**2. Company value**

business activities from the universal owner-entrepreneurs to the well-educated and welltrained professionals who should perform all of their tasks in the best interests of the owners of such large and complex economic entities. This feature of contemporary economics has been made possible through the transparent and efficient financial market, particularly the capital or, more specific, the stock market. The stock market allowed the generalization of individual and personalized owner's goals and transformed them at a level of the company's long-term stock market values, and the stock market values became the owner's instrument

The separation of ownership and entrepreneurship raises the issue of additional mediation between people because of the entrepreneurship and property rights which were once contained in a single person (i.e., owner), now manifest through the action of the managers as the agents (the principal) working under conditions of information asymmetries. Therefore, one can conclude that the agency problem [1] exists not only in modern public corporations with the relation between the management and the owners, but also within owner interest groups, primarily between small and large shareholders, those who hold significant interests in the company. Agency theory [2] shows how the problem of agents in terms of conflict of interest can lead to specific securities' categories agency cost [3]. The problems of agents and associated information asymmetries have begun to interest the academics and the practitioners in the early twentieth century, especially after the Great Crisis [4] in a framework known as

It is possible to significantly reduce the agency problem in an environment that increases the information symmetry between agents and principals, managers, and owners (shareholders). Therefore, for a public company, the communication with public investors on financial markets is *conditio sine qua non* of existence as well as the privilege of the public company to obtain the largest amount of capital at the lowest costs [5]. This necessity is primarily related to communication with existing and potential shareholders. However, possible conflicts of interest between creditors and owners may also arise. Conflicts of interest are commonly brought up in the context of over indebtedness and deterioration of the company, unless one does not wish to expand the concept of a creditor on those who spontaneously lend to the company,

The financial economy and the financial industry are considered to be important and extremely sensitive segments of the economy, which is why the financial markets, particularly the capital market, are highly regulated. Of course, this implies that the financial market regulation and financial supervision, have a significant impact on the public company communication with the overall investment public. Financial supervision is organized differently in different countries. Still, most often, it is decentralized, with demands that often impose supervision of banks focused primarily on banking business and the protection of creditors [6]. In a broader sense, public company communication with investors is affected also with other supervisory bodies in the economy. The globalization of the financial markets on public company's communication with investor's public is increasingly affected by the international financial supervision, where once again the supervision of banks dominates, along with dif-

ferent international bodies responsible for communication harmonization.

for achieving greater wealth.

116 Firm Value - Theory and Empirical Evidence

corporate governance.

such as, for example, the vendors.

Corporate governance is a complex concept which is differently understood, in part due to the broad understanding of the term "governance," as the job between the board and the reign. However, both the board and the reign have their legal basis, but with respect to those that are managed or governed, it can also be based on promises (paraphrase of [7]). Because of this, the communication with those who are governed, as well as with other stakeholders, is an integral part of corporate governance. Corporate governance encompasses processes, customs, laws, policies, regulations, and institutions that affect how a firm is managed and controlled. Although corporate governance refers to many stakeholders, it is mainly focused on the shareholders of the company.

Corporate governance is an internal system which comprises policies, processes, and people that serve the needs of shareholders and other stakeholders, by directing and controlling management activities according to sound business practice, company goals, responsibilities, and integrity. Proper corporate governance is evaluated by obligations made to the external market and legislation, as well as by healthy governance that protects policies and processes [8]. It is aimed at maintaining the balance between economic and social goals and likewise between individual and common goals. The aim is to align the interests of individuals, corporations, and society as nearly as possible [9]. Corporate governance could also be considered as an economic discipline focused on incentive mechanisms for motivating the management of a corporation, such as contracts, organizational schemes, and legislation. It is often limited to issues of improving financial performance of the company [10].

Corporate governance is primarily focused on the principal-agent problem and asymmetry of information in creating value for shareholders. Valuation under corporate governance is also connected with the transaction cost theory introduced by Ronald Coase [11]. Principals are shareholders, and the principal-agent problem is often observed between shareholders, government, and executive management. The role of government is to protect the interests of shareholders, or to direct the business according to shareholders' interests. Essential aspect of effective corporate governance with lowest possible agency costs is whether the government will assume the role of managing operations (executive management) or will it be protecting the interests of shareholders. Furthermore, agency problem can be observed inside interest groups with key potential conflicts among shareholders, primarily between large and small stockholders. The great, as a rule, appears as a part of the Administration, and to some extent directs the company according to their partial interests.

