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The Scope Of Corporate Finance

The Scope Of Corporate Finance. Professor Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics. Corporate Finance. Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement. Commercial Banking. Consumer banking

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The Scope Of Corporate Finance

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  1. The Scope Of Corporate Finance Professor Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics

  2. Corporate Finance • 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 • Opportunities in investment advisory firms, mutual fund companies, pension funds, investment arms of financial departments Money Management • Advise on business practices and strategies of corporate clients Consulting Finance Career Opportunities

  3. 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 Securities markets growing in importance

  4. (2) (1) (4a) (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 Role of The Financial Manager Financial Financial Firm's manager operations markets

  5. External Financing Capital Budgeting Financial Management Risk Management Corporate Governance Corporate Finance Functions • Corporate Finance Functions

  6. Dimensions of the External Financing Function Equity vs. debt Funding via capital market vs. via financial intermediary Public vs. private capital markets Going public 6

  7. Capital Budgeting – the process firms use to choose the set of investments that generate the most wealth for shareholders The Capital Budgeting Function Select investments for which the marginal benefits exceed the marginal costs.

  8. 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

  9. The Risk Management Function Managing the firm’s exposure to significant risks: Interest rate risk Exchange rate risk Commodity price risk

  10. Boards of directors • Ownership structures • Capital structures • Compensation plans • Country’s legal environment - in U.S., Sarbanes-Oxley Act of 2002 Dimensions of corporate governance The Corporate Governance Function Ensuring that managers pursue shareholders’ objectives Takeover market disciplines firms that don’t govern themselves.

  11. Profit maximization as goal: Does not account for timing of returns Profits - not necessarily cash flows Ignores risk What Should Managers Maximize? Maximize shareholder wealth • 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.

  12. Principal – Agent Relations Controlling Procedures(Agency Costs) Fringe – BenefitConsumption Information Asymmetry Management Compensation Schemes MoralHazard Fringe – BenefitConsumption Separation of Ownership and Control

  13. 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 Goals of The Corporation

  14. 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. Managerial Goals

  15. 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. Do Shareholders Control Management ?

  16. Example: Moral Hazard in Financial Relations Moral Hazard can destroy business opportunities: Increase the interest rate to 20% does not lead to a solution

  17. 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 Expected Value Option B =

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