Transcript FINANCIAL ADMINISTRATION OF THE FIRM FIN 5043--930

Chapter 1
The Scope Of Corporate Finance
Professor John Zietlow
MBA 621
Spring 2006
The Scope Of Corporate Finance
• What Is Corporate Finance?
– Can Be Defined By Functions of Corporate Finance
– Skills Developed Studying Corp Fin Applicable Everywhere
• Career Opportunities In Finance
– Corporate Finance
– Investment & Commercial Banking
– Money Management & Consulting
• Goals Of The Financial Manager
– Why Maximize Shareholder Wealth?
• Basic Forms of Business Organization
– In the U.S. and Internationally
The Five Basic Corporate Finance Functions
• Capital-Raising (Financing)
– Obtaining External Funding For Firm’s Operations
• Capital Budgeting
– Allocating the Firm’s Resources To Most Productive Use
• Financial Management
– Managing Firm’s Cash Flows To Pay Maturing Liabilities
– Managing Firms’ Capital Structure (Mix Of Debt & Equity)
• Corporate Governance
– Ensuring Firm Is Run Ethically & In Shareholders’ Interest
• Risk Management
– Managing Insurable & Uninsurable Risk Exposures
Raising Capital: Basic Terminology
• Primary vs Secondary Market Transactions Or Offerings
– Primary: Capital-Raising Transaction
• Funding Via Capital Market vs Via Financial Intermediary
– Sell Securities To Investors For Cash On Capital Markets
• Money vs Capital Markets
– Money Market: For Short-Term (Max 1 Year) Debt Obligations
• Public vs Private Capital Markets
– Public: Security Listed On Regulated Exchange, Freely Traded
• Going Public
– Selling Stock To Public Investors & Listing On Exchange
Raising Capital: Key Facts
• Internally-Generated Cash Flow The Dominant Source Of
Funding In All Developed Economies
– Typically 60-80% For US Firms, 50-60% Other OECD
• Bulk of External Funding Is In The Form Of Debt
– Seasoned Equity Issues Only 4-8% Of External Financing
• Profits Re-Invested In A Firm (Retained Earnings) Equal To A
New Equity Issue Each Year
– This Keeps 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, Japan
• Huge Increase In Total Security Issuance Volume Since 1990
Growth in Global Security Issues, 1990-2002
$ Bn 4500
4000
3500
3000
Global debt & equity
2500
2000
1500
1000
U.S. Issuers worldwide
500
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
World Stock Market Capitalization, 1983-2002
40000
35000
30000
25000
Em erging Markets
Other Developed
20000
Japan
United Kingdom
15000
10000
5000
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20
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0
United States
The Critical Importance Of Corporate
Governance
• Historical Experience, Academic Research Both Suggest
That Ownership Structure Very Important
– Concentrated vs Atomistic Ownership Structure
– At Least Three Forms Of Capitalism (US, Japan, Europe)
– Country’s History & Legal/Regulatory System Very Important
• Incentives Of Managers, Stockholders, Other Stakeholders
Often Conflict
– S/Hs Face Collective Action Problem Monitoring Management
• The Role Of Takeovers In Corporate Governance Has Grown
Dramatically In Recent Years
– Long Important In US, UK; Increasingly In Europe
Value of Global Mergers & Acquisitions,
1991-2002 ($US Billions)
4000
3500
3000
2500
2000
1500
1000
500
0
1990
1991
1992
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U.S. targets
1996
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1998
Non-U.S. targets
1999
2000
2001
2002
Career Opportunities In Finance For Finance
Graduates
• Corporate Finance (Including International)
– Financial Analyst, Treasurer, Controller, CFO, Possibly for a
Nonprofit or Governmental Organization
• Commercial Banking
– Corporate & Consumer Banking, Operations, International
• Investment Banking
– High Salaries, Massive Stress; Mostly In NYC, London
• Money Management & Investment Services
– Booming During 1990s; Baby-Boomers Fueling Demand
– Now Over 5,000 Mutual Funds; Large Funds Still Dominant
• Consulting
– High Salaries; Rapid Recent Growth; Much Traveling
Career Opportunities For Finance Graduates:
Prerequisites For Success
• All Require Good Communications Skills, Ability To Work In
Teams, Computer Expertise
– Sound Like Cliches, But True Nonetheless
• Basic Financial Analysis Skills Critically Important
– Especially Valuation Skills (Securities, Projects, Firms)
• Finance Now Seen As A Source Of Strategic Advantage
– View Firm As Portfolio Of “Growth Options” To Be Developed
• International Business Knowledge Increasingly Important
– U.S. Represents Less Than 30% Of “Global GDP”
• Financial Transactions, Trading Moving To Internet
– Business-To-Business Marketing, Payment; Securities Trading
Financial Use Of The Internet
•
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As A Source Of Financial & General Business Information
– General Info: CNNFN (money.cnn.com), Yahoo (www.yahoo.com)
– Purchased Databases: S&P (www.standardandpoors.com)
– Corporate Websites: Deutsche Telekom (www.dtag.de), IBM
(www.ibm.com), Goldman Sachs (www.gs.com)
– Business Periodicals: Financial Times (www.ft.com); Wall Street Journal
(www.wsj.com); Investors Business Daily (www.investors.com);
Economist (www.economist.com)
– Government: U.S. Federal Reserve (www.federalreserve.gov)
– Exchanges: NYSE (www.nyse.com);NASDAQ (www.nasdaq.com)
– Financial Sites: Smart Money (www.smartmoney.com)
Providing Instant, Low-Cost Brokerage Services
– Pioneers: Schwab (www.schwab.com);ETrade (www.etrade.com);
Ameritrade (www.ameritrade.com)
– Now Merrill Lynch (www.ml.com), others Offering Service
What Should Managers Try To Maximize?
