Lecture 1 - Introduction Flashcards
Corporate Finance
The Building Blocks
- Capital Budgeting
- Capital structure
- Risk management
- Payout Policy
Corporate Finance
Analytical Tools
- Portfolio theory
- Asset pricing theory
- Option pricing theory
- Agency theory
- Game theory
Corporate Finance
Important Principles
- Corporations generate value for their shareholders by making real investments
- the goal is t maximize the ewalth of the shareholders
- Firms should invest in positive NPV projects
- Firms should choose a financing mix that minimizes the costs of capital
- Cash that cannot be invested into positive NPV projects, and does not generate value for the firm through other channel, should be returned to the owners of the firm
- Avoid conflicts of interest that increase the costs of capital
Corporate Finance
Why focus on Maximizing Shareholder Wealth?
- Stock price is directly observable
- Stock price is updated almost immediately
- Stock prices should reflect the common opinion on decisions instanteneously, if investors are rational
- Stock market price continuously provides a measure of the value of assets in place and, therefore, on the impact of managerial behaviors on investor returns
Corporate Finance
Problems of Stockholder Wealth Maximization
- Financial markets do not operate efficiently, and stock prices do not relfect the underlying value of the firm
- Significant social costs can be creted a a by-product of stock price maximizations (negavtive externalities)
- Short vs. long-term maximization
- Imperfection in contracts and laws together with poor information
Corporate Finance
Shareholder value or Stakeholder society?
Recommendation that managers internalize the externalities that their decisions impose on various groups
- Environment / Charitable contributions / Workers
Challenges:
- ESG vague emasures, poor managerial incentives
- undersired outcomes: firm sacrifices profit to benefit some stakeholder –> danger of takeover, lay off workers, etc.
Corporate Finance
Corporate Governance
- Ways in which suppliers of capital to corporations assure themelves of getting a return on their investment
- NEcessary due to the separation of ownership and control: Corporate insiders need not act in the best interest of the providers of funds
- Insufficient effort, extravagent investments, entrenchement strategies, self-dealing, conflicts of interests
Corporate Finance
Instruments of CG
- BoD
- Market for corporate control
- Inestor activism
- Monitoring
- Convenants
- Laws, regulations
- Monetary incentives
Corporate Governance
BoD
- Monitor management on behalf of shareholders
- Approve major business decisions and corporate strategy
- Independence, attention, incentives, collusion
- Codes of good governance
- Risk: lack of time and attention, collusion, focus on reputations, etc
Corporate Governance
Market for Corporate Control
- Takeovers may be needed to keep managers on their toes
- Management reacts by lobbying for restrictive antitakeover laws, and by adopting takeover defences
- Leveraged buyout: Taking a firm private by purchasing its shares and allocating them to a concentrated ownership –> often financed with high debt
Corporate Governance
Investor Activism
- Active monitoring requires control
- Linked to the structure of ownership
- A possibility but not the best option, very time consuming, except perhaps for large institutional investors
Problems:
- Who monitors the monitor?
- Congruence with other investors
- Costs of providing proper incentives to the monitor
- Perverse effects of monitoring on managers
- Legal, fiscal, and regulatory hurdles
Corporate Governance
Monitoring
BoD, Large shareholders, large creditors, IBs, rating agencies
- Active vs. speculative monitoring
- Conflicts of interests
Corporate Governance
Laws, Regulation
Firm’s ability to commit to return funds to the investor depends on the policy environment
- variation across countries
- Common vs. civil law
- Protection of shareholders strongest in common law countries
- civil law tends more towards protection of creditors
Corporate Governance
Monetary Incentives
From 1978-2022, top CEO compensation shot up 1’209.2% compared with a 15.3% increase in typical worker’s compensation.
- Motivate only if managers are not able to undo their incentives
- Straight shares or stock options?
- Explicit and implicit incentives
- Downward trend of fixed salaries against stocks
