Corporate Issuers Flashcards
Refers to integrating social or environmental considerations in general into investment decisions:
Responsible/sustainable investing
Negative screening refers to :
excluding specific companies or industries from portfolio consideration based on ESG factors
Positive screening refers to:
including/identifying companies or industries for portfolio consideration based on ESG factors
According to this theory:
The focus of corporate governance is managing conflicts of interest among owners and several groups that have an interest in a company’s activities, including creditors
Stakeholder theory
Under this theory:
The primary focus of corporate governance is to manage the the activities of a firm in the best interest of it’s** owners**
Shareholder Theory
Foscus: Maximizing shareholder profits/value
Conflicts of interest, under shareholder theory, arise between:
shareholders (owners) and managers of a company
Information asymmetry arises between _____ and _____, and decreases their ability to _____ and _____ whether _____ are acting in their best interest
shareholders and managers;
monitor and evaluate whether the managers are acting in their best interests
Effective stakeholder management consists of:
1.
2.
effective communication with stakeholders
good understanding of all the stakeholder’s interests
An agreement between a company and a labor union, is considered part of the company’s:
Organizational infrastructure, of corporate governance
Which type of voting allows minority stockholders greater representation on the BOD?
Cumulative voting
The type of resolution most likely to require a supermajority of shareholder votes for passage is a resolution to:
mergers/acquisition
Ordinary resolutions include:
& require a ____ vote
approval of auditor and election of BOD
simple majority vote
In a two-tier BOD, the ____ are independent of the supervisory board:
Executive directors (make up the management board)
This BOD committee
reviews proposals for large acquisitions or projects and also monitors the performance of acquired assets and of projects requiring large capital expenditures
investment committee
Corporate governance is the system of ______ and _____ by which individual companies are managed.
internal control and procedures
Corporate governance uses checks, balances, and incentives to achieve a goal of:
* minimizing
* managing
- minimizing principal agent conflicts
- manage conflicting interests between insiders and external shareholders
Which stakeholder group tends to the less concerned with/affected by a company’s financial performance?
customers
In the context of of a corporation, who are the players in a principal-agent conflict?
principal: shareholders (owners)
agent: management & BOD
The most common principal agent conflict:
- Shareholders prefer:
- Managers prefer
Risk tolerance
* shareholders prefer more risk
* managers prefer less risk because they have more stake in the game on the firm’s performance, since their employment is dependent on the firm, where shareholder’s hold diversified portfolios
Straight voting means one share, one vote, which leaves minority shareholders with much less representation and can be an example of an:
agency conflict
This type of voting:
facilitates shareholder activism
Cumulative
by allowing shareholders to accumulate and vote all their shares for a single candidate in an election involving more than one candidate
In recent trends of corporate governance, most firms are expanding the scope to consider the interests of:
employees, customers, and suppliers
Ensuring a company has an appropriate enterprise risk management system is a responsibility of:
BOD
The two roles that should be separated to prevent too much executive power.
CEO & board chair
T/F: The board has the authority to select and terminate senior management
True
- Allows for some shares to be entitled to several votes/share, while others only have one vote/share
- Aligns economics ownership with control of:
- Promotes company stability by:
Dual-class structure:
* Allows for some shares to be entitled to several votes/share, while others only have one vote/share
* Aligns economic ownership with control of the founding shareholders
* Promotes company stability by being controlled by a consistent group (family)
ESG approach to achieving one goal/factor
thematic
Refers to promoting a specific social or environmental goal through investment actions, which may include investing in a particular project:
Impact investing
Like investing in green financing
Green financing is an example of ____ investing, by producing ______ growth in a sustainable way
impact investing
produces economic growth in a sustainable way
ESG considerations may conflict with fiduciary duty if they result in the manager accepting:
Lower returns or higher risk than they otherwise would
Using ESG factors in estimating the risk and returns of a company is not considered a violation of a manager’s fiduciary duty to clients and beneficiaries.
