Module Overview and Assessment

• Course title: Corporate Finance & Financial Strategies

• Week 1 focus: Coursework & Corporate Governance

• Course Leader/University: Dr Sanjukta Brahma, Glasgow Caledonian University (GCU)

• Contact details are provided for module leader and team members (email and room numbers on the Britannia Building)

• Semester context: University for the Common Good

Module overview and readings

• Topics/Reading list:

  • Introduction: Coursework & Corporate Governance – Ch. 1

  • Measuring Corporate Performance – Ch. 4

  • Time Value of Money – Ch. 5

  • Equity Markets and Stock Valuation – Ch. 7

  • Risk, Return and the Opportunity Cost of Capital – Ch. 11

  • Investment Appraisal Criteria – Ch. 8

  • International Financial Management – Ch. 22

  • Bond Markets and Bonds Valuation – Ch. 6

  • WACC and Company Valuation – Ch. 13

  • Capital Budgeting – Ch. 9 & 10

  • Options – Ch. 23

  • Exam Revision – (no chapter specified)

• These chapters provide the theoretical and practical foundations for coursework and exams.

Lecture 1: Goals and Governance of the Corporation

• Topic Covered:

  • What is a Corporation?

  • Goals of the Corporation

  • Investment and Financing Decisions

  • Agency Problems, Executive Compensation, and Corporate Governance

  • The Ethics of Maximizing Value

What is a Corporation?

Types of Business Organizations (Detailed comparison)

• Sole Proprietorship: Simplest form, owned by one individual, fully responsible for debts.

• Partnership: Owned by two or more individuals, sharing profits and liabilities according to partnership agreement.

• Corporation: Separate legal entity, offering limited liability to owners (shareholders), easier access to capital.

• Limited Liability Company (LLC): Combines the benefits of a corporation's limited liability with the flexibility of a partnership.

Forms of Business Organizations (McGraw Hill concepts)

• Sole Proprietorship

  • Owned and managed by one person

  • Very easy to form

  • Profits taxed as personal income

  • Unlimited liability

  • Life of company linked to life of owner

  • Funding limited by owner's wealth

• Partnership

  • Easy to form; requires a partnership agreement

  • Can have limited and unlimited partners

  • Partnership terminated when a partner dies or leaves

  • Difficult to raise cash

  • Profits taxed as personal income

  • Generally controlled by general partners; major decisions may require votes

• Limited Corporation (Limited Liability Company common framing)

  • Articles and Memorandum of Incorporation required

  • Limited liability

  • Profits taxed at corporate rate

  • Board of directors

  • Life of company hypothetically unlimited

Articles of Incorporation vs Memorandum of Association

• Articles of Incorporation: Name, intended life, business purpose, number of authorized shares, rights of different share classes, nature of shareholder rights, initial board size

• Memorandum of Association: The rules by which the corporation is organized

Board Structures: Single-Tier vs Two-Tier

• Single-Tier Boards (Unitary):

  • Chairman/CEO; Directors; Non-Executive Directors

  • Board reports to shareholders; shareholders elect directors at AGM

• Two-Tier Boards (Supervisory):

  • Supervisory Board; Chairman/CEO; Directors

  • Board reports to supervisory board; supervisory board elects directors

  • Supervisory board includes representation from banks, government, trade unions, and other stakeholders

  

Global Context: Unitary vs Two-Tier across jurisdictions

• Unitary board structure emphasized in many markets; two-tier structures found in some European contexts

• British and German board structures summarized (Hillier reference)

  • Unitary: Board reports to shareholders; shareholders elect directors at AGM

  • Two-Tier: Board reports to supervisory board; supervisory board includes stakeholder representation

  

Goals of the Corporation

• Shareholders desire wealth maximization

• Profit maximization: Which profits? – Year-specific profits vs. market value vs. market share

• Opportunity cost of capital: Minimum acceptable rate of return set by investment opportunities in financial markets

The Investment Trade-Off

Tangible vs Intangible Assets

• Tangible assets: e.g., aircraft, machinery, physical capital

• Intangible assets: e.g., R&D, software, brand value

• Examples:

  • Delta Air Lines: Purchase new planes (tangible)

  • GlaxoSmithKline: R&D expenditures (intangible)

Investment Decisions

• Capital Budgeting Decision: Decision to invest in tangible or intangible assets

• Capital budgeting is the planning process used by companies to evaluate potential major investments or expenditures, such as purchasing new equipment, building a new plant, or launching a new product. It involves analyzing a project's expected cash flows and comparing them to the cost of the investment to determine whether it will generate a satisfactory return.

• Also called: Investment decision or Capital Expenditure (CAPEX) decision

Recent Investment Decisions (Illustrative Examples)

• Delta Air Lines (U.S.): Ordered 100 Airbus A321 airliners

• ExxonMobil (U.S.): Offshore oil discovery development in Guyana

• Facebook (U.S.): Acquires Two Big Ears (British VR audio company)

• Fiat Chrysler (Italy): Spins off its Ferrari luxury car unit

• GlaxoSmithKline (U.K.): Spends 3.6\text{ billion} on R&D for new drugs

• Lenovo (China): Plans to build a new manufacturing facility in India to produce PCs and smartphones

• LVMH (France): Acquires high-end perfumery Maison Francis Kurkdjian

• Procter & Gamble (U.S.): Spends over 7\text{ billion} on advertising

Financing Decisions

• Financing Decision: Choice of sources and amounts of financing

  A financing decision is a decision made by a company about how to raise funds to finance its operations, investments, or growth — primarily through debt, equity, or a mix of both.These decisions are influenced by factors such as cost of capital, market conditions, and the company's financial strategy. Additionally, companies must weigh the risks and benefits associated with each financing source to determine the most suitable approach for their objectives. The right financing decision can significantly impact a company's overall financial health and its ability to compete effectively in the market.

