Chap 1


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Chap 1

  1. 1. Professor John Zietlow MBA 621 Spring 2006 The Scope Of Corporate Finance Chapter 1
  2. 2. The Scope Of Corporate Finance <ul><li>What Is Corporate Finance? </li></ul><ul><ul><li>Can Be Defined By Functions of Corporate Finance </li></ul></ul><ul><ul><li>Skills Developed Studying Corp Fin Applicable Everywhere </li></ul></ul><ul><li>Career Opportunities In Finance </li></ul><ul><ul><li>Corporate Finance </li></ul></ul><ul><ul><li>Investment & Commercial Banking </li></ul></ul><ul><ul><li>Money Management & Consulting </li></ul></ul><ul><li>Goals Of The Financial Manager </li></ul><ul><ul><li>Why Maximize Shareholder Wealth? </li></ul></ul><ul><li>Basic Forms of Business Organization </li></ul><ul><ul><li>In the U.S. and Internationally </li></ul></ul>
  3. 3. The Five Basic Corporate Finance Functions <ul><li>Capital-Raising (Financing) </li></ul><ul><ul><li>Obtaining External Funding For Firm’s Operations </li></ul></ul><ul><li>Capital Budgeting </li></ul><ul><ul><li>Allocating the Firm’s Resources To Most Productive Use </li></ul></ul><ul><li>Financial Management </li></ul><ul><ul><li>Managing Firm’s Cash Flows To Pay Maturing Liabilities </li></ul></ul><ul><ul><li>Managing Firms’ Capital Structure (Mix Of Debt & Equity) </li></ul></ul><ul><li>Corporate Governance </li></ul><ul><ul><li>Ensuring Firm Is Run Ethically & In Shareholders’ Interest </li></ul></ul><ul><li>Risk Management </li></ul><ul><ul><li>Managing Insurable & Uninsurable Risk Exposures </li></ul></ul>
  4. 4. Raising Capital: Basic Terminology <ul><li>Primary vs Secondary Market Transactions Or Offerings </li></ul><ul><ul><li>Primary: Capital-Raising Transaction </li></ul></ul><ul><li>Funding Via Capital Market vs Via Financial Intermediary </li></ul><ul><ul><li>Sell Securities To Investors For Cash On Capital Markets </li></ul></ul><ul><li>Money vs Capital Markets </li></ul><ul><ul><li>Money Market: For Short-Term (Max 1 Year) Debt Obligations </li></ul></ul><ul><li>Public vs Private Capital Markets </li></ul><ul><ul><li>Public: Security Listed On Regulated Exchange, Freely Traded </li></ul></ul><ul><li>Going Public </li></ul><ul><ul><li>Selling Stock To Public Investors & Listing On Exchange </li></ul></ul>
  5. 5. Raising Capital: Key Facts <ul><li>Internally-Generated Cash Flow The Dominant Source Of Funding In All Developed Economies </li></ul><ul><ul><li>Typically 60-80% For US Firms, 50-60% Other OECD </li></ul></ul><ul><li>Bulk of External Funding Is In The Form Of Debt </li></ul><ul><ul><li>Seasoned Equity Issues Only 4-8% Of External Financing </li></ul></ul><ul><li>Profits Re-Invested In A Firm (Retained Earnings) Equal To A New Equity Issue Each Year </li></ul><ul><ul><li>This Keeps Leverage Ratio From Rising Too High With Time </li></ul></ul><ul><li>Banks Everywhere Are Declining As A Source Of Capital For Large Firms </li></ul><ul><ul><li>Especially True In US; Less So In Europe, Japan </li></ul></ul><ul><li>Huge Increase In Total Security Issuance Volume Since 1990 </li></ul>
  6. 6. Growth in Global Security Issues, 1990-2002 Global debt & equity U.S. Issuers worldwide $ Bn
  7. 7. World Stock Market Capitalization, 1983-2002
  8. 8. The Critical Importance Of Corporate Governance <ul><li>Historical Experience, Academic Research Both Suggest That Ownership Structure Very Important </li></ul><ul><ul><li>Concentrated vs Atomistic Ownership Structure </li></ul></ul><ul><ul><li>At Least Three Forms Of Capitalism (US, Japan, Europe) </li></ul></ul><ul><ul><li>Country’s History & Legal/Regulatory System Very Important </li></ul></ul><ul><li>Incentives Of Managers, Stockholders, Other Stakeholders Often Conflict </li></ul><ul><ul><li>S/Hs Face Collective Action Problem Monitoring Management </li></ul></ul><ul><li>The Role Of Takeovers In Corporate Governance Has Grown Dramatically In Recent Years </li></ul><ul><ul><li>Long Important In US, UK; Increasingly In Europe </li></ul></ul>