The manager may consider ESG in the anlysis of the company’s risk & return, but there is conflict of a manger’s fiduciary duty if integrating ESG differs from the stated portfolio objectives (Risk & Return)
A value-based appraoch would include:
Avoidance of companies that conflict with moral or ethical values
This approach:
- Refers to considering ESG-related risks and opportunities alongside traditional investment considerations
- Objective: mitigating risks & identifying opportunities
A “value-based” approach to ESG investing
A values based **investment objective: **
- Investment decisions express an investor’s:
Expresses the investor’s ethical beliefs through investment decisions
the framework defining rights, roles, and responsibilities of groups
Corporate governance
Covenants protect the interests of:
creditors
Proxy voting and restrictions on related party transactions are measures that protect _____ interest
shareholder’s
Help to protect management from shareholder pressures and function as a takeover defense
cross-shareholding
Equity performance components, like stock options, included in executive remuneration plans are good or bad?
Good; helps to better align the interests of executives and investors
Best-in class approach to ESG investing:
- Selecting firms with the best ESG practices within:
- Preserves the:
- Selecting firms with the best ESG practices within each sector
- Preserve the sector weightings of the benchmark portfolio
- Uses positive screening
The process of planning expenditures on assets where the cash flows to the firm are expected to be greater than 1 year:
Capital allocation
Making good capital allocation decisions must be consistent with the manager’s primary goal of:
maximizing shareholder value
Are interest costs included in the estimate of the incremental cash flows from an investment?
No. Costs to finance the investment are taken into account when the cash flows are discounted at the appropriate cost of capital;
including interest costs in the cash flows would result in double-counting the cost of debt
Should sunk costs be considered in a project/s cash flows?
Sunk costs should not be considered when analyzing a project’s cash flows
These costs are not affected by the accept/reject decision because they cannot be avoided
Ex: R & D
The effects on other firm cash flows, when accepting a project:
externatilites
A common example of a ____ externality is cannibalization, which occurs when:
negative externality because the new project takes sales from an existing one
Cash flows are based on:
opportunity costs
Cash flows are analyzed on a basis of:
after tax basis
the impacts of taxes must be considered when analyzing all capital allocation projects
Financing costs, like interest payments, are reflected in the project’s:
Required rate of return (discount rate) & therefore should not be included in the incremental cash flows
The net present value (NPV) of an investment is equal to the sum of the expected cash flows discounted at the:
opportunity cost of capital
When NPV is negative, the IRR
IRR < Discount rate
IRR is the discount rate that makes the net present value:
IRR is the discount rate that results in: NPV = 0
IRR is the discount rate to make PV inflows = PV outflows
ROIC can be compared to a company’s WACC to indicate:
whether the company has increased or decreased the firm value over time
When NPV is postitive, the ROIC is greater than the cost of capital, and these projects are providng returns greater than the:
opportunity cost of capital
When comparing ROIC and cost of capital, if all projects have a positive NPV, ROIC is:
ROIC > cost of capital
A direct measure of the expected change in firm value from undertaking a project:
NPV
____ is related to share value; and should cause a proportionate increase in a company’s stock price, of _____/shares outstanding, but other factors are related
NPV
NPV per shares outstanding
IRR shows the return on:
Percentage Return on each dollar invested
(advantage of using IRR since it is easier to use/understand)
When dealing with mutually exclusive projects, the most reliable decision rule is:
NPV
The value of a company is the value of its __ plus the __ of all of its future investments
existing investments + net present values
The net present value (NPV) method assumes that cash flows are reinvested at:
cost of capital
The internal rate of return method assumes that the cash flows from a project are reinvested at the project’s:
IRR
Which step is this in the capital allocation process?
