Transcript The Scope Of Corporate Finance
The Scope Of Corporate Finance
Professor Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Finance Career Opportunities
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Corporate Finance Commercial Banking Investment Banking Money Management Consulting • Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement • Consumer banking • Corporate banking • High income potential • Very competitive industry • Opportunities in investment advisory firms, mutual fund companies, pension funds, investment arms of financial departments • Advise on business practices and strategies of corporate clients
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Raising Capital: Key Facts
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Most financing comes from internal rather than external sources (“pecking order”).
Most external financing issued as debt Primary vs. secondary market transactions or offerings Traditional financial intermediaries (banks) declining as a source of capital for large firms Securities markets growing in importance
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Role of The Financial Manager
4 Firm's operations (2) Financial manager (4a) (3)
(1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors
(4b) (1) Financial markets Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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Corporate Finance Functions
Corporate Finance Functions
External Financing Capital Budgeting Financial Management Risk Management Corporate Governance Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Dimensions of the External Financing Function Equity vs. debt Funding via capital market vs. via financial intermediary Public vs. private capital markets Going public
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
The Capital Budgeting Function
Capital Budgeting – the process firms use to choose the set of investments that generate the most wealth for shareholders
7 Select investments for which the marginal benefits exceed the marginal costs
.
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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The Financial Management Function
Managing daily cash inflows and outflows Forecasting cash balances Building long-term financial plans Choosing the right mix of debt and equity
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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The Risk Management Function
Managing the firm’s exposure to significant risks: Interest rate risk Exchange rate risk Commodity price risk
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
The Corporate Governance Function
Ensuring that managers pursue shareholders’ objectives
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Dimensions of corporate governance • Boards of directors • Ownership structures • Capital structures • Compensation plans • Country’s legal environment - in U.S., Sarbanes-Oxley Act of 2002 Takeover market disciplines firms that don’t govern themselves.
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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What Should Managers Maximize?
• Profit maximization as goal: – Does not account for timing of returns – Profits - not necessarily cash flows – Ignores risk
Maximize shareholder wealth
• Maximize stock price, not profits • Accounts for risk • As “residual claimants,” shareholders have better incentives to force management to maximize firm value than do other stakeholders.
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Separation of Ownership and Control
Principal – Agent Relations
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Fringe – Benefit Consumption Fringe – Benefit Consumption Information Asymmetry Moral Hazard Controlling Procedures (Agency Costs) Management Compensation Schemes
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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Goals of The Corporation
• Shareholders desire wealth maximization • Do managers maximize shareholder wealth?
• Managers have many constituencies or “stakeholders” • “Agency Problems” represent the conflict of interest between management and owners
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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Managerial Goals
• Managerial goals may be different from shareholder goals – Expensive perquisites – Survival – Independence • Increased growth and size are not necessarily the same thing as increased shareholder wealth.
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
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Do Shareholders Control Management ?
• Shareholders vote for the board of directors, who in turn hire the management team.
• Compensation Schemes can be carefully constructed to be incentive compatible .
• There is a market for managerial talent—this may provide market discipline to the managers—they can be replaced.
• If the managers fail to maximize share price, they may be replaced in a hostile takeover.
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Example: Moral Hazard in Financial Relations
Moral Hazard can destroy business opportunities:
Option A Option B Loan 100 100 p 1,0 0,5 0,5 Cash Flow 120 200 0 Creditor/Bank 110 110 0
Option B 100 55 Debtor/Corp.
10 90 0 45
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Increase the interest rate to 20% does not lead to a solution
Option A Option B
Option B Loan 100 100 p 1,0 0,5 0,5 Cash Flow 120 200 0 100 Creditor/Bank 120 120 0 60 Debtor 0 80 0 40
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics
Solution of Moral Hazard Problems By Credit Limits 17
A solution should provide no incentives to the management to follow the risky option B, i.e. the expected values of each option should at least equal
Expected Value Option A = Expected Value Option B
120
x
1 , 10
1
200
120
1 , 1 x x
1 , 10
100
0 , 55 x
0 , 5 0 , 55 x
20 x
36 , 36
Option A Option B
Option B Equity 63,64 63,64 Loan 36,36 36,36 p 1,0 0,5 0,5 Cash Flow 120 200 0 100 Creditor 40 40 0 20 Debtor 80 160 0 80
Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics