The Scope Of Corporate
Finance
Professor Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Finance Career Opportunities
Corporate
Finance
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• Budgeting, financial forecasting, cash
management, credit administration,
investment analysis, fund procurement
Commercial
Banking
• Consumer banking
• Corporate banking
Investment
Banking
• High income potential
• Very competitive industry
Money
Management
• Opportunities in investment advisory firms,
mutual fund companies, pension funds,
investment arms of financial departments
Consulting
• Advise on business practices and strategies
of corporate clients
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Raising Capital: Key Facts
Most financing comes from internal rather
than external sources (“pecking order”).
Most external financing issued as debt
Primary vs. secondary market transactions or
offerings
Traditional financial intermediaries (banks)
declining as a source of capital for large firms
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Securities markets growing in importance
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Role of The Financial Manager
(2)
(1)
Financial
manager
Firm's
operations
(4a)
Financial
markets
(4b)
(3)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Corporate Finance Functions
External Financing
Capital Budgeting
Corporate
Finance
Functions
Financial Management
Risk Management
Corporate Governance
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Dimensions of the External Financing
Function
Equity vs. debt
Funding via capital market vs. via financial
intermediary
Public vs. private capital markets
Going public
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
The Capital Budgeting Function
Capital Budgeting – the
process firms use to
choose the set of
investments that
generate the most
wealth for shareholders
Select investments for which the marginal benefits
exceed the marginal costs.
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building long-term financial plans
Choosing the right mix of debt and equity
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
The Risk Management Function
Managing the firm’s exposure to significant risks:
Interest rate risk
Exchange rate risk
Commodity price risk
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
The Corporate Governance
Function
Ensuring that managers pursue shareholders’
objectives
Dimensions
of corporate
governance
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•
•
•
•
•
Boards of directors
Ownership structures
Capital structures
Compensation plans
Country’s legal environment - in U.S.
Sarbanes-Oxley Act of 2002
Takeover market disciplines firms that don’t
govern themselves.
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
What Should Managers Maximize?
• Profit maximization as goal:
– Does not account for timing of returns
– Profits - not necessarily cash flows
– Ignores risk
Maximize shareholder wealth
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• Maximize stock price, not profits
• Accounts for risk
• As “residual claimants,” shareholders have better
incentives to force management to maximize firm
value than do other stakeholders.
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Separation of Ownership and Control
Principal – Agent
Relations
Fringe – Benefit
Consumption
Fringe – Benefit
Consumption
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Information
Asymmetry
Moral
Hazard
Controlling
Procedures
(Agency Costs)
Management
Compensation
Schemes
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Goals of The Corporation
• Shareholders desire wealth
maximization
• Do managers maximize shareholder
wealth?
• Managers have many constituencies or
“stakeholders”
• “Agency Problems” represent the
conflict of interest between
management and owners
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Managerial Goals
• Managerial goals may be different from
shareholder goals
– Expensive perquisites
– Survival
– Independence
• Increased growth and size are not necessarily
the same thing as increased shareholder
wealth.
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Do Shareholders Control Management ?
• Shareholders vote for the board of directors,
who in turn hire the management team.
• Compensation Schemes can be carefully
constructed to be incentive compatible.
• There is a market for managerial talent—this
may provide market discipline to the
managers—they can be replaced.
• If the managers fail to maximize share price,
they may be replaced in a hostile takeover.
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Example: Moral Hazard in Financial Relations
Moral Hazard can destroy business opportunities:
Loan
p
Cash Flow
Creditor/Bank
Debtor/Corp.
Option A
100
1,0
120
110
10
Option B
100
0,5
200
110
90
0,5
0
0
0
100
55
45
 Option B
Increase the interest rate to 20% does not lead to a solution
Loan
p
Cash Flow
Creditor/Bank
Option A
100
1,0
120
120
0
Option B
100
0,5
200
120
80
0,5
0
0
0
100
60
40
 Option B
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Debtor
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
Solution of Moral Hazard Problems By Credit Limits
A solution should provide no incentives to the management to
follow the risky option B, i.e. the expected values of each option
should at least equal
Expected
Value
Option A
=
120  x  1,10  1  200  x  1,10   0 ,5
Expected
Value
Option B
120  1,1x  100  0 ,55 x
0 ,55 x  20
x  36 ,36
Equity
Loan
p
Cash Flow
Creditor
Debtor
Option A
63,64
36,36
1,0
120
40
80
Option B
63,64
36,36
0,5
200
40
160
0,5
0
0
0
100
20
80
 Option B
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Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics