Basics of Corporation Flashcards
What is the investment decision?
Purchases of real assets.
Managing assets already in place and deciding where to disposes of assets
What is the financing decision?
Sale of securities and other financial assets.
Choice between alternative forms of financing: capital structure.
What are financial assets?
Claims for real assets
What type of investors are shareholders?
Equity investors
What is the capital structure decision?
The choice between debt and equity
What does capital refer to?
The firm’s sources of long-term financing
How is equity finance raised?
Raised by issuing shares
What is the investment decision known as?
Capital budgeting or CAPEX decision
What is a corporation?
A corporation is a business entity that is owned by its shareholder(s), who elect a board of directors to oversee the organisations activities.
What is equity?
The sum of all ownership value
Is there a limit on the number of shareholders and what does this mean?
No, so the amount of funds a company can raise by selling shares has no limit
What are owners of a business entitled to?
Dividend payments
What are shareholders said to have in a corporation?
Limited liability
What are the two types of corporations?
Public and private corporations
What is meant by limited liability?
The shareholder can be held personally responsible for the corporation’s debt only up to the extent of the nominal value of their shares
What are public corporations?
The ownerships of the company is traded in the external market, so the shares are traded in an open market.
What are private corporations?
Corporations who do not trade shares in an open market
What are the benefits of corporations? (3)
Limited liability
Infinite lifespan
Ease of raising capital
What are the drawbacks of corporations? (2)
Double taxation
Agency problem (principal agency problem)
What is double taxation?
Compensation eared form investing in a company (dividends), is taxed via corporation tax and personal tax
What is the role of financial managers?
To transfer cash raised from investors to investment in firms and the cash generated by operations to be reinvested and returned to investors.
In traditional corporate finance, what is the objective?
To maximise the value of the firm
What is the narrower objective in traditional corporate finance?
To maximise shareholder wealth.
When the stock/share is traded and markets are viewed to be efficient, the objective is to maximise stock price.
What is unethical value maximisation?
Finding unethical ways, such as employing cheap labour, to push up share prices
What is the principal agent problem?
Managers are agents for stockholders, but the managers may act in their own interests rather than maximising value that the principal wants
What is a stakeholder?
Anyone with an interest in a firm
What are annual meetings?
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.
Why in practice is the power of the shareholders in annual meetings diluted? (3)
Cost of attendance
Managers’ advantage of proxies
Large stakeholders’ reluctance to involve
What are proxies in corporations?
A proxy is a person who represents a member in the shareholders’ meeting of a company
What is CalPERS?
The California Employees Pension Fund
What did CalPERS suggest in 1997 for an independent board?
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
What did CalPERS do every year?
List the 10 companies that were the worst culprits when it came to putting managerial interests over stockholder interests
What can happen when managers do not fear stockholders?
They will often put their interests over stockholders interests
How can managers put their interests over stockholders interests? (5)
Over-paid compensations
Informational fraud
Self-interest
Takeover defences
Overpaying on takeovers
Why do some managers sometimes overpay on takeovers?
In order for the manager to appear on newspaper headlines and be a self-interested individual
What could happen if managers are not signifiant stockholders in the firm?
There could be conflicts of interest between managers and stockholders
What happens to conflicts if individuals are significant stockholders in the firm as well as part of top management?
There is potential conflicts between inside stockholders and outside stockholders
What is a positive and negative if the government is a large stockholder?
May keep managers in some check, but it can cause conflicts of interest between the other stockholders and the government
What is the benefit of an institutional investor?
Active managed funds believed to lead to better governance.
However, latest evidence says otherwise.
What day does bad news tend to be delivered on?
Friyay
