1. Introduction to Corporate Finance
James R. Garven, Ph.D.

2. Chapter Outline Chapter Outline
Corporate Finance and the Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation

3. Corporate Finance
Some important questions that are answered using finance:
What long-term investments should the firm take on?
2. Where will the firm obtain the long-term financing needed pay for the investment?
3. How will the firm manage its everyday financial activities (e.g., payments to vendors, employees, extending credit customers to customers, etc.?

4. Financial Managers
Chief Financial Officer (CFO): The top financial manager within a firm
Treasurer: Oversees cash management, credit management, capital expenditures, and financial planning
Controller: Oversees taxes, cost accounting, financial accounting and data processing

5. Chapter Outline Chapter Outline
Corporate Finance and the Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation

6. Forms of Business Organization in the U.S.
Sole Proprietorship
Single Owner
Partnership
General
Limited
Corporation
C-Corporation
S-Corporation
Limited Liability Company (LLC)

7. Sole Proprietorship Advantages of Sole Proprietorship:
Easiest to start
Least regulated
Single owner keeps all the profits
Taxed once as personal income
Another “feature” is that since the ownership and management of the firm are merged, there are no incentive conflicts between owners and managers since these roles are performed by the same person. As we move from the sole proprietor to the partnership to the corporation, incentive conflicts arise (aka “agency problems”).

8. Sole Proprietorship Disadvantages of Sole Proprietorship:
Limited to life of owner
Equity capital limited to owner’s personal wealth
Unlimited liability
Difficult to sell ownership interest

9. Forms of Business Organization in the U.S.
Sole Proprietorship
Single Owner
Partnership
General
Limited
Corporation
C-Corporation
S-Corporation
Limited Liability Company (LLC)

10. Partnership Advantages of Partnerships: Two or more owners
More capital available; risks shared between owners
Relatively easy to start
Income taxed once as personal income

11. Partnership Disadvantages of Partnerships: Unlimited liability
General partnership Limited partnership
Partnership dissolves when one partner dies or wishes to sell
Difficult to transfer ownership

12. Forms of Business Organization in the U.S.
Sole Proprietorship
Single Owner
Partnership
General
Limited
Corporation
C-Corporation
S-Corporation
Limited Liability Company (LLC)

13. Corporation Advantages of Corporation: Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Separation of ownership and management conveys an advantage through specialization – owners focus on risk bearing and managers focus on creating value for owners.

14. Corporation Disadvantages: Separation of ownership and management
Double taxation (income taxed at the corporate rate and then dividends taxed at the personal rate)
Separation of ownership and control also has its downsides – need to worry whether incentives of agents (managers) coincide with interest of principals (owners) – regulate this through compensation schemes, corporate governance, internal auditing, markets for corporate control.
By double taxing equity versus debt income, the tax system creates a bias in favor of debt – also true at personal level (e.g., mortgage finance).

15. Chapter Outline Corporate Finance and the Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation

16. Goal of Financial Management
What should be the goal of a corporation?
Maximize profits?
Minimize costs?
Maximize market share?
Maximize the current value of the company’s stock?
Here, introduce the Fisher Separation Theorem proof.

17. Chapter Outline Corporate Finance and the Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation

18. The Agency Problem Agency relationship
Principal hires an agent to represent his/her interests
Stockholders (principals) hire managers (agents) to run the company
Agency problem
Conflict of interest between principal and agent

19. Ways to Mitigate Agency Problems
Managerial compensation
Incentives can be used to align management and stockholder interests
The incentives need to be structured carefully to make sure that they achieve their goal
Corporate control
The threat of a takeover may result in better management

20. Chapter Outline Corporate Finance and the Financial Manager
Forms of Business Organization
The Goal of Financial Management
The Agency Problem and Control of the Corporation
Financial Markets and the Corporation

21. Financial Markets and the firm
Key point here is financial markets provide signals for the most highly valued uses of capital – later in the course this will be where consideration of the cost of capital comes into play.