Basics of Corporation

Question 1

What is the investment decision?

Answer 1

Purchases of real assets.
Managing assets already in place and deciding where to disposes of assets

Question 2

What is the financing decision?

Answer 2

Sale of securities and other financial assets.
Choice between alternative forms of financing: capital structure.

Question 3

What are financial assets?

Answer 3

Claims for real assets

Question 4

What type of investors are shareholders?

Answer 4

Equity investors

Question 5

What is the capital structure decision?

Answer 5

The choice between debt and equity

Question 6

What does capital refer to?

Answer 6

The firm’s sources of long-term financing

Question 7

How is equity finance raised?

Answer 7

Raised by issuing shares

Question 8

What is the investment decision known as?

Answer 8

Capital budgeting or CAPEX decision

Question 9

What is a corporation?

Answer 9

A corporation is a business entity that is owned by its shareholder(s), who elect a board of directors to oversee the organisations activities.

Question 10

What is equity?

Answer 10

The sum of all ownership value

Question 11

Is there a limit on the number of shareholders and what does this mean?

Answer 11

No, so the amount of funds a company can raise by selling shares has no limit

Question 12

What are owners of a business entitled to?

Answer 12

Dividend payments

Question 13

What are shareholders said to have in a corporation?

Answer 13

Limited liability

Question 14

What are the two types of corporations?

Answer 14

Public and private corporations

Question 15

What is meant by limited liability?

Answer 15

The shareholder can be held personally responsible for the corporation’s debt only up to the extent of the nominal value of their shares

Question 16

What are public corporations?

Answer 16

The ownerships of the company is traded in the external market, so the shares are traded in an open market.

Question 17

What are private corporations?

Answer 17

Corporations who do not trade shares in an open market

Question 18

What are the benefits of corporations? (3)

Answer 18

Limited liability
Infinite lifespan
Ease of raising capital

Question 19

What are the drawbacks of corporations? (2)

Answer 19

Double taxation
Agency problem (principal agency problem)

Question 20

What is double taxation?

Answer 20

Compensation eared form investing in a company (dividends), is taxed via corporation tax and personal tax

Question 21

What is the role of financial managers?

Answer 21

To transfer cash raised from investors to investment in firms and the cash generated by operations to be reinvested and returned to investors.

Question 22

In traditional corporate finance, what is the objective?

Answer 22

To maximise the value of the firm

Question 23

What is the narrower objective in traditional corporate finance?

Answer 23

To maximise shareholder wealth.
When the stock/share is traded and markets are viewed to be efficient, the objective is to maximise stock price.

Question 24

What is unethical value maximisation?

Answer 24

Finding unethical ways, such as employing cheap labour, to push up share prices

Question 25

What is the principal agent problem?

Answer 25

Managers are agents for stockholders, but the managers may act in their own interests rather than maximising value that the principal wants

Question 26

What is a stakeholder?

Answer 26

Anyone with an interest in a firm

Question 27

What are annual meetings?

Answer 27

They are a device for a company’s owners to designate its responsibility to act on their behalf.
Owners vote on managers and management decisions.

Question 28

Why in practice is the power of the shareholders in annual meetings diluted? (3)

Answer 28

Cost of attendance
Managers’ advantage of proxies
Large stakeholders’ reluctance to involve

Question 29

What are proxies in corporations?

Answer 29

A proxy is a person who represents a member in the shareholders’ meeting of a company

Question 30

What is CalPERS?

Answer 30

The California Employees Pension Fund

Question 31

What did CalPERS suggest in 1997 for an independent board?

Answer 31

To run three tests of an independent board:
- Are a majority of the directors outside directors?
- Is the chairman of the board independent of the company (and not the CEO of the company)?
- Are the compensation and audit committees composed entirely of outsiders

Question 32

What did CalPERS do every year?

Answer 32

List the 10 companies that were the worst culprits when it came to putting managerial interests over stockholder interests

Question 33

What can happen when managers do not fear stockholders?

Answer 33

They will often put their interests over stockholders interests

Question 34

How can managers put their interests over stockholders interests? (5)

Answer 34

Over-paid compensations
Informational fraud
Self-interest
Takeover defences
Overpaying on takeovers

Question 35

Why do some managers sometimes overpay on takeovers?

Answer 35

In order for the manager to appear on newspaper headlines and be a self-interested individual

Question 36

What could happen if managers are not signifiant stockholders in the firm?

Answer 36

There could be conflicts of interest between managers and stockholders

Question 37

What happens to conflicts if individuals are significant stockholders in the firm as well as part of top management?

Answer 37

There is potential conflicts between inside stockholders and outside stockholders

Question 38

What is a positive and negative if the government is a large stockholder?

Answer 38

May keep managers in some check, but it can cause conflicts of interest between the other stockholders and the government

Question 39

What is the benefit of an institutional investor?

Answer 39

Active managed funds believed to lead to better governance.
However, latest evidence says otherwise.

Question 40

What day does bad news tend to be delivered on?

Answer 40

Friyay