An Overview of Financial and Multinational Financial Management

Learning Objectives Questions to be answered: What is the role of financial management? What are the three main areas of finance? How are companies organized? What are the goals of the corporation? What key trends are affecting financial management today? What factors make multinational financial management different? What agency relationships exist within corporations?

What three questions does financial management seek to answer? What causes a company to have a particular stock value? How can managers make choices that add value to their companies? How can managers ensure that their companies don’t run out of cash while executing their plans?

The Field of Finance Capital Markets/Financial Institutions Investments Financial Management

Financial Decisions Within the Firm Investment Decisions Financial Decisions Both

Financial Management and Analysis Financial Management Financial Analysis

Alternative Forms of Business Organization Sole proprietorship Partnership Corporation

Sole Proprietorship Advantages: Ease of formation Subject to few regulations No corporate income taxes Disadvantages: Limited life Unlimited liability Difficult to raise capital

Partnership A partnership has roughly the same advantages and disadvantages as a sole proprietorship.

Corporation Advantages: Unlimited life Easy transfer of ownership Limited liability Ease of raising capital Disadvantages: Double taxation Cost of set-up and report filing

Goals of the Corporation The primary goal is shareholder wealth maximization, which translates to maximizing stock price. Should firms behave ethically? YES! Do firms have any responsibilities to society at large? YES! Shareholders are also members of society.

Goals of the Corporation Maximizing the owners’ wealth Maximizing shareholders’ wealth Maximizing the price per share Maximizing economic profits

Economic Profit Versus Accounting Profit Economic profit Opportunity cost Normal profit Accounting profit Ignores opportunity costs and normal profits Does not reflect the firm’s actual cash flows

Is maximizing stock price good for society, employees, and customers? Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in: firms that make managers into owners firms that were owned by the government but that have been sold to private investors

Is maximizing stock price good for society, employees, and customers? Consumer welfare is higher in capitalist free market economies than in communist or socialist economies. Fortune lists the most admired firms. In addition to high stock returns, these firms have: high quality from customers’ view employees who like working there

Factors That Affect the Firm’s Stock Price Internal Factors Amount of cash flows expected by shareholders Timing of the cash flow stream Risk of the cash flows Use of debt Dividend policy External Factors Legal constraints General level of economic activity Tax laws Conditions in the stock market Investor expectations

Three Determinants of Cash Flows Sales Current level Short-term growth rate in sales Long-term sustainable growth rate in sales Operating expenses Capital expenses

Factors that Affect the Level and Risk of Cash Flows Decisions made by financial managers: Investment decisions (product lines, production processes, geographic market, use of technology, marketing strategy) Financing decisions (choice of debt policy and dividend policy) The external environment

Financial Management Issues of the New Millennium Use of computers and electronic transfers of information The globalization of business Corporate governance

Agency Relationships An agency relationship exists whenever a principal hires an agent to act on his or her behalf. Within a corporation, agency relationships exist between: Shareholders and managers Shareholders and creditors

Shareholders versus Managers Managers are naturally inclined to act in their own best interests. But the following factors affect managerial behavior: Managerial compensation plans Direct intervention by shareholders The threat of firing The threat of takeover

Shareholders versus Creditors Shareholders (through managers) could take actions to maximize stock price that are detrimental to creditors. In the long run, such actions will raise the cost of debt and ultimately lower stock price.

What is a multinational corporation? A multinational corporation is one that operates in two or more countries. At one time, most multinationals produced and sold in just a few countries. Today, many multinationals have world- wide production and sales.

Why do firms expand into other countries? To seek new markets To seek new supplies of raw materials To gain new technologies To gain production efficiencies To avoid political and regulatory obstacles To reduce risk by diversification

What are the major factors that distinguish multinational from domestic financial management? Exchange rate risk Currency differences Economic risk Political risk Government roles Cultural, legal, and institutional differences Cultural differences Language differences Legal differences

Seat Work Discuss the agency problem and the associated risk that debt holders face when lending money to a company.