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L1 flash cards corporate finance (ss11)


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L1 flash cards corporate finance (ss11)

  1. 1. Capital Budgeting Process:Steps of the Capital Budgeting Process Brainstorming potential investment ideas Gathering and analysing information relating to potential futurecash-flows that different projects can generate. Capital Budget Planning involves integrating new profitable projectsinto the firm’s overall investment strategy. Post auditing and monitoring helps determine why there is a gapbetween the predicted and realized values of sales, netprofit, expenses and cash flows. Post-Auditing tracks systematic errors Business operations can be improved Post-auditing will help the company make better capitalbudgeting decisions in the future.Study Session 11, Reading 36
  2. 2. Categories of Capital BudgetingTypes of Projects Replacement Projects: When the company needs toreplace old equipment in order to continue operations. Expansion Projects: When the size of the business isincreased and therefore, more uncertainties arise. New Products and Services: Determining whether thecompany should expand its product range into newmarkets. The uncertainty (ie risk) is higher for new productsand services than expansion projects. Safety, Regulatory and Environment Projects: Are normallyforced by government agencies and are high in cost, andmay generate negative returns.Study Session 11, Reading 36
  3. 3. Basic Principle of Capital BudgetingCapital budgeting considers after tax cash flows (notearnings), the timing of cash flows, the opportunity cost ofcapital, it ignores financing costs, and also sunk costs.Study Session 11, Reading 36
  4. 4. Cash Flow Estimation Cash flows are used rather than earnings. Only incremental cash flows are considered The timing of cash flows is crucial Opportunity cost of incremental cash flows is considered. Cash flows on an after tax basis are considered. Ignores financing cost as after tax cash flows are discountedat the investor’s cost of capital to derive the ‘Net PresentValue’. Incremental cash flow –cash flow after decision minus cashflow without decision Externalities are considered.Study Session 11, Reading 36
  5. 5. Selection of Capital Projects Mutually exclusive projects Project sequencing Capital rationingStudy Session 11, Reading 36
  6. 6. Methods to Evaluate a Single Capital ProjectNet Present Value (NPV) NPV can be calculated as: CF = Cash flow after taxr = required rate of returnOutlay = cash flow investment in the beginning Net Present Value (NPV) is the present value of the after taxnet cash flows that the company will receive in the future froma given project If the NPV is >0, the company should invest in the project. If the NPV is <0, the company should not invest in the project.Study Session 11, Reading 36
  7. 7. Methods to Evaluate a Single Capital ProjectInternal Rate of Return (IRR) The IRR is the discount rate which makes the NPV of theproject = 0. That is, it is the discount rate required to make thepresent value of all future cash flows = 0. IRR can be back solved, using the following formula: If the IRR of the project is > r (required rate of return), thenthe company should invest. If the IRR of the project is < r (required rate of return), thenthe company should not invest.Study Session 11, Reading 36
  8. 8. Methods to Evaluate a Single Capital ProjectPayback Period The Payback Period is the number of years that a projectstakes to fully recover the invested capital in a given project. The drawbacks of the payback period method are that it doesnot consider the riskiness of the expected future cash flows,the time value of money is ignored, and this it ignores all cashflows after the payback amount is achieved. An advantage of the payback period is that it provides anindicator of the likely liquidity of the project.Study Session 11, Reading 36
  9. 9. Methods to Evaluate a Single Capital ProjectDiscounted Payback Period The Discounted Payback Period is the number of years aproject takes to generate its initial invested capital, whileconsidering the time value of money and the risk profile of thefuture cash flows. However cash flows after the discounted payback period areignored.Study Session 11, Reading 36
  10. 10. Methods to Evaluate a Single Capital ProjectAverage Accounting Rate of Return (AARR) The Average Accounting Rate of Return is calculated as: Unlike the other capital budgeting tools, it uses Net Income(earnings) rather than cash flows. Advantages of AAR are that it is easily understandable andsimple to calculable. Disadvantages are that it is not based on cash flows, no timevalue of money is captured and AAR does not tell us if it is agood or a bad investmentStudy Session 11, Reading 36
