Dr Kevin Campbell

1. Dr Kevin Campbell CORPORATE FINANCE CORPORATE FINANCE: INTRODUCTION March 2011

2. CORPORATE FINANCE INTRODUCTION • What is corporate finance? • The nature of the modern corporation • The agency problem • Corporate governance • The lessons of the global financial crisis • Major ideas in finance

3. Recommended Textbook • Best-selling international textbook • Very helpful the end-of-chapter Questions and Problems • Visit the online learning centre http://www.mcgraw-hill.co.uk/textbooks/hillier/

4. The Financial Times • http://www.ft.com • Highly recommended

5. Cash flows between the firm and the financial markets SOURCE: Hillier, Ross, Westerfield, Jaffe and Jordan, 2010, Corporate Finance: European Edition, McGraw-Hill, Figure 1.3

6. DECISIONS MADE BY THE FINANCIAL MANAGER • Investment decisions • Financing decisions • Capital structure decisions • Dividend policy decisions • Short-term financial management decisions

7. THE GOAL OF THE FIRM • Maximizing shareholders’ wealth, ie • maximizing the share price • maximizing the value of the equity • maximizing the value of the firm • Managers may not share the same goals as shareholders • this is called an agency problem

8. CORPORATE GOVERNANCE Separation of ownership and control Board of Directors Management Debtholders Shareholders Debt Assets Equity

9. THE AGENCY PROBLEM • Separation of ownership and control • Berle & Means (1932), The Modern Corporation and Private Property • Asset ownership versus control • The core issue – Managers are the agents of shareholders– Managers may act in their own self interest if the consequences are not severe enough • Shareholders vs Management • Bondholders vs Shareholders

10. Board Structure • Poland has a two-tier board structure, in common with many continental European countries • both a supervisory and a management board • the management board runs the business • the supervisory board appoints and supervises the management board • the supervisory board also controls the firm’s compliance with the law and articles of the corporation and its business strategies • In the UK and US there is a unitary (one-tier) board • executive and non-executive directors sit together on one board

11. Executive vs Non-Executive Directors • Executive Directors • ‘Inside’ directors • Determine strategy and manage day-to-day operations • CEO has overall charge of the Executive directors • Non-Executive Directors (NEDs) • ‘Outside’ directors • Provide independent judgement and outside experience and objectivity • Represent the interests of shareholders • May be executives of other firms • The Chairman of the Board should be elected from the NEDs

12. Board Structure Anglo-American Model Continental European Model Unitary structure Two-tier structure • Board of directors • Executive Directors (incl. CEO) • Non-executive Directors (NEDs) • Supervisory board • only non-executive Directors Board committees Executive committee • Management board • Executive Directors only Other board committees (Majority NEDs) Audit Nominating Remuneration

13. Corporate Governance Models Shareholders Shareholders Firm (management) Main Bank Firm (management) Banks Employees Anglo-American Model “Impatient Capital” Continental European Model “Patient Capital” Frequently criticized for its lack of accountability to shareholders while focusing on the demands of too diffuse a group of stakeholders Frequently criticized as focusing on short-term profitability rather than long-term growth

14. Corporate governance conflicts Management Controlling Minority shareholders shareholders

15. Corporate governance conflicts • Type I agency problem: the conflict of interest between managers and shareholders (the ‘classic’ agency problem) • Type II agency problem: when controlling shareholders are present, eg families, they may have an incentive to extract private benefits of control at the expense of minority shareholders

16. THE AGENCY PROBLEM IN THE SPOTLIGHT • Enron • Tyco • Xerox • Global Crossing • Merrill Lynch • WorldCom • Hollinger International…. Business Week, May 6, 2002

17. THE AGENCY PROBLEM ILLUSTRATED:‘Conrad Black & Corporate Kleptocracy’ • Former Chairman of Hollinger International • Accused of ‘skimming’ more than $400m from the business over 7 years • Examples: • Charged Hollinger almost $43,000 for his wife’s birthday party at a New York restaurant • Claimed as expenses $2,463 for Lady Black's handbags, $3,530 for silverware for the Blacks' corporate jet and $24,950 for "summer drinks". [Source: Report of the Investigation of the Special Committee of theBoard of Directors of Hollinger International, 2004] • July 2007: found guilty on three charges of fraud and one charge of obstructing justice • November 2007: sentenced to 6.5 years in jail • July 2010: released on bail pending appeal

18. THE AGENCY PROBLEM ILLUSTRATED “NORTHERN ROCK BOARD ATTACKED OVER PAY BOOST FOR EXECUTIVES BEFORE BAILOUT” Headline, The Times, September 17, 2007 • CEO Adam Applegarth awarded a 10 per cent rise (from £690,000 to £760,000) at the AGM on April 24 2007 • The impact of the sub-prime crisis on the business was known to directors at the time

19. Mitigating the Agency Problem • Internal control mechanisms • Board of directors • Audited financial statements • Share value–based compensation • Share ownership • External control mechanisms • Managerial labour market • Market for corporate control • Shareholder activism • Corporate Governance codes (‘soft law’)

20. Codes of Best Practice ... • UK: FRC - independent regulator responsible for promoting confidence in corporate reporting and governance “The UK Corporate Governance Code” (2010) • Poland: The Warsaw Stock Exchange “Code of Best Practice for WSE Listed Companies” (2010) • “OECD Principles of Corporate Governance” (2004)

21. Corporate Governance dilemmas ... • Remuneration policy (eg share-value based schemes) can align managerial interests with those of shareholders • But excessive remuneration is one of the possible ways that managers can expropriate wealth from shareholders

22. Homework Exercise #1 Agency Problems Suppose you own shares in a company. The current price per share is £25. Another company has just announced that it wants to buy your company, and will pay £35 per share to acquire all the outstanding equity. Your company’s management immediately begins fighting off this hostile bid. QUESTIONS: Is management acting in the shareholders’ best interests? Why or why not?

23. Homework Exercise #2 Agency Problems In 2009 the US company Kraft launched a takeover bid for the UK chocolate company Cadbury. Though Cadbury’s management initially resisted the bid, they eventually recommended acceptance and Cadbury was acquired by Kraft in 2010. TASK & QUESTIONS: Research the background to the bid using the Internet (eg FT.com). Do you believe that Cadbury’s shareholders benefitted from the takeover? Do you believe that Kraft’s shareholders benefitted? Why or why not?

24. Homework Exercise #3 Agency Problems In 1999, the UK company Cadbury bought Wedel, the Polish chocolate company. After Cadbury’s acquisition by the US company Kraft in 2010, Wedel was sold to the Japanese conglomerate Lotte Group to meet European Commission requirements. TASK & QUESTIONS: Research the background to this transaction using the Internet (eg FT.com). Why did Kraft have to sell Wedel? Who benefitted from this transaction?

25. kevin.campbell@stirling.ac.uk Koniec Dziękuję za Uwagę!