Daniel: The single goal of every public company is to maximize its stock price. Simple, right? Except the man they call the 'Dean of Valuation' wrote an entire book explaining why that simple rule can create corporate civil wars, bad decisions, and why most boards are built to fail. Sophia: I love that. It’s so true. You think it’s this clean, mathematical objective, but then human nature gets involved and everything goes sideways. And you’re talking about the legendary NYU professor, Aswath Damodaran. Daniel: Exactly. Today we’re diving into his classic book, Applied Corporate Finance. And it’s less a dense academic text and more of a user's manual for people who actually have to make these decisions in the real world. Sophia: That’s why it’s so highly-rated among practitioners. It’s the book people actually use. Damodaran starts by laying out this supposedly simple objective—maximize value—and then, as you said, spends the rest of the book showing us why it’s a minefield. Daniel: A complete minefield. He argues that for stock price maximization to be a perfect, costless goal, four things need to be true: managers act only in the stockholders' best interest, lenders are fully protected, financial markets are perfectly efficient, and there are no major social costs. Sophia: Okay, hold on. That sounds like a description of a fantasy land, not the real world. When has a manager not prioritized their own job security or a bigger bonus over some abstract shareholder value? Daniel: Precisely. And Damodaran uses the perfect story to blow this up: the battle for Disney in the mid-1990s under CEO Michael Eisner.

Sophia: Oh, this is a great story. Eisner was the hero who saved Disney in the 80s, right? Daniel: He was. He took a struggling company and turned it into a powerhouse. But with that success came immense power. By the mid-90s, the board of directors, the very group meant to oversee the CEO on behalf of shareholders, was filled with his allies. Fortune magazine even named it the worst board in corporate America. Sophia: The worst? For Disney? That’s shocking. Daniel: It was a classic case of a compromised board. It included Eisner's personal attorney and the architect who designed his house. The board was essentially a rubber stamp. And this led to a disastrous decision: the hiring of his friend, Hollywood agent Michael Ovitz, as president. Sophia: I remember this! Ovitz was a huge name, but it was a terrible fit. Daniel: A complete disaster. He was out in just over a year, but with a severance package worth over a hundred million dollars. The shareholders were furious. Here was the board, supposedly representing them, signing off on a golden parachute for the CEO's friend that cost the company a fortune. Sophia: So the very people meant to hold the CEO accountable were just his buddies. It's like asking a fox to guard the henhouse, and then asking the hens for a performance review of the fox. Daniel: That’s a perfect analogy. The situation got so bad that Walt Disney's own nephew, Roy Disney, launched a shareholder revolt. At the 2004 annual meeting, an incredible 43% of shareholders withheld their votes for Eisner's re-election to the board. It was a massive protest vote. Sophia: Wow. So the 'stockholder's best interest' was really just a suggestion until they staged a rebellion. It proves the point that the simple goal of maximizing value is actually a human drama, a power struggle. Daniel: It's a perfect illustration of what economists call the 'agency problem.' And it shows why Damodaran argues that without strong, independent governance, the default state of a company isn't value maximization. It's managerial entrenchment. The system is often designed to protect the managers, not the owners. Sophia: That Disney story is such a powerful example of how human behavior just messes up the simple rules. Which makes me wonder about the other big decisions a company makes, like where to invest its money. Is that just a simple math problem, or is it just as messy?

Daniel: It's even more strategic, and this is where Damodaran’s thinking gets really fascinating. He says the best investments aren't always the ones with the highest immediate return. Sometimes, the most valuable projects are the ones that give you the option to do something great later. He calls these 'real options'. Sophia: A 'real option'? That sounds a bit abstract, like something out of a philosophy class. Can you give me an example? What does that actually look like for a real company? Daniel: Absolutely. Think of it this way. Damodaran uses the example of a pharmaceutical company that develops a patent for a new drug. Let's say right now, the market for that drug is small and the manufacturing process is incredibly expensive. A simple Net Present Value, or NPV, calculation would scream, "Don't launch this! It's a money-loser." Sophia: Right, the spreadsheet says no. Daniel: The spreadsheet says no. But the patent gives the company the exclusive right, but not the obligation, to launch that drug for the next 17 years. That right to wait, to see if the market grows or if a new technology makes manufacturing cheaper... that flexibility has enormous value. That right to wait and decide later is the real option. Sophia: Ah, I see! So the project isn't just about launching the drug today. The real asset is owning the patent. It's like a movie studio owning the rights to a sequel for a new film. The first movie might barely break even, but owning the option to make a blockbuster sequel if it becomes a hit is where the real value is. Daniel: Exactly! You're paying for the chance at a huge future payoff. And Damodaran applies this to Disney. An initial investment in, say, a new theme park in an emerging market might look incredibly risky on its own. The NPV might even be negative. Sophia: Because you don't know if people will show up, or if the local economy will be stable. Daniel: Correct. But what if that first park gives Disney the foothold, the brand recognition, and the operational know-how to then expand and build a dozen more parks across that entire continent? The value of that option to expand could be so massive that it makes the initial, risky project a brilliant strategic move. The first park is just the price you pay to acquire the option for future dominance. Sophia: That completely reframes how you should look at big, risky bets. It’s not just about the immediate payoff. It’s about what doors it opens. Daniel: It’s about buying future flexibility. And this idea of balancing risk and reward is at the heart of the final big decision every company has to make: how to pay for all these investments. The financing decision.