  11. 11. Methods to Evaluate a Single Capital ProjectProfitability Index The Profitability Index (PI) is the ratio of the present value offuture cash flows to the investment made initially. It iscalculated as: For independent projects, a company should invest in a projectif PI > 1.0, and should not invest if PI is < 1.0. Although PI is not used as frequently as NPV and IRR, it is usedfor guiding purposes under capital rationing constraintsStudy Session 11, Reading 36
  12. 12. NPV and IRR Conflict Due to DifferentCash Flow Patterns Supply Project A and B have similar initial investment, butdifferent cash flow: If the two projects are mutually exclusive and there is aconflict between the decision suggested by NPV and IRR, aninvestor should make the investment decision suggested bythe NPV method. The reinvestment assumption is basically assuming that thecash flow will be reinvested at the same discount rate used inthe NPV calculation.Study Session 11, Reading 36
  13. 13. NPV and IRR Conflict Due toProject Scale Another issue arises when the scale of the projects is different.For example, should an investor invest in a smaller projectwith a higher return, or a larger project with lower returns (butstill greater than its cost of capital). An example of conflict between NPV and IRR due to differencein project scale is exemplified below.Study Session 11, Reading 36
  14. 14. NPV and IRR Conflict Due to MultipleIRRsStudy Session 11, Reading 36 Multiple IRR problems ‘might’ arise when the sign of cashflows change twice and the project is non-conventional. Multiple IRR - IRR satisfy these equations, when IRR wasbetween 100% and 200% the NPV was positive and at thepeak when IRR = 140%.
  15. 15. NPV and IRR Conflict Due to No IRR It is possible that a project has no IRR at all. Having no IRR does not mean the project is unacceptable.Study Session 11, Reading 36
  16. 16. Most Common Capital BudgetingMethods NPV and IRR are the most taught capital budgeting techniques. Larger companies prefer NPV and IRR. Private corporations consider the payback period as access tocapital is more limited.Study Session 11, Reading 36
  17. 17. Relationship between NPV, CompanyValue and Stock PricesStock Prices and NPV If listed corporations invest in a positive NPV project, itincreases the wealth of its shareholders. For example, assume XYZ Corporation invests in a $600mproject which has an after tax cash flow of $850m. XYZ has200m shares outstanding with a market price of $32 per share. The value of any company is basically the sum of its currentinvestments, plus the NPV of its future investments.Study Session 11, Reading 36
  18. 18. Weighted Average Cost of Capital The cost of capital is directly proportionate to the riskiness ofthe expected cash flows . The cost of capital is the amount of money (compensation)paid for the supply capital. It compensates owners of thecapital. An investor will only invest, if the returns meet or exceed itscost of capital. The Marginal Cost of Capital is the cost of additional capitalneeded for a potential project investmentStudy Session 11, Reading 37
  19. 19. Weighted Average Cost of Capital The WACC can be calculated as:t = marginal tax rate company= proportion of debt taken by company= before –tax marginal cost of debt= marginal cost of preferred stock= proportion of preferred stock the company uses= marginal cost of equity= proportion of equity the company uses.Study Session 11, Reading 37
  20. 20. Impact of Tax on the Cost of Debt If debt is included in the capital structure of the company, taxreduces the cost of capital because interest on debt is typicallytax deductible.- The Cost of Debt finance is therefore typically expressed asr-d(1-t)Study Session 11, Reading 37
  21. 21. Estimating the Cost of Equity Estimating the cost of common equity is more difficult thanestimating the cost of debt. That being said, several methods can be used to estimate thecost of equity, based on equity market values In the case of preferred stock, calculating the cost of capital iseasier as the dividends are typically fixed.Study Session 11, Reading 37
  22. 22. Weighted Average Cost of Capital Analysts can use three approaches to estimate the capitalstructure of a company for the purpose of calculating theWACC: Assume the current capital structure is ongoing. Examine the past trend and management statementsregarding the capital structure Use industry average as the target capital structureStudy Session 11, Reading 37