The step used to identify systematic errors in the forecasting process and improve operations
conducting post audit (last step)
For mutually exclusive projects the NPV decision rule is to:
accept the project with the highest NPV
For independent projects the NPV decision rule is to:
accept all projects with a positive NPV
- changing the inputs into a production process:
- option to sell:
- option to increase capacity:
flexibility option
abandonment
expansion
IRR analysis will yield ____ accept/reject decision for a single project compared to NPV
the same
NPV is the preferred method, but should be used especially when there are ____ IRR
multiple project IRRs
Unconventional cash flows where the sign of the cash flows change more than once cause:
multiple IRRs
Conventional cash flows= 1 IRR
NPV will give the sample accept/reject decisions for:
- Independent projects
- With conventional cash flows
Conflict between the NPV and IRR decision rules can arise when evaluating mutually exclusive projects with conventional cash flows because:
1) the scale of investments may differ and/or 2) the timing of the cash flows may differ
Operating cycle =
days of inventory + days of receivables
Occurs when disbursements are made too quickly:
* current liabilities are paid instead of being held
* when credit availability is reduced or limited
A “pull” on liquidity
Decrease in days of payables
Occurs when liquidity is delayed or reduces cash flows;
receipts lag: non-cash current assets do not convert to cash quickly
“drag” on liquidity
Measures the amount of time it takes the firm to turn the firm’s cash investments in inventory, back into cash:
Cash conversion cycle
(Measure of Liquidity)
Shorter cycle indicates the company is better able to generate cash, and has a lesser need for outside finance
Short cash conversion cycle
(aka Net operating cycle)
High cash conversion cycle implies that a company:
Has excessive investment in working capital
Liquidity position is undesireable
A revolving line of credit is typically ______ than an uncommitted or committed line of credit and thus is considered :
for a longer term
a more reliable source of liquidity
Debt is generally _____ than preferred or common stock
less costly
Cost of capital uses _ values:
uses market values only, not book values
the rate of return required by stockholders
cost of equity
the market interest rate (YTM)
cost of debt
What is the formula for calculating cost of preferred stock?
dividend/ current price
____ risk does not change with a higher debt-to-equity ratio.
Asset
____risk rises with higher debt
Equity
NPV w/ floatation costs=
PV of cash inflows - cost of project - floatation costs
Flotation costs are an additional cost of the project and should be incorporated as an adjustment to the _______ in the valuation computation
initial-period cash flows
(aka initial project costs)
fees charged by investment bankers when a company raises external equity capital
floatation costs
For a publicly traded company, the beta of a stock is estimated from the ____ relationship between returns on the stock and the returns on a ______
linear relationship
proxy- S&P500 (independent variable)
stock returns (dependent variable)
Stock’s systematic risk
beta
Capital=
debt + equity
When calculating a company’s cost of equity, the floatation costs of issuing new common stock should included as an:
initial cash outflow
Stock dividends, like stock splits, have what impact on a company’s equity?
No impact on the value of a company’s equity
Therefore, no affect to the capital structure
Share appreciation/depreciation has what impact on a company’s equity?
increase the market value of equity, thus increasing equity relative to debt
Cash flow typically turns positive during the _____ stage, but it may be negative, particularly at the beginning of this stage
growth stage
Modigliani-Miller Proposition I, with _____ states that in perfect markets the level of debt versus equity in the capital structure has what effect?
no taxes;
capital structure has no effect on company value
aka “the capital structure irrelevance theorem”
Modigliani-Miller Proposition, with taxes states that a company’s WACC is ______ and its value maximized, with _____
WACC minimized
value maximized with 100% debt financing
the value of the levered company is greater than that of the all-equity company by an amount equal to the tax rate multiplied by the value of the debt, also termed the debt tax shield.”
The optimal capital structure:
maximizes firm value and minimizes its WACC
The cost of equity _____ with the _____ debt in the capital structure
equity increases with the use of debt
Modigliani- Miller proposition no taxes, proposition II
If the company’s WACC increases as a result of taking on additional debt, the company has moved beyond _____
the optimal capital range
The static trade-off theory indicates that there is a trade-off between:
Trade off between:
* tax shield from interest on debt
* costs of financial distress
Debt can be a significant portion of the optimal capital structure because of the ______
tax-deductibility of interest
Because of information asymmetry, Issuing debt may signal to investors:
that management is confident in company’s ability to make these payments
Because of information asymmetry, Issuing equity may signal to investors:
that management believes the stock is overvalued
The pecking order state:
1. ____________ are preferable to both:
2. ______
3. _____
- internally generated funds
- new debt
- new equity
arise because management and shareholders may have conflicting interests
agency costs
Agency costs can be reduced by:
increased debt issuance
A company will typically use debt for the largest percentage of its financing during which stage?
Mature companies are able to support more debt than start-up companies or growth stage companies because they typically have predictable positive cash flows, lower business risk, and significant liquid assets.
Companies have an optimal level of debt & equity, according to which theory?