  9. 9. Value of Global Mergers & Acquisitions, 1991-2002 ($US Billions)
  10. 10. Career Opportunities In Finance For Finance Graduates <ul><li>Corporate Finance (Including International) </li></ul><ul><ul><li>Financial Analyst, Treasurer, Controller, CFO, Possibly for a Nonprofit or Governmental Organization </li></ul></ul><ul><li>Commercial Banking </li></ul><ul><ul><li>Corporate & Consumer Banking, Operations, International </li></ul></ul><ul><li>Investment Banking </li></ul><ul><ul><li>High Salaries, Massive Stress; Mostly In NYC, London </li></ul></ul><ul><li>Money Management & Investment Services </li></ul><ul><ul><li>Booming During 1990s; Baby-Boomers Fueling Demand </li></ul></ul><ul><ul><li>Now Over 5,000 Mutual Funds; Large Funds Still Dominant </li></ul></ul><ul><li>Consulting </li></ul><ul><ul><li>High Salaries; Rapid Recent Growth; Much Traveling </li></ul></ul>
  11. 11. Career Opportunities For Finance Graduates: Prerequisites For Success <ul><li>All Require Good Communications Skills, Ability To Work In Teams, Computer Expertise </li></ul><ul><ul><li>Sound Like Cliches, But True Nonetheless </li></ul></ul><ul><li>Basic Financial Analysis Skills Critically Important </li></ul><ul><ul><li>Especially Valuation Skills (Securities, Projects, Firms) </li></ul></ul><ul><li>Finance Now Seen As A Source Of Strategic Advantage </li></ul><ul><ul><li>View Firm As Portfolio Of “Growth Options” To Be Developed </li></ul></ul><ul><li>International Business Knowledge Increasingly Important </li></ul><ul><ul><li>U.S. Represents Less Than 30% Of “Global GDP” </li></ul></ul><ul><li>Financial Transactions, Trading Moving To Internet </li></ul><ul><ul><li>Business-To-Business Marketing, Payment; Securities Trading </li></ul></ul>
  12. 12. Financial Use Of The Internet <ul><li>As A Source Of Financial & General Business Information </li></ul><ul><ul><li>General Info: CNNFN ( ), Yahoo ( ) </li></ul></ul><ul><ul><li>Purchased Databases: S&P ( ) </li></ul></ul><ul><ul><li>Corporate Websites: Deutsche Telekom ( ), IBM ( ), Goldman Sachs ( ) </li></ul></ul><ul><ul><li>Business Periodicals: Financial Times ( ); Wall Street Journal ( ); Investors Business Daily ( ); Economist ( ) </li></ul></ul><ul><ul><li>Government: U.S. Federal Reserve ( ) </li></ul></ul><ul><ul><li>Exchanges: NYSE ( );NASDAQ ( ) </li></ul></ul><ul><ul><li>Financial Sites: Smart Money ( ) </li></ul></ul><ul><li>Providing Instant, Low-Cost Brokerage Services </li></ul><ul><ul><li>Pioneers: Schwab ( );ETrade ( ); Ameritrade ( ) </li></ul></ul><ul><ul><li>Now Merrill Lynch ( ), others Offering Service </li></ul></ul>
  13. 13. What Should Managers Try To Maximize? <ul><li>Though Plausible, Profit Maximization Has Problems </li></ul><ul><ul><li>Does Not Account For Timing Of Returns </li></ul></ul><ul><ul><li>Profits Are Not Necessarily Cash Flows </li></ul></ul><ul><ul><li>Most Important: Ignores Risk </li></ul></ul><ul><li>Proper Management Objective: Maximize Shareholder Wealth </li></ul><ul><ul><li>Maximize Stock Price, Not Profits </li></ul></ul><ul><ul><li>Accounts For Risk, Timing, Maximizing Value Of Cash Flows </li></ul></ul><ul><ul><li>As “Residual Claimants,” S/Hs Have Better Incentives To Maximize Firm Value than Other Stakeholders </li></ul></ul><ul><ul><li>S/Hs Can Benefit Only Once Other Claims Paid In Full </li></ul></ul><ul><ul><li>Historical Justification: Success Of Financial Capitalism </li></ul></ul>
  14. 14. The Importance of Agency Costs In Corporate Finance <ul><li>Agency Costs Due To Separation of Ownership And Control </li></ul><ul><ul><li>Managers Are The Agents Of S/Hs, But Are Also Human </li></ul></ul><ul><ul><li>Interests of Managers & S/Hs Inevitably Diverge </li></ul></ul><ul><li>Three Ways To Deal With Agency Costs; Cannot Truly Solve </li></ul><ul><ul><li>Can Rely On Market Forces: Takeovers, Proxy Contests </li></ul></ul><ul><ul><li>Can Incur Monitoring & Bonding Costs </li></ul></ul><ul><ul><li>Align Manager & S/H Interests Via Compensation Contracts </li></ul></ul><ul><li>Most Controversial Method: Executive Compensation </li></ul><ul><ul><li>Bull Market Has Led To Huge Payments </li></ul></ul><ul><ul><li>Average Total S&P 500 CEO Pay In 2001: $9.7 Million </li></ul></ul><ul><ul><li>Bulk Of This Pay Comes From Stock Options </li></ul></ul><ul><ul><li>Sometimes non-cash perks as well: Gulfstream for Jobs </li></ul></ul>
