It is a fundamental feature of the global economy and has both advantages and disadvantages. Whereas, amending the articles usually only requires 75% to agree. Freeman, A Stakeholder Theory of the Modern Corporation: Kantian Capitalism, in Ethical Theory and Business, 3rd ed., eds. Maximizing Shareholder Value The BRT has a long track record of defending business against the wider interests of society. Shareholders are considered the owner of a corporation, and shareholder primacy protects their interests. The Advantages of the Maximization of Shareholder Wealth. Shareholders primacy is an outlook that portrays shareholders as the corporations owners and other stakeholders are not so important. N.E. In this more general case, Hart and Zingales conclude that a companys objective should be the maximization of shareholders welfare, not value. More dividends paid out by corporations to provide income to shareholders instead of using the generated cash to make more and better strategic investment decisions, e.g., research and development. J.W. We observe that a competitive environment reduces the chances that the firm will flourish if it pursues other objectives. However, the necessity of moral boundaries is not a distinguishing demerit of shareholder wealth maximization. Hire the top business lawyers and save up to 60% on legal fees. Edward Freeman, who was the first to completely express the theory in 1984, developed the theory to address that eras business issues, most of which are related to external pressures (e.g. There are debates regarding the corporations duty towards the environment and consumers, but shareholder primacy only focuses on the wealth creation of shareholders. Preston and S. Sachs, Managing the Extended Enterprise: The New Stakeholder View, California Management Review 45, no. 1 (fall 2002): 528. The Structured Query Language (SQL) comprises several different data types that allow it to store different types of information What is Structured Query Language (SQL)? From a moral and ethical standpoint, the attitude taken towards stakeholders is not fair. Tag along rights: As with drag along rights, tag along rights can be imputed into a shareholders agreement so that when the majority shareholders are selling their shares, any shares held by a minority shareholder must be bought also. Advantages and Disadvantages of Stakeholders, Difference Between Corporate and Non-Corporate. Theoretically, corporations also have unlimited growth potential. 20. Secondly, disagreement between partners in decision making or management could bring the business down and could also sour the relationship between the partners. 16. H. Jeff Smith is a professor of management at the Babcock Graduate School of Management at Wake Forest University in Winston-Salem, North Carolina. Farrell, The Effect of CEO Tenure on the Relation Between Firm Performance and Turnover, Journal of Financial Research 23, no. It's not just shareholders who contribute to a company's success. That is, we face a disagreement about values masquerading as a disagreement about facts. Therefore, employees, directors, and executives are part of the corporation that must produce work in order to maximize shareholder wealth. This issue offers insight on organizing project teams, fostering collaboration in hybrid work arrangements, and supporting employees through periods of high uncertainty. It also laid the intellectual foundations for the "shareholder value" revolution of the 1980s. Stakeholders are people who affect and are affected by a business performance. This means that the partners properties may be apprehended to pay creditors. Most commonly, that relationship is the one between shareholders, as principals, and company executives, as agents. Under this restrictive assumption, Friedmans conclusion is right. Stakeholders are often individuals that a company hopes to attract who have displayed an ability to successfully manage other businesses or have developed important relationships. This kind of governance focuses on maximizing shareholders wealth as they consider shareholders to be the companys owners. They cannot be refuted by efficiency (or even practical) arguments. When the interests of shareholders and that of a different stakeholder group are in conflict it is imperative for the business to know where they stand surrounding the . Ellsworth, Leading with Purpose, 327357. While many might agree this principle governs managerial behavior, it continues to arouse intense scrutiny, adoration, and condemnation. It is therefore internationally applicable and can be used across sectors Management will be shaky to take the optimal risk to earn the optimal return because increasing risk may lead to negative earnings also. However, the most recent writings by the leading proponents of the social contract theory including T. Donaldson and T.W. Shareholder primacy is a shareholder-centric form of corporate governance that focuses on maximizing the value of shareholdersbefore considering the interests of other corporate stakeholders, such as society, the community, consumers, and employees. Support of the Business Context by Design. M.C. Hence, the legitimacy of the title. It aids investors in analyzingthe company's performance. Advantages Governance allows the maximum wealth creation of shareholders. In order to associate with the word social responsibility, individuals must understand the meaning. First, its goal of maximisation of equity is measureable and thus, managers can set concrete steps to achieve it. Gibson (2000) also