Lecture 1: Goals and Governance of the Firm

Two Major Questions

1. Where to Invest (Assets)

2. How to finance (Liabilities) the Investment

Opportunity cost of capital

• Investor needs Adequate return to provide capital (At least same Rate of Return as similar risk investments).

  • Assumption: Investors are Risk Averse

Sole Proprietorship

• Owner = Manager

• Personal Liability

• No conflict of interest

• Most owner Control

Partnership (OHG)

• Owners = Managers

• Personal Liability

• No General Conflict of Interest between Managers and Owners

Corporation (AG)

• Owners ≠ Managers

• Limited Liability

• Conflicts of Interest may arise between Owners and Managers

• Easiest to raise Equity —> Harder to raise Debt

German Corporate Structure

• 2 Tier Board

American Corporate Structure

• 1 Tier Board

Owner and Manager Separation

• Owners may lack key skills, be capital constrained, firm might be to big to manage alone

• Separate management allows Ownership changes to not affect company that much

• Managers have own self interests though (Money, Leisure)

Shareholder, Stakeholder and Shareholder Value theory

Shareholder Theory: Maximize Shareholder Value

• Stakeholders get legal protection and security

• Shareholders take the risk, therefore get control and residual profits (Once stakeholders are protected)

• Issue: If managers focus on shareholders stakeholders might get hurt (Layoffs)

Stakeholder Theory: Consider stakeholder interests —> Create value for all stakeholders (This cannot just be a monetary goal)

• Big Issue: Less attractive Investment, Hard to measure success, Easier for Managers to be self interested

Supply Chain of Capital

• Cash Raised —> Invested —> Firm Generates Cash —> Reinvest or payout Dividends