Lecture 3 - Goals & Governence Of The Corporation

Question 1

What is the financial goal of firms ?

Answer 1

Maximise wealth of the shareholders

• maximise profits?
• maximise sales?

Efficient market hypothesis:
- the stock price reflects instantly all available information regarding the firm

Maximise the market value of the firm

Question 2

Investment decision

Answer 2

Maximise the market value of the firm

How can we achieve this goal?

Invest in assets that earn a return higher than the minimum acceptable hurdle rate

• invest in real assets (tangible or intangible)
• the minimum acceptable hurdle rate it known a (opportunity) cost of capital

Question 3

Financing decision

Answer 3

Maximise the market value of the firm

Invest in assets that earn a return higher than the minimum acceptable hurdle rate

How can we finance these investments ?
- find the right kind of debt for the firm and decide on the capital structure to fund operations

Question 4

Dividend decision

Answer 4

Maximise the market value of the firm

• investment decision
• financing decision

What if we can’t find ‘good’ investments?

Return the cash to the shareholders either through dividends or through stock repurchases

Question 5

Who takes these decisions ?

Answer 5

Financial manager (chief financial officer, treasurer, controller)

• firms operations/ investments, real assets
• investors, financial assets

1. Raises cash from investors
2. Invests cash in the firm
3. Cash is generated by operations
4. Reinvests cash in the firm and/or returns to investors

Question 6

What is a corporation?

Answer 6

A business organised as a legal entity distinct from its owners

• confers limited liability
• can be public or private and in both cases can be closely held
• identified as by: inc(USA), plc. (UK), SA (FRANCE)

Question 7

Corporate governance

Answer 7

CFO. COO. CTO

Chief Executive Officer - appointed & monitored by board

Board of Directors - elected by shareholders

Shareholders - Owners of the Firm

Question 8

Agency issues

Answer 8

Is it realistic to expect managers to always act on the best interests of the shareholders?

A combination of ‘measures’ is required to reduce the principal-agent problem in corporations:

• diverse board of directors
• specialist monitoring
• appropriate compensation plans
• threat of a potential takeover