Chapter 1 - Goals and Governance of the Corporation
After studying this chapter, you should be able to:
1.1 Give examples of the investment and financing decisions that financial managers make
1.2 Distinguish between real and financial assets
1.3 Cite some of the advantages and disadvantages of organizing a business as a
corporation
1.4 Describe the responsibilities of the CFO, treasurer, and controller
1.5 Explain why maximizing market value is the natural financial goal of the corporation
1.6 Understand what is meant by ‘agency problems,’ and cite some of the ways they
corporate governance helps mitigate them
1.7 Understand why maximizing market value does not justify behaving unethically
1.1 Investment and Financing Decisions
The Investment (Capital Budgeting) Decision
Capital budgeting decision (capital expenditure or CAPEX decision), the decision to
invest in tangible or intangible assets.
- Tangible assets are assets that you can touch and kick.
- Intangible assets are such as research and development, advertising and the design
of computer software.
The Financing Decision
The financial manager’s second main responsibility is to raise the money that the firm
requires for its investments and operations. The financing decision, decision on the
sources and amounts of financing.
When a company needs to raise money, it can invite investors to put up cash in exchange
for a share of future profits, or it can promise to pay back the investors’ cash plus a fixed rate
of interest.
- In the first case, the investors receive shares of stock and become shareholders,
part-owners of the corporation. The investors in this case are referred to as equity
(=eigen vermogen) investors, who contribute equity financing.
- In the second case, the investors are lenders (=kredietverstrekkers), that is, dept
investors, who one day must be repaid.
⇒ The choice between debt and equity financing is often called the capital
structure decision. (Here ‘capital’ refers to the firm’s sources of long-term
financing). A firm that is seeking to raise long-term financing is said to be ‘raising
capital’.
When the firm invests, it acquires real assets (assets used to produce goods and services),
which are then used to produce the firm’s goods and services. The firm finances its
investment in real assets by issuing financial assets (financial claims to the income
generated by the firm’s real assets) to investors.
- Financial assets that can be purchased and traded by investors in pubic markets are
called securities (=effecten).
In some ways, financing decisions are less important than investment decisions.
→ Financial managers say that ‘value comes mainly from the investment side of
the balance sheet’.
The financial manager has the responsibility for two decisions:
, 1. The investment decision = purchase of real assets
2. The financing decision = sale of financial assets
1.2 What Is a Corporation
Corporation, a business organized as a separate, permanent legal entity owned by
stockholders. A corporation’s owners are called shareholders or stockholders.
- The shareholders do not directly own the business’s real assets. Instead they have
indirect ownership via financial assets.
- A corporation is legally distinct from the shareholders. Therefore, the shareholders
have limited liability and cannot be held personally responsible for the corporation’s
debts.
Public shareholders cannot possibly manage or control the corporation directly. Instead, they
elect a board of directors, who in turn appoint the top managers and monitor their
performance. This separation of ownership and control gives corporations permanence.
The separation of ownership and control can also have a downside, fir it can open the door
for managers and directors to act in their own interests rather than in the stockholders’
interest.
Other Forms of Business Organization
1. Corporation
2. Partnership
3. Sole proprietorships
Partners, like sole proprietors, face unlimited liability. If the business runs into difficulties,
each partner can be held responsible for all the business’s debts. Partnerships have tax
advantage. Partnerships, unlike corporations, do not have to pay income taxes on their
shares of the profits.
In a limited partnership, partners are classified as general of limited.
Many states allow limited liability partnerships or limited liability companies. These are
partnerships in which all partners have limited liability. In the case of the professional
corporation, the business has limited liability, but the professionals can still be sued
personally.
1.3 Who Is the Financial Manager
Most large corporations have a chief financial officer (CFO), who supervises all financial
functions and sets overall financial strategy.
Below the CFO are usually a treasurer (responsible for financing, cash management, and
relationships with banks and other financial institutions) and a controller (responsible for
budgeting, accounting, and taxes).
