Questions and Answers
What is one key role of independent boards of directors in corporate governance?
Which of the following best describes corporate governance?
What can regular evaluation of investment projects prevent?
How can market forces, such as hostile takeovers, influence corporate governance?
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What is the primary goal of financial decision-making within a firm?
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Which decision type aligns with investing in projects that meet or exceed a specific return benchmark?
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What is meant by 'hurdle rate' in investment decisions?
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What happens when there are insufficient investments that meet the hurdle rate?
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Which strategy does NOT contribute to solving the agency problem in corporate governance?
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Which of the following is NOT a characteristic of an effective corporate governance system?
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Study Notes
Strengths and Weaknesses of Corporate Business Organization
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Benefits of Corporate Form:
- Limited liability protects owners from personal debts.
- Ownership transfer is straightforward, enhancing liquidity.
- Corporations have an unlimited lifespan unless restructured or liquidated.
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Drawbacks of Corporate Form:
- No confidentiality; financial information is publicly accessible.
- Potential delays in decision-making processes due to corporate governance.
- Subject to extensive regulatory scrutiny.
- Double taxation applies to corporate profits distributed as dividends.
Double Taxation Explained
- Corporations pay corporate tax (e.g., 25% on $1,000 profit = $250).
- Dividends distributed to shareholders incur additional taxation (e.g., 20% on $750 = $150).
- Total tax burden for shareholders sums to $400 or 40% of the original income.
Financial Management Function
- Financial management varies with firm size; small firms often involve the president in finance.
- As firms grow, finance typically transitions to a dedicated department linked to the firm’s leadership.
Finance's Relationship with Economics
- Finance is an extension of economics, often referred to as financial economics.
- Finance managers utilize marginal cost-benefit analysis for financial decisions, emphasizing the balance between benefits and costs.
Finance and Accounting Relationship
- Financial and accounting functions are interconnected, especially in smaller companies where one individual may handle both roles.
- Accountants focus on accrual accounting methods while finance emphasizes cash flow analysis.
- Example: Under accrual accounting, sales reported at RM100,000 despite collection status; cash method shows RM0 sales.
Financial Management Decisions
- Objective: Maximize shareholder wealth as a primary long-term goal.
- Short-term share price fluctuations may mislead managers to prioritize immediate profits over sustainable growth.
Stakeholder Considerations in Firms
- Stakeholders include owners, employees, customers, suppliers, creditors, governments, and communities.
- The "Stakeholder View" promotes minimizing harm to all stakeholders, advocating for corporate social responsibility.
Specific Stakeholder Interests
- Ordinary Shareholders: Aim to maximize wealth from share ownership.
- Employees: Seek fair compensation, job security, and better working conditions.
- Trade Creditors: Require timely payments to maintain business relationships.
- Long-term Creditors: Expect timely interest and principal repayments on loans.
- Customers: Desire quality products with reliable delivery and service.
- Government: Seeks tax compliance and contributions to economic policies.
- Local Community: Concerns with environmental practices and community involvement.
Agency Problem
- Arises from the separation of ownership and control, where managers' interests may diverge from those of shareholders.
- Consequences include managers prioritizing personal objectives over shareholder wealth maximization.
Signs of Agency Problems
- Heavy reliance on equity financing by managers.
- Preference for low-risk, short-term investments.
- Pursuit of personal projects rather than shareholder interests.
- Reward structures that do not correlate with superior performance.
Mitigation of Agency Problems
- Corporate governance promotes fairness, accountability, and transparency, addressing agency challenges.
- Market mechanisms, such as hostile takeovers, may incentivize managerial alignment with shareholder interests.
Financial Objectives
- Aim to maximize firm value and shareholder wealth through strategic investment, financing, and dividend decisions.
- Investments should yield returns above the minimum acceptable hurdle rate. If not, surplus cash should be returned to shareholders.
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Description
Explore the advantages and disadvantages of common legal forms of business organization, