Professor Megginson BAD 5283

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Chapter 1
The Scope Of Corporate Finance
Professor Megginson BAD 5283
Spring 2006
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Finance Career Opportunities
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Corporate Finance Functions
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Raising Capital Key Facts
Most financing from internal rather than external
sources
Most external financing is debt
Primary vs. secondary market transactions or
offerings
Financial intermediaries declining as a source of
capital for large firms
Securities markets growing in importance
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Growth in Global Security Issues 1990-2004
Global debt equity
U.S. Issuers worldwide
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The 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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The Capital Budgeting Function
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The Financial Management Function
Managing daily cash inflows and outflows
Forecasting cash balances
Building a long-term financial plan
Choosing the right mix of debt and equity
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The Risk Management Function
Managing the firms exposure to significant risks
Interest rate risk
Exchange rate risk
Commodity price risk
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The Corporate Governance Function
Ensuring that managers pursue shareholders
objectives
Takeover market disciplines firms that dont
govern themselves
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Global Mergers and Acquisitions, 1991-2004 (
Billions)
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What Should Managers Maximize?

• Problems with profit maximization
• Does not account for timing of returns
• Profits - not necessarily cash flows
• Ignores risk

Maximize shareholder wealth

• Maximize stock price, not profits
• Account for risk
• As residual claimants, shareholders have better
  incentives to maximize firm value than other
  stakeholders

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Agency Costs In Corporate Finance
Due to separation of ownership and control

• Divergence between interests of managers and
  shareholders

Ways to deal with agency costs

• Takeovers
• Monitoring and bonding costs
• Compensation contracts
• Controversial method executive compensation
• Average pay in 2004 for CEOs of large companies
  in U.S. 9.6 million (Source Business Week,
  April 2005)

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Forms Of Business Organization In The U.S.
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Forms Of Business Organization - Corporations
What was the major weakness for corporations
before passage of the Tax Relief Act of 2003?
Double taxation
The Job and Growth Tax Relief Reconciliation Act
of 2003 reduced the double taxation problem
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The Double Taxation of Dividends
Taxation of Business Income Corporations vs
Partnerships(Corporate Tax Rate (tc) 0.35
Personal Tax Rate (tp) 0.38)
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The Tax Relief Act of 2003
Dividends are treated as capital gains, dividend
tax rate 0.15 (Corporate Tax Rate (tc) 0.35
Personal Tax Rate (tp) 0.35)
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Non-U.S. Forms Of Business Organization
Limited liability companies can be traded
publicly or be privately held
Limited liability companies play an important
role in many economies
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Corporate Form of Organization

• Financial managers responsible for maximizing
  shareholders wealth
• How? Perform the 5 basic duties of corporate
  finance external financing, capital budgeting,
  financial management, risk management, corporate
  governance
• Select investments for which the marginal
  benefits exceed the marginal costs