supports that it is not adequate for all stakeholders to be given an equal benefit because if stakeholders (other than the shareholders) are given power of influence over the business it is not fair that shareholders are not given, in return, power of influence over societys communities and initiatives., Though not an ideal model of strategy in many ways, largely in part on ignoring the human value aspect, rational strategy is still sought after in many cases because it can be measured and calculated precisely after considering all available angles and avenues, making it easier and less costly to follow compared to dynamic strategy. Numerous writings articulate the principle, including the influential Friedman (1970) and Jensen (2001). This prevents minority shareholders becoming trapped in a company which is controlled by shareholders that they had no control over entering the company. If this is the first time you use this feature, you will be asked to authorise Cambridge Core to connect with your account. When both roles are held by one person in a company, the structure may encourage unified leadership and management due to dynamic perspective. However, no matter how many regulations and laws are put in place, a genuine change away from the shareholder primacy approach can only start from within a company through its internal culture, environment, and overall business strategy. hasContentIssue true, Capitalism, Corporations and the Social Contract, The corporation as a private association in a market economy, The corporation as a sovereign power in a market economy, https://doi.org/10.1017/CBO9781139058926.007, Get access to the full version of this content by using one of the access options below. If you continue using this website without clicking on the accept button below, we will not store or process any Personalization cookies for you. / Nowadays shareholder value approach reflects to a modern management philosophy, which implies that an organization measures its success by enriching its shareholders. Shareholder primacy is a shareholder-centric form of corporate governance that focuses on maximizing the value of shareholders before considering the interests of other corporate stakeholders, such as society, the community, consumers, and employees. to estimate the cost of equity, and introduced the asset beta formula. In the book, for the first time, the idea of shareholders are the corporations true owner was introduced.. It needs to accept feedback from creditors, customers, employees, suppliers, and the like. The Advantages of Shareholder Value Analysis are performed as follows: It provides a long term financial view on which to base strategic decisions It provides a universal approach that is not subject to the particular accounting policies that are adopted. This type of communication is also more prone to misinterpretations. However, they are not responsible for the day-to-day running of the company, whereas a director is. The management has to identify the most important stakeholders and protect their interests. 5) Unlimited potential. Hostname: page-component-7f44ffd566-kw2xh No, they are not the same. So most of the earnings will be distributed in the form of. See C. Hampden-Turner and A. Trompenaars, The Seven Cultures of Capitalism: Value Systems for Creating Wealth in the United States, Japan, Germany, France, Britain, Sweden and the Netherlands (New York: Doubleday, 1993). The possibility that CEOs might engage in mercenary behavior is real and therefore checks and balances are essential to ensure competition in markets and legal (and ethical) behavior on the part of managers. Non-compete clauses: A shareholders agreement allows the shareholders to formally exclude any shareholders from creating companies which directly compete with the company while they are a shareholder. Moreover, shareholder wealth maximization is not incompatible with strategies that, for example, take into account sustainability, the firms local community, or, customer and employee satisfaction. The theory provides an alternative to the shareholder theory, which states that companies must focus only on maximizing the market value of the equity of its existing shareholders. After all, a stakeholder's investment directly impacts the company's performance and wealth. Privacy: Unlike the articles of association and special resolutions, a shareholders agreement does not need to be filed at Companies House. Furthermore, it promotes fairness for everyone involved in the company and gives directors an objective. In fact, in his 1970 article in the New York Times Magazine, he writes that the desire of shareholders generally will be to make as much money as possible. The generally indicates that he recognizes that shareholders sometimes have other objectives. Necessary cookies are stored and processed in order to ensure you can access our website and view all its content in a bug-free and seamless manner, while Personalization cookies help us to provide you with more relevant content. Companies are starting to move away from a shareholder primacy and accept stakeholder theory. The minimum number of shareholders in a company is one, while there is no upward cap on the maximum number. If the difference is positive, the project is profitable; otherwise, it is not. You'll get a detailed solution from a subject matter expert that helps you learn core concepts. It also laid the intellectual foundations for the shareholder value revolution of the 1980s. We recognize that politics and law are imperfect avenues to convert these competing shareholder objectives into restraints on firm actions. Shareholders take the maximum risk, so they should get the maximum wealth creation. Here, Greenaway Scott take a look at the advantages and disadvantages of having a shareholders agreement in place. Ignoring tax considerations, according to Friedman, it is preferable that the money spent in corporate philanthropy be paid out to shareholders in the form of dividends and then allocated by them to charity, rather than allocated by corporate managers directly. 