  23. 23. Marginal Cost of Capital An optimal capital budget occurs when capital is invested tothe point that the marginal cost of capital is equal to themarginal return of the investment. If the systematic risk of a certain project is higher or lowerthan the average of the current project portfolio, a respectiveadjustment is made to the WACC of the companyStudy Session 11, Reading 37
  24. 24. Debt Rating Approach If the current market price of debt issued by a company is notavailable, then the debt-rating approach is used to estimatethe before-tax cost of debt. The debt rating approach considers the cost of debt of otherobservable companies, with a similar credit rating and othercharacteristics.Study Session 11, Reading 37
  25. 25. Cost of Preferred Stock If the current market price of debt issued by a company is notavailable, then the debt-rating approach is used to estimatethe before-tax cost of debt. The debt rating approach considers the cost of debt of otherobservable companies, with a similar credit rating and othercharacteristics.Study Session 11, Reading 37
  26. 26. Capital Asset Pricing Model Under the capital asset pricing model (CAPM) approach, weuse the basic CAPM theory to come to the conclusionexpected return on a stock, as highlighted in the followingformula: The equity risk premium (ERP) of the CAPM isStudy Session 11, Reading 37
  27. 27. Capital Asset Pricing Model A multifactor model incorporates factors like pricedrisk, macro-economic factor and factors specific to companytypes. It is an alternative to the CAPM (which only considerssystematic risk as its sole factor). A typical factor risk premiumis:Study Session 11, Reading 37
  28. 28. The Historical Equity Risk PremiumApproach The historical equity risk premium approach assumes that theequity risk premium calculated over a long period of time is agood indicator of the expected equity risk premium.Study Session 11, Reading 37
  29. 29. The Survey Approach Under the survey approach, a panel of experts are asked toestimate an equity risk premium. The average of those resultsis taken.Study Session 11, Reading 37
  30. 30. Dividend Discount Model Approach The dividend discount model approach uses the followingformula: where the expected dividend is divided by current share priceplus the expected dividend growth rate. We use this formula to find out the required rate ofreturn, from which we subtract the risk free rate to arrive at anestimate of the risk premium.Study Session 11, Reading 37
  31. 31. The Gordon Growth Model The Gordon Growth Model can be defined as: where:V = the intrinsic value of a shareD = dividend per sharer= cost of equityStudy Session 11, Reading 37
  32. 32. Bond-Yield-Plus Risk-Premium The bond yield plus risk premium (BYPRP) approach suggeststhat the cost of capital for equity capital (the riskier cash flows)is higher than the cost of debt (the less risky cash flows).re=rd + Risk Premium Here, the risk premium is compensation for the additional riskof equity capital relative to debt capital.Study Session 11, Reading 37
  33. 33. Estimating Beta Beta estimates are sensitive to estimation methods such as: Estimation period Periodicity of the return interval Selected of appropriate market index Smoothing technique Adjustment for small-cap stocksStudy Session 11, Reading 37
  34. 34. Country Risk Premium for aDeveloping Country Investors need to be compensated for bearing country risk. A country spread estimate is also the sovereign yield spread. Itis also the difference between the government bond yield ofthe country and a similar Treasury Bond Yield with samematurity in the home country. Equity premium of country canbe calculated as follows:Study Session 11, Reading 37
  35. 35. Marginal Cost of Capital Rises asAdditional Capital is Raised As companies raise more funds, the cost of capital changes fortwo reasons: The company may be unable to issue additional debt at thesame seniority level as its existing debt. Hence has to offeradditional debt at higher rates. The deviation from the target capital structure due to‘lumpiness’ of security issuance.Study Session 11, Reading 37
  36. 36. Breaking Points of Capital Structure A breaking point in capital structure occurs when the cost ofcapital changes due to a change in source. Raising capital is not typically smooth. Therefore, raising newcapital may result in a step up in the capital cost schedule.Study Session 11, Reading 37
  37. 37. Flotation Costs Flotation Costs are a fee that investment banks chargecompanies for assistance in raising capital. The size of the feedepends on the size and type of capital that a company raises. There are two methods to treat flotation costs: Add flotation costs into the cost of capital. Flotation costs should be added into a project’sevaluation, and not in the cost of capital.Study Session 11, Reading 37
