Topic 1 – Introduction to Corporate Finance (ch01)
Lakehead University
Faculty of Business Administration
Business 5039 – Managerial Finance
Summer 2025
Robert Feicht, THD, ECRI
www.th-deg.de/ecri-en
Any comments or suggestions: rfeicht@lakeheadu.ca
Readings and Copyright:
Ross S.A., Westerfield R., Jaffe J., Jordan B.D., Driss H.;
"Corporate Finance";
McGraw-Hill; 9th Can. Edition; 9781260881370
version 2025/07/02 – 11:53:19
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
Chapter Outline
(1.1) What is Corporate Finance?
(1.2) Corporate Securities as Contingent Claims on Total Firm Value
(1.3) Business Organization Forms
(1.4) Goals of the Corporate Firm
(1.5) Financial Institutions, Financial Markets, and the Corporation
(1.6) Trends in Financial Markets and Management
(1.7) Summary and Exercises
Topic 1 – Introduction to Corporate Finance (ch01)
2 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.1)
What is Corporate Finance?
Topic 1 – Introduction to Corporate Finance (ch01)
3 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Corporate Finance – An Overview
Corporate Finance addresses the following three questions:
1. In what long-lived assets should the firm invest?
2. How can the firm raise cash for required capital expenditures?
3. How should short-term operating cash flows be managed?
Topic 1 – Introduction to Corporate Finance (ch01)
4 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Balance-Sheet Model of the Firm
Topic 1 – Introduction to Corporate Finance (ch01)
5 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Two Pie Models of the Firm
Topic 1 – Introduction to Corporate Finance (ch01)
6 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Hypothetical Organization Chart
Topic 1 – Introduction to Corporate Finance (ch01)
7 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) How to create value
To create value, the financial manager should:
1. Try to make smart investment decisions
▶ Buy assets that generate more cash than they cost
2. Try to make smart financing decisions
▶ Sell bonds, shares, and other financial instruments that raise more cash than they
cost
Topic 1 – Introduction to Corporate Finance (ch01)
8 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Cash Flows between the firm and the financial markets
Topic 1 – Introduction to Corporate Finance (ch01)
9 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.1) Factors that affect Stock prices
▶ Size of cash flows
▶ Reporting of sales versus collection of cash
▶ Reporting of expenses versus payment of expenses
▶ Timing of cash flows
▶ A dollar received today is worth more than a dollar received next year
▶ Investors prefer to receive cash flows earlier than later
▶ Risk of cash flows
▶ Amount and timing of future cash flows is not certain
▶ Most investors are risk averse
Topic 1 – Introduction to Corporate Finance (ch01)
10 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.2)
Corporate Securities as Contingent
Claims on Total Firm Value
Topic 1 – Introduction to Corporate Finance (ch01)
11 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.2) Corporate Securities as Contingent Claims on Total Firm Value (1/3)
▶ Debt: a promise by the borrowing firm to repay a fixed dollar amount by a certain
date.
▶ The shareholder’s claim on firm value is the residual amount that remains after
the debtholders are paid.
▶ If the value of the firm is less than the amount promised to the debtholders, the
shareholders get nothing.
▶ Debt and equity securities are contingent claims, contingent on the total firm
value.
Topic 1 – Introduction to Corporate Finance (ch01)
12 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.2) Corporate Securities as Contingent Claims on Total Firm Value (2/3)
Debt and Equity as Contingent Claims:
Topic 1 – Introduction to Corporate Finance (ch01)
13 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.2) Corporate Securities as Contingent Claims on Total Firm Value (3/3)
Payoffs to Debt and Equity:
▶ If the value of the firm is less than $F, the shareholder’s claim is
Max[0,$X − $F] = $0 and the debtholder’s claim is Min[$F,$X] = $X.
The sum of these is = $X
▶ If the value of the firm is more than $F, the shareholder’s claim is
Max[0,$X − $F] = $X − $F and the debtholder’s claim is Min[$F,$X] = $F.
The sum of these is = $X
Topic 1 – Introduction to Corporate Finance (ch01)
14 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.3)
Business Organization Forms
Topic 1 – Introduction to Corporate Finance (ch01)
15 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Business Organization Forms – Overview
▶ The corporate form of business is the standard method for solving the problems
encountered in raising large amounts of cash.
