An Overview of Financial and Multinational Financial Management Corporate Finance Dr. A. DeMaskey
Learning Objectives • Questions to be answered: • What is the role of financial management? • What are the three main areas of finance? • How are companies organized? • What are the goals of the corporation? • What key trends are affecting financial management today? • What factors make multinational financial management different? • What agency relationships exist within corporations?
What three questions does financial management seek to answer? • What causes a company to have a particular stock value? • How can managers make choices that add value to their companies? • How can managers ensure that their companies don’t run out of cash while executing their plans?
The Field of Finance • Capital Markets/Financial Institutions • Investments • Financial Management
Financial Decisions Within the Firm • Investment Decisions • Financial Decisions • Both
Financial Management and Analysis • Financial Management • Financial Analysis
Alternative Forms ofBusiness Organization • Sole proprietorship • Partnership • Corporation
Sole Proprietorship • Advantages: • Ease of formation • Subject to few regulations • No corporate income taxes • Disadvantages: • Limited life • Unlimited liability • Difficult to raise capital
Partnership • A partnership has roughly the same advantages and disadvantages as a sole proprietorship.
Corporation • Advantages: • Unlimited life • Easy transfer of ownership • Limited liability • Ease of raising capital • Disadvantages: • Double taxation • Cost of set-up and report filing
Goals of the Corporation • 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 the Corporation • Maximizing the owners’ wealth • Maximizing shareholders’ wealth • Maximizing the price per share • Maximizing economic profits
Economic Profit Versus Accounting Profit • Economic profit • Opportunity cost • Normal profit • Accounting profit • Ignores opportunity costs and normal profits • Does not reflect the firm’s actual cash flows
Is maximizing stock price good for society, employees, and customers? • Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in: • firms that make managers into owners (such as LBO firms) • firms that were owned by the government but that have been sold to private investors
Is maximizing stock price good for society, employees, and customers? • Consumer welfare is higher in capitalist free market economies than in communist or socialist economies. • Fortune lists the most admired firms. In addition to high stock returns, these firms have: • high quality from customers’ view • employees who like working there
Internal Factors Amount of cash flows expected by shareholders Timing of the cash flow stream Risk of the cash flows Use of debt Dividend policy External Factors Legal constraints General level of economic activity Tax laws Conditions in the stock market Investor expectations Factors That Affect the Firm’s Stock Price
Three Determinants of Cash Flows • Sales • Current level • Short-term growth rate in sales • Long-term sustainable growth rate in sales • Operating expenses • Capital expenses
Factors that Affect the Level and Risk of Cash Flows • Decisions made by financial managers: • Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy) • Financing decisions (choice of debt policy and dividend policy) • The external environment
Financial ManagementIssues of the New Millennium • Use of computers and electronic transfers of information • The globalization of business • Corporate governance
Agency Relationships • 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
Shareholders versus Managers • 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
Shareholders versus Creditors • Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors. • In the long run, such actions will raise the cost of debt and ultimately lower stock price.
What is a multinational corporation? • A multinational corporation is one that operates in two or more countries. • At one time, most multinationals produced and sold in just a few countries. • Today, many multinationals have world-wide production and sales.
Why do firms expand into other countries? • To seek new markets • To seek new supplies of raw materials • To gain new technologies • To gain production efficiencies • To avoid political and regulatory obstacles • To reduce risk by diversification
What are the major factors that distinguish multinational from domestic financial management? • Exchange rate risk • Currency differences • Economic risk • Political risk • Government roles • Cultural, legal, and institutional differences • Cultural differences • Language differences • Legal differences