Finance 300: Chapter One Introduction to Corporate Finance Assessment Preparation 1 Mark J. Laplante, Ph.D. Wisconsin School of Business University of Wisconsin-Madison Key Terms agency relationship A situation where the principal hires an agent to act in their best interests. In the case of a corporation, the stockholders are the principals, and the board of directors and managers are their agents. agency costs, direct The measurable monetary costs that arise from conflicts of interest that may arise between the owners and managers of a corporation. There are two types of direct agency costs. First, there is the money the C-suite wastes on itself rather than paying to the shareholders. Second, the resources expended to monitor the managers, such as audits. agency costs, indirect Valuable opportunities that managers may forgo because they are highly risk-averse. These are impossible to measure. agent The party in an agency relationship hired to act in the principal’s best interests. ask price The high price at which a dealer is willing to sell to a buyer. The price at which the client buys. auction market A market where a broker acts as an intermediary, matching buyers with sellers for a fee. Auction markets have physical locations such as 11 Wall Street, the address of the New York Stock Exchange (NYSE), the most important stock market in the world. bid price The low price at which a dealer is willing to buy from a seller. The price at which the client sells. bid-ask spread The per-unit profit a dealer makes by buying something at the low bid price and selling it high at the ask price. For example, a dealer may stand ready at a moment in time to buy a share of Manitowoc stock for $28.70 and sell a share of Manitowoc stock for $28.84. Therefore, the dealer’s profit is the bid-ask spread of $.14 per share of Manitowoc stock. board of directors or the board The elected representatives of the shareholders who have a fiduciary obligation to act in the interests of the stockholders. buyback or share repurchase When a corporation uses profits to buy its shares in secondary markets. bylaws The rules and procedures that govern the operation of a corporation. C-corporation A corporation with more than 100 owners that falls under subchapter C of the IRS tax code. C-corporation profits pay corporate income tax, and their dividend distributions to the shareholders are taxed at the personal level. capital budgeting The process of planning and managing a firm's long-term investments, considering the size, timing, and risk of an investment’s cash flows. It is typically the responsibility of the chief financial officer and the treasury department. Capital budgeting decisions change the long-term assets on the company’s balance sheet and define the identity of the business. capital providers Owners and lenders. capital structure How a business acquires and maintains financing for its assets, usually focused on long-term financing for the company’s long-lived investments. The result is a mixture of debt and equity, often referred to as its leverage, that impacts the balance sheet and provides the maximum benefit to the company.2 chief executive officer (CEO) The highest ranking manager of a company who oversees the day to day operations of the business and directs the efforts of the senior management team. The CEO regularly reports to the board of directors on the performance and strategic goals of the company. For large corporations, the CEO is often the public face of the company. chief financial officer (CFO) The manager who oversees a company’s treasury and controller departments and reports to the CEO. The CFO presents timely and accurate accounting information to those who need it, develops strategies for acquiring and financing the company’s long-term assets, and manages the short-term cash flows associated with the business’s current assets and liabilities. corporation A business created as a distinct legal entity from the owners, stockholders, or shareholders. The corporation is liable for the claims of the creditors, not the owners, thus providing the shareholders limited liability. dealer market A market where buyers and sellers for a good or service transact through an intermediary called a dealer. This market structure implies that the dealer must hold inventory and that there is a risk that the price of the inventory may change while waiting to be sold. dealers Market intermediaries that always stand ready to buy from sellers at the bid (low) price and sell to buyers at the ask (high) price, thus taking the bid-ask spread as the per-unit profit. debt The funding of a business enterprise that comes from lenders. dividends When a corporation disgorges its profits as payments to the stockholders. double-taxation of profits A disadvantage of C-corporations that occurs when the profits pay corporate income tax and the shareholders pay personal income tax on dividend distributions. equity The funding of a business enterprise that comes from owners. general partnership All the partners share in the gains and losses, and all have unlimited liability for all partnership debts. illiquid The inability to sell an asset quickly at its fair market value. initial public offering (IPO) When shares of a corporation become available to the public at large for the first time. limited liability When the maximum loss an owner can realize is their investment in the business. Iimited liability company (LLC) A hybrid business form that combines the characteristics of partnerships and corporations. They have the limited liability of corporations and are tax pass-throughs like partnerships. limited partnership A special type of partnership where there are two types of partners. Limited partners provide capital to the business but do not participate in day-to-day decisions. In that role, limited partners have limited liability. General partners also contribute money to the business, except they make the business decisions and face unlimited liability. liquidity The ability to sell an asset quickly at its fair market value. Ownership interests in business enterprises can vary greatly in their liquidity. market capitalization or market cap The market value of a corporation, calculated as price per share times the number of shares outstanding. monitoring The principals spend time, money, and