Chapter 1 Introduction to Corporate Finance

Agency Problems: Who owns a corporation? Describe the process whereby the owners control the firm's management.

Shareholders. They vote for the board of directors who in turn select the managers. They can engage in a proxy fight to combine their votes to change the board of directors and ultimately the managers.

Agency Problems: What is the main reason that an agency relationship exists in the corporate form of organization? In this context, what type of problems can arise?

The agency relationship exists because there is a separation of ownership and management. This separation creates room for situations where the best interests of management conflicts with the best interest of shareholders and vice versa. An investment opportunity could increase shareholder value but might jeopardize the security of management jobs.

Not-for-profit Firm Goals: Suppose you were the financial manager of a not for profit business. What kind of goals do you think would be appropriate?

making sure the non profit is able to at a minimum cover its expenses in addition to further invest in the nonprofit activities to create value for participants/customers

Goal of the Firm: Evaluate the following statement: managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits.

Money today is worth more than money tomorrow.

Ethics and Firm Goals: Can the goal of maximizing the value of the stock conflict with other goals, such as avoiding unethical or illegal behavior? In particular, do you think subjects like customer and employee safety, the environment, and the general good of society fit into this framework, or are they essentially ignored?

They can be ignored but they should not be. The ultimate negative consequences of bad behavior will do more harm than any good they could possibly generate.

International Firm Goal: would the goal of maximizing the value of the stock differ for the financial management in a foreign county? Why or why not?

In many other countries stock is not readily owned by individuals. Banks and large organizations own stock.

Agency Problems: suppose you own stock in a company. The current price per share is $25. Another company has just announced that is wants to buy your company and will pay $35 per share to acquire all the outstanding stock. your company's management immediately begins fighting off this hostile bid. Is management acting in the shareholders' best interest? why or why not?

Based off this information no they are not. Their goal is to maximize stock value and this takeover would accomplish that.

Agency Problems: corporate ownership varies around the world. Historically, individuals, have owned the majority of shares in public corporations in the United States. In Germany and Japan, however, banks and other large financial institutions, and other companies own most of the stock in public corporations. Do you think agency problems are likely to be more or less severe in Germany and Japan than in the United States?

Depends on your perspective

Agency Problems: In recent years, large financial institutions such as mututal funds and pension funds have become the dominant owners of stock in the United States, and these instituions are becoming more active in corporate affairs. What are the implications of this trend for agency problems and corporate control?

ff

Critics have charged that compensation to top managers in the US is too high and should be cut back. Are such amounts excessive?

yes

Why is the foal of financial management to maximize the current value of the company's stock? why isn't the goal to maximize future value?

present value is usually worth more.

current liability

A short-term debt, payment of which is expected to occur within one year.

capital budgeting

the decision-making process for accepting or rejecting projects

capital structure

the mix of the various debt and equity capital maintained by a firm

net working capital

current assets - current liabilities

sole proprietorship

a business owned by a single individual. pays no income tax but has unlimited liability for business debts and obligations

partnership

a business organization owned by two or more persons who agree on a specific division of responsibilities and profits

corporation

form of business organization recognized by law as a separate legal entity with all the rights and responsibilities of an individual, including the right to buy and sell property, enter into legal contracts, and to sue and be sued

goal of financial management for a corporation

maximize the current value per share of the existing stock

goal of financial management of non corporations?

maximize the value of the existing owners' equity

agency problem

conflict of interest between a principal and an agent

agency cost

the cost of the missed opportunities from the conflict of interest created by an agency problem

Securities act of 1933

o Requires a corporation to file a registration statement with the SEC that must be available to every buyer of a new security

o Intended to provide potential stockholders with all the necessary information for them to make a reasonable decision

· Securities and Exchange Act of 1934

o Extends the disclosure requirements of the 1933 act to securities trading in markets after they have been issued

o Established the SEC

o Covers reporting, tender offers, and insider trading

o Requires corporations to file reports to the SEC on an annual basis: yearly Form 10-K, quarterly Form 10-Q, monthly Form 8-K

· Sarbanes-Oxley

o Prohibits personal loans from a company to its officers

o Section 404 requires that the annual must have an assessment of the company's internal control structure and financial reporting

§ Auditor must evaluate and attest to the management's assessment

Proxy fight

· refers to the act of a group of shareholders joining forces and attempting to gather enough shareholder proxy votes to win a corporate vote. The voting bids in a proxy vote could include replacing corporate management or the board of directors.

How do financial manager create value

1. Buying assets that generate more cash than they cost

2. Sell bonds, stocks, and other financial instruments that raise more cash than they cost

What is the focus of corporate finance

cash flows

Importance of Cash Flow Timing

· Individuals prefer to receive cash flows earlier rather than later

o A dollar received today is worth more than a dollar received next year

Pros of Corporations

o Separation of ownership from management

o Ownership is easily transferable because it is represented by shares of stock

o Unlimited lifespan> perpetual succession

o Shareholder's liability is limited to the amount invested in ownership shares

cons of corporations

o Double taxation > corporate income is taxed and the personal income tax of shareholders is taxed on the dividend income they receive

What must the articles of incorporation include?

o Name of the corporation

o Intended life of the corporation (it may be forever)

o Business purpose

o Number of shares of stock that the corporation is authorized to issue, with a statement of limitations and rights of different classes of shares

o Nature of the rights granted to shareholders

o Number of members of the initial board of directors