Introduction to corporate finance
Dr Yifan Zhou
Content
✓ Key information
✓ Introduction to corporate finance
✓ Agency Problems and Corporate Governance
Lecturer Information
• Dr Yifan Zhou
• Email: yifan.zhou@leicester.ac.uk
• Office hours:
By appointment (please email)
Module Outline
• Lectures: 10 x 2 hours
• Seminars: 8 x 1 hour
• Assessment:
✓ 20% Online midterm test
✓ 80% examination
Lectures
Lecture 1: Introduction to Corporate Finance
Lecture 2: Ownership
Lecture 3: Corporate Governance
Lecture 4: ESG
Lecture 5: Introduction to Corporate Financing
Lecture 6: Capital Structure (1)
Lecture 7: Capital Structure (2)
Lecture 8: Valuation
Lecture 9: Working capital
Lecture 10: Revision
Learning outcomes
CFA Level I
1. Corporate Structures and Ownership L1&2
2. Introduction to Corporate Governance and ESG L3&4
3. Business Models & Risks
4. Capital Investments
5. Working Capital and Liquidity L9
6. Cost of Capital-Foundational Topics L5&6
7. Capital Structure L7&8
8. Measures of Leverage
Learning outcomes
CFA Level I Corporate Issuers Topics
1. Concepts and theories
2. Analysis techniques
3. Empirical evidence
4. Current issues of corporate finance
Learning outcomes
CFA Level I: 1.5 minutes per multiple choice questions
•
The Level I exam consists of 180 multiple choice questions, split between
two 135-minute sessions (session times are approximate).
There is an optional break between sessions.
•
First session (2 hours, 15 minutes): 90 multiple choice questions, covering the
topics of ethics & professional standards, quantitative methods, economics,
and financial statement analysis.
•
Second session (2 hours, 15 minutes): 90 multiple choice questions, covering
the topics of corporate issuers, equity, fixed income, derivatives, alternative In
vestments and portfolio management.
•
Recourse: https://www.cfainstitute.org/en/programs/cfa/exam/level-i
Career perspectives
Knowledge and skills of the corporate finance are the
essential fundamentals for:
Industry routes:
1. Financial manager/CFO
2. Providing financial service:
Investment Bankers: IPO, M&A, advice
Career perspectives
Knowledge and skills of the corporate finance are
the essential fundamentals for:
Entrepreneur route:
Financial manager/CFO/CEO
Career perspectives
Knowledge and skills of the corporate finance are
the essential fundamentals for:
Academic route:
Research in fields of corporate finance
Learning materials:
• Core textbook: Principles of Corporate Finance 13th edition.
• Journal articles: will be updated via blackboard.
Core textbook:
• Principles of Corporate Finance 13th edition
• Learning materials:
✓ Journal articles: will be available on blackboard.
✓ Learning tips: 1-hour lecturers = 7 hours self-learning
• Lectures:
✓ Pre-reading: Principles of Corporate Finance
✓ Journal Articles
• Seminars
✓ Self test the learning outcomes from lectures.
✓ https://blackboard.le.ac.uk/webapps/blackboard/execute/mod
ulepage/view?course_id=_28431_1&cmp_tab_id=_75343_1
&editMode=true&mode=cpview
Introduction to corporate finance
• First, what is a corporation?
Introduction to corporate finance
• First, what is a corporation?
• In the view of the law, corporation is a legal entity (person)
that is owned by its shareholders.
• As a legal person, the corporation can:
✓ make contracts, carry on a business,
✓ borrow or lend money,
✓ make a takeover bid for another and then merge
usinesses.
• Corporations pay taxes—but cannot vote!
the two b
What is a corporation?
• In the view of the economic, corporation is :
➢Managing a group of “contracts”.
➢The device that generates cash flow.
What is a corporation?
• In the view of the Business structures refer to how businesses are
set up from a legal and organizational point of view.
➢ Key features
1. The legal relationship between the business and its owners.
2. Whether the owners of the business also operate the business?
3. Whether the owners’ liability for the actions and debts of the
business is limited or unlimited?