Static trade off
____-term debt is more exposed to the risk of a management decision that is not debt-holder friendly, likely resulting in debt-equity conflicts
long term debt
The additional uncertainty about operating earnigns caused by fixed operating costs:
The higher the proportion of fixed costs to variable costs the:
Operating risk increases when a firm has more fixed costs compared to variable costs
Business risk is:
- The uncertainty (risk) associated with a:
- Results from both:
- The uncertainty (risk) associated with a firm’s operating income (EBIT)
- Results from both operating risk and sales risk:
Sales risk: the uncertainty about the firm’s sales
Risk associated with the refinancing of debt:
Rollover risk:
a company financing long-term assets with short-term obligations faces rollover risk, which may threaten profitability if short-term financing costs go up over the financing period
A company financing short-term assets by issuing long-term debt most likely increases:
Default risk
Greater leverage of firm leads to:
greater variability of:
* After tax operating earnings
* Net income
The amount of fixed costs a firm has, including:
* fixed operating expenses
* fixed financing costs
leverage
Risk associated with the firm’s operating income (EBIT), due to the variability of sales & production costs
business risk
measures the percentage of a firm’s costs that are fixed:
Degree of operating leverage (DOL)
Business risk
Higher DOL = Higher _____ risk = more susceptible to _____ = _____ optimal debt ratio
The higher DOL= the higher business risk= the more susceptible to business cycle fluctuations
=lower optimal debt ratio
Companies with a high degree of operating risk tend to have highly variable operating cash flows, making them less able to service debt compared to companies with less operating risk, resulting in a capital structure consisting of:
High proportion of equity
According to pecking order theory, managers prefer to finance a firm with:
internally generated capital, than with additional debt
Funding an acquisition, especially one that is expected to generate significant cash flows, is often a reason for a company to:
issue additional debt
Stable cash flows and high proportions of liquid assets typically enable companies to service a:
Higher proportion of debt in their capital structures.
Company most likely has a low operating risk
the additional uncertainty about earnings caused by fixed operating costs
operating risk
This risk increases when the firm takes on more fixed expenses, in the form of interest payments
financial risk
level of sales required to cover fixed operating costs only
breakeven quantity of sales; ignoring fixed financing costs (interest)
With regard to a corporation’s legal environment, the interests of shareholders and firm creditors are typically best served by:
Common Law
Viewed as better protection to shareholders/creditors
Judges/laws; because judges may rule against management actions in situations that are not specifically addressed by statutes
A company’s corporate governance procedures and internal systems and practices for managing stakeholder relationships.
Organizational Infrastructure
Executives & non-executives (independent directors) jointly serve on:
One-tier board of directors
joint responsible for determining corporate strategy
- Idea generation
- Analyze project proposals
- Create the firm wide capital budget
- Monitor decisions and conduct a post-audit
Capital Budgeting Process
An example of matrix pricing when determing the cost of debt:
Debt-rating approach
The weights used to calculate WACC should be based on:
the firm’s target capital structure
If the company does not provide information about its target capital structure, an analyst can use:
-the company’s current capital structure
-the average capital structure weights for the industry
Operating profit/income is also known as:
EBIT
Measures the sensitivity of EPS to change in sales:
Degree of total leverage
Combines DOL & DFL
Greater financial leverage decreases:
net income, due to interest expense
When leverage increases and ROA is greater than debt costs, ROE will:
Increases, due to lower equity
When deciding between mature companies that are most likely to employ debt, make decisions based on:
- Stable cash flows
- Fixed asset base/model implies that debt has already been employed
- Predictable revenues
- Cyclicality of a business (Less cyclical industries preferred)
Ex: electric utility would employ high portion of debt
Which debt-equity situation is most likely to create conflicts?
long-term debt
long term debt is more exposed to the possibility of management turnover and differing views on holding debt
Common Capital Allocation pitfalls:
Basing investment decisions on:
* The change in EPS in the short term
* The effects of not spending the entire capital budget available
Ex: If a division decides against the project, the firm will allocate his division a smaller capital budget next year.. should not be used in consideration
The threat of hostile takeovers can acts as a strong:
Incentive for managerst to act in the best interests of shareholders
Full integration of ESG investing:
Including ESG in fundamental analysis
