1. Goals and Governance of the Firm
Principles of
Corporate Finance
Tenth Edition
Chapter 1
Goals and Governance of the Firm
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved. 1 1 1 1 1 2

2. Topics Covered Corporate Investment and Financing Decisions
The Role of the Financial Manager and the Opportunity Cost of Capital
Goals of the Corporation
Agency Problems and Corporate Governance 2 2 2 2 3 2

3. Investment and Financing Decisions
Capital Budgeting Decision
Decision to invest in tangible or intangible assets.
…also called the Investment Decision
…also called Capital Expenditures or (CAPEX) 5 5 5 5 6 5

4. Investment and Financing Decisions
“Capital Budgeting”
Tangible Assets
Expand Stores
@ $800 million
Intangible Assets
New Drug R&D
@ $800 million 5 5 5 6 5 5

5. Role of The Financial Manager
(2) Cash invested in firm
(2)
(1) Cash raised from investors
(1)
Firm's
(4a) Cash reinvested
(4a)
Financial
Financial
manager
operations
markets
(3) Cash generated by operations
(3)
(4b) Cash returned to investors
(4b)

6. Who is The Financial Manager?
Chief Financial Officer
Treasurer
Controller

7. The Investment Trade-off

8. The Investment Trade-off
Hurdle rate
Cost of capital
Opportunity cost of capital

9. Goals of The Corporation
Profit maximization is not a well-defined financial objective, for at least two reasons:
1. Maximize profits? Which year’s profits? A corporation may be able to increase current profits by cutting back on outlays for maintenance or staff training, but that may add value. Shareholders will not welcome higher short-term profits if long-term profits are damaged.
2. A company may be able to increase future profits by cutting this year’s dividend and investing the freed-up cash in the firm. That is not in the shareholders’ best interest if the company earns less than the opportunity cost of capital. 18

10. Whose Company Is It?
** Survey of 378 managers from 5 countries

11. Dividends vs. Jobs
** Survey of 399 managers from 5 countries. Which is more important...jobs or paying dividends?

12. Goals of The Corporation
Shareholders desire wealth maximization
Do managers maximize shareholder wealth?
Managers have many constituencies “stakeholders”
“Agency Problems” represent the conflict of interest between management and owners 17

13. Agency Problem Ownership vs. Management Difference in Information
Stock prices and returns
Issues of shares and other securities
Dividends
Financing
Different Objectives
Managers vs. stockholders
Top mgmt vs. operating mgmt
Stockholders vs. banks and lenders

14. Agency Problem Agency costs are incurred when:
managers do not attempt to maximize firm value and
shareholders incur costs to monitor the managers and constrain their actions. 3 3 3 3 4 3

15. Agency Problem Agency Problems Stakeholder
Managers, acting as agents for stockholders, may act in their own interests rather than maximizing value.
Stakeholder
Anyone with a financial interest in the firm. 3 3 3 3 4 3

16. Agency Problem
Tools to Ensure Management Pays Attention to the Value of the Firm
Manager’s actions are subject to the scrutiny of the board of directors.
Shirkers are likely to find they are ousted by more energetic managers.
Financial incentives such as stock options

17. Agency Problem Agency Problem and Corporate Governance Solutions
Legal and Regulatory Requirements
Compensation plans
Board of Directors
Monitoring
Takeovers
Shareholder pressure 18

18. Web Resources Click to access web sites Internet connection required