Every business is a specific, distinctive operating unit, which, to a degree, makes every firm unique. On one hand, this uniqueness determines the risk of investments, but on the other hand, fit determines the desirability of investment in its business. Business' uniqueness impacts both risk and desirability of investments, as well as the value of assets and earnings. In short, it reflects firm's earnings power value. Expected earnings must be evaluated with opportunity costs, founded on risk-reward trade-off. Opportunity costs can be quantified with risk adjusted discount rate for determining earnings present value. This refers to the net present concept of business cash flows which quantitatively depends on discount technique. Each of the aforementioned components of business value has a specific influence on its value. They can be combined in various ways with a, sometimes, surprising result. For example, a firm which owns respectable assets can produce goods unaccepted by the market and in turn loses money in operations. For a normal investor, the value of this firm is pore. However, for an only competitor, this firm may have a high acquisition value to obtain monopolistic extra profits, or to acquire assets below replacement costs for additional outputs. In contrast, a firm with pore assets can produce high profits and generate significant cash flows, if its location allows monopolistic position. However, with the construction of new roads, the location of

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If the observed value of a company from the buyer's or investor's standpoint is in the equity, then it is certainly the case of buying earning power of the expected cash flows. Such an investor plays the role of external analysts who observes the component of earning power more easily in the financial potential of the assets, because the fine procedures of using that potential in the realized and expected profits and cash flows, which can be easily detected by an internal analyst, are hidden from him. This, of course, does not mean that an external analyst

If the company's assets are its earning potential, then the value of a company can be viewed as the total value of the assets and as the value of the expected cash flows. Even more, under certain conditions, these two values should be equal. This means that the market value of the assets of the company in its basis should have the present value of the expected cash flows from its profitable use. These expected cash flows will be, in a variety of ways, distributed across the company's investors, so that the value of the companies' financing instruments (stocks and bonds and other financing contracts) must be equal to the value of the assets of the company. This is because one deals with the present value of the same amount of expected

One can declare the market value as the intrinsic value that corresponds to the value of the earning strength only in the conditions of a perfect market, which acts as an ideal laboratory for the analysis of the economic impact solely according to the model of the Nobel Prize winners, Modigliani and Miller [16]. Even then, it is valid only in the conditions of the market equilibrium, where all assets and all liabilities are fairly evaluated with market prices [17]. Namely, in the conditions of equilibrium on the perfect market, all assets and liabilities are perfectly marketable and have no doubtful transparent prices. In such conditions, the company is worth as much as its total assets and that is the present value of expected cash income from its holdings. This value must match the value of the obligations of the company

will avoid exploring deeply the component values of the analyzed companies.

this firm can become bad and disable future high profitability.

cash flows, which are allocated with the financing instruments.

The principal-agent problem under asymmetry of information incites communication between the firm and its shareholders. In this sense, financial reporting is, along with other publications and announcements for the investment community, subject to corporate governance. While investors seek to influence the practice of financial reporting and communication of publicly traded companies with their financial environment (primarily through associations of financial analysts), the fact is that financial reporting is strongly influenced by financial supervision and is primarily concerned with protecting creditors and preserving the stability of financial institutions and the financial system in general. This argument is further enforced with practices of earnings management. This is significantly under the influence of financial market regulation, several corporate governance standards, and is, to a great extent, under the influence of the financial market's strength to force corporate administration to established dividend policy in the interests of the small shareholders [12].

Regardless of the interests of other stakeholders, corporate governance is always focused on satisfying the interests of the owners of the corporation. Their interest can be viewed through a consensually accepted goal of the firm in the context of financial analysis—long-term increase in stock value, which is always the subject to the interdependence of risk and reward [13]. According Peterson [14], the value of all businesses, large or small, is based on these three components:


A business owns specific assets. Total assets represent the specific financial potential available for making money. This implicates that a business may hold assets which might prove unnecessary for operations and could be questionable to profitable holding. Assets can be found in the business's balance sheet, which is thus a starting point for firm's asset evaluation and a useful indicator of business value.

Every business earns through its business operation. This can be viewed as profits or incomes or as cash flows. Firm's profits are determined with accounting convention based on both commodity and cash flows, while firm's cash flows, as earnings results, are determined on cash flows. Realized profits in near or distant past can be found in profits and losses (or income) statements. This makes aforementioned statements a starting point for forecasting firm's earnings [15]. Earnings analysis is the first step for analyzing the earnings power as well as analyzing and forecasting the expected cash flows as usable economics incomes unlike profits as accounting or accrual income.

