Chapter 1: Intro to Corporate Finance

activist investor

a party that buys a significant stake in a company in order to improve the stock price by changing how the board and C-suite run the company; if disagreements arise, a proxy fight often ensues

agency relationship

a situation where the principal hires an agent to act in their best interests; in the case of a corporation, the stockholders are the principals, and the board of directors and managers are their agents

agency costs (direct)

the measurable monetary costs that arise from conflicts of interest between the owners and managers of a corporation; 2 types of direct agency costs

• money the C-suite wastes on itself rather than paying to the shareholders

• resources expended to monitor the managers, such as audits

agency costs (indirect)

valuable opportunities that managers may forgo because they are highly risk-averse; impossible to quantify but they deprive the owners of potentially significant value creation

agent

the party in a an agency relationship hired to act in the principal’s best interest

articles of incorporation (charter)

documents a business files with a state to create a corporation; must include info about the corporations such

• purpose

• number of shares of stock

• structure of the board of directors

• etc

asymmetric info

situation where 2 contracting parties have different info sets; when one party has superior information and the other inferior, it can be difficult and costly to arrive at mutually agreeable termsb

board of directors 

the elected representatives of the shareholders who have a fiduciary obligation to act in the best interest of the stockholders

bond

a standardized debt instrument that is an alternative way to borrow money instead of a bank loan

bylaws

the rules and procedures established by the owners that govern the operation of a corporation

C-corp

a corporation with more than 100 owners that falls under subchapter C of the IRS tax code

• c-corp profits pay corporate income tax, and the government taxes their dividend distributions to the shareholders again at the personal level

c-suite

the senior manages, chiefs or vice presidents, who are responsible for running a corporation

capital

the physical and intellectual assets deployed by a business to produce goods and services

capital budgeting

the process of planning and managing a firm’s long-term investments, taking into account the size, timing, and risk of an investment’s cash flows; typically the responsibility of the cfo and the treasury department; capital budgeting decisions change the long-term assets on the company’s balance sheet and define the business’s identity

capital expenditures (capex)

the money a business spends on its long-term assets

capital providers

owners and lenders; they provide the funding that makes the business possible in the first place

commodity money

objects that have value in themselves as well as their use as a medium of exchange, unit of account, and store of value (ex: copper pennies)

controller’s office

the business unit that handles the corporation’s accounting systems

corporate or business finance

a field within finance that examines how businesses allocate their scarce capital to maximize the value of the firm, all the while not knowing what the future truly holds; despite its many equations, it is a social science

corporate governance

the set of rules, procedures, processes, social norms, and ethics that create an environment that determines the alignment between the wishes of the shareholderds with the actions of their board and C-suite

corporation

a business created as a distinct legal entity from the owners, its stockholders, or shareholders. the corporation is liable for the claims of the creditors, not the owners, thus providing the shareholders with limited liabilty

dividends

the profit distributions a corporation gives to the stockholder

double-taxation of profits

a disadvantage of c-corps is that profits are first taxed at the corporate income tax rate, then again at the personal level when shareholders recieve dividends

economics

a social science that studies how individuals and businesses make production, distribution, and consumption decisions while facing resource scarcity

federal reserve (FED)

the central bank of the U.S., which means it has the sole authority to create dollars

fiat money

currency that a government declares to be legal tender and has no intrinsic value

• dollar bills

finance

a field within economics that examines how people use money and markets to achieve their goals without a crystal ball

general partnership

all the partners share in the gains and losses, and all have unlimited liability for all partnership debts

going dark

taking a public company private; there can be many reasons this happens

• avoiding costly regulatory compliance costs of public corps is most noteable

hostile takeover

when a company or individual tries to rest control of a corporate target from its unwilling board and management team

• common motivation is the belief that the target is undervalued because it’s poorly run

illiquid

the property of an asset that makes it difficult for the owner to sell quickly at its fair market value

inflation

a general rise in the general price level; reason money is an imperfect store of value

leverage

the extent to which a firm uses debt to finance its assets

levering down

increasing the importance of funding the firm’s assets with equity instead of debt by decreasing the firm’s debt-to-equity ratio

levering up

increasing the importance of financing the firm’s assets with debt instead of equity by increasing the firm’s debt-to-equity ratio

limited liability

when the max loss an owner can realize is their invesment in the business

limited liability companies (llc)

a hybrid business from that combines the characterists of sole propreitorships and partnerships with those of a corporation. an llc has the limited liaiblity of a corporation and is tax passthrough like a sole propreitorship or partnership. though they can be large, we will think of an llc as a sole proporeitorship with the addtional benefit of limited liability

liquidity

the degree to which one can sell an asset quickly at its fair market value. ownerships interests in business enterprises can vary significantly in their liquidity, with shares in public companies being the most liquid and sole proprietorships being the most illiquid.