  38. 38. Leverage A highly leveraged company has volatile earnings and cashflows which in turn increases the risk of lending. Highly leveraged companies have a higher probability ofbankruptcy in downturns of the economic cycle.Study Session 11, Reading 38
  39. 39. Fixed Cost Leverage The cost structure of a company consists of two components:variable costs and fixed costs. Variable costs fluctuate with the number of goods produced.Fixed costs stay constant, regardless of output levels. A company with a greater portion of fixed costs vs. variablecosts has greater variation in net income, because smallchanges in revenue can have a greater impact on earnings.Study Session 11, Reading 38
  40. 40. Business Risk Business risk is possibility that a company will achieve lowerthan expected profits. Business risk is a combination of sales and operating risk. Sales Risk Operating risk Financial risk relates to how a company finances its operatingassets.Study Session 11, Reading 38
  41. 41. Degree of Operating Leverage The Degree of Operating Leverage is the ratio of fixed tovariable costs. The level of operating risk largely relates to theindustry that the business operates in. It calculates the operating income elasticity to a change inrevenue (ie how sensitive operating income is to changes inrevenue). . DOL = (% change in operating income)/(% change in units sold) Operating Income = (# of units sold) [(Price/ unit)-(Variablecost / unit)] - [Fixed operating costs]Study Session 11, Reading 38
  42. 42. Degree of Financial Leverage The Degree of Financial Leverage (DFL) tells us how sensitivenet income is to a change in operating income. Degree of Financial Leverage = (% change in net income)/(%change in operating income) The Degree of Total Leverage is the sum of the Degree ofOperating Leverage and the Degree of Financing Leverage.Study Session 11, Reading 38
  43. 43. Effect of Financial Leverage on ACompany’s Net Income Financial leverage can improve the ability of a company toearn a greater return on shareholder capital. Financial leverage magnifies increases in earnings per shareduring periods of rising operating income, but adds to the risksfor stockholders and creditors because of added interestobligation. A firm that has a higher amount of debt also has additionalfixed financial costs in the form of interest payments. Financial leverage (or gearing) can be calculated as:Financial Leverage (Debt on Equity Ratio) = Debt / EquityStudy Session 11, Reading 38
  44. 44. Return on Equity Higher financial leverage is riskier than a firm with lowfinancial leverage, the return on equity (ROE) may be highersince the highly leveraged firm is using borrowed money toinvest in profitable (positive NPV) projects. Return on Equity can be calculated as:Return on Equity = Return on Assets Financial LeverageStudy Session 11, Reading 38
  45. 45. The Break-Even Point Breakeven analysis indicates the relationship between cost,production, volume and returns. The business owner or manager usually considers severalfactors when studying break-even analysis: The capital structure of the company. Variable expenses. Fixed expenses such as rent, insurance, heat, and light. The inventory, personnel, and space required to operateproperly. Setup of the organization.Study Session 11, Reading 38
  46. 46. The Break-Even Point The Breakeven Point can be calculated as: Breakeven Point =Study Session 11, Reading 38
  47. 47. The Break-Even PointStudy Session 11, Reading 38Variable costsBreak Even PointProfitOutput VolumeSales$1000100Fixed CostsTotal CostsRevenue
  48. 48. Margin of Safety The Margin of Safety enables a business to know the amount ithas gained or lost for each quantity of sales. It helps a businesseasily determine whether they are over or below thebreakeven point. It can be calculated as:Margin of Safety = Total budgeted or actual sales − Break even salesStudy Session 11, Reading 38
  49. 49. Dividends A payment made out of a firm’s earnings to its owners, in theform of either cash or stock. If a payment is made from other sources than current oraccumulated retained earnings, the term distribution is used. A distribution from earnings is a dividend, while a distributionfrom capital is a liquidating dividend.Study Session 11, Reading 38
