The Scope Of Corporate FinanceCorporate Finance FunctionsThe Dimensions of the Capital Acquisition FunctionRaising Capital: Key FactsSlide 5Slide 6Growth in Global Security Issues 1990-2002World Stock Market Capitalization, 1983-2002The Financial Management FunctionThe Risk Management FunctionThe Corporate Governance FunctionSlide 12Slide 13Slide 14Value of Global M & A 1991-2002 ($U.S. Billions)What Should Managers Maximize?Slide 17Agency Costs In Corporate FinanceSlide 19Slide 20Forms Of Business Organization In The U.S.Forms Of Business Organization - CorporationsThe Double Taxation of DividendsLess Double Taxation of DividendsThe Traditional Accounting Balance SheetSlide 26Slide 27Slide 28Slide 29The Market Value Balance SheetValuationThe Goal of the FirmHow Is Value Created?The Investment Decision in a NutshellThe Hurdle RateThe Expected Rate of ReturnThe Dividend Decision in a NutshellThe Financing Decision in a NutshellFinancing Trade-OffsSlide 47The Scope Of Corporate FinanceDr. Del HawleyFIN 6342Corporate Finance FunctionsFinancial Management(Manage Cash, Pay Bills)Capital Acquisition(Finance the Company)Capital Budgeting(Invest Resources)Risk Management(Deal w/ Uncertainty)Corporate Governance(Serve the Shareholders)Finance supports, facilitates, and guides the company’s strategic initiatives. It does not dominate them.The Dimensions of the Capital Acquisition Function•Primary Market vs Secondary Market •Capital Market vs Financial Intermediary•Money Market vs Capital Market•Public vs Private Capital Markets•Going Public vs Privately Held•Pay Dividends vs Retain Earnings34Raising Capital: Key Facts•Internally-generated cash flow is the dominant source of funding in all developed economies.–Typically 60-80% for US firms, 50-60% for others. •The bulk of external funding is in the form of debt.–Seasoned equity issues are only 4-8% of external financing.5Raising Capital: Key Facts•Profits reinvested (retained earnings) are the same as a new equity issue each year.–This keeps the leverage ratio from rising too high with time.•Banks everywhere are declining as a source of capital for large firms.–Especially true in US; less so in Europe, Japan6Raising Capital: Key Facts•There has been a huge increase in total security issuance volume since 1990.7Growth in Global Security Issues1990-20020500100015002000250030003500400045001990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002Global debt & equityU.S. Issuers worldwide$ Bn8World Stock Market Capitalization, 1983-20029The Financial Management FunctionChoosing the Right Mix of Debt and EquityBuilding a Long-Term Financial PlanForecasting Cash BalancesManaging Daily Cash Inflows and Outflows10The Risk Management FunctionManaging the Firm’s Exposure to Significant RisksInterest Rate RiskExchange Rate RiskCommodity Price Risk11The Corporate Governance Function The governance structure must ensure that managers make decisions that are will maximize shareholders’ wealth – not just their own wealth.12The Corporate Governance FunctionIncentives of managers, stockholders, and other stakeholders often conflict–Shareholders face a collective action problem in monitoring management–This is called the “agency problem”13The Corporate Governance Function Historical experience and academic research both suggest that ownership structure is very important.–Concentrated vs atomistic ownership structure–At least three forms of capitalism (US, Japan, Europe)–The country’s history & legal/regulatory system is very important as well14The Corporate Governance Function The role of takeovers in corporate governance has grown dramatically in recent years–Has long been important in the US and UK–Becoming increasingly important in Europe15Value of Global M & A1991-2002 ($U.S. Billions)050010001500200025003000350040001990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002U.S. targets Non-U.S. targets16What Should Managers Maximize?Though plausible as a management objective, profit maximization has problems–Does not account for the timing of returns–Profits are not necessarily cash flows–Most importantly – it ignores risk17What Should Managers Maximize?The best management objective: Maximize shareholder wealth by maximizing the VALUE of the company, thereby maximizing stock price –Accounts for risk, timing, and cash flows–As “Residual Claimants,” shareholders have better incentives to maximize firm value than other stakeholders–Shareholders can benefit only after other claims are paid in full–Historical justification: Success of financial capitalism18Agency Costs In Corporate FinanceAgency costs are due to the separation of ownership and control–Managers are the agents of the shareholders, but are also human. The interests of managers and shareholders inevitably diverge.19Agency Costs In Corporate FinanceThree ways to attempt to deal with agency costs:–Can rely on market forces: Takeovers, proxy contests, etc.–Can incur monitoring and bonding costs–Can align manager and shareholder interests via compensation contracts (stock options)20Agency Costs In Corporate FinanceMost controversial method: Executive compensation–The bull market led to huge payments–Average total S&P 500 CEO pay in 2001: $9.7 Million –The bulk of this pay came from stock options–Sometimes non-cash perks are used as well: Gulfstream for Steve Jobs21Forms Of Business Organization In The U.S.Proprietorship•No distinction between business and person (the owner)•Easy to set up and operate; Taxed as personal income•Personal liability, limited life, difficult to transferPartnership•Two or more business owners•Partners - Liable for every other partner’s actions Limited Partnership •One general and many limited partners•Limited liability of corporation, tax benefits of partnership •Real-estate, R&D companies22Forms Of Business Organization - CorporationsAre there any weaknesses for corporations? YES! Double taxation Corporation •Legal entity with all the economic rights and responsibilities of a person•Incorporation occurs at state level; Based on state law•Strengths - Limited liability to investors, unlimited business life23The Double Taxation of Dividends Corporation Partnership Operating income $100,000 $100,000 Corporate profits tax (c = 0.35) (35,000) 0 Net income available for dividends 65,000 100,000 Cash dividends or distributions 65,000