FINANCE AND ENTERPRISES Zoubida SAMLAL - MBA, CFA Member, PHD candidate for HBS program

2 TYPES OF BUSINESSES 1.Sole Proprietorship 2.Partnership 3.Corporation

3 THE SOLE PROPRIETORSHIP FORMED BY A SINGLE INDIVIDUAL 1.Simplest and least regulated 2.Owner keeps all profits and pays taxes as personal income 3.Owner has an unlimited liability 4.Ceases to exist once the owner dies or withdraws 5.Cannot raise equity beyond the owner’s wealth (limits growth)

THE PARTNERSHIP FORMED BY 2 OR MORE INDIVIDUALS General Partnership  An agreement between partners to provide work/cash and share profits/losses  Control resides with a majority of the general partners  Unlimited liability f each general partner Limited Partnership  Limited liability for some partners (not involved in management)  There must be at least one general partner Owners pay taxes as personal income Ceases to exist once a general partner dies or withdraws Difficult to raise equity capital

THE CORPORATION A distinct legal entity owned by one or more individuals Owned by shareholders who elect directors – oversee managers More complicated (articles of incorporation, bylaws) Liquidity and marketability of ownership – more easily transferable than with proprietorships or partnerships Limited liability of shareholders Continuity of Existence Double taxation: corporate tax and income tax

CORPORATE GOVERNANCE SEPARATION OF OWNERSHIP AND CONTROL Board of Directors Management Assets Debt Equity Shareholders Debt holders

CONFLICTS BETWEEN MANAGERS AND STOCKHOLDERS Managers are naturally inclined to act in their own best interests (which are not always the same as the interest of stockholders). But the following factors affect managerial behavior: – Managerial compensation plans – Direct intervention by shareholders – The threat of firing – The threat of takeover 1-7

ASYMMETRIC INFORMATION AND AGENCY COSTS There is asymmetric information between shareholders and managers. How to induce managers to act in the shareholders’ interests ? – The shareholders can devise contracts that align the incentives of the managers with the goals of the shareholders. – The shareholders can monitor the managers behavior. (Agency Cost) This contracting and monitoring is costly.

RESPONSIBILITY OF THE FINANCIAL STAFF Maximize stock value by: – Forecasting and planning – Investment and financing decisions – Coordination and control – Transactions in the financial markets – Managing risk 1-9

FACTORS THAT AFFECT STOCK PRICE Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows

STOCK PRICES AND INTRINSIC VALUE In equilibrium, a stock’s price should equal its “true” or intrinsic value. To the extent that investor perceptions are incorrect, a stock’s price in the short run may deviate from its intrinsic value. Ideally, managers should avoid actions that reduce intrinsic value, even if those decisions increase the stock price in the short run.

DETERMINANTS OF INTRINSIC VALUE AND STOCK PRICES

SOME IMPORTANT TRENDS Recent corporate scandals have reinforced the importance of business ethics, and have spurred additional regulations and corporate oversight. The effects of changing information technology have had a profound effect on all aspects of business finance. The continued globalization of business.