  50. 50. Stock Splits A stock split is usually undertaken by companies that haveseen their share price increase to levels that are either toohigh or are beyond the price levels of similar companies intheir sector. A Reverse stock split or reverse split occurs when a companyissues a smaller number of new shares to each shareholder, inproportion to that shareholders original shares.Study Session 11, Reading 38
  51. 51. Dividend Payment Chronology Dividend is the payment declared by a company’s board ofdirectors and given to its shareholders out of the companyscurrent or retained earnings. The key dates relating to the payment of a dividends are: Declaration Date Ex-dividend Date Record Date Payment DateStudy Session 11, Reading 39
  52. 52. Methods of Share Repurchases On-market share repurchases occur when a company buysback its own shares in the marketplace, reducing the numberof outstanding shares. Off-market share repurchase is any purchase of shares directlyfrom the shareholders.Study Session 11, Reading 39
  53. 53. Reasons for Share Repurchases Repurchase announcements are viewed as positive signals byinvestors because the repurchase is often motivated bymanagements belief that the firms shares are undervalued. It can remove a large block of stock that is overhanging themarket and keeping the price of per share down. Companies can use the residual model to set a target cashdistribution level, then divide the distribution into a dividendcomponent and a repurchase component.Study Session 11, Reading 39
  54. 54. Earnings Per Share (EPS) Earnings Per Share (EPS) represents the portion of acompanys earnings, net of taxes and preferred stockdividends, that is allocated to each share of common stock. EPS can be calculated by dividing net income earned in a givenreporting period by the total number of shares outstandingduring the same period. Earnings Per Share (EPS) =Study Session 11, Reading 39
  55. 55. Price Effect of a Stock Repurchase A stock repurchase typically has the effect of increasing theprice of a stock as it signals to the market that managementbelieve the stock is undervalued.Study Session 11, Reading 39
  56. 56. Book Per Value Share Book value per share indicates the book value of each share ofstock. Book value is a companys net asset value, which iscalculated by total assets minus total liabilities. Its formula is:Book value per share =Study Session 11, Reading 39
  57. 57. Impact of Share Repurchases onBook Value Per Share A share repurchase can be either positive or negative for bookvalue per share, depending on the share repurchase pricerelative to book value. If the share repurchase is undertaken at a price less than bookvalue, then the repurchase will be BVPS accretive. If it isundertaken at a price greater than book value, then it is BVPSdecretive.Study Session 11, Reading 39
  58. 58. Shareholder’s Wealth A share repurchase can be either positive or negative for bookvalue per share, depending on the share repurchase pricerelative to book value. If the share repurchase is undertaken at a price less than bookvalue, then the repurchase will be BVPS accretive. If it isundertaken at a price greater than book value, then it is BVPSdecretive.Study Session 11, Reading 39
  59. 59. Liquidity PositionSources of Liquidity The liquidity of an asset is its ease of convertibility into cash ora cash equivalent asset. The investment portfolio represents a smaller portion ofassets, and serves as the primary source of liquidity. Secondary sources include negotiating debtcontracts, liquidating assets, and filing for bankruptcy andreorganization.Study Session 11, Reading 40
  60. 60. Factors Influencing Liquidity Position Liquidity risk can arise through the inability to access, ateconomically viable conditions, the financial resources neededto guarantee the firm’s ability to operate. The two main factors influencing the firm’s liquidity positionare the resources generated or used by operating andinvesting activities, and the maturity and renewal profiles ofdebt or liquidity profile of financial investments.Study Session 11, Reading 40
  61. 61. Working Capital Working Capital it the relationship between a firms short-termassets and its short-term liabilities. It indicates the ability to satisfy both maturing short-term debtand upcoming operational expense. Formula of working capital:Working Capital = Current Assets - Current LiabilitiesStudy Session 11, Reading 40
  62. 62. Measuring Liquidity The Cash Ratio is a formula for measuring the liquidity of acompany by calculating the ratio between all cash and cashequivalent assets and all current liabilities. The Cash Ratio is measured as: Cash ratio ==Study Session 11, Reading 40