Every business is a specific, distinctive operating unit, which, to a degree, makes every firm unique. On one hand, this uniqueness determines the risk of investments, but on the other hand, fit determines the desirability of investment in its business. Business' uniqueness impacts both risk and desirability of investments, as well as the value of assets and earnings. In short, it reflects firm's earnings power value. Expected earnings must be evaluated with opportunity costs, founded on risk-reward trade-off. Opportunity costs can be quantified with risk adjusted discount rate for determining earnings present value. This refers to the net present concept of business cash flows which quantitatively depends on discount technique.

will assume the role of managing operations (executive management) or will it be protecting the interests of shareholders. Furthermore, agency problem can be observed inside interest groups with key potential conflicts among shareholders, primarily between large and small stockholders. The great, as a rule, appears as a part of the Administration, and to some extent

The principal-agent problem under asymmetry of information incites communication between the firm and its shareholders. In this sense, financial reporting is, along with other publications and announcements for the investment community, subject to corporate governance. While investors seek to influence the practice of financial reporting and communication of publicly traded companies with their financial environment (primarily through associations of financial analysts), the fact is that financial reporting is strongly influenced by financial supervision and is primarily concerned with protecting creditors and preserving the stability of financial institutions and the financial system in general. This argument is further enforced with practices of earnings management. This is significantly under the influence of financial market regulation, several corporate governance standards, and is, to a great extent, under the influence of the financial market's strength to force corporate administration to established

Regardless of the interests of other stakeholders, corporate governance is always focused on satisfying the interests of the owners of the corporation. Their interest can be viewed through a consensually accepted goal of the firm in the context of financial analysis—long-term increase in stock value, which is always the subject to the interdependence of risk and reward [13]. According Peterson [14], the value of all businesses, large or small, is based on these three

A business owns specific assets. Total assets represent the specific financial potential available for making money. This implicates that a business may hold assets which might prove unnecessary for operations and could be questionable to profitable holding. Assets can be found in the business's balance sheet, which is thus a starting point for firm's asset evaluation and a

Every business earns through its business operation. This can be viewed as profits or incomes or as cash flows. Firm's profits are determined with accounting convention based on both commodity and cash flows, while firm's cash flows, as earnings results, are determined on cash flows. Realized profits in near or distant past can be found in profits and losses (or income) statements. This makes aforementioned statements a starting point for forecasting firm's earnings [15]. Earnings analysis is the first step for analyzing the earnings power as well as analyzing and forecasting the expected cash flows as usable economics incomes unlike

directs the company according to their partial interests.

118 Firm Value - Theory and Empirical Evidence

dividend policy in the interests of the small shareholders [12].

components:

• what a business owns;

• what a business earns; and

• what makes the business unique.

useful indicator of business value.

profits as accounting or accrual income.

Each of the aforementioned components of business value has a specific influence on its value. They can be combined in various ways with a, sometimes, surprising result. For example, a firm which owns respectable assets can produce goods unaccepted by the market and in turn loses money in operations. For a normal investor, the value of this firm is pore. However, for an only competitor, this firm may have a high acquisition value to obtain monopolistic extra profits, or to acquire assets below replacement costs for additional outputs. In contrast, a firm with pore assets can produce high profits and generate significant cash flows, if its location allows monopolistic position. However, with the construction of new roads, the location of this firm can become bad and disable future high profitability.

If the observed value of a company from the buyer's or investor's standpoint is in the equity, then it is certainly the case of buying earning power of the expected cash flows. Such an investor plays the role of external analysts who observes the component of earning power more easily in the financial potential of the assets, because the fine procedures of using that potential in the realized and expected profits and cash flows, which can be easily detected by an internal analyst, are hidden from him. This, of course, does not mean that an external analyst will avoid exploring deeply the component values of the analyzed companies.

If the company's assets are its earning potential, then the value of a company can be viewed as the total value of the assets and as the value of the expected cash flows. Even more, under certain conditions, these two values should be equal. This means that the market value of the assets of the company in its basis should have the present value of the expected cash flows from its profitable use. These expected cash flows will be, in a variety of ways, distributed across the company's investors, so that the value of the companies' financing instruments (stocks and bonds and other financing contracts) must be equal to the value of the assets of the company. This is because one deals with the present value of the same amount of expected cash flows, which are allocated with the financing instruments.

One can declare the market value as the intrinsic value that corresponds to the value of the earning strength only in the conditions of a perfect market, which acts as an ideal laboratory for the analysis of the economic impact solely according to the model of the Nobel Prize winners, Modigliani and Miller [16]. Even then, it is valid only in the conditions of the market equilibrium, where all assets and all liabilities are fairly evaluated with market prices [17]. Namely, in the conditions of equilibrium on the perfect market, all assets and liabilities are perfectly marketable and have no doubtful transparent prices. In such conditions, the company is worth as much as its total assets and that is the present value of expected cash income from its holdings. This value must match the value of the obligations of the company including those implied according to the ownership equity. Overall, it represents the present value of expected cash flows of the bonds and other debts, as well as from the stocks.