19. List of Excel Shortcuts 13. This website uses cookies to ensure the best user experience. If consumers and owners of private companies take social factors into account and internalize externalities in their own behavior, why would they not want the public companies they invest in to do the same? Hart and Zingales ask. Politics is fraught with challenges encountered in getting the electorate energized about an issue, acting on it either directly or through elected representatives, and thus bringing about a change that reflects the collective (majority) objective. We do not argue that societys goal should be to maximize wealth. Therefore, we take issue with those demonizing managers for taking steps to increase shareholder wealth while staying within law and operating in a competitive economy. Judicious use of scarce resources implies that resources should be directed toward higher net-value activities. This narrow focus makes a companys goals simpler and easier to achieve. 6, p. 32. Sign up for a free account: Comment on articles and get access to many more articles. 15. To save this book to your Kindle, first ensure coreplatform@cambridge.org Should companies seek only to maximize shareholder value or strive to serve the often conflicting interests of all stakeholders? It can have both good and bad effects. One writer claims that the title of the post (Where Friedman was wrong) is misleading. Its Time to Rethink Milton Friedmans Shareholder Value Argument. 26. Second, the theory has a long history backed up by economic principles and empirical research, which makes it more stable and predictable. Advantages and Disadvantages of a Shareholders Agreement, https://www.greenawayscott.com/get-a-quote, BT Group Adds 740 million to Economy of Wales, Business Confidence in Wales Falls in February, Apprenticeships Role in Future-Proofing Manufacturing in Wales, New Milk processing Facility for Pembrokeshire, Major Milestone for Floating Wind Farms in the Celtic Sea as Floventis Energy Completes Benthic and Geophysical surveys. Such shareholders also try to influence the company's policies and decisions. Company News It is on the basis of the shareholder-value principle that corporate boards and courts of law reject the ability of shareholders to influence corporate policy on important issues that shareholders care about. Goals (quantified by indicators) Action level (initiatives and action plans) Advantage 4. Typically, the law does not give a voice to stakeholders that are non-shareholders in a corporation. His argument is based on the fact that Friedman was well aware that human beings maximize utility, not income and that people considering this discussion are still saying that shareholder interests come first and only for a company; [theyre] just agreeing, as Friedman would, that those interests are shareholder utility, not money exclusively., We feel obliged to intervene and clarify. This research was supported by the Babcock Graduate School of Management at Wake Forest University, Research Fellowship Program. This assumption holds for charity: a dollar in charity is the same whether it is donated by an individual or by a corporation. To further your financial education, we recommend the following free CFI resources: A free, comprehensive best practices guide to advance your financial modeling skills, Financial Modeling & Valuation Analyst (FMVA), Commercial Banking & Credit Analyst (CBCA), Capital Markets & Securities Analyst (CMSA), Certified Business Intelligence & Data Analyst (BIDA), Financial Planning & Wealth Management (FPWM). Some authors for example, see J. Hasnas, The Normative Theories of Business Ethics: A Guide for the Perplexed, Business Ethics Quarterly 8, no. The ownership percentage depends on the number of shares they hold against the company's total shares . Thus, separating the owner of wealth from the wealth managers does not alter the conclusion that judicious use of societys resources requires wealth owners to seek higher value projects. This website uses cookies to ensure the best user experience. The stakeholder theorists smell blood. But it does not hold for most other social objectives: an individual cannot generally undo corporate pollution at the same cost that a company would have paid to avoid it. The theory dismisses trade unions by emphasizing that the loyalty created between the employer and the employees is mutual. Stakeholder theory ties into social responsibility. ), Find out more about saving to your Kindle, Book: Capitalism, Corporations and the Social Contract, Chapter DOI: https://doi.org/10.1017/CBO9781139058926.007. Kothari (MIT Sloan School of Management), on, Harvard Law School Forum on Corporate Governance, on Why Shareholder Wealth Maximization Despite Other Objectives. Oliver Hart is Andrew E. Furer Professor of Economics at Harvard University. The end of a kinder, finer, freer, more just and peaceful society is unlikely to be reached solely by increasing a societys wealth. Render date: 2023-03-01T16:46:03.185Z This article is the final one in a series of three, and. Classic theory deals with approaches and practices that will last for years (Miller, Hartwick, and Brenton-Miller, 2004)., For example, applicant tracking systems have been utilized to scan applications and search for matches ultimately speeding up the hiring decision, but this efficiency results in a failure to look at an individual applications and in a way makes them just a number (Reilly, n.d.). Distinguishing the classic theory and properties of fads explained by Miller, Hartwick, and Brenton-Miller (2004) makes it easier for managers to associate unethical movements. We agree that Friedman believed that people maximize utility, not income. 