  15. 15. Forms Of Business Organization In The U.S. Proprietorships & Partnerships <ul><li>Proprietorship Is A Business That Is Owned By One Person </li></ul><ul><ul><li>No Distinction Between Business & Person </li></ul></ul><ul><ul><li>Benefits: Easy To Set Up, Operate; Taxed As Personal Income </li></ul></ul><ul><ul><li>Drawbacks: Personal Liability, Limited Life, Difficult To Transfer </li></ul></ul><ul><li>A Partnership Has Two Or More Business Owners </li></ul><ul><ul><li>Similar Benefits & Drawbacks As Proprietorships </li></ul></ul><ul><ul><li>Partners Are Liable For Every Other Partner’s Actions </li></ul></ul><ul><ul><li>Goldman Sachs Became Corporation, Went Public May 1999 </li></ul></ul><ul><li>A Limited Partnership Has One General & Many Limited Partners, But Only General Partner Has Unlimited Liability </li></ul><ul><ul><li>Tax Benefits Of Partnership, Limited Liability Of Corporation </li></ul></ul><ul><ul><li>Attractive For Funding Real Estate, Certain Types Of R&D </li></ul></ul>
  16. 16. Forms Of Business Organization In The U.S. Corporations & LLCs <ul><li>A Corporation Is A Separate Legal Entity With All The Economic Rights & Responsibilities Of A Person </li></ul><ul><ul><li>Can Sue & Be Sued, Own Property, Execute Contracts </li></ul></ul><ul><ul><li>Incorporation Occurs At State Level; Based On State Law </li></ul></ul><ul><li>Corporate Form Has Decisive Strengths </li></ul><ul><ul><li>Offers Limited Liability To Investors; Unlimited Business Life </li></ul></ul><ul><ul><li>Most Businesses Become Corps As They Mature </li></ul></ul><ul><li>Key Weakness Is Double Taxation Of Dividends [next slide] </li></ul><ul><ul><li>S Corporation Overcomes This, But Its Use Is Restricted </li></ul></ul><ul><li>Limited Liability Company (LLC) The Newest Form </li></ul><ul><ul><li>Combines Corp’s Limited Liability & Partnership’s Taxation </li></ul></ul><ul><ul><li>Allowed In All 50 States; Can Choose Finite Or Infinite Life </li></ul></ul><ul><li>Franchising a Specialized Form </li></ul>
  17. 17. The Double Taxation of Dividends: Corporate Tax Rate (  c ) = 0.35 Personal Tax Rate (  p ) = 0.40 Taxation of Business Income: Corporations vs Partnerships
  18. 18. Non-U.S. Forms Of Business Organization <ul><li>Almost All Countries Allow Limited-Liability Companies--In Some Form--And Promote Stock Market Listings </li></ul><ul><ul><li>Called PLC In Britain, SA In Spain, Latin America </li></ul></ul><ul><ul><li>GMBH or AG In Germany, Austria, Switzerland </li></ul></ul><ul><ul><li>Mid-Sized Firms The Backbone Of All Advanced Economies </li></ul></ul><ul><li>Most Countries Besides U.S. Have State-Owned Enterprises </li></ul><ul><ul><li>SOEs Have Traditionally Operated Utilities, Airlines, Banks </li></ul></ul><ul><ul><li>Account For 5% GDP In OECD; about 7% In non-OECD </li></ul></ul><ul><li>Privatization Programs Have Reduced Role Of SOEs and Raised Almost $1.5 Trillion For Governments Since 1980 </li></ul><ul><ul><li>Began In Margaret Thatcher’s UK In Early 1980s </li></ul></ul><ul><ul><li>Usually Over $100 Bn Annually, Mostly Via Share Offerings </li></ul></ul>
  19. 19. Privatization Proceeds $US Billions, 1988-2001
  20. 20. Organization of Course Textbook: Divided Into Eight Parts <ul><li>I. Introduction </li></ul><ul><li>II. Risk, Return and Valuation </li></ul><ul><li>III. Capital Budgeting Processes and Techniques </li></ul><ul><li>IV. Capital Structure and Dividend Policy </li></ul><ul><li>V. Long-Term Financing </li></ul><ul><li>VI. Options, Derivatives and International </li></ul><ul><li> Financial Management </li></ul><ul><li>VII. Short-Term Financing Decisions </li></ul><ul><li>VII. Special Topics </li></ul>