▶ However, businesses can take other forms:
1. The Sole Proprietorship
2. The Partnership
3. The Corporation
4. The Income Trust
Topic 1 – Introduction to Corporate Finance (ch01)
16 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Sole Proprietorship
The Sole Proprietorship: business owned by one person
▶ Advantages:
▶ The cheapest type of business to form
▶ Pays no corporate income taxes; profits are taxed as individual income
▶ Disadvantages:
▶ Unlimited liability for business debts and obligations
▶ Life limited by the life of the sole proprietor
▶ Equity money raised limited by the sole proprietor’s personal wealth
Topic 1 – Introduction to Corporate Finance (ch01)
17 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Partnership (1/2)
The Partnership: two or more co-owners form a business
▶ General partnership: all partners provide some fraction of the work and cash to
share the profits and losses
▶ Limited partnership: permit the liability of some (but not all) of the partners to
be limited to the amount of cash each has contributed to the partnership
Topic 1 – Introduction to Corporate Finance (ch01)
18 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Partnership (2/2)
▶ Advantage:
▶ Inexpensive and easy to form
▶ Disadvantages:
▶ General partners have unlimited liability (liability of limited partners limited to the
contribution each has made to the partnership)
▶ Difficult to transfer ownership without dissolving
▶ Difficult to raise large amounts of cash
Topic 1 – Introduction to Corporate Finance (ch01)
19 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Corporation
The Corporation: distinct legal entity owned by its shareholders
▶ Advantages:
⇒ Limited shareholder liability
⇒ Separates ownership from management
⇒ Ease of ownership transfer
⇒ Perpetual life
▶ Disadvantages:
⇒ Double taxation of corporate income
→ At the corporate level - corporate tax rate
→ At the shareholder level - dividends are taxable with dividend tax credit
Topic 1 – Introduction to Corporate Finance (ch01)
20 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.3) Corporation vs. Partnership
Liquidity and
marketability
Voting Rights
Taxation
Reinvestment and
Dividend Payout
Liability
Continuity of
Existence
Corporation
Shares can easily be
exchanged
Usually each share
gets one vote
Double taxation with
dividend tax credit
Broad latitude
Limited liability
Perpetual life
Topic 1 – Introduction to Corporate Finance (ch01)
Partnership
Subject to substantial
restrictions.
General Partner is in charge;
limited partners may have some
voting rights.
Taxed as personal income to the
partners
All net cash flow is distributed to
partners.
General partners may have
unlimited liability. Limited
partners enjoy limited liability.
Limited life
21 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.4)
Goals of the Corporate Firm
Topic 1 – Introduction to Corporate Finance (ch01)
22 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Goals of the Corporate Firm – Overview
▶ What is the primary goal of the corporation?
⇒ Impossible to give a definitive answer
⇒ Traditional answer: Add value for the shareholders
→ Problem: Vague
⇒ Set-of-contracts viewpoint: Offers an alternative answer
▶ The firm can be viewed as a set of contracts.
▶ One of these contracts is between shareholders and managers.
▶ Managers are agents hired to act on behalf of shareholders, who are the
principals.
▶ Both managers and shareholders pursue their own self-interests.
Topic 1 – Introduction to Corporate Finance (ch01)
23 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Agency Costs (1/3)
▶ Managers will usually act in the shareholders’ interests.
▶ Shareholders can devise contracts that align the incentives of managers with the
goals of the shareholders.
▶ Shareholders can monitor managers’ behaviour.
▶ But: this contracting and monitoring is costly.
▶ These costs are agency costs that arise from conflicts of interest between
managers and shareholders.
▶ Agency problems do not mean that interests of managers and shareholders
cannot be aligned. Only that it is costly to do so.
▶ Agency problems can never be perfectly solved.
Topic 1 – Introduction to Corporate Finance (ch01)
24 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Agency Costs (2/3)
▶ Managerial goals may be different from shareholder goals
▶ Expense preferences (Williamson, 1963)
▶ Survival
▶ Independence
▶ Self-sufficiency
▶ Increased growth and size of firm are not necessarily the same thing as increased
shareholder wealth.
Topic 1 – Introduction to Corporate Finance (ch01)
25 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Separation of Ownership and Control
Topic 1 – Introduction to Corporate Finance (ch01)
26 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Agency Costs (3/3)
▶ Argument: shareholders do not control management because ownership is too
diffuse and fragmented.
▶ Over 70 percent of U.S. corporations are widely held compared to around 15 percent
in Canada
▶ The extent to which shareholders can control managers depends on
▶ The costs of monitoring management
▶ The costs of control devices
▶ The benefits of control
Topic 1 – Introduction to Corporate Finance (ch01)
27 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Control Devices Available to Shareholders
1. Shareholders vote for the board of directors, who in turn hire the management
team.
2. Contracts can be carefully constructed to be incentive compatible.
3. If the managers fail to maximize share price, they may be replaced in a hostile
takeover.
4. There is a market for managerial talent—this may provide market discipline to the
managers—they can be replaced.
Topic 1 – Introduction to Corporate Finance (ch01)
28 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.4) Stakeholders
▶ In addition to shareholders and management, employees, customers, suppliers, and
the public all have a financial interest in the firm and its decisions.
▶ Different stakeholders may have different goals.
▶ Ethical or socially responsible investing: screening and selecting securities based
on social or environmental criteria
▶ Does it create value?
Topic 1 – Introduction to Corporate Finance (ch01)
29 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.5)
Financial Institutions, Financial
Markets, and the Corporation
Topic 1 – Introduction to Corporate Finance (ch01)
30 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.5) Financial Institutions, Financial Markets, and the Corporation
Indirect vs Direct finance
Topic 1 – Introduction to Corporate Finance (ch01)
31 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.5) Financial Markets – An Overview
▶ Money Markets
▶ For short-term debt instruments
▶ Capital Markets
▶ For long-term debt and equity
▶ Primary Market
▶ When a corporation issues securities, cash flows from investors to the firm.
