Chapter 1
Principles of
Corporate Finance
Tenth Edition
Goals and
Governance of
the Firm
Slides by
Matthew Will
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
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
1-2
Investment and Financing
Decisions
1-3
 Common Finance Terminology
– Real assets
– Financial assets / Securities
– Capital markets and financial
markets
– Investment / capital budgeting
– Financing
Investment and Financing
Decisions
Real Assets
– Assets used to produce goods and services.
Financial Assets
– Financial claims to the income generated by
the firm’s real assets.
1-4
Investment and Financing
Decisions
1-5
Investment decision
– purchase of real assets
Financing decision
– sale of financial assets
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)
1-6
Investment and Financing
Decisions
1-7
– “Capital Budgeting”
Tangible Assets
Intangible Assets
Expand Stores
New Drug R&D
@ $800 million
@ $800 million
Investment and Financing
Decisions
Company (revenue in billions
for 2007 or 2008)
Recent Investment Decision
Recent Financing Decision
Boeing ($61 billion)
Began production of its 787
The cash flow from Boeing’s
Dreamliner aircraft, at a forecast
operations allowed it to repay
cost of more than $10 billion.
some of its debt and repurchase
$2.8 billion of stock.
Royal Dutch Shell ($458 billion)
Invests in a $1.5 billion deepwater oil
In 2008 returned $13.1 billion of
and gas field in the .
cash to its stockholders by buying
back their shares.
(¥26,289 billion)
In 2008 opened new engineering
Returned ¥443 billion to
and safety testing facilities in .
shareholders in the form of
dividends.
GlaxoSmithKline (£24 billion)
Spent £3.7 billion in 2008 on
Financed R&D expenditures
research and development of new
largely with reinvested cash flow
drugs.
generated by sales of
pharmaceutical products.
Wal-Mart ($379billion)
Union Pacific ($18 billion)
Wells Fargo ($52 billion)
LVMH (€17 billion )
Lenovo ($16 billion)
In 2008 announced plans to invest
In 2008 raised $2.5 billion by an
over a billion dollars in 90 new stores
issue of 5-year and 30-year
in .
bonds.
Acquired 315 new locomotives in
Largely financed its investment in
2007.
locomotives by long-term leases.
Acquired Wachovia Bank in 2008 for
Financed the acquisition by an
$15.1 billion.
exchange of shares.
Acquired the Spanish winery,
Issued a 6-year bond in 2007,
Bodega Numanthia Termes.
raising 300 million Swiss francs.
Expanded its chain of retail stores to
Borrowed $400 million for 5 years
cover over 2,000 cities.
from a group of banks
1-8
Role of The Financial
Manager
(2)
(1)
Financial
manager
Firm's
operations
(3)
1-9
(4a)
Financial
markets
(4b)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
Who is The Financial
Manager?
Chief Financial Officer
Treasurer
Controller
1-10
The Investment Trade-off
The Investment Trade-off
Hurdle rate
Cost of capital
Opportunity cost of capital
1-11
1-12
Goals of The Corporation
1-13
Each stockholder wants three things:
1. To be as rich as possible, that is, to maximize his or her current wealth.
2. To transform that wealth into the most desirable time pattern of
consumption either by borrowing to spend now or investing to spend
later.
3. To manage the risk characteristics of that consumption plan.
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 longterm 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.
1-14
1-15
Whose Company Is It?
** Survey of 378 managers from 5 countries
3
97
Japan
17
Germany
83
22
France
78
71
29
United Kingdom
76
24
United States
0
20
The Shareholders
40
60
80
100
120
% of responses
All Stakeholders
1-16
Dividends vs. Jobs
** Survey of 399 managers from 5 countries. Which is more
important...jobs or paying dividends?
3
97
Japan
40
Germany
41
France
United Kingdom
11
United States
11
0
Dividends
Job Security
20
60
59
89
89
40
60
80
% of responses
100
120
Goals of The Corporation
1-17
 Shareholders desire wealth
maximization
 Do managers maximize shareholder
wealth?
 Mangers have many constituencies
“stakeholders”
 “Agency Problems” represent the
conflict of interest between
management and owners
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
1-18
Agency Problem
1-19
Agency costs are incurred when:
1. managers do not attempt to maximize firm value
and
2. shareholders incur costs to monitor the managers
and constrain their actions.
Agency Problem
Agency Problems
– 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.
1-20
Agency Problem
1-21
Tools to Ensure Management Pays
Attention to the Value of the Firm
– Manger’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
Agency Problem
Agency Problem and Corporate
Governance Solutions
1. Legal and Regulatory Requirements
2. Compensation plans
3. Board of Directors
4. Monitoring
5. Takeovers
6. Shareholder pressure
1-22
Web Resources
Click to access web sites
Internet connection required
www.corpgov.net
www.thecorporatelibrary.com
www.riskmetrics.com
1-23