Outline…

1. What is corporate finance?

2. The goal of financial management
3. The agency problem and control of the corporation
4. Managing Managers
5. Financial markets
What is Corporate Finance?

 Corporate Finance addresses the following three questions:

Main tasks of corporate finance
Balance Sheet Model of the Firm
The Capital Budgeting Decision

Current
Liabilities
Current Assets

Long-Term
Debt

Fixed Assets
What long-
1 Tangible term Shareholders’
2 Intangible investments Equity
should the firm
choose?
Three Types of Business Organizations

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Sole Proprietorship
 It is a business owned by a single individual that is entitled to all the firm’s
profits and is responsible for all the firm’s debt.
 There is no separation between the business and the owner when it comes to
debts or being sued.
 Sole proprietorships are generally financed by personal loans from family and
friends and business loans from banks.

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Partnership
 A general partnership is an association of two or more persons who
come together as co-owners for the purpose of operating a business
for profit.
 There is no separation between the partnership and the owners with
respect to debts or being sued.

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Modern form of firms:
Corporation
 Corporation is “an artificial being, invisible, intangible, and existing only in the
contemplation of the law.”
 Corporation can individually sue and be sued, purchase, sell or own property,
and its personnel are subject to criminal punishment for crimes committed in
the name of the corporation.
 Corporation is legally owned by its current stockholders.
 The Board of directors are elected by the firm’s shareholders.

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The Importance of Cash Flows

 The most important job of a

financial manager is to create
value from the firm’s capital
budgeting, financing, and net
working capital activities.
 Question may arise….HOW???
 Try to buy assets that
generate more cash than
they cost.
 Sell bonds and stocks and
other financial instruments
that raise more cash than
they cost.

Fig: Cash Flows between the Firm and the Financial Markets
The Importance of Cash Flows (Cont’d)
Who make the decisions?: Financial managers

 Frequently, financial managers try to address these tasks.

 The top financial manager within a firm is usually the Chief Financial Officer
(CFO).
 Treasurer – oversees cash management, credit management, capital
expenditures and financial planning.
 Controller – oversees taxes, cost accounting, financial accounting and
data processing.

 Owners (typically in small businesses).

Possible goals of financial management
 Survive
 Beat the competition
 Maximize sales
 Maximize net income
 Maximize market share
 Minimize costs
 Maximize the value of (stock) shares

 The “appropriate” goal of financial management

 Maximize the (fundamental or economic) value of (stock) shares is the
right goal.
 Why? Shareholders own shares. Managers, as agents, ought to act in a
way to benefit shareholders; i.e., to enhance the value of the shares.
 A limitation of this goal is that value is not directly observable.
A quick quiz
 The primary goal of financial management is to:
 a. maximize current dividends per share of the existing stock.
 b. maximize the current value per share of the existing stock.
 c. avoid financial distress.
 d. minimize operational costs and maximize firm efficiency.
 e. maintain steady growth in both sales and net earnings.

 Mr. Argho, the CEO of Hindustan Unilever Limited, who came under heavy
criticism for his pay package and failure to lift the chain ’s stagnant stock
price, has abruptly resigned. He will receive about $150 million in
compensation from the company, including the current value of retirement
and other benefits. Who would blame him for quitting?
Value vs. price

 The value of shares are not observable. In contrast, the price of shares can be
observable.
 If one believes that share price is an accurate/good estimate of share value,
the appropriate goal would be to maximize the price of shares.
 This belief/assumption is, however, questionable.
 But the previous slide (Hindustan Unilever ex-CEO), nevertheless, showed
that investors care about stock price, and that stock price performance is very
important to the tenure of managers.
Value maximization and sustainability

 Business sustainability: often viewed as managing the triple

bottom line - a process by which companies manage their
economic/financial, ecological, and social opportunities and
risks.
 Sustainability and value maximization are somewhat different.

 3 aspects of sustainability
 Economic/financial – here is more about economic viability
and profitability, and not directly about value
maximization.
 Ecological – reaching your financial goals should not
impose burden on the current natural environment.
 Social – reaching your financial goals should not damage
the well-being of the society (employees, etc.).
Shareholders and other stakeholders
 Customers
 Suppliers
 Employees (human capital and assets)
 Creditors (bondholders, banks, debt
holders)
 Government: tax and regulations
 Community (local / global)
 Owner/shareholder
The agency problem
 Agency relationship:
 Principals (citizens) hire an agent (the president) to
represent their interest.
 Principles (stockholders) hire agents (managers) to run the
company.

 Agency problem:
 Conflict of interest between principals and agents.
 This occurs in a corporate setting whenever the agents do not
hold 100% of the firm’s shares.
 The source of agency problems is the separation of (owners’)
control and management.
Agency costs
 Direct costs: (1) unnecessary expenses, such as a corporate jet,
and (2) monitoring costs.
 Indirect costs: For example, a manager may choose not to take
on the optimal investment. She/he may prefer a less risky project
so that she/he has a higher probability keeping her/his tenure.

 Managerial goals are frequently different from shareholders’

goals.
 Expensive perks.
 Survival.
 Independence.
 Growth and size (related to compensation) may not relate to
shareholders’ wealth.
Do Managers Act In The Stockholders ’ Interests?:
Managing Managers

Managing Managers
Managerial Compensation:

 Incentives (bonuses, options, promotions)

Corporate control:

 Proxy Fight
 Takeover
Regulation

 According to the Companies Act 1994, companies are registered and

operated in Bangladesh.
 According to the Companies Act 1991, banking companies are registered and
operated in Bangladesh.
Financial markets

 Cash flows (i.e., financing and payoffs/dividends/interests)

between firms and financial markets.
 Primary markets.
 Secondary markets.
 DSE
 CSE