• Though Plausible, Profit Maximization Has Problems
– Does Not Account For Timing Of Returns
– Profits Are Not Necessarily Cash Flows
– Most Important: Ignores Risk
• Proper Management Objective: Maximize Shareholder Wealth
– Maximize Stock Price, Not Profits
– Accounts For Risk, Timing, Maximizing Value Of Cash Flows
– As “Residual Claimants,” S/Hs Have Better Incentives To
Maximize Firm Value than Other Stakeholders
– S/Hs Can Benefit Only Once Other Claims Paid In Full
– Historical Justification: Success Of Financial Capitalism
The Importance of Agency Costs In
Corporate Finance
• Agency Costs Due To Separation of Ownership And Control
– Managers Are The Agents Of S/Hs, But Are Also Human
– Interests of Managers & S/Hs Inevitably Diverge
• Three Ways To Deal With Agency Costs; Cannot Truly Solve
– Can Rely On Market Forces: Takeovers, Proxy Contests
– Can Incur Monitoring & Bonding Costs
– Align Manager & S/H Interests Via Compensation Contracts
• Most Controversial Method: Executive Compensation
– Bull Market Has Led To Huge Payments
– Average Total S&P 500 CEO Pay In 2001: $9.7 Million
– Bulk Of This Pay Comes From Stock Options
– Sometimes non-cash perks as well: Gulfstream for Jobs
Forms Of Business Organization In The U.S.
Proprietorships & Partnerships
• Proprietorship Is A Business That Is Owned By One Person
– No Distinction Between Business & Person
– Benefits: Easy To Set Up, Operate; Taxed As Personal Income
– Drawbacks: Personal Liability, Limited Life, Difficult To Transfer
• A Partnership Has Two Or More Business Owners
– Similar Benefits & Drawbacks As Proprietorships
– Partners Are Liable For Every Other Partner’s Actions
– Goldman Sachs Became Corporation, Went Public May 1999
• A Limited Partnership Has One General & Many Limited
Partners, But Only General Partner Has Unlimited Liability
– Tax Benefits Of Partnership, Limited Liability Of Corporation
– Attractive For Funding Real Estate, Certain Types Of R&D
Forms Of Business Organization In The U.S.
Corporations & LLCs
• A Corporation Is A Separate Legal Entity With All The
Economic Rights & Responsibilities Of A Person
– Can Sue & Be Sued, Own Property, Execute Contracts
– Incorporation Occurs At State Level; Based On State Law
• Corporate Form Has Decisive Strengths
– Offers Limited Liability To Investors; Unlimited Business Life
– Most Businesses Become Corps As They Mature
• Key Weakness Is Double Taxation Of Dividends [next slide]
– S Corporation Overcomes This, But Its Use Is Restricted
• Limited Liability Company (LLC) The Newest Form
– Combines Corp’s Limited Liability & Partnership’s Taxation
– Allowed In All 50 States; Can Choose Finite Or Infinite Life
• Franchising a Specialized Form
The Double Taxation of Dividends:
Corporate Tax Rate (c) = 0.35
Personal Tax Rate (p) = 0.40
Taxation of Business Income: Corporations vs Partnerships
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
100,000
Personal tax, owner income (p=0.4)
(26,000)
(40,000)
After-tax disposable income
$39,000
60,000
Non-U.S. Forms Of Business Organization
• Almost All Countries Allow Limited-Liability Companies--In
Some Form--And Promote Stock Market Listings
– Called PLC In Britain, SA In Spain, Latin America
– GMBH or AG In Germany, Austria, Switzerland
– Mid-Sized Firms The Backbone Of All Advanced Economies
• Most Countries Besides U.S. Have State-Owned Enterprises
– SOEs Have Traditionally Operated Utilities, Airlines, Banks
– Account For 5% GDP In OECD; about 7% In non-OECD
• Privatization Programs Have Reduced Role Of SOEs and
Raised Almost $1.5 Trillion For Governments Since 1980
– Began In Margaret Thatcher’s UK In Early 1980s
– Usually Over $100 Bn Annually, Mostly Via Share Offerings
Privatization Proceeds
$US Billions, 1988-2001
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Organization of Course Textbook:
Divided Into Eight Parts
I.
Introduction
II.
Risk, Return and Valuation
III.
Capital Budgeting Processes and Techniques
IV.
Capital Structure and Dividend Policy
V.
Long-Term Financing
VI.
Options, Derivatives and International
Financial Management
VII.
Short-Term Financing Decisions
VII.
Special Topics