Capitalization as an indicator of corporation’s effective development

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The essence of any business is that the main purpose of its creation and existence is to maximize profits. However, it is obvious that the company's development in the long term also requires production of other tasks. The importance of growth of the cost of the company's capitalization, as well as the effectiveness of the existing mechanisms in the organization is increasing.

Capitalization, market value, shares, cost of the company, market capitalization

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Текст научной статьи Capitalization as an indicator of corporation’s effective development

Modern financial crisis, which began in the banking sector, seriously affected the production sphere and manifested through a decrease in capitalization corporations due to the fall of quotations of shares on the stock market. This, in turn, hit the creditworthiness of companies, which were forced to prematurely return the loans to banks or to provide additional collateral. This was due to the fact that the drop in prices has led to a mismatch of the market value of corporations and the amounts of their credit obligations. The additional financial risks demanded major economy from corporations, which reflected not only in reducing the number of employees, but also in the closing of the investment projects, which caused an additional drop in their market capitalization

The cost of the company is the present value of expected cash flows from a set of assets, and the future growth, discounted at the rate of capital formation.

The cost of the company may be increased as a consequence of growth in cash flows from specified assets, increase expected growth and its duration, as well as from reducing capital raising rates.

Market capitalization refers the total dollar market value of a company's outstanding shares. Commonly referred to as "market cap," it is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to using sales or total asset figures.

Market cap is a relatively good way to quickly value a company. That's because stock prices are generally based on investors' expectations of a company's earnings. As earnings rise, stock traders will bid more for the stock price. Including the number of shares in the calculation offsets the impact of stock splits.

Companies can be ranked according to their market capitalizations, and the general format is to rank them as large-cap, mid-cap and small-cap companies. Investors use market cap to divide the stock market into three size categories.

Small cap companies have a market cap of less than $1 billion. They are smaller companies, many of which recently went through their Initial Public Offering, or IPO. They are riskier, because they are more likely to default during a downturn. On the other hand, they have lots of room to grow, and could become very profitable.

Mid cap companies are less risky, but may not have the same potential for growth. They typically have a capitalization of between $1 billion to $5 billion. A recent study showed they actually outperformed both small cap and large cap stocks over the last 20 years.

Large cap companies have the least risk, because they typically have the financial resources to weather a downturn. Since they tend to be market leaders, they also have less room to grow. Therefore, the return may not be as high as small or mid cap stocks. On the other hand, they are more likely to reward stockholders with dividends. The market cap for these companies is $5 billion or more.

The crisis has made it abundantly clear that the capitalization as the epitome of the market price of the shares is shown through a recognized market value of the company. In other words, the cap is not only a reflection of the aggregate market value of the shares, but also includes an integrated assessment of the sustainability of corporations, profitability, demand for products, qualified personnel.

However, the immaturity of the Russian securities market restrains the growth of capitalization of the significant number of corporations because of such a source of investment, as an additional issue of shares.

This is due to the following reasons:

  • -    Russia's economy is experiencing a continual redistribution of property. In this regard, in order to protect against a possible takeover corporations are in no hurry to issue its shares in free circulation;

  • -    Activities of Russian companies lacks transparency, as there are no legal requirements on financial reporting transparency and information on affiliated persons;

  • -    In Russia has spread insider form of ownership capital, characterized by lack of interest in expanding the circle of shareholders.

The stock market crash in late 2008 led to significantly decreased quotations of all without exception of the securities. Negative external factors, the liquidity outflow, the high degree of dependence of the leading corporations of credit resources and other factors led to the fact that the stock market is actually no longer effectively function as an objective assessment of the value of companies. The high degree of uncertainty about the dynamics of the financial crisis, the possible timing and pace of economic recovery hinders investors from buying corporate securities, leading to an outflow of capital to less risky instruments.

At the same time, as the investor activity is restoring and the growth of the volume of transactions on the organized securities market is growing, the importance of market capitalization of the companies to assess their value will increase. This is due to the fact that the development of the capitalization process determines not only the increment value in the form of growth in the market value of firms or growth equity quotations on the stock market, but also helps to increase the volume of economic resources, the realization of its economic strategy in the long term, as well as it helps provide the change in the ratio between innovative and traditional ways of management.

Activation of the capitalization process occurs in response to a sharp increase in the quantitative and qualitative indicators of the functioning of the economic entity at any level. Thus, the size of the market value of companies on the one hand, is determined by the selected financial indicator (eg EBITDA), evaluating the results of the current year.

On the other hand, it is influenced by the so-called multiplier that can increase (decrease) the cost many times over. The integrated value of the multiplier factors affect different factors of creating the value, which primarily include:

  • -    Company's selected development strategy;

  • -    Quality and innovative products;

  • -    The presence of brands;

  • -    Leadership in the market;

  • -    The quality of strategic and operational management;

  • -    Modern corporate governance [1].

The Company capitalizes production assets belonging to them, trademarks and other intangible assets, cash holdings, securities, inventories, which is reflected in the growth of the market value of the company's share capital or increase the market valuation of the company.

The realization of increment market value’s strategy of the company is an organic subordination of the interests of the owners to interests of managers, which is provided by the establishment of remuneration, depending on the control of growth of the market value of the company as a major source of capital owners compensation. As a result, there is a tendency of convergence of income management structure and corporate income shareholder owners. Thus, the increase in the market value of the company provides socio-economic conditions, which in result maximize company’s utility function that determines their role as the subject of the process.

In this regard, an important role in the process of capitalization of the corporation determines the need to adjust index of market capitalization for the purpose of adaptation to the impact of negative market factors. To do this, you must use the actual financial and operational performance of the company (income, value of fixed assets, cash flow), whose relation to the company's profit can be regarded as a multiplier for calculating capitalization. This will significantly improve the quality of management decisions regarding the formation and changes in the capital structure of the corporation, including in the following cases:

  • -    The preparation of the business transactions of purchase and sale, restructuring of companies;

  • -    In attracting credit resources to adequately assess the collateral, which may be the company's shares;

  • -    The planning of the issue of securities;

  • -    The preparation and implementation of business plans of the company for the evaluation of impact of management decisions on the company's capitalization.

Список литературы Capitalization as an indicator of corporation’s effective development

  • Малова Т.А. Капитализация в условиях российской экономики. Теоретические и практические аспекты. -М.: УРСС, 2009. -С. 23
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