L1Introduction.ppt
LECTURE 1 Introduction
(Chapter 1)
- Corporation
Major characteristics
- Agency relationships
- Sole proprietorship
- Partnership
- Corporation
Alternative Forms of
Business Organization
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- Shareholders
- Managers
- Debtholders
- Other parties
Parties in a Corporation
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Separation of Ownership and Control
Ownership: the shareholders are the owners of the corporation.
Control: ultimate control rests with the shareholders, but the managers control the day to day operations.
Features of Corporation (#)
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Risk Bearing: While all parties associated with the corporation bear the risk, shareholders bear all residual risk, and
receive only the residual return.
Features of Corporation (#)
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The separation of ownership and control improves efficiency, but also creates agency problem between shareholders and managers.
Residual risk creates agency problem between shareholders and other parties especially creditors.
Ownership, control and residual bearing are interrelated.
Features of Corporation (#)
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- The primary goal is shareholder wealth maximization, which translates to maximizing stock price.
- Should firms behave ethically? YES!
- Do firms have any responsibilities to society at large? YES! Shareholders are also members of society.
Goals of Corporation
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Better defined than accounting profits,
Considers timing of cash flows in future,
Considers differences in risk among
alternative investments or other managerial decisions.
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- Advantages:
- Unlimited life
- Easy transfer of ownership
- Limited liability
- Ease of raising capital
- Disadvantages:
- Double taxation
- Cost of set-up and report filing
Other Features of Corporation
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- Dealing with the financial decisions corporations make and the tools and analysis used to make these decisions.
- Goals: consistent with the goals of a corporation.
Corporate Finance
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- Include decisions on investment, capital structure, capital raising, dividend payout, restructuring, governance, risk management, etc.
- These decisions may affect equity value by changing the magnitudes and/or the riskness of a firm’s cash flows.
Financial Decisions in a Corporation
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- An agency relationship exists whenever a principal hires an agent to act on his or her behalf.
- Within a corporation, agency relationships exist between:
- Shareholders and managers
- Shareholders and creditors
Agency Relationships
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- Managers are naturally inclined to act in their own best interests.
- But the following factors affect managerial behavior:
- Managerial compensation plans
- Direct intervention by shareholders
- The threat of firing
- The threat of takeover
- High dividends or more short-term debts that help reduce redundant cash holdings.
Shareholders versus Managers
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- Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors.
- Underinvestment, risk-shifting and debt dilution.
- In the long run, such actions will raise the cost of debt and ultimately lower stock price.
- Restrictive covenants of debt help reduce the conflict.
Shareholders versus Creditors (#)
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- Corporate governance is the set of rules that control a company’s behavior towards its directors, managers, employees, shareholders, creditors, customers, competitors, and community.
- Corporate governance can help control agency problems
Corporate Governance
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- Two major features and other characteristics of a corporation.
- Agency problems: types, reasons, examples, solutions.
Lecture Highlights
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- Find partners.
- Select a real corporation. Try to avoid:
- any financial, real estate or insurance company,
- any private company,
- any company that experienced (in the last three years) or will experience (in the near future) significant restructuring activities.
- Collect background information on this corporation.
Project
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