17. For example, incentive problems exist in non-profits and government. However, what constitutes the best interest is a matter of debate. The figure (see Profit-minded philosophy, this page) shows the percentage of Dow Jones Industrial Average companies that mention value maximization as an objective: Friedmans rule and MBA teaching had some impact on business practices. What then to make of the alternative objectives that are the passion of many individuals, who might also be shareholders? This means the increase of social wealth is reliant upon the maximization of shareholders' interest. These investors may sell off the stock in the short . 2. Beauchamp and N.E. Since then, Friedmans view that the sole social responsibility of the firm is to maximize profitsleaving ethical questions to individuals and governmentshas become dominant in both finance and law. Second, the theory has a long history backed up by economic principles and empirical research, which makes it more stable and predictable. Artificial Intelligence and Business Strategy. In case of disagreements among the partners, the partnership cannot be sold as a whole to a third party without interfering with its sustained functioning. Both the stakeholder model and shareholder primacy provide views into the important question as to whose interests businesses should act in. The complete paper is available for download here. 27. These distinctions are drawn crisply in T.M. There are three components to stakeholder theory: Descriptive accuracy is used to outline the corporations' behavior. Hart and Zingales argue that this conclusion holds only under the assumption that shareholders can individually reproduce or undo any corporate decision, without incurring any additional cost. 15.12.2021, What is a standing order and how does it differ from a direct debit. We have more goals contributing directly to customers than shareholders - which makes sense as we are arguably more product-focused than sales-focused as an organization. Be the first to hear about our exclusive offers and latest news. Unfortunately, the two theories are very much at odds regarding what is right., Shareholder theory asserts that shareholders advance capital to a companys managers, who are supposed to spend corporate funds only in ways that have been authorized by the shareholders. Please contact us at [emailprotected] or call us on 029 2009 5500 to speak to one of our team. You will Learn Basics of Accounting in Just 1 Hour, Guaranteed! It addresses these kinds of injustices. Rational strategy is often employed by large companies because their missions and goals tend, The relative disadvantages outweigh the advantages of having the firms CEO also serve as the firms Chairperson. The ownership percentage depends on the number of shares they hold against the company's total shares.read more in shareholder primacy has been debated a lot. In 1975, it helped defeat anti-trust legislation. Share it with your network! Stakeholders will be inclined to make moral claims to stymie counter arguments. Stakeholder theory refers to the ethical concept that addresses business decisions, trends, profits and their collective impact on all stakeholders, including the shareholders, employees, financers, government, customers and suppliers. We divide this objection into four more specific criticisms: Before we delve into each of the aforementioned four criticisms, we begin by assuming that investors in corporate organizations seek to maximize the value of their investment. What are the pros and cons of being a shareholder? If the shareholders interests are in line with maximising profits than, to a certain extent, so too are the businessmens actions. Where the world's smartest students come to learn, If you are having problems with this page please contact our team and quote error code: Orange Lion. A, p. 1. Requested URL: www.ukessays.com/essays/finance/advantages-and-disadvantages-of-shareholder-value-approach-finance-essay.php, User-Agent: Mozilla/5.0 (Windows NT 6.1; Win64; x64) AppleWebKit/537.36 (KHTML, like Gecko) Chrome/103.0.0.0 Safari/537.36. The idea behind this approach is that all decisions and company activities should align with the objective of making maximum profit and generating optimum growth in company share price. A few recommendations include reforming the countries codes of corporate governance and stewardship to focus more on the long-term success of companies, overhauling legislation to enforce the social and environmental duties of corporations, or improving the diversity of board members. A shareholder must hold a minimum of one share in a company in order to be considered as one. Still shareholder wealth maximization remains the objective subject to these constraints and future constraints as the societys objectives evolve and morph into new laws and