After studying this chapter, you should be able to:
1.1 Give examples of the investment and financing decisions that financial managers make
1.2 Distinguish between real and financial assets
1.3 Cite some of the advantages and disadvantages of organizing a business as a
corporation
1.4 Describe the responsibilities of the CFO, treasurer, and controller
1.5 Explain why maximizing market value is the natural financial goal of the corporation
1.6 Understand what is meant by ‘agency problems,’ and cite some of the ways they
corporate governance helps mitigate them
1.7 Understand why maximizing market value does not justify behaving unethically
1.1 Investment and Financing Decisions
The Investment (Capital Budgeting) Decision
Capital budgeting decision (capital expenditure or CAPEX decision), the decision to
invest in tangible or intangible assets.
- Tangible assets are assets that you can touch and kick.
- Intangible assets are such as research and development, advertising and the design
of computer software.
The Financing Decision
The financial manager’s second main responsibility is to raise the money that the firm
requires for its investments and operations. The financing decision, decision on the
sources and amounts of financing.
When a company needs to raise money, it can invite investors to put up cash in exchange
for a share of future profits, or it can promise to pay back the investors’ cash plus a fixed rate
of interest.
- In the first case, the investors receive shares of stock and become shareholders,
part-owners of the corporation. The investors in this case are referred to as equity
(=eigen vermogen) investors, who contribute equity financing.
- In the second case, the investors are lenders (=kredietverstrekkers), that is, dept
investors, who one day must be repaid.
⇒ The choice between debt and equity financing is often called the capital
structure decision. (Here ‘capital’ refers to the firm’s sources of long-term
financing). A firm that is seeking to raise long-term financing is said to be ‘raising
capital’.
When the firm invests, it acquires real assets (assets used to produce goods and services),
which are then used to produce the firm’s goods and services. The firm finances its
investment in real assets by issuing financial assets (financial claims to the income
generated by the firm’s real assets) to investors.
- Financial assets that can be purchased and traded by investors in pubic markets are
called securities (=effecten).
In some ways, financing decisions are less important than investment decisions.
→ Financial managers say that ‘value comes mainly from the investment side of
the balance sheet’.
The financial manager has the responsibility for two decisions:
, 1. The investment decision = purchase of real assets
2. The financing decision = sale of financial assets
1.2 What Is a Corporation
Corporation, a business organized as a separate, permanent legal entity owned by
stockholders. A corporation’s owners are called shareholders or stockholders.
- The shareholders do not directly own the business’s real assets. Instead they have
indirect ownership via financial assets.
- A corporation is legally distinct from the shareholders. Therefore, the shareholders
have limited liability and cannot be held personally responsible for the corporation’s
debts.
Public shareholders cannot possibly manage or control the corporation directly. Instead, they
elect a board of directors, who in turn appoint the top managers and monitor their
performance. This separation of ownership and control gives corporations permanence.
The separation of ownership and control can also have a downside, fir it can open the door
for managers and directors to act in their own interests rather than in the stockholders’
interest.
Other Forms of Business Organization
1. Corporation
2. Partnership
3. Sole proprietorships
Partners, like sole proprietors, face unlimited liability. If the business runs into difficulties,
each partner can be held responsible for all the business’s debts. Partnerships have tax
advantage. Partnerships, unlike corporations, do not have to pay income taxes on their
shares of the profits.
In a limited partnership, partners are classified as general of limited.
Many states allow limited liability partnerships or limited liability companies. These are
partnerships in which all partners have limited liability. In the case of the professional
corporation, the business has limited liability, but the professionals can still be sued
personally.
1.3 Who Is the Financial Manager
Most large corporations have a chief financial officer (CFO), who supervises all financial
functions and sets overall financial strategy.
Below the CFO are usually a treasurer (responsible for financing, cash management, and
relationships with banks and other financial institutions) and a controller (responsible for
budgeting, accounting, and taxes).
