Topic 1- Basics of Corporation Flashcards
What is covered by the Investment/CAPEX decision or capital budgeting?
Real assets
What are the 2 things covered by the Financing decision (capital structure)?
- Financial assets
- Choice between alternative forms of financing
What is a corporation?
A business organised as a separate legal entity owned by shareholders
What is equity?
Sum of all ownership value of a corporation
What are the 2 types of corporation?
- Public corporation: publicly traded
- Private corporation: not on stock market
Give 3 main benefits of corporation
- Limited liability
- Infinite lifespan
- Ease of raising capital
Give 2 main drawbacks of corporation
- Double taxation: subject to corporate and income tax
- Agency problems: as an owner/shareholder, your managers (agents) may not act in your interest
What is the traditional objective in decision making in corporate finance?
To maximise the value of the firm
Give 3 main agency problems
- Ethics in value maximisation
- Shareholders desire wealth maximisation
- Managers are agents for stockholders, but the managers may act in their own interests rather than maximising value
How is there a difference in information between stockholders and management?
In theory, stockholders have significant control over management but in practice managers usually have information on: stock prices, issues of shares, dividends, financing
Describe 2 main disciplinary mechanisms for shareholders
- Annual meetings: a venue for shareholders to vote on managers and management decisions
- Board of directors: the board represents shareholders and acts as a check on management
Give 2 practical flaws of annual meetings
Power significantly diluted because of:
- Cost of attendance
- Large stockholders reluctance to involve
Give 3 practical flaws of boards of directors
- Directors are well paid by managers
- Directors just don’t care
- CEO often hand-picks directors
What are the 3 main criteria for the CaIPERS tests for independent boards?
- Are a majority of the directors outside directors?
- Is the chairman of the board independent as the company?
- Are the compensation and audit committees composed entirely of outsiders