  63. 63. Operating Cycles An operating time cycle is the average time period betweenthe acquisition of inventory and the receipt of cash from theinventorys sale. A short operating cycle means a more prompt return oninvestment for the firms inventory. Operating cycle calculations are completed with this formula: Operating cycle = DIO + DSO – DPODIO represents day’s inventory outstandingDSO represents day sales outstandingDPO represents day’s payable outstanding.Study Session 11, Reading 40
  64. 64. Cash Conversion Cycles The cash conversion cycle is the duration of time it takes a firmto convert its activities requiring cash back into cash returns. The cycle is composed of the three main working capitalcomponents: Accounts receivables outstanding in days (ARO) Accounts payable outstanding in days (APO) Inventory in days (IOD).Study Session 11, Reading 40
  65. 65. Cash Position Management Managing short-term cash flows may result in reducing costs. Carrying costs indicates the return forgone by investing tooheavily in short-term assets. Shortage cost is the cost of running out of short-term assets.Study Session 11, Reading 40
  66. 66. Forecasting Predict minimum cash balances during the specific period. Measuring the typical cash inflows and outflows of thecompany in a period. Prepare cash forecasts for shorter periods of time if cash flowsare tight. Cash flow forecasting is extremely difficult in periods of rapidgrowth.Study Session 11, Reading 40
  67. 67. Net Cash Position Net Cash Position can be calculated as:NCP = WC –WCRWhere,NCP = Net Cash PositionWC = Working CapitalWCR = Working Capital Requirement If WC > WCR : we have a positive net cash positionIf WC < WCR : we have a negative net cash positionStudy Session 11, Reading 40
  68. 68. Daily Cash Flows Monitoring It is important to collect cash flow information on a timelybasis. Use short-term investments and borrowings to help with cashposition management.Study Session 11, Reading 40
  69. 69. What is Yield? Yield is one component of the total return of holding asecurity. A high yield on one security may be offset by a decline inmarket value of the capital over the period. Higher returnoften means higher risk . Yield levels are impacted by inflation expectations.Study Session 11, Reading 40
  70. 70. Yield To Maturity Yield to Maturity (YTM) is the rate of return anticipated on abond if it is held until the maturity date. YTM is calculated as:Study Session 11, Reading 40
  71. 71. Short Term Investments Money market funds can be used as short-term investmentvehicles. They provide flexibility to a company’s liquidity position asthey can be sold at any time at the current share price.Study Session 11, Reading 40
  72. 72. Management of Inventory Inventory management is the process of efficiently overseeingthe constant flow of units into and out of an existing inventory. Inventory turnover can be used to measure how efficiently acompany is using its inventory. It can be calculated as:revenue/average inventory Buffer stock is additional units above and beyond theminimum number required to maintain production levels.Study Session 11, Reading 40
  73. 73. Accounts Receivable Accounts receivable represents money owed by entities to thefirm on the sale of products or services on credit. The process commences with a receipt of a customer orderand ends with the collection of the cash from the customer Receivables turnover is calculated as:Study Session 11, Reading 40
  74. 74. Accounts Payable Accounts payable are debts that must be paid off within agiven period of time in order to avoid default. They are usuallydebts owed to suppliers of the business. The accounts payable turnover ratio indicates how many timesa company pays off its suppliers during an accounting period.Study Session 11, Reading 40
  75. 75. Short Term Funding Short-term financing programs are designed to be repaidwithin a one-year period and are designed to meet the variousneeds of companies. Short-term Financing Methods facilitate the smooth running ofbusiness operations by meeting day to day financialrequirements.Study Session 11, Reading 40
  76. 76. Modes of Financing Unsecured Loans If the company`s credit rating is deficient, the bank may lendmoney only on a secured basis Under a revolving line of credit, the bank agrees to lendmoney up to a specified amount on a recurring basis.Study Session 11, Reading 40
  77. 77. Calculating the Cost of Finance In order to compare the costs of various sources of short termfinance, an analyst may use: Annual Rate of Interest= When credit is unavailable from a bank, the company mayhave to go to a commercial finance company, which typicallycharges a higher interest rate than the bank and requirescollateral.Study Session 11, Reading 40