Clearly, the communication between the public company and the investor's public is the key element of corporate governance. Communication reduces the information asymmetry and allows investors to rationally decide what to do with the public company financing instruments. However, this communication must not expose critical information to the competitor which will ensure that the company achieves greater value for shareholders. Limited communication takes place with the objective to attract the largest circle of investors that will supply the public company with capital and is, as such, targeted to paint an attractive picture of the

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Public company communications with investor's public is conducted through various announcements, disclosures, and company activities in areas particularly sensitive to future profitability and the risks of holding the financing instruments of the company. This communication can be continuous or occasional. Continuous communication is achieved by the implementation of the adopted decisions in the areas of financing, investment, and dividend policy. Because it is vital to keep certain information away from the competition, this communication is most frequently implemented through signals that the public investors group receives when such procedures are carried out in the public company. Signaling occurs as a continuous communication that puts pressure on the company to pay close attention to decision-making and how it will reflect with public investors. One of the key signals is those which communicate fair relations with stockholders without any tendencies for expropriation

Information that can be publicly disclosed regardless of the competition can represent occasional or continuous communication. A good example is the publication of declared quarterly dividends, which represents a daily as well as specialized means of communication in many public companies in the US, and has become a regular form of communication. The announcement seeks to show strength and financial stability of public society which can continuously distribute profits to their owners and in this way, ensure a stable growing current income [22]. A special, extremely significant, part of communication is the financial reporting. Today, it is linked to the quarterly publication report, whereby the annual set of financial statements must pass a public verification from an independent audit. Financial reporting, today is, a standardized form of communication with the investor's public that, along with a standardized set of financial statements, includes specific justifications which make these reports easier to "read" for the interested investor audience. Because of continuity and the importance of this form of communication one cannot avoid cherry picking the information in the reports,

More exhaustive and meaningful form of communication with the investor's public is the company's emission prospectus. Unlike financial reporting, it contains a set of financial statements and a set of pro-forma financial statements of the expected future period, as well as a number of other relevant information. It is a form of occasional communication that is compiled for the purposes of the emission of stocks, bonds, and other public company financing instruments. The most significant prospectus for the public company is the new common stock emission, while other emission prospectuses cover smaller content. How public companies emit bonds and other forms of obligation's much more often than stocks, emission is

society to the potential suppliers of capital [23].

in order to show the company as more attractive to investors.

especially emphasizes occasional form of communication.

of their wealth.

We can all agree that a perfect market does not exist. Although the financial markets, at least in the developed countries, can be considered efficient [18], they are far from a perfect market. In fact, the market values the company's earning power. Partly that power is contained in the value of the assets as the financial potential presented in the company's financial statements, and partly, it is the result of some kind of intangible assets that is visible only in the perfect market. Talking about the financial statements leads us to a new controversy, that of evaluation, which is expressed through the concept of fair value of the asset that is embedded in the dual normative basis of financial reporting.

The questionable term fair value, originates from the principles of evaluation of the assets in the financial statements according to the principle of market value. Therefore, the fair value is embodied with the assumptions that it is the result of consensus between at least two parties (buyer and seller) that neither side is not in force and that all sides are well informed. This defines the price which only oscillates around values, so it is only exceptionally equal to true, intrinsic values. Even more, it seems questionable to talk about fair prices if they are not determined in a transparent market with many competitors on both sides (i.e., buyers and sellers). Bilaterally negotiated price can hardly result in satisfaction on both sides. It can hardly be a fair price. Subjective estimations are too often used to determine the fair value, and thus, fair values are even more questionable than historical values based on explicit and documented acquiring costs.

Through the fair value principle, one can easily derive the value of firm's stocks or equity, by solving the balance sheet equation. The equity is equal to the difference between the value of the assets and the value of the obligations. The financial statements present mainly the real, tangible assets, and not the intangible assets that truly define the earning power. By ignoring the various reserves and by treating current, not yet distribute earnings, as retained earnings, the book value of equity can be viewed as par value shares plus a premium at the time of issuing, minus a value for which the company bought it back in treasury. This refers to a paid-in capital which is related to the outstanding stocks. This value is periodically increased with generated and non-distributed earnings (profit), and reduced through losses.
