works; a movie show involving a superstar is bound to have plenty of demand (at least for the initial few days)- many people want a ticket (demand is very high) but the number of seats/ tickets available are limited (supply is low). So, a blackie guy having a ticket can quote a high price because he knows that there are many people who desperately are wanting a ticket but can't get one.
• Demand high, supply low (limited) implies soaring prices! 
• The oppostie scenario: When demand is low and supply is high then the price of the commodity will be really low. For example if a manufacturer has ended up producing 1000 soap bars when there is a demand for only 10 in the market; then the price of the soap bar has to be reduced. Why? By reducing the price more people might buy the soap bar (it might tempt some people to buy a cheap soap bar). But if the price is high; then people won't even consider buying. 
• Same logic applies to the black market as well. If the film flops and our blackie has many tickets with him; he can't demand money because no one wants it- but if he reduces it (might have to reduce it below the normal rate), then some people might buy it because the ticket is cheap (our blackie guy incurs a loss but at least he gets something)! 
• Same applies to stocks which are also like commodities. Stocks are just a piece of paper which have been bought; thus they can be resold as well.
• Food for thought: you should now be able to figure out how and why stock prices vary?

That's all for this edition (we'll soon try to alternate between tech. and management editions),

KR-92 (Management refresher VIII)

We've seen our whizkid issue stocks to raise capital and we've also seen some of the benefits for a stockholder.
One question arises: if there are so many people who have a right on our whizkid's company, then how will they manage the company? Too many cooks spoil the broth!

• Our stockholders won't be able to run the company (maybe some of them can but certainly all can't take part in management); so the stockholders elect the directors and a person to head the company- the CEO (chief executing officer). This leads to two divisons: the stockholders and the management. Stockholders elect the management to run the company on their behalf. 
• The interests of the stockholders is that the value of the stock should increase in the market. How does that happen? When demand rises the price automatically rises. The number of stocks are limited and if many people want to buy the stocks of a particular company, then the stockholders can demand more and the stock price would have an upward trend. 
• Thus the managers of the company are expected to increase the price of the stocks in the market (and also the dividends paid out). But whenever a piece of work is delegated to someone else there is bound to be conflict of interests. 

AGENCY CONFLICTS

• In our case, the stockholders want the stock price to increase but what about the managers? Generally managers don't own a major share of stocks; thus even if the stock prices rise they won't be benfitted much. The managers might thus spend more on other personal things- like increasing salaries, hiring more people, trying to increase their influence and power in the company (so that they can't be fired) etc. This is termed an "agency conflict" (i.e. conflicts arising when work is delegated to someone else). 
• To deal with this there are various methods but one point to note is that "the stockholders elect the management team to run the organization. So if managers spend more money on personal luxuries then the profits will dip, expenses will rise, company performance will dip etc. When that happens the stockholders might decide to sack the management/CEO". It has a cascading/rippling effect; the CEO has to ensure that people under him/her aren't spending extravagantly, if they do he/she takes action; the people under the CEO have to keep an eye on activities running under their nose; in case something is wrong they have to take action and so on. This woukd ensure that no one deviates too far for personal gains.

Well, that's all for this edition; we shall take a short break from management and resume where we've left off later (perhaps after a couple of techie editions).
Before we sign off; did you know that we have clipboards in mainframes?

Go back to the main contents page