Sophia: Right, the classic debt versus equity question. My gut feeling is that debt is scary. You have to make those interest payments no matter what. Equity feels safer because you're not on the hook to pay dividends. Is that how Damodaran sees it? Daniel: Not quite. He frames it as a delicate trade-off. Debt has one huge, undeniable advantage: the interest you pay is tax-deductible. It's like the government gives you a coupon for borrowing money. This makes debt a cheaper source of capital than equity. Sophia: A government-sponsored discount. I like that. But what’s the catch? Daniel: The catch is exactly what you said: risk. Specifically, bankruptcy risk. The more debt you take on, the bigger your fixed payments become. If your earnings dip, you could find yourself unable to pay, and the lenders can force you into bankruptcy and take over the company. Too much debt, and you can lose everything. Sophia: So how on earth do you find the right balance? Is there a magic number, a perfect debt ratio? Daniel: Damodaran gives us a really powerful and practical tool called the Cost of Capital approach. The goal is to find the specific mix of debt and equity that results in the lowest possible overall cost of capital for the firm. When you minimize your cost of capital, you maximize the value of your company. Sophia: Okay, so you're looking for that financial sweet spot. Daniel: Precisely. And he runs the numbers for Disney in 2013 and finds something fascinating. At the time, Disney was a very conservative company, with a debt-to-capital ratio of only about 11%. But his analysis showed their optimal debt ratio—the point where their value would be maximized—was actually around 40%. Sophia: Wait, 40%? So Disney, this massive, global, successful company, was making a fundamental financial mistake? Daniel: According to the model, yes. They were being too conservative and leaving billions of dollars in potential value on the table by not taking advantage of the tax benefits of debt. They were underlevered. Sophia: That’s incredible. But what about a different kind of company? Does this apply to a high-growth tech firm, for example? Their business is way more volatile. Daniel: Great question, because it highlights the main point. He runs the same analysis for Baidu, the Chinese tech giant. For them, the optimal debt ratio is close to zero. And the reason isn't just because it's a 'tech company.' It's because its operating income and cash flows are much smaller and more volatile relative to its high market value. It simply doesn't have the stable earnings base to support a lot of debt. Sophia: So the answer is completely different for every company. It’s not about a universal rule, but about a company’s specific situation—its stability, its cash flow, its assets. Daniel: Exactly. It proves the point: there is no one-size-fits-all answer. Finding the financial sweet spot is a custom job for every single business.

Sophia: It's fascinating. We started with these three seemingly simple principles from corporate finance—have a clear goal, make good investments, and finance them wisely. But at every single turn, Damodaran shows us how the messy, unpredictable real world makes it so much more complex. Daniel: That's the core of the book. It’s not a set of rigid rules; it's a framework for thinking. The elegant theories of finance are the starting point, but they have to be applied with an understanding of corporate politics, competitive strategy, and human behavior. Sophia: So the goal is to maximize value, but you have to fight your own board to do it. The best investment might be one that loses money today to give you an option tomorrow. And the right amount of debt for Disney could bankrupt a company like Baidu. Daniel: You've got it. The value of a company isn't just a number on a spreadsheet; it's the sum of its future options and the wisdom of its present decisions. Damodaran teaches you to see the story behind the numbers. Sophia: It really does make you look at companies in a whole new light. When you see a firm with very little debt, you start to ask, 'Are they being prudent and safe, or are they being too conservative and leaving value on the table, just like Disney was?' It's a powerful lens for understanding the world. Daniel: Absolutely. And it's a great question for our listeners to think about. Look at a company you admire—or even your own business. Is it playing it too safe, or is it taking smart, calculated risks that open up future options? We'd love to hear your thoughts on our social channels. Sophia: This is Aibrary, signing off.