An overview of Corporate Finance by Binam Ghimire

Learning Objectives Concept, Scope and Significance Key Decisions in Corporate Finance Agency problem Appreciate Business Ethics and social Responsibilities

Finance: What is it? Finance as a resource Finance as a discipline Monetary means of financing assets of an entity Collection and allocation of resources

Specialised areas of finance Personal

Specialised areas of finance Public

Specialised areas of finance Securities and investment Source: London Evening Standard, 18 May 2011

Specialised areas of finance Institutional Source: The Telegraph, 29th July 2011

Specialised areas of finance International Finance Table from Bringham and Huston (2002, p. 7) £, $, €, ¥, %

Corporate Finance ?

The Corporate Firm ? ? ?

Sole Proprietorship Business is owned and run by one person Typically have few, if any, employees Advantages: Easy to create Disadvantages: Unlimited personal liability, No separation between the firm and the owner, Limited life, Difficult to transfer ownership

Partnership Similar to a sole proprietorship, but with more than one owner Income is taxed at the personal level All partners have unlimited personal liability The partnership ends with the death or withdrawal of any single partner General and limited partner

The Corporation AKA: JSC, PLC, LLC, Corporation,

The Corporation A legal entity separate from its owners Has many of the legal powers individuals have such as the ability to enter into contracts, own assets, and borrow money …

Source: www.bizstats.com

The Corporation Several advantages: Limited liability, ease of ownership transfer and unlimited life. These give the corporation an enhanced ability to raise cash, However Starting is more complicated than others: Articles of associations and a set of bylaws, and one great disadvantage is _ _ _ _ _ e _ _ x_ _ _ _ n

Liquidity/ sale of share Dividend Corporation Partnership Liability Perpetuity Taxation Voting Rights Liquidity/ sale of share Dividend

Liquidity/ sale of share Dividend Corporation Partnership Liability No Limited: no General: yes Perpetuity Yes Taxation Double: corporate income and dividends to shareholders Partnerships is not taxed, partners are on their partnership profit Voting Rights One vote per share, vote to elect director Some by limited partners, general are active in managing and operating Liquidity/ sale of share Yes – common stock can be listed in exchange and traded There is usually no established trading market Dividend Not bound legally Generally no retention i.e. distribute all

Corporate Finance: Concept Corporate finance: Finance for the corporate or beyond? limited to management of funds? Sell - Cash - Value

Corporate Finance: concept Corporate Finance deals with: Determining value of a Corporate Entity Adding Value to a Corporate Entity The Value of X is what X is worth now at time t. Making the best decision when that decision involves a consideration or an opportunity cost and the cost of consideration may be higher or lower given time t This is part of strategy

Corporate Finance: the concept Strategy is how an organization achieves her long term objectives through re-configuration of her resources in response to a changing external business environment to achieve competitive advantage in order to satisfy stakeholder’s objectives

Corporate Finance: the concept Corporate Finance is the: The Reconfiguration of Resources The study of the external changing Business Environment Definition of what stakeholder’s Financial objectives are Gaining of competitive advantage

The Three Key Corporate Finance Decisions Investment Decisions concerned with whether to undertake capital expenditure projects or not Financing Decisions concerned with the collection of funds from appropriate sources Managerial Decisions concerned with dividend, working capital and other decisions at management level

Investment Decisions The Investment Decisions of a Firm are taken using the various investment appraisal techniques which we will study This techniques are tools which work well if applied properly They have various decision criteria's and can be very effective if used by the right kind of managers While they can cause a loss of corporate value if used wrongly

Investment Decisions The process of making and managing expenditures on long-lived assets: Capital budgeting/ Investment appraisal

Financing Decision The Financing Decision if informed by the Target Capital Structure desired by the firm The cost of capital the firm has to bear The sources of finance available to her

Financing Decision The sources of finance available can be current and long term Long term debt and equity falls in capital structure Cost of capital explains about the cost associated with such components of debt and equity capital

Managerial Decisions How large should the firm grow? How Much Dividend Should be Paid and How Much profit should be retained for growth? How fast should this growth be? How should the firm manage its receivables and payables? e.g. Should the firm grant credit to a customer?

The Role of The Financial Manager 6 6 6 6 11 10

Organisational Chart of a Typical Corporation

Firm's Financial operations Investors Manager (1) (2) (3) 4 5 Real assets 6 6 6 6 11 10

Financial Manager’s Roles 5. Cash returned to investors 3. Cash generated by the firm’s operations 2. Cash invested in the firm’s operations 1. Cash raised by selling financial assets to investors 4. Cash reinvested

Goals of a firm Profit Maximisation vs. Wealth Maximisation Accounting concept Zero dividend Time value of benefits Quality of benefits Modern business environment Who are the shareholders? Conflict of interest among stakeholders of a firm

The Three Different Views of the Firm The Investment Vehicle Model of the Firm The Accounting Model of the Firm Set of Contracts Model of the Firm

The Investment Vehicle Model of the Firm Investment Decisions Financing Decisions Investors Financial Intermediaries Markets Exchange of Money and Financial Assets The World Exchange of Money and Real Assets Three Main Areas of Finance: Corporate Financial Management Financial Markets and Intermediaries Investments

The Accounting Model of the Firm The Investment Decision Current Assets Cash Marketable Securities Accounts Receivable Inventory Total Fixed Assets Tangible Fixed Assets Intangible Fixed Assets The Financing Decision Current Liabilities Accounts Payable Current Debt Long-Term Liabilities Long-Term Bank Debt Bonds Shareholder’s Equity Common Stock Retained Earnings Net Working Capital =CA - CL

