1. Chapter 1 Learning Objectives
1. Give examples of the investment and financing decisions that financial managers make.
2. Distinguish between real and financial assets.
3. Cite some of the advantages and disadvantages of organizing a business as a corporation.
4. Describe the responsibilities of the CFO, treasurer, and controller.
5. Explain why maximizing market value is the logical financial goal of the corporation.
6. Explain why value maximization is not inconsistent with ethical behavior.
7. Explain how corporations mitigate conflicts and encourage cooperative behavior.

2. Goals and Governance of the Corporation
This chapter introduces the corporation, its goals, and the roles of financial managers.
Chapter 1 Outline
Investment and Financing Decisions
The Corporation
The Financial Managers
Goals of the Corporation
Value Maximization
Corporate Governance
Note: What are the primary differences among the various legal forms of business?
Source: U.S. Census 2008 SUSB Annual Data 5 5 5 6 5 5

3. Investment and Financing Decisions
The Investment Decision
Real Assets
The Financing Decision
Financial Assets
The Investment Decision – Decision to invest in tangible or intangible assets.
Also known as the “capital budgeting” or “CAPEX” decision.
The Financing Decision – The form and amount of financing of a firm’s investments.
Real Assets – Assets used to produce goods and services.
Financial Assets – Financial claims to the income generated by the firm’s real assets. 5 5 5 6 5 5

4. Investment and Financing Decisions
Are the following capital budgeting or financing decisions?
Apple decides to spend $500 million to develop a new iPhone.
GE borrows $400 million from bond investors.
Microsoft issues 100 million shares to buy a small technology company.
When Apple spends $500 million to develop a new iPhone it is investing in real assets and is making a capital budgeting decision.
When GE borrows $400 million from bond investors it is investing in financial assets and is making a financing decision.
When Microsoft issues 100 million shares to buy a smaller company it is investing in both financial and real assets. It is making both a capital budgeting and financing decision.

5. What is a Corporation?
Corporation-A business organized as a separate legal entity owned by stockholders.
Types of Corporations:
Public Corporations
Private Corporations
Corporation – A business organized as a separate legal entity owned by stockholders.
Public Company – A corporation whose shares are traded in public markets such as the New York Stock Exchange or NASDAQ.
Private Corporation – A corporation whose shares are not traded publicly.

6. Benefits of the Corporation
Limited liability
Infinite lifespan
Ease of raising capital
Limited Liability – The owners of a corporation are not personally liable for its obligation.

7. Drawbacks of the Corporation
Corporations face the problem of double taxation
Improper corporate structures may lead to “Agency Problems”
Double Taxation – Corporations pay taxes on their profits and the shareholders are taxed again when they receive dividends or realize capital gains.
Agency Problem – Managers are agents of the shareholders, but the managers may act in their own interests rather than maximize value.

8. Goals of The Corporation
Shareholders want wealth maximization
Wealth maximization vs. profit maximization:
Pitfall: Profits from which period?
Pitfall: Cutting dividends to increase cash reserves
The ideal goal of any firm is simple: Maximize the current market value of shareholders’ investment in the firm; not simply to maximize profits.
Potential pitfalls in profit maximization:
Which period’s profits should be maximized?
A corporation can make short term wasteful investments to increase profits, but long-term profits and value will be damaged.
Cut dividends to increase cash reserves?
A company may increase future profits by cutting today’s dividend and reinvesting the cash in the firm. In most cases, this decreases the value of shareholder investment in the firm. 17

9. The Ethics of Maximizing Value
Does value maximization justify unethical behavior?
Recent examples:
Enron
WorldCom
Bernard Madoff 18

10. Agency Problem Do managers really maximize value?
Agency Problems
Managers are agents for stockholders, but the managers may act in their own interests rather than maximizing value
Shareholders vs. Stakeholders
Agency Problem – Managers are agents for stockholders, but the managers may act in their own interests rather than maximizing value.
Stakeholder – anyone with a financial interest in the firm.
Note: Managers may act in ways that are not in the best interests of shareholders. This is known as an “agency problem.”
Note: Shareholders want managers to maximize the market value of the firm. However, managers are often obliged to appease not only the shareholders but all of the stakeholders as well. 3 3 3 4 3 3

11. Different Information
Agency Problem
Different Information
Stock prices vs. returns
Dividend Policy
Financing Decisions
Different Objectives
Managers vs. shareholders
Top managers vs. lower managers
Stockholders vs. banks and lenders

12. Agency Problem Solutions
Compensation plans
Board of Directors
Blockholders
Potential agency problem solutions:
Compensation plans – Provide managers with incentive schemes that produce big returns if shareholders gain but little or nothing if they do not.
Board of directors – The Sarbanes-Oxley Act has led to more independent control of corporation Boards. Through a vote, the board of directors gives shareholders an opportunity to have a say in the operations of a firm.
Blockholders – Individual investors who hold 5% or more of the company. These blockholders may offer some solutions to agency problems by closely monitoring the firm.
Takeovers - Poorly performing companies are more likely to be taken over by another firm. The further a company’s stock price falls, the easier it is for another company to buy up a majority of its shares.
Specialist monitoring - Managers are subject to the scrutiny of specialists. Their actions are monitored by the security analysts who advise investors to buy, hold, or sell the company’s shares.
Regulatory requirements - CEOs and financial managers have a legal duty to act responsibly and in the interests of investors. 18

13. Agency Problem Solutions
Takeovers
Specialist Monitoring
Legal and Regulatory Requirements
Potential agency problem solutions:
Compensation plans – Provide managers with incentive schemes that produce big returns if shareholders gain but little or nothing if they do not.
Board of directors – The Sarbanes-Oxley Act has led to more independent control of corporation Boards. Through a vote, the board of directors gives shareholders an opportunity to have a say in the operations of a firm.
Blockholders – Individual investors who hold 5% or more of the company. These blockholders may offer some solutions to agency problems by closely monitoring the firm.
Takeovers - Poorly performing companies are more likely to be taken over by another firm. The further a company’s stock price falls, the easier it is for another company to buy up a majority of its shares.
Specialist monitoring - Managers are subject to the scrutiny of specialists. Their actions are monitored by the security analysts who advise investors to buy, hold, or sell the company’s shares.
Regulatory requirements - CEOs and financial managers have a legal duty to act responsibly and in the interests of investors. 18

14. Role of the Financial Manager
(1)
(2)
(3)
(4a)
(4b)
Real assets
Investors
Assets
Firm’s
Operations
Cash raised from investors (how?)
Cash invested in firm
Cash generated by operations
4A. Cash reinvested in the firm
4B. Cash returned to investors 6 6 6 11 10 6

15. Most large companies have 3 top-level financial managers:
The Financial Manager
Most large companies have 3 top-level financial managers:
Chief financial officer (CFO)
Oversees the treasurer and controller. Responsible for setting the overall financial strategy of the firm.
Treasurer
Responsible for financing, cash management, and maintaining relationships with banks and other financial institutions.
Controller
Responsible for budgeting, accounting, and taxes. 3 3 3 4 3 3

16. Appendix: Careers in Finance