term 2 - lecture 1 Flashcards
what are the traits of sole propriertorship?
buissness owned by one person, typically has few employees. its advantage is its easy to make, disadvantage is unlimted personal liability, limited life
what are the traits of a partnership?
*similiar to a sole proprietorship, but with more than one owner.
* All partners are personally liable for all of the firm’s
debts. A lender can require any partner to repay all of
the firm’s outstanding debts.
* The partnership ends with the death or withdrawal of
any single partner
what is a corporation?
A legal entity separate from its owners:
* Has many of the legal powers individuals have such as the ability to enter into contracts, own assets, and borrow money.
* The corporation is solely responsible for its own obligations. Its owners are not liable for any obligation the corporation enters into.
* Corporations must be legally formed. Setting up a corporation is more costly than setting up a sole proprietorship
what are the tax implications for corporations?
As a separate legal entity, a corporation’s profits are subject to taxation separate from its owners’ tax obligations.
Thus, shareholders of a corporation effectively pay
taxes twice (double taxation):
* Corporation first pays taxes on its profits
* Shareholders then pay personal income taxes on the remaining profits which are distributed to them
what is the corporate management team?
It is often not feasible for the owners of a corporation to have direct control of the firm (there are many owners who can freely trade their shares).
the shareholders exercise their control by electing aboard of directors which has the ultimate decision-making authority in the corporation.
The board of directors creates rules on how the corporation should be run, sets policies, and monitors the performance of the corporation.
The board of directors appoints and delegates most decisions that involve day-to-day running of the corporation to a chief executive officer (CEO).
The separation of powers between the CEO and the board of directors is not always distinct. It is not uncommon for the CEO to also be the chairman of the board of directors.
what are the reasons for combining CEO and chair rules?
unified leadership, knowledge as CEO, bridge between management and board, leadership structure has served well, efficiency and effectiveness of board
what are the reasons for seperating CEO and chair roles?
differences between tasks and roles
faciliatates monitoring
CEO focuses on management
chairs experience with company
what is the financial manager?
The most senior financial manager is the chief financial officer (CFO) who often reports directly to the CEO.
the financial manager is responsible for:
- investment decisions - identifying and implementing projects that create value for shareholders
financing decisions - once investments are identified, the financial manager has to decide how to pay for them e.g. raise more money by selling more shares (equity) or borrowing (issuing bonds or other debt)
treasury management - managing working capital (whether a company has enough short term assets to cover its short term debt)
what is the goal of the firm?
the shareholders will agree that its better off if management will make decisions which increase the value of their shares
what are agency costs?
the costs that arise when there are conflicts of interest between buissness owners (the principals) and the managers ( the agents) are called agency costs
these costs are caused by suboptimal allocations of resources in the firm
that is, managers make investment and financial decisions that reduce the value of the firm, e.g. intiate risky projects with negative NPV, forego profitable projects, spend on prerequisites
what is financial distress?
firms that are unable to service their debts are said to be in financial distress
financially distressed firms either file for bankruptcy or can avoid bankruptcy by negotiating directly with creditors
what is bankruptcy?
after a firm defaults, debt holders take legal ownership of a firms assets through a legal process called bankruptcy
what is default?
when a firm fails to make the required interest or principal payments on debt it is in default
when do conflict of interests arise in investment decisions?
a conflict of interest arises if investment decisions have different consequences for the value of equity and the value of debt
this is most likely to occur when there is a greater likelihood of financial distress. the equity holders will have nothing to lose in this case as they are not liable for debt
what are debt holders entitled to in the capital structure?
debt holders are entitled to fixed payments of interest and the principal. they lend funds to the firm for a limited time
what are equity holders entitled to in the capital structure?
the equity holders are entitled to the residual payment of future earning of the firm. they have voting rights and control investment decisions
what are agency problems?
in corporations, managers run firms on behalf of the firm owners.
however despite being hired as the agents of the shareholders, managers often put their own interests ahead of the interest of the shareholders