Set of Contracts Model of the Firm Bondholders Banks Employees Customers Environment Governments Firm Common Stockholders Preferred Stockholders Communities Society Creditors Suppliers Managers

Managers and Owners The Wall Street Journal Survey of CEO Compensation http://www.businessinsider.com/25-most-overpaid-ceos-2010-10#18-news-corp-rupert-murdoch-8

Agency Problem: Responsibility for the financial manager Agency Theory Michael C. Jensen and William H. Meckling propounded this theory in 1976 Principal and Agent Management and Shareholders, Creditors and shareholders

Agency Problem: Responsibility for the financial manager Manager owns less than 100% of the company Agency Problem Agency Cost (Monitoring, Structuring and opportunity costs)

Agency Problem Owners of Corporations cannot manage them Personally They have to employ Directors to Manage their Businesses on their Behalf These Directors May not carry out the management to the standard expected of them They may do it but to their own advantage or at a higher cost Shareholders have to pay the Directors and these is part of Agency Cost Because of Breakdown of Trust, Shareholders have to employ Auditors to Vouch the Stewardship Report of Directors All theses add up and the management of the Agent Principal Relationship with its attendant cost to the Principals is the Agency Cost

Agency Problem/cost: How to reduce? Managerial compensation plan (e.g. performance stock) Direct Intervention by shareholders Threat of firing Threat of takeover (e.g. hostile takeover, M&A)

Stakeholder? Stakeholders identification Models Stakeholder Theory A Stakeholder is someone who can affect or be affected by the operations of an organization as it seeks to meet its corporate objectives Stakeholder? Stakeholders identification Models Who are these To what Extent Should Companies take them into consideration? Stakeholders Mapping What if what is good for one stakeholder is Bad for Another? Satisficing What if What is good for stakeholders is viewed as unethical? Moral Frameworks and Guidelines

Business Ethics Ethics: The study of right and wrong “in action” Making a business decision can involve ethical dilemmas

An Ethical Dilemma? Choice to be made Implicates competing values, rights, & goals Potential harm to decision maker? Potential harm to others? “Ripple effect:” long-term, far reaching implications of decision to be made.

How to Resolve Ethical Dilemmas in Business Identify relevant facts Identify relevant issue(s) Identify primary stakeholders Identify possible solutions Evaluate each possible solution Compare and assess consequences Decide on solution Take action

Additional Approaches to Ethical Decision Making Five Question Approach (Tucker) Moral Standards Approach (Velasquez) Pastin’s Approach

Practical Approaches to Ethics Five Question Approach (Tucker) Evaluate each alternative on: Profitability (shareholders) Legality (society at large) Fairness Impact on the rights of stakeholders Impact on sustainable development (environment)

Practical Approaches to Ethics Tuckers Five Questions Is it profitable? Is it fair? Is it legal? Is it right? Is it sustainable?

Practical Approaches to Ethics Moral Standards Approach (Velasquez) Is the decision: Of net benefit to society Fair to all stakeholders (fair distribution of benefits and burdens) Consistent with each person’s rights

Practical Approaches to Ethics Pastin’s approach (Pastin) Ground rule ethics (organization/individual rules and values) End-point ethics (greatest net good for all concerned) Rule ethics (determine ethical boundaries to take into account – impingement of rights) Social contract ethics (how to move boundaries)

Consider This: “You and John” You are the manager for Tesco. You recently fired John, a sales clerk, after John punched a customer during a dispute in the store. John admitted this after the customer complained. Lisa, manager of your competitor, Asda, calls you to tell you that John has applied for a job at Asda, and to ask you whether John is “good with customers.” What will you reply to Lisa?

Legal Vs. Ethical: “You and John” Action Legal/Illegal Ethical/Unethical Tell the Truth Lie No Comment Other

Corporate Social Responsibility Milton Friedman's argument There is one and only one responsibility of business: to use its resources and energy in activities designed to increase its profit so long as it stays within the rule of game and engages in open and free competition, without deception and fraud. Source: The New York Times Magazine, September 13, 1970, The New York Times Company.

Corporate Social Responsibility This is Davis and Blomstrom (1971) Iron Law of Responsibility An iron law of responsibility which states that in the long-term those who do not use power in a manner that society considers responsible will tend to lose it. Source: Davis, K. and Blomstrom, R. (1971) Business, Society and Environment. Social Power and Social Response, 2nd edition, New York, McGraw-Hill. Davis, K. (1973) The case for and against Business assumptions of Social Responsibilities, The Academy of Management Journal, 16, 2, 312-322

Corporate Social Responsibility Gray, Owen and Adams (1996) described society as a series of social contracts between members of society and society itself.

Corporate Social Responsibility Gray, Owen and Adams (1996) 1.Pristine Capitalist, 2.Expedient, 3.Social contract, 4.Social Ecologists, 5.Socialists, 6.Radiacal Feminists, 7.Deep Ecologists

Corporate Social Responsibility Different approaches Social Obstruction Social Obligation Social Response Social Contribution Charity Principle Stewardship Principle

Discussion Sarbanes-Oxley Act (2002), USA

Discussion Ethics & Management Objectives Does value maximization justify unethical behavior? Enron example WorldCom example AIG example 18

Careers in Finance Discuss 18

Thank You