market capitalization (market cap)

The total value of the equity claims on a business. In the case of a corporation,
it is the share price times the number of shares outstanding

maximize the value of the firm

The primary goal of a for-profit business.

medium of exchange

An intermediary instrument used to facilitate the sale, purchase, or trading of goods and
services between market participants

money

An intermediary instrument used by buyers and sellers to reduce the costs of barter. Money acts as a medium
of exchange, store of value, and a unit of account

monitoring

The principals spend time, money, and effort to watch the activities of their agents to alleviate, to the
extent possible, agency problems

NASDAQ

One of the two largest stock markets in the U.S

New York Stock Exchange (NYSE)

One of the two largest stock markets in the U.S

nexus of contracts

The view that a firm creates a web of contracts with its owners, lenders, customers, employees,
suppliers, and other counterparties as it pursues value creation

partnership

A business formed by two or more individuals or entities

partnership agreement

A contract that delineates the rules under which a partnership operates. It typically includes
provisions for the distribution of profits, the obligations of the partners, procedures for selling a partner’s ownership
interest, and mechanisms for conflict resolution.

principal

The party in an agency relationship who hires an agent to act in their best interests

principal-agent problem (agency problem)

Conflicts of interest between the principal and the agent. In the case
of a corporation, it occurs between stockholders (principals) and the managers (agents). The C-suite may operate
the corporation in their own best interests at the expense of the shareholders, severely damaging the owners’ wealth

private corp

public corp

A business whose ownership claims are freely available to anybody with the money to purchase
them. Consequently, these claims, called shares of stock, trade on at least one stock exchange, such as the NYSE
or NASDAQ

proxy fight

It is a battle over corporate control and the destiny of the firm that results when shareholders have
strongly held but divergent views on the proper path forward to value creation. Often, the warring parties make
every effort to make their case to undecided shareholders

residual claimant

owners, who have the lowest priority claim on the cash flows of the business enterprise and, therefore, assume a business’s riskiest position

restricted stock

Corporate shares included in an employee’s compensation package for the intended goal of
aligning the incentives of the employee with those of the owners, the principals. The shares become the
unconditional property of the employees after the vesting period defined in the employment contract lapses.

s-corp

A corporation with 100 or fewer owners that falls under subchapter S of the IRS tax code. S-
corporation profits have a tax-paying option, which allows them to pay taxes once at the personal level if they wish

sarbanes-oxley act (SOX)

a u.s. law designed to improve the reliability of financial statements of public companies and increase the penalties to company executives for fradulent financials

securities and exchange commission (SEC)

A federal regulatory agency. From their website, “The mission of
the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The
SEC strives to promote a market environment that is worthy of the public’s trust.” Regular SEC disclosures provide
valuable information to investors, reducing information asymmetries between shareholders and their agents, as well
as between traders. Increased investor confidence and liquidity are the overall positive impacts

shares of stock

standardized ownership claims on a corporation that convey certain rights to the shareholders, such as voting on the board of directors and sharing in dividends

sole proprietorship

A business owned by a single individual.

stockholders and shareholders

The owners of a corporation.

stock exchange

an organized market that gives traders the opportunity to buy and sell corporate shares quickly with relatively low transaction costs

store of value

An asset that you can save, retrieve, exchange, and will be predictably useful when you retrieve it.

tax pass-through entity

When the government taxes business profits once as the personal income of the owner.
Sole proprietorships, partnerships, S-corporations (if they wish), and LLCs are pass-throughs

ticker symbol

A one to four-letter shorthand designation for a publicly traded company. Harley-Davidson’s ticker
is HOG

treasury department

the business unit that conducts financial planning, manages the company’s cash, determines
capital expenditures, raises the required funds, and manages the financial risks the firm faces.

unit of account

A unit of measure used to value goods, services, or any other economic item. Examples include
dollars, pounds, and euros

unlevered

An all-equity company

unlimited liability

Creditors can look beyond the business assets to the owner’s personal assets for payment

value

What a business is worth to a prospective buyer

value maximization

The goal of for-profit businesses. For corporations, the term is synonymous with maximizing
the current stock price. For other business forms, it means maximizing the market value of the owners’ equity.

working capital

The difference between a firm’s short-term assets, such as cash and inventory, and its short-term
liabilities, such as money owed to suppliers and workers

working capital management

The daily management of the business’s cash inflows and outflows, which typically result from the current assets and liabilities