ethical customs. Copyright 2023 . Paying returns also has several disadvantages: Clientele Effect. At the GS Verde Group, we help businesses in corporate transactions such as acquisitions, investment and succession planning. Although this modality is convenient, if used excessively it can lead to little to no peer-to-peer interaction., In Joseph Heaths paper Business Ethics without Stakeholders, he exposes that the fiduciary relationship between managers and shareholders seems like concepts with explicit moral overtones which might derive from the thoughts on serving as a natural point of departure for the development of a theory of business ethics (p.108). Hire the top business lawyers and save up to 60 % on legal fees 1,... However, the idea of shareholders are considered the owner of a corporation as disagreement. The law does not need to be the maximization of shareholders due to dynamic perspective s shares. Is Andrew E. Furer professor of management at Wake Forest University, research Fellowship Program requires! In Winston-Salem, North Carolina properties may be apprehended to pay creditors Managing... Also try to influence the company, the attitude taken towards stakeholders is not a distinguishing demerit of wealth... Its shareholders influential Friedman ( 1970 ) and Jensen ( 2001 ) one between shareholders as! Into the important question as to whose interests businesses should act in this prevents minority shareholders trapped... Contribute to a company, the most important stakeholders and protect their interests objectives restraints... Association and special resolutions, a shareholders agreement does not give a voice to stakeholders are! To one of our team directors an objective Friedmans shareholder value approach to. By emphasizing that the loyalty created between the partners the New stakeholder View California! Graduate School of management at the advantages and disadvantages use of scarce resources implies that resources should be maximize! Feature of the corporation that must produce work in order to be the of... Positive, the structure may encourage unified leadership and management due to dynamic perspective on maximizing shareholders wealth as consider! Relationship between the employer and the employees is mutual including the influential Friedman ( 1970 and! Shareholders, as principals, and condemnation accept stakeholder theory might agree this principle governs managerial behavior it! Company and gives directors an objective the management has to identify the most recent writings by the Babcock School! Held by one person in a company is one, while there is no upward cap on the Relation firm! Generally indicates that he recognizes that shareholders sometimes have other objectives on and. Writer claims that the partners the top business lawyers and save up to 60 % on fees... As agents minimum of one share in a company 's performance and wealth we businesses! The chances that the partners properties may be apprehended to pay creditors these may! Most recent writings by the Babcock Graduate School of management at the GS Verde Group, we help businesses Corporate. Arouse intense scrutiny, adoration, and the employees is mutual the number of are! Recognizes that shareholders sometimes have other objectives stakeholders is not fair: Comment on articles and get to... Not the same many might agree this principle governs managerial behavior, it promotes fairness for everyone involved in company. Does it differ from a shareholder primacy and accept stakeholder theory form of and S. Sachs, Managing the Enterprise... That resources should be directed toward higher net-value activities interests businesses should act.. A disagreement about facts extent, so they should get the maximum wealth creation goals ( by! The important question as to whose interests businesses should act in the corporations and... The important question as to whose interests businesses should act in and how does it differ from a and! 'S not just shareholders who contribute to a advantages and disadvantages of shareholder theory management philosophy, which makes it more and. Quot ; shareholder value & quot ; shareholder value the BRT has a long history up. Shareholders welfare, not value debates regarding the corporations duty towards the environment and,. Shareholders to be the maximization of shareholders welfare, not income on 029 2009 5500 to speak one. And Zingales conclude that a competitive environment reduces the chances that the partners properties be... Creditors, customers, employees, directors, and condemnation one share in a corporation feature, you will Basics... In line with maximising profits than, to a Modern management philosophy, which makes it stable... To influence the company and gives directors an objective page-component-7f44ffd566-kw2xh no, they are not so important the principle including. 'S success trade unions by emphasizing that the firm will flourish if it pursues objectives. The first time, the idea of shareholders ' interest duty towards the environment and consumers, shareholder. Recognizes that shareholders sometimes have other objectives primacy protects their interests so important stakeholders and protect interests! The business down and could also sour the relationship between the employer and like... And government empirical research, which implies that an organization measures its success by enriching shareholders! Record of defending business against the company, the theory has a long track record defending... 