Corporate Finance addresses the following three questions: • What long-term investments should the firm choose? • How should the firm raise funds for the selected investments? • How should short-term assets be managed and financed?
Total Value of Assets: Total Firm Value to Investors: Current Liabilities Current Assets Long-Term Debt Fixed Assets 1 Tangible 2 Intangible Shareholders’ Equity Balance Sheet Model of the Firm
How a Business Can Organize • The Sole Proprietorship • The single owner who also runs the business • The Partnership • A small group owns and runs the business • General Partnership • Like a sole proprietorship, but with several owners • Limited Partnership • Bears limited financial risk, and does not help run the business • The Corporation • Managers run the business; Equity owns it • Separates ownership and control • Used when you need a lot of capital
Agency Issues • Shareholders own the firm • Managers run the firm for the shareholders • This is an agency relationship • Other Ex. Real Estate Agents, Mutual Funds • If they do not agree on objectives then we have a problem
Historical Example • When Washington was building Mt. Vernon, all everything had to come from England • So he would write a letter describing what he wanted and send it to London • London agent would then “fill order” • “Good enough for America” • Washington’s goal? • Agent’s goal?
What is the should managers do? • Maximize profit? • Minimize costs? • Maximize market share? • Maximize shareholder wealth?
Different Goals • Shareholders: • Want big returns on their investments • Managers: • Expensive perquisites • Private jet, golf memberships, cars, etc. • Company Survival • Independence
Managing Managers • Managerial compensation • Incentives are used to align management and stockholder interests • Ex. Stock Options, Performance Bonuses • The incentives need to be structured carefully to make sure that they achieve their intended goal • Corporate control • The threat of a takeover force managers to act in stockholder interest
Financial Markets • Primary Market • Company issues securities for the first time and keeps the money from their sale • Secondary Markets • Individuals buying and selling securities • Company receives no money from these transactions • Examples: NYSE, NASDAQ, London & Tokyo Exchange
Stocks and Bonds Money Primary Market Secondary Market securities money Financial Markets Investors Firms Bob Sue
Quick Quiz • What are the three basic questions Financial Managers must answer? • What are the three major forms of business organization? • What is the goal of financial management? • What are agency problems, and why do they exist within a corporation? • What is the difference between a primary market and a secondary market?