• Capital Structure: The mix of long-term debt and equity financing

  (Capital structure refers to the way a company finances its overall operations and growth by using different sources of funds, primarily debt and equity.)

Financing Decisions (Examples of recent actions)

• Delta Air Lines: Issues 1\,\text{billion}, 5-year bond; Reinvests cash generated from operations; Leases large new office building in San Francisco

• ExxonMobil: (unspecified) debt actions

• Facebook: Leases large new office building (financing of real estate)

• Fiat Chrysler: Repays 1.8\text{ billion} of bank debt

• GlaxoSmithKline: Issues additional short-term euro debt

• Lenovo: Issues 500\text{ million} of dollar bonds and 850\text{ million} of preferred shares

• LVMH: Partly finances acquisitions by issuing debt

• Procter & Gamble: Buys back 4.6\text{ billion} of stock and pays a 7.2\text{ billion} dividend

Capital Budgeting or Financing Decisions?

• Determine whether the following are capital budgeting or financing decisions:

  • Intel spends 7\,\text{billion} to develop a new microprocessor (capital budgeting)

  • BMW borrows 350\,\text{million} euros (financing)

  • Royal Dutch Shell builds a pipeline to bring natural gas onshore from an offshore platform (capital budgeting)

  • Avon spends €200\,\text{million} to launch a new cosmetics range (capital budgeting)

  • Pfizer issues new shares to buy a small biotech company (financing)

Real vs Financial Assets

• Real assets: Acquired to produce goods and services; used in production (e.g., factories, machinery, IT systems)

• Financial assets: Claims to income generated by real assets (e.g., shares, bank loans, bonds)

• Real assets are physical and tangible resources that are used in the production of goods and services. These include assets like land, buildings, machinery, and equipment. They have intrinsic value and are essential for running the operational side of a business.

  On the other hand, financial assets are intangible instruments that represent a claim to ownership or a right to future income. Examples include shares, bonds, and bank deposits. Unlike real assets, financial assets do not have physical form and their value depends on the performance or promise of an underlying entity or contract.

  While real assets are used to create value, financial assets are used to store or transfer value in the financial system.

Real vs Financial Assets – Quick Checks

• Examples and classification:

  • A patent: Real asset

  • A share of stock issued by Wells Fargo: Financial asset

  • A blast furnace in a steelmaker factory: Real asset

  • A mortgage loan for a home: Financial asset

  • A successful advertising campaign by FedEx: Real asset (intangible asset, marketing asset)

  • An IOU from your brother-in-law: Financial asset

The Agency Problem

• Agency problem arises from separation of ownership and control

• Managers act as agents for stockholders but may pursue their own interests

• Agency problems arise when stakeholders’ interests do not coincide

• Agency cost: Value lost from agency problems or from mitigating such problems

Agency Theory: Types and Relationships

Management Goals

Agency Costs

• Costs of resolving problematic agency relationships

Do Managers Act in Shareholders’ Interests?

• Managerial compensation: Performance-based pay

• Control of the firm: Are shareholders powerful?

• Shareholder rights: Ability to call managers to account

• Proxy voting: Shareholders grant authority to vote their shares

Stakeholders and Corporate Governance

Corporate Governance

• Definition: The laws, regulations, institutions, and corporate practices that protect shareholders and other investors

• Elements of good corporate governance:

  • Well-designed compensation packages

  • Legal requirements

  • Board of directors

  • Activist shareholders

  • Takeovers

  • Information for investors

Executive Compensation

• Purpose: Mitigate agency costs by aligning executives’ incentives with firm performance

• Structure: Fixed base salary + annual award tied to earnings or other performance measures (e.g., stock price)

• At senior levels: Compensation often includes shares and stock options

• Vesting: Managers may keep shares only if they stay with the firm or meet performance criteria

Executive Pay Across Countries (Cross-country patterns)

• Across countries, pay structures show variations in: base salary, short-term incentives, long-term incentives, guaranteed pay

• Data samples include: France, Switzerland, United Kingdom, Germany, Italy, United States, etc. (Long-term vs Short-term incentives and guarantees vary by country)

  

Ethics of Maximizing Value

• Adam Smith quote (1776):

  • It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.

  • We address ourselves to their self-love, not their humanity, when seeking value

• Key points:

  • In most cases, maximizing value and doing good are not in conflict; successful firms tend to have satisfied customers and loyal employees

  • Unwritten rules of behavior: a firm’s reputation is among its most important assets

  • Ethical issues do arise in business as in other areas of life

Greenwashing

• Definition: Promoting green initiatives or images while operating in damaging or contrary ways to the stated environmental goals

• Motivation: Creating perceived benefits such as higher stock price, more customers, or favorable partnerships

• Reality: Many large corporations devote real resources to sustainability programs and social welfare, though skepticism remains about greenwashing