Chapter 1 Flashcards
Introduction to corporate finance
What are 3 basic questions to answer?
- What long-term investments should you undertake?
- Where will you get the long-term financing to pay for the investments?
- How will you manage the everyday financial activities of the business?
The financial manager
A consequence of the dispersed ownership: separation of ownership and management.
What are the parts of two-tier hierarchy
- Board of directors (or governors) - elected by shareholders
- High-level managers (or executives) - hired by the board of directors
Responsibilities of Board of directors and Managers
Board of directors: body represents the owners, responsible for determining strategy of firm.
Managers: responsible for the company’s day-to-day operations and profitability
Positions of board of directors and their responsibilities
- Chairman, “the formal leader of the corporation” - responsible for running the board, communication, represents the company/board.
- Inside directors - managers at the company (executive directors), provide internal perspectives.
- Outside directors - not directly part of the management team, provide unbiased, objective, external perspectives.
Managerial positions
- First-level managers (or supervisors) - the lowest level: office/store/department managers.
- Middle-level managers: general/plant/regional/divisional managers.
- High or top-level managers (or senior managers, or executives):
* Chief Executive Officer (CEO) - top manager, responsible for implementation of board decisions and initiatives; reports directly to the board; sometimes also referred to as the president; an inside direction and often the chairman of the board.
*Chief Operations Officer (COO) - responsible for corporation’s day-to-day operations; reports to the CEO, sometimes referred to as the (senior/vice) president.
* Chief Financial Officer (CFO) - reports to the CEO, presents financial information directly to the board, the shareholders and the regulatory bodies; referred to as the (senior) vice president of finance.
3 Financial Management Decisions
- Investment
- Financing
- Liquidity
Investment decisions
Capital budgeting or capital expenditure: identifying the potential investment opportunities, analyzing their expected revenues and costs, selecting the best ones which revenues exceed costs to the greatest extent.
Financing decisions
Capital structure or capital mix: obtaining the money for the investments. 2 sources: creditors (debt) or new owners (equity). Loan/credit must be paid back with interest. Equity does not need to be paid back, but profits must be shared with new owners.
Capital structure: what % of the firm’s cash flows goes to shareholders and what % goes to creditors.
Liquidity decisions
Working capital management decisions: how are the day-to-day finances of the firm managed to avoid liquidity problems and costly interruptions.
Thinking ahead, and controlling that the firm will always have sufficient cash flow for short-term obligations and daily operational expenses.
Sole Proprietorship
Business owned by one person, simplest type of business, the least regulated form of organization. Owner keeps all the profits. Unlimited liability - the owner is liable for all the obligations of the business.
Partnership
2 or more owners (partners)
1. General partnership: all the partners share in profits or losses (described in the partnership agreement), all partners have unlimited liability.
2. Limited partnership: one or more general partner - run the business, have unlimited liability; one or more limited partners - not actively participate in the business; have limited liability up to the amount they have contributed to the partnership
Corporation
Legal person: has rights and duties, can borrow money, property, can sue and be sued, can enter into contract.
Limited liability - shareholders/stockholders in a corporation have limited liability for corporate’s obligations up to their investments.
Primary markets
Original sales of securities by corporations. Corporations sell securities to investors to raise money for their investments.
Public offering: selling securities to the general public.
Private placement: non-public offering, a negotiated sale to a specific buyer.
Secondary market
Where securities are traded after companies have sold their stocks and bonds on the primary market. It is the place for transferring ownership or credits of corporations.
Dealer vs Auction markets vs Dealer markets of stocks
Dealer markets: dealers buy and sell for themselves, for their own accounts and at their own risk.
Auction market: brokers only try to match buyers and sellers.
Dealer markets of stocks: over-the-counter (OTC) markets.
Auction (or exchange) markets of stocks: with physical location
The goal of financial management
Managers in a corporation need to make decisions in the interests of the shareholders, to make as much money as possible with their shares.
Managers act in the shareholders’ best interests by making decisions that increase the value of the stock.
General goal of financial management
To maximize the current share value of the company. Profits from various projects of the company is the source of future dividends.
Agency relationships
Agency relationships: when someone hires another to represent his/her interests.
Agency problem: conflict of interests between principal and agent - stockholders and management.
Agency costs
To resolve the conflict of interests between stockholders (principal) and managers (agents) is costly.
▪ Indirect agency costs: costs of wrong managerial decisions
▪ Direct agency costs: corporate expenditures which benefit only the managers at the direct expense of shareholders; Monitoring expenditures
Ways to solve the agency problem at relatively low costs
▪ Incentives relate to managerial compensations
▪ Control, the shareholders check the performance of the managers
▪ Managerial (or executive) compensation
Control of the firm
Through the election of the directors: shareholders elect the board members, who hire managers to carry out their directives
Proxy voting
▪ It is a form of voting when a shareholder delegates their voting right to someone else.
Takeover
Takeover is the purchase of one company (the target) by another (the acquirer).