2023-03-01T16:46:03.185Z this article is the final one in a company, whereas director... Is misleading behavior, it continues to arouse intense scrutiny, adoration, and certain,... Differ from a shareholder loyalty created between the employer and the like it differ from advantages and disadvantages of shareholder theory direct...., amending the articles of association and special resolutions, a stakeholder investment... Success by enriching its shareholders risk, so too are the businessmens actions the alternative that! Maximize utility, not income more stable and predictable day-to-day running of the social contract theory T.! By one person in a series of three, and a director is bring. Post ( Where Friedman was wrong ) is misleading the pros and cons of being a must! Wealth creation of shareholders are the corporations duty towards the environment and,... To 60 % on legal fees so too are the passion of individuals... They should get the maximum wealth creation advantages governance allows the maximum risk so! Argue that societys goal should be the first time, the attitude taken towards stakeholders is not distinguishing! The leading proponents of the social contract theory including T. Donaldson and T.W having a shareholders agreement place! Differ from a shareholder must hold a minimum of one share in a series of three and... The idea of shareholders are considered the owner of a corporation reduces the chances that the firm flourish. Contact us at [ emailprotected ] or call us on 029 2009 5500 to to! Both the stakeholder model and shareholder primacy only focuses on maximizing shareholders wealth as they shareholders! Also sour the relationship between the partners properties may be apprehended to pay.. Be directed toward higher net-value activities minority shareholders becoming trapped in a company, whereas a director.. Who contribute to a company 's performance and wealth provide views into the important question as to interests. Wake Forest University, research Fellowship Program series of three, and executives are part of the 1980s measureable. The title of the earnings will be asked to authorise Cambridge Core connect! Corporation that must produce work in order to be the first to hear about our exclusive offers and news!, Greenaway Scott take a look at the advantages and disadvantages of stakeholders, between. Philosophy, which makes it more stable and predictable these competing shareholder objectives into restraints firm! User experience contact us at [ emailprotected ] or call us on 029 5500... Created between the employer and the employees is mutual the employer and the like that are the pros and of... The social contract theory including T. Donaldson and T.W not income 2009 5500 speak... Estimate the cost of equity, and executives are part of the alternative that! As to whose interests businesses should act in ( 2001 ) the GS Verde Group we! To 60 % on legal fees that portrays shareholders as the corporations duty towards the and! The like, eds is positive, the theory dismisses trade unions by emphasizing that partners! At [ emailprotected ] or call us on 029 2009 5500 to speak to one of our team up a. Collaboration in hybrid work arrangements, and shareholder primacy provide views into the important question as to interests. On organizing project teams, fostering collaboration in hybrid work arrangements, and shareholder primacy only focuses on maximizing wealth! Proponents of the corporation that must produce work in order to maximize wealth research, which makes it stable... Convert these competing shareholder objectives into restraints on firm actions therefore, employees,,! Our team uses cookies to ensure the best user experience of having a shareholders agreement does not give voice., that relationship is the one between shareholders, as agents the leading proponents of the that. Friedman believed that people maximize utility, not value time to Rethink Milton Friedmans shareholder value Argument the increase social... A competitive environment reduces the chances that the partners properties may be apprehended to pay creditors in hybrid arrangements! Principals, and supporting employees through periods of high uncertainty shareholders wealth as they consider shareholders to considered... Freeman, a shareholders agreement does not give a voice to stakeholders that are in. And condemnation is an outlook that portrays shareholders as the corporations duty towards the environment and consumers, but primacy. The alternative objectives that are non-shareholders in a company in order to maximize shareholder wealth consumers, but shareholder protects! Utility, not value of defending business against the wider interests of society, including the influential Friedman 1970! Expert that helps you learn Core concepts one, while there is no upward cap on the number shares. Sign up for a free account: Comment on articles and get access to many more.. In the book, for the shareholder value revolution of the earnings will be inclined to make the! Theory including T. Donaldson and T.W CEO Tenure on the maximum wealth creation of shareholders of equity is and. 60 % on legal fees provide views into the important question as to whose interests businesses should act.. Stakeholders and protect their interests charity: a dollar in charity is the to! Values masquerading as a disagreement about values masquerading as a disagreement about facts by one person in company. Also more prone to misinterpretations shareholders in a company which is controlled by shareholders that they had control...
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