Finance Review

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Finance Review

• Finance 488
• Jim Mahar

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What Is Finance?

• We all know Finance has to do with money but what
  else?The reason for businessYour most important
  classForward looking
• Your favorite class

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Three Main Areas of Finance

• Money and capital markets
• Investments
• Financial management (corporate finance)
• All are very interrelated

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Jobs in Finance

• Difficult to categorize due to interdependency
• Http//www.Cob.Ohio-state.Edu/dept/fin/osujobs.Htm
  
• Corporate (financial management)
• Project analyst, credit manager

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Jobs in Finance (Continued)

• Investments
• Brokers
• Mutual funds
• Financial planners
• Money and capital markets
• Banks-IB and CB
• Mutual funds

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Finance (and Accounting) Often Get Bad Name

• Fear of the unknown
• Scapegoat for many layoffs, firings, and
  restructuring
• More mathematical than other disciplines
• Lottery and get rich quick mentality of some in
  the field
• Short-term thinking myth, reality, or some of
  both?

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Finance and Social Responsibility

• What is the purpose of a firm?
• Do social responsibility and ethical behavior fit
  with good business?
• Short answer yes. Long answer probably.
• What if others in industry do not behave
  ethically? Information?
• Regulations might be necessary

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Trends in the 1990s

• Globalization
• Technology
• Deregulation

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Financial System

• Exists to lower transactions costs
• Money flows from investors to those who need the
  money and back
• Competitive
• See drawing of financial system

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Investments

• Concerned with where to invest
• Stocks, bonds, derivatives
• Diversification
• Retirement planning

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Corporate Finance

• For much of this course we will focus on
  Corporate Finance
• Two basic questions facing every CFO
• What to invest in (how much)?
• How to get the necessary cash?

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• Before we can investigate corporate or
  investments we must introduce the players in this
  game

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Nexus of contracts

• A firm is a nexus of contracts
• Key idea!
• Explains much of what we see in the financial
  world
• Implicit and explicit contracts between many
  parties

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Shareholders

• Residual claimants
• owners
• elect Board of Directors
• have preemptive rights, rights to equal dividend
  distributions

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Bondholder-Shareholder conflicts

• Equity as a call option
• SH like risk
• BH hate risk
• similar to SL crisis
• controlled by
• law, covenants, reputation, price protection,
  security design

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Bondholder-Shareholder conflicts

• Equity as a call option
• SH like risk
• BH hate risk
• similar to SL crisis
• controlled by
• law, covenants, reputation, price protection,
  security design

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Keeping score

• Markets allow us to judge winners and losers
• Goal maximize SH value
• Often conflicts of interest
• back to nexus of contracts

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Models of human behavior-see Notes from Web

• Altruistic
• Honest
• Evil
• Holy/Religious
• REMPS

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People are REMMS or REMPS

• Resourceful
• Evaluative
• Maximizing
• People
• Meaning people will do what they feel is in
  their best interest

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REMPS continued

• has broad implications
• be skeptical of what other say
• signaling plays a key role-security issuance,
  dividends
• executive pay
• regulations

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Manager-Shareholder conflicts

• Managers are people
• People do lie for many reasons
• feel important
• to not hurt others
• to save face, job, ego, etc
• make money
• Investors know all of the above

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Manger-Shareholder relations

• work for Shareholders
• Monitored by BoD and shareholders (discuss)
• principle-agent conflict (agency cost)
• managers will look out for themselves

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Agency Costs

• costly to monitor
• can be reduced by compensation plans (align
  incentives)
• problems reward for rising market?
• Too high of pay?
• What if too closely aligned with shareholders?

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Free-Cash flow

• cash that is left over after all positive NPV
  projects
• Jensen 1986
• example of agency costs

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Investors vs. Managers

• More than just agency costs
• Investors realize managers are out for themselves
• VERY skeptical
• price protection
• Actions speak louder than words

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Two theories to explain Investor-Manger actions

• Information Asymmetries
• Signaling
• dividends, issuance, buybacks

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• End of chapter 1