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Corporate Finance. FINA1003, Fall 2009 Xiaohui Gao Faculty of Business and Economics University of Hong Kong. Chapter 1: Introduction to Corporate Finance. What is corporate finance Forms of business organization Role and goal of the financial manager Agency Problems

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corporate finance

Corporate Finance

FINA1003, Fall 2009

Xiaohui Gao

Faculty of Business and Economics

University of Hong Kong

Corporate Finance, Xiaohui Gao

chapter 1 introduction to corporate finance
Chapter 1: Introduction to Corporate Finance

What is corporate finance

Forms of business organization

Role and goal of the financial manager

Agency Problems

Financial markets and the corporation

Corporate Finance, Xiaohui Gao

what is corporate finance
What is Corporate Finance?

What long-term investments should the firm take on? (Capital budgeting)

Where will we get the long-term financing to pay for the investment? (Capital structure)

How will we manage the everyday financial activities of the firm? (Working capital)

Corporate Finance, Xiaohui Gao

business organizations
Business Organizations

In terms of organization, business falls into the following four categories:

Sole Proprietorships



Hybrids forms (of the above basic 3 types)

They differ in their ownership, taxation form, the liability limitation, and the ability to raise cash.

Corporate Finance, Xiaohui Gao

sole proprietorships
Sole Proprietorships

Manager is the sole owner; bears all the costs and keeps all the profits after taxes

Personal liability for the business activity is unlimited

Firm profit is taxed only once

This type of the firm is easy to establish

Corporate Finance, Xiaohui Gao


Several entrepreneurs come together to set up a business, by pooling money and expertise

A partnership agreement sets out how management decisions are taken, profits are shared etc.

General partner; limited partner

Unlimited personal liability

Firm profit is taxed only once

This type of the firm is easy to establish

Corporate Finance, Xiaohui Gao


A legal entity separate from its owners (shareholders)

Limited liability for the business activity from its owners, ownership transfer is easy

Firm profit is double taxed

This type of the firm is difficult and expensive to establish

Separation of ownership and management

Corporate Finance, Xiaohui Gao

corporate structure
Corporate Structure

Unlimited liability

Personal tax on profits

Sole Proprietorships


Limited liability

Corporate tax on profits +

Personal tax on dividends


Corporate Finance, Xiaohui Gao

who is the financial manager
Who is the Financial Manager

Financial manager: responsible for a significant corporate investment or financing decision.

The financial managers in large corporations:

Chief Financial Officer (CFO): financial policy, corporate planning

Treasurer: cash management, raising capital, banking relationships

Controller: preparation of financial statement, accounting, taxes

Corporate Finance, Xiaohui Gao

financial management decisions
Financial Management Decisions
  • Capital Budgeting Decision (investment decision)
    • Determine the size, timing, and risk of future cash flows that can be generated by investments
  • Financing Decision
    • Determine how to raise the money needed
    • Determining the mix and tenure of the security to be issued
  • Working Capital Management
    • Manage day-to-day finances of the firm.

Corporate Finance, Xiaohui Gao


Are the following capital budgeting or financing decisions?

Issuing shares of stock to finance the construction of a new manufacturing plant.

Buying the rights to use NFL logos on clothing.

Borrowing money from the bank to repurchase shares of stock in the secondary market.

Hiring a new researcher at an automobile company.

Corporate Finance, Xiaohui Gao

goals of a corporation
Goals of a Corporation
  • Shareholders value maximization
  • This is the only clear and unambiguous objective on which most shareholders agree
  • Do managers always maximize value?
    • The answer is NOT ALWAYS.
    • How closely are management goals aligned with stockholder goals? (compensation)
    • Is the manager easy to be replaced? (control)

Corporate Finance, Xiaohui Gao

agency problems
Agency Problems

Agency relationship between shareholders and managers

Managers are Agents

Agency problems are represented by agency costs (direct or indirect)

How do agency costs affect firm value (and shareholder wealth)?

Corporate Finance, Xiaohui Gao

management behavior
Management Behavior
  • Agents have considerable freedom to act
    • Personal Benefits and corporate perks
  • Management is constrained by numerous forces.
    • Compensation Plans
    • Board of Directors Oversight
    • Takeovers
    • Specialist (Analyst) Monitoring
    • Financial Market Discipline

Corporate Finance, Xiaohui Gao

financial markets
Financial Markets

The Purpose of Financial Markets

Issue Debt

Issue Equity




Corporate Finance, Xiaohui Gao

financial markets16
Financial Markets
  • Consist of Primary and Secondary markets
  • Primary markets: where a new issue of securities (primary issue) takes place
  • Secondary markets: where investors trade securities among themselves
    • Exchange markets- NYSE, AMEX, NASDAQ
    • Over-the-counter (OTC) – OTCBB, pink sheets
  • A primary issue, such as an IPO, increases the amount of securities held by the public, and also the cash within the issuing company
  • Trading in the secondary market usually does not generate cash inflows or outflows for the company

Corporate Finance, Xiaohui Gao

careers in finance
Careers in Finance
  • Corporate Finance
    • Financial analyst
    • Financing decision and investment decision
  • Financial Institutions
    • Banks
    • Insurance Companies
    • Finance Companies and Mortgage Banking

Corporate Finance, Xiaohui Gao

what you should be capable of now
What you should be capable of now

Explain the advantages and disadvantages of the most common forms of business organization.

Cite the major business functions and decisions that the firm’s financial managers are responsible for and understand some of the possible career choice in finance.

Explain why it makes sense for corporations to maximize their market values.

Show why conflicts of interest may arise in large organizations and discuss how corporations can provide incentives for everyone to work toward a common end.

Explain the role of financial markets.

Corporate Finance, Xiaohui Gao

after class notes
After-class Notes

Get the textbook and a financial calculator (if you haven’t done so).

Read Chapter 1 together with the lecture notes.

Work on the concept questions at the end of Chapter 1.

Corporate Finance, Xiaohui Gao