1. An Overview of Financial Management
Chapter 1
An Overview of Financial Management
Role of Finance Forms of Business Organization Intrinsic Values, Stock Prices, and Managerial Incentives Business Ethics Important Business Trends Conflicts Between Managers, Stockholders, and Bondholders
Balancing Shareholder Value and Society Interests

2. What is Finance?
Not too old – developed within economics – the pricing of financial assets – studies financial markets – Financial flows within firms

3. Modern Economics Adam Smith (1723-1790) What should firms maximize?
Finance:
Corporate Finance, or Financial Management
What assets to acquire, how, and for how much
How to raise capital & run the firm to maximize its value
Capital Markets Financial Institutions
Investments
Security Analysis, Portfolio Theory, Market Analysis
Behavioral Finance
Profits?
Shareholder value?
Stakeholder value?

4. Finance Within the Organization
Board of Directors
Chief Executive Officer (CEO)
Chief Operating Officer (COO)
Marketing, Production, Human Resources, and Other Operating Departments
Chief Financial Officer (CFO)
Accounting, Treasury, Credit, Legal, Capital Budgeting, and Investor Relations

6. Finance Among Occupations, Thousands of People, US Bureau of Labor Statistics

7. Forms of Business Organization
Proprietorship
Partnership
Corporation

8. Proprietorships & Partnerships
Advantages
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages
Difficult to raise capital
Unlimited liability
Limited life
Often set up through LLCs/LLPs.

9. Corporation Advantages Unlimited life Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages
Double taxation
Cost of setup and report filing

10. Why are corporations the most used form of business?
Limited liability reduces the risks faced by investors
Easier to attract capital
The liquidity of the corporations’ stocks
Note:
A Majority of businesses operate as Proprietorships, but when based on $$ dollar value of sales, the majority of all business is conducting by Corporation

11. What is a stock? Ownership in the firm
You expect to receive dividends + capital gains

12. Stock Prices & Shareholder Value
The primary financial goal of management is shareholder wealth maximization,
Which translates to maximizing stock price in the long run
Value of any asset is present value of future cash flow
Decisions are evaluated in terms of their financial consequences
Stock prices change over time as conditions change and as investors obtain new information about a company’s prospects
Managers recognize that being socially responsible is not inconsistent with maximizing shareholder value.
Explain shareholder value and how its maximization translates into stock price maximization – How does management affect stock price? Through their investment decisions which change expectations of the firm’s future – Therefore managers should make decisions that maximize the stock price

13. How do those differing expectations affect the stock price?

14. Stock Prices and Intrinsic Value
In equilibrium, a stock’s price should equal its “true” or intrinsic value.
Intrinsic value is a long-run concept.
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.
Should managers maximize the stock price then or the intrinsic value?
Managers could maximize the stock price easily by giving investors and the market false expectations
Should managers help investors improve their estimate’s of the firm’s intrinsic value?
Is it better for a firm’s actual stock price in the market to be under, over, or equal to its intrinsic value?
Would your answer be the same from the standpoint of shareholders or that of the CEO of the firm?

15. Determinants of Intrinsic Values and Stock Prices
Managerial Actions, the Economic Environment, Taxes, and the Political Climate
“True” Investor Returns
“True” Risk
“Perceived” Investor Returns
“Perceived” Risk
Stock’s Intrinsic Value
Stock’s Market Price
Examples: Zain & Agility – over time market prices converge to intrinsic value – Different analysts come up with different intrinsic values; this is where risk exists for equity investments, if everybody knew the intrinsic value there would be no risk
Market Equilibrium: Intrinsic Value = Stock Price

16. Undervalued Vs. Overvalued

17. How would you define Business Ethics?
Ownership in the firm
You expect to receive dividends + capital gains

18. Business Ethics
Company’s attitude and conduct toward its employees, customers, community & stockholder
High standards demand that firm treat all parties in a fair and honest manner
Unethical actions can have consequences far beyond that perpetrate them
Examples:
Insider trading: Founder of Galleon LLC ($63.8 Millions)
Accounting: Enron & Arthur Andersen
Transparency: Theranos blood testing scandal
Can happen in any part of the organization and at organizations of all sizes

19. EX: Illegal Insider Trading
May 1995 secretary at IBM was asked to Xerox documents related to secret plans to take over Lotus, to be announced June 5.
She told husband, a beeper salesman.
June 2 he told two friends who immediately bought.
By June 5, 25 people spent half a million dollars to buy on this tip: pizza chef, electrical engineer, bank executive, dairy wholesaler, schoolteacher, and four stockbrokers. All caught by surveillance.

20. EX: Illegal Insider Trading- Emulex Corporation
Mark S. Jacob, 23, had shorted stock of his former employer, stood to lose money.
Sent fake news release to Internet wire, was picked up by Bloomberg, Dow Jones News Wire and CNBC. He immediately covered.
FBI, using Internet Protocol Numbers, tracked down initial news to El Camino Community College library. Police questioned librarians, and eventually tracked him down.

21. Conflicts Between Managers & Stockholders
Managers are naturally inclined to act in their own best interests
which are not always the same as the interest of stockholders
Examples : Disney’s former president & Tyco’s CEO’s
But the following factors affect managerial behavior:
Managerial compensation packages
Direct intervention by shareholders
The threat of firing
The threat of takeover
Disney’s former president severance package of $140 million after 14 months on the job & Disney’s former CEO pay of $575 million
Tyco’s CEO’s $1 million birthday party for his wife

22. Some Important Business Trends
Corporate scandals have reinforced the importance of business ethics
Drive additional regulations and corporate oversight.
Increased globalization of business
The effects of ever-improving information technology have had a profound effect on all aspects of business finance.
Stockholders now have more control of corporate governance.

23. Conflicts Between Stockholders and Bondholders
Stockholders are more likely to prefer riskier projects
because they receive more of the upside if the project succeeds
By contrast, bondholders receive fixed payments and are more interested in limiting risk.
Bondholders are particularly concerned about the use of additional debt
Bondholders attempt to protect themselves by including covenants in bond agreements that limit the use of additional debt and constrain managers’ actions.

24. Questions?