4. The tax treatment of profits or losses from the business.
What is a corporation?
Types of business structures:
1.
Sole proprietorships
2.
General partnerships
3.
Limited partnerships
4.
Corporations
What is a corporation?
Types of business structures:
Sole proprietorships
1.
Owned and operated by an individual
2.
Unlimited liability including taxes
3.
Only claim on the net profits from business
4.
Sole proprietorships tend to be small in scale
What is a corporation?
Types of business structures:
General partnerships
-two or more individuals can form a general partnership.
partnership agreement on responsibilities for business operations
1.
Unlimited liability
2.
Profits are allocated to each partner are taxed as personal income.
What is a corporation?
Types of business structures:
Limited partnerships
1.
Limited liability: only for the amount they invest in the partnership.
2.
Claims to its profits that are proportionate to their investments.
➢ Private capital firms and hedge funds
➢ Large providers of professional services: legal and accounting firms.
What is a corporation?
Types of business structures:
Corporations
1. A legal entity separates from its owners and managers.
2.
Corporation’s shareholders have limited liability.
3. Bankrupt:
➢ Shares value goes to zero
➢ No legal liability for any further claims against the corporation
What is a corporation?
Types of business structures:
Corporations
A corporation are required to distribute its profits to its
owners?
What is a corporation?
Types of business structures:
Corporations
A corporation are required to distribute its profits to its owners?
➢ A corporation may, but is not required to, distribute its profits to its
owners.
➢ Dividend policy
What is a corporation?
Corporations
A corporation are required to distribute its profits to its owners?
What is a corporation?
Types of business structures:
Corporations
Separation of its owners and managers
1. Not directly influence the company’s day-to-day operations.
2. To appoint a board of directors:
✓
Hiring the senior managers to operate the company.
✓
Ensure the managers are acting in the interests of the shareholders.
What is a corporation?
Types of business structures:
Corporations
Corporations can only be for profit?
What is a corporation?
Types of business structures:
Corporations
Corporations can be for profit or no profit.
Not-for profit corporation:
1. For social benefit or pursue a charitable goal.
2.
Profits must be reinvested toward its missions rather than
distributing them to owners.
3.
Usually not taxed.
What is a corporation?
Types of business structures:
Corporations
For-profit corporations may be public or private.
➢ Public corporation:
1. For many countries, a public corporation is one that has shares are trading
by in organized market.
2. In some countries, the firm has at least a designated number of owners, and
the share might not be trading.
➢ The one does not meet these definitions is a private corporation.
What is a corporation?
Types of business structures:
Corporations
For-profit corporations
Double taxation: Taxes on earnings and dividends as personal income.
The corporations pay 30% tax on gross profits and individuals pay 20% tax on
dividends received,
The effective tax rate on profits distributed as dividends is 30% plus 20% of the
remaining (1 – 30%), which equals 44%.
What is a corporation?
Types of business structures:
Corporations
Most large firms are corporations because that structure gives them the
greatest access to capital:
➢ Debt (borrowed capital)
➢ Equity (ownership capital).
What is a corporation?
Compare public and private companies:
The public companies: initial public offering (IPO).
Regulators require report financial results with accepted accounting
principles
Relevant information: share purchases/sales by company executives.
What is a corporation?
Private companies
• Raise equity capital through a private placement of shares to
accredited investors.
• Disclosure requirements are less strict.
• Investors tend to have long time horizons.
• Cannot sell their shares readily or without the company’s approval.
What is a corporation?
Private companies
Raise equity capital : Special purpose acquisition company (SPAC)
is a corporate structure set up to acquire a private company in the future.
Raises capital through an IPO
Keep the funds into a trust
Pay for an acquisition within a specified period of time.
The acquired company does not have to be identified at the time of the
IPO. SPACs are also known as blank check companies.
What is a corporation?
Types of business structures:
Corporations
Compare public and private companies:
1. How they issue shares to owners
2. How owners can transfer their shares
3. Disclosure requirements
Non-finance
• Non-finance staff concern about
business, products, and branding of
companies.
Finance
• Finance professionals concern with
the firms’ cash flow.
What is corporate finance?
•
It is about how corporations make appropriate financial decisions.
1.
Financing decisions (raising fund)
2.
Investment decisions (spending money)
Financing Decisions
• A corporation can raise money from
• Lenders: Debt
• Shareholders: Equity
Investment Decisions
• The investment decisions are often referred to as ca
pital budgeting or capital expenditure (CAPEX)
decisions.
“Spend money”
“Raising fund”
Compensation
L2
Ownership
L2
ESG
L3
Corporate Finance
Corporate Financing
L5
Valuation
L8
Capital Structure (1)
L6
Working capital
L9
Capital Structure (2)
L7
The role of the financial manager
•
Financing
decision
•
The flow starts when cash is raised from investors (arrow 1 in
the figure).
The financial manager must understand how financial markets
work, for it is there that value is ultimately determined.
Investment
decisions
•
(2) cash invested in the firm’s operations and used to
purchase real assets.
Investment
decisions
•
(3) cash generated by the firm’s operations
Investment
decisions
•
The cash is reinvested in the projects (arrow 4a)
Investment
decisions
•
Return the funds to the investors who furnished
the money in the first place (arrow 4b).
Investment
decisions
• What are the problems raised
here?
Problems: Re-invest cash or return it to shareholders?
• Investment decisions involve a trade-off problem.
• Firm re-invests cash in projects
• Shareholders bear the opportunity cost of capital.
Investment decisions involve a trade-off
•
The CFO chose the investments projects.
•
The earned return higher than the opportunity cost of capital.
•
The stock price increases.
Problems: Managers personal interests Vs
Shareholders interests
• Managers might not act with value-maximizing missions.
• Cause conflicts between insiders and outsiders.
• Principal–agent problem, losing value as agency cost.
Agency Problems and Corporate Governance
• As separation of ownership and control.
• The owners (shareholders) cannot control the
management.
Agency Problems and Corporate Governance
• Agency problems:
• Conflicts between shareholders’ and managers’ objectives.
• The shareholders are the principals; the managers are their agents.
• Agency problems arise when agents work for principals.
Agency Problems and Corporate Governance
• Agency costs are incurred when
• (1) Managers do not attempt to maximize firm value.
• (2) Shareholders incur costs to monitor the managers
and constrain their actions.
Agency Problems and Corporate Governance
• Fama and Jensen (1983) suggest that the important decision agents bear
limited share of the wealth effects of their decisions.
• Successful firms need good governance systems to align managers’ and share
holders’ interests.
Agency Problems and Corporate Governance
• Company’s lenders (debt holders) have a legal, contractual claim to the interest
and principal payments.
• Owners (equity holders) have a residual claim to the company’s net assets (i.e.,
what remains after all other claims have been paid).
• Lenders have a higher priority of claims than equity owners.
Agency Problems and Corporate Governance
• Regardless of a company’s success, debt holders can receive the interest and
principal payments promised by the company.
• Shareholders can get returns company growth over time.
• Difference in their risk profiles, the interests of debt holders may conflict
with the interests of equity holders.
Agency Problems and Corporate Governance
• Debt holders: company’s ability to repay its obligations, not growth prospects.
• Equity holders: company’s potential growth, but also increase its risk level.
• Debt holders may oppose such actions because increasing the company’s
risk (and the probability of defaulting on its debts) does not increase
their expected return.
Five themes for corporate finance
1. Corporate finance is all about maximizing value.
2. The opportunity cost of capital sets the standard for investment decisions.
3. A safe dollar is worth more than a risky dollar.
4. Smart investment decisions create more value than smart financing decisions.
5. Good governance matters.
Introduction to Corporate Finance
Types of business structures:
1. Sole proprietorships
2. General partnerships
3. Limited partnerships
4. Corporations
Introduction to Corporate Finance
A corporation can raise money from
Lenders: Debt
Shareholders: Equity
Introduction to Corporate Finance
Agency Problems and Corporate Governance
1. Agency costs
2. Conflicts between owners and managers.
3. Conflicts between debtholders and shareholders.