▶ Usually, an underwriter is involved
▶ Secondary Markets
▶ Involve the sale of “used” securities from one investor to another.
▶ Securities may be exchange traded or trade over-the-counter in a dealer market.
Topic 1 – Introduction to Corporate Finance (ch01)
32 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.5) Financial Markets – Listing
▶ Listing on an organized exchange
▶ Enhances trading liquidity
▶ cross list on domestic and foreign exchanges
▶ Facilitates raising equity
▶ To be listed, firms must meet certain minimum criteria.
▶ Listing on Canadian exchange - “comply or explain” regime
▶ Listing on U.S. exchange - significant disclosure requirement (SOX) and
compliance costs
Topic 1 – Introduction to Corporate Finance (ch01)
33 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.5) Foreign exchange market – An Overview
▶ Foreign exchange market is the world’s largest financial market for trading
currencies
▶ Is an over-the-counter market.
▶ Many different types of participants:
▶ Importers and exporters
▶ Portfolio managers
▶ Foreign exchange brokers
▶ Traders
Topic 1 – Introduction to Corporate Finance (ch01)
34 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.6)
Trends in Financial Markets and
Management
Topic 1 – Introduction to Corporate Finance (ch01)
35 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.6) Trends in Financial Markets and Management – An Overview
▶ Integration and globalization
▶ Increased risk from volatility
▶ Financial Engineering reduces costs related to
▶ Risk
▶ Taxes
▶ Financing costs
▶ Improved computer technology allows economies of scale and scope
▶ Deregulation is opening the possibility for further changes.
▶ Recent financial crisis: causes and recovery.
▶ These trends have made financial management a much more complex and
technical activity.
Topic 1 – Introduction to Corporate Finance (ch01)
36 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(Chapter 1.7)
Summary and Exercises
Topic 1 – Introduction to Corporate Finance (ch01)
37 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Chapter Summary
▶ Basic ideas of corporate finance
▶ The ways in which financial managers can create value for the firm.
▶ The description of debt and equity securities as contingent claims.
▶ The different types of firms
▶ The role of financial markets in corporate finance.
▶ The types of financial markets.
▶ The latest trends in the financial markets.
Topic 1 – Introduction to Corporate Finance (ch01)
38 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Quick Quiz
1. What are the three basic questions financial managers must answer?
2. What are the three major forms of business organization?
3. What is the goal of financial management?
4. What are agency problems, and why do they exist within a corporation?
5. What is the difference between a primary market and a secondary market?
Topic 1 – Introduction to Corporate Finance (ch01)
39 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Exercise 1.1
a) In the absence of agency problems, what is the primary goal of managers in a
corporation?
b) How can managers achieve this goal?
Topic 1 – Introduction to Corporate Finance (ch01)
40 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Exercise 1.2
a) Who owns a corporation? Describe the process whereby the owners control the
firm’s management.
b) What is the main reason that an agency relationship exists in the corporate form
of organization?
c) In this context, what kinds of problems can arise?
Topic 1 – Introduction to Corporate Finance (ch01)
41 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Exercise 1.3
Corporate ownership varies around the world. Historically, individuals have owned the
majority of shares in public corporations in the United States. In Canada this is also the
case, but ownership is more often concentrated in the hands of a majority shareholder.
In Germany and Japan, banks, other financial institutions, and large companies own
most of the shares in public corporations. How do you think these ownership differences
affect the severity of agency costs in different countries?
Topic 1 – Introduction to Corporate Finance (ch01)
42 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Exercise 1.4
What are the major types of financial institutions and financial markets in Canada?
Topic 1 – Introduction to Corporate Finance (ch01)
43 / 44
Robert Feicht
Corp. Finance
Corp. Securities
Business Organization
Goals of Corp. Firm
Institutions & Markets
Trends
Sum. & Ex.
(1.7) Exercise 1A.4
(Refer to Table 1A.3.) Corporation X has $100,000 in taxable income, and Corporation Y, a manufacturer, has $1 million in taxable income.
a) What is the tax bill for each firm in Ontario?
b) Suppose both firms have identified a new project that will increase taxable income
by $10,000. How much in additional taxes will each firm pay?
Table 1A.3 – Corporate Tax Rates in Percentages, 2020
Basic corporations
All small corporations with a taxable income up to $500,000
Federal
Ontario
Combined
15%
9%
11.5%
3.2%
26.5%
12.2%
Source: Adapted from Canada Revenue Agency, "Corporation Tax Rates," July 2020. Available at http://www.cra-arc.gc.ca/tx/bsnss/tpcs/crprtns/rts-eng.html
Topic 1 – Introduction to Corporate Finance (ch01)
44 / 44
Robert Feicht