Responsibilities of the financial manager

1

• Responsibilities of the financial manager
• One - Capital Budgeting (Investment) decision
• Two - Capital structure decision
• Three - Dividend policy decision
• All firms - individual proprietorships to large
  multinational corporations face these decisions
• Common tool to analyze all these decisions (and
  much more)
• These decisions are made within the context of
  financial markets

2
Responsibilities of the financial manager

• Company uses real assets
• Tangible - building, plant
• Intangible -trademarks, patents
• To pay for these real assets
• Company sells claims
• On the assets
• And the cash they generate
• Financial assets or securities
• Stocks and bonds
• Leases

3
Responsibilities of the financial manager

• Financial manager stands between
• Cash flows generated by the real assets of the
  firm, and
• Financial markets
• Investors, holding financial assets
• Equity, receiving share of profits
• Debt, receiving set payments

4
Financial Markets

• Money Market
• Market for debt securities that have short
  maturities (less than one year)
• Capital Market
• Long term securities market (equity and debt)
• Primary market -
• Market for new issues
• Private placements
• Public offerings through investment banks
• Secondary market
• Auction markets (NYSE,AMEX)
• Dealer markets (OTC, Debt markets)

5
Corporate Finance - The Big Picture

(1)
(2)
Financial
Firm's
Financial
(4a)
manager
operations
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
6
Firm - Forms of organization

• Sole Proprietorship
• Owned by one person ( More sole proprietorships
  than any other type of business organization )
• No formal charter
• Taxes - Taxed as personal income - No distinction
  between business income and personal income
• Unlimited liability - Creditors can look beyond
  business assets to personal assets
• Limited transferability

7
Parntership

• General
• Partners provide a fraction of the work and the
  cash needed
• Each partner is liable for the debt of the
  partnership
• Each partner has unlimited liability for all
  partnership debts
• Not just partners share
• All partners share in gains and losses
• Gains and losses usually based on capital
  contributions
• Described in partnership agreement

8
Partnership

• Limited Partnership
• Limited partners do not participate in managing
  the business
• General partner runs business and has unlimited
  liability
• Liability (but not tax liability) limited to
  contribution to partnership
• Income taxed as personal income to partners
• Reported on Schedule E of form 1040
• Limited transferability of partnership interest
• Examples - Real estate, Oil and gas,Warehouses

9
Corporation

• Most important form of business organization
• Legal person
• Separate and distinct from owners
• Can borrow money
• Enter into contracts
• Own property
• Sue and be sued
• Can own stock in another corporation

10
Corporation

• Requires articles of incorporation
• Name
• Intended life
• Business Purpose
• Authorized capital - May be amended by
  shareholders
• Rights to shareholders
• Number of directors on the board
• How directors are elected
• Filed in a given state
• Corporation is a resident of that state

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Corporation

• Stockholders elect board of directors
• Board of directors has the legal authority
• To declare a dividend
• Issue securities
• Commit large investment outlays
• Directors select senior management
• CEO, president
• To run corporation in interests of shareholders

12
Corporation

• Advantages
• Unlimited life
• Independent of shareholders or managers
• Limited liability
• Stockholders have limited liability for debts of
  corporation
• Easy to raise new capital by issuing more equity
  or debt

13
Corporation

• Disadvantages
• Double taxation
• Dividends paid to stockholders out of after - tax
  profits
• Dividends then taxed again as income to
  shareholders
• Most countries (but not the United States)
• Give shareholders credit for taxes already paid
  at corporate level
• In Greece and Norway, dividends are paid out of
  before tax income - dividends are treated like
  interest

14
Corporation - Organization of financial officers

• Treasurer
• Capital budgeting
• Financing
• Cash management
• Recommending dividend policy
• Insurance
• Pension plans
• Controller
• Accounting
• Preparation of financial statements
• Preparing budgets
• Internal auditing

15
Objective of the firm

• Individual owner
• Maximize profits
• Maximize the value of the business
• Corporation -
• Maximize the value of the firm
• Maximize shareholder value
• Maximize price per share
• These objectives are generally considered
  interchangeable

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Objectives of the firm

• Is maximizing firm value Maximizing shareholder
  value?
• Modern day large corporations
• Stakeholders
• Shareholders
• Managers
• Lenders
• Employees
• Customers
• Society
• Objectives of these groups may not always be
  aligned

17
Objectives of the firm

• 1. Shareholders versus bondholders
• 1.A. Source of conflict
• Difference in the nature of claims
• Debt - Fixed claim, Equity - Residual claim
• Bondholders discount risk more than shareholders
  since they do not participate in the upside
  element of risk
• Increases in financial leverage
• Makes existing bondholders worse off
• 1988 Leveraged Buy Out (LBO) by RJR Nabisco -
• Prices of existing bonds dropped by 20 at
  announcement (default probability increased)

18
Objectives of the firm

• Dividend policy
• Bondholders react negatively to large dividend
  increases

19
Objectives of the firm

• 1.B. Protective covenants
• Covenants are restrictions built into contractual
  agreements (Bonds in this case) that place
  restrictions on the firms investment and
  financing decisions
• Ex Limitations on the amount of debt issued,
  dividends paid, requirements on working capital
• Convertible bonds
• Enable bond holders to convert their debt (bonds)
  to equity (shares) under certain conditions
• Aligns bond holder and shareholder interests

20
Objectives of the firm

• These and other problems can be reduced
• Tie manager compensation to the performance of
  the firm - warrants, options
• Convertible debt
• Hence, the basic objective of the firm (at least
  for this course) is to

21
Maximize share value