  78. 78. Dupont Model Three-component Dupont ModelStudy Session 11, Reading 41
  79. 79. Dupont Model Five-component Dupont ModelStudy Session 11, Reading 41
  80. 80. Proforma Statements Performa statements are made on last year’s results with abold assumption that the company will grow similar to its lastyear’s results. Proforma analysis incorporates: Relationship between revenues and sales are estimated Revenues forecasting Financial burdens estimation Income statement and balance sheet construction on thebasis of predictionsStudy Session 11, Reading 41
  81. 81. Corporate Governance Corporate governance can be defined as the system by whichcompanies are directed and controlled. Corporate governance structure specifies the distribution ofrights and responsibilities among different participants in thecorporation It also provides the structure through which the companyobjectives are set, and the means of attaining those objectivesand monitoring performance. There are no formal penalties for non-complianceStudy Session 11, Reading 42
  82. 82. The OECD and Corporate Governance The Organisation for Economic Co-operation and Development(OECD) has set out principles of corporate governance thatcountries may use to develop their own standards of corporategovernance. These principles are as follows. The corporate governance framework should promotetransparent and efficient markets The corporate governance framework should protect andfacilitate the exercise of shareholder’s rights. The corporate governance framework should ensure theequitable treatment of all shareholdersStudy Session 11, Reading 42
  83. 83. Shareholder Protection When investors finance firms, they typically obtain certainrights or powers that are generally protected through theenforcement of regulations and laws. Rules protecting investors includecompany, security, bankruptcy, takeover, and competitionlaws, but also from stock exchange regulations and accountingstandards.Study Session 11, Reading 42
  84. 84. The Role of the Board of Directors The primary responsibility of the Board is to foster the long-term success of the corporation, consistent with its fiduciaryresponsibility to shareowners. To carry out this responsibility, the Board must ensure that it isindependent and accountable to shareowners and must exertauthority for the continuity of executive leadership withproper vision and values. The Board is singularly responsible for the selection andevaluation of the corporations CEO and included in thatevaluation is assurance as to the quality of seniormanagement.Study Session 11, Reading 42
  85. 85. Benefits of Independent BoardMembers Counterbalance management weaknesses. Ensure legal and ethical behaviour at the company, whilestrengthening accounting controls. Extend the “reach” of a company throughcontacts, expertise, and access to debt and equity capital. Help a company survive, grow and prosper over timethrough improved succession planningStudy Session 11, Reading 42
  86. 86. Qualifications of Board Members Leadership Experience Industry-specific experience Area of expertise Relationships Diversity TimeStudy Session 11, Reading 42
  87. 87. The Audit Committee An audit committee is an operating committee of the Board ofDirectors that the responsibility of providing oversight offinancial reporting and disclosure. Committee members are drawn from members of thecompanys board of directors. A qualifying audit committee is sometimes required for acompany to be listed on a stock exchange.Study Session 11, Reading 42
  88. 88. The Compensation Committee The Compensation Committee has primary responsibility forreviewing and approving the compensation of the CompanysCEO and other executive officers; overseeing the Companysbenefit plans; and reviewing and making recommendations tothe full Board regarding Board compensation.Study Session 11, Reading 42
  89. 89. The Nomination Committee The Nomination Committee has role of evaluating the board ofdirectors and examining the skills and characteristics that areneeded in board candidates.Study Session 11, Reading 42
  90. 90. Corporate Code of Ethics A code of business ethics often focuses on social issues. A Corporate Code of Ethics may set out general principlesabout an organizations beliefs on matters such asmission, quality, privacy or the environment. It should dictate procedures to determine whether a violationof the code of ethics has occurred and, if so, what remediesshould be imposed.Study Session 11, Reading 42
  91. 91. Areas of Shareholder Rights Voting Rules Shareholder Sponsored Proposals Common Stock Classes Takeover DefensesStudy Session 11, Reading 42