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Educator John Zietlow MBA 621

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  1. Chapter 1 The Scope Of Corporate Finance Professor John ZietlowMBA 621 Spring 2006

  2. 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

  3. 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

  4. 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

  5. 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

  6. Growth in Global Security Issues, 1990-2002 $ Bn Global debt & equity U.S. Issuers worldwide

  7. World Stock Market Capitalization, 1983-2002

  8. 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

  9. Value of Global Mergers & Acquisitions, 1991-2002 ($US Billions)

  10. 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

  11. 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

  12. Financial Use Of The Internet • 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. The Double Taxation of Dividends:Corporate Tax Rate (c) = 0.35Personal Tax Rate (p) = 0.40 Taxation of Business Income: Corporations vs Partnerships

  18. 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

  19. Privatization Proceeds$US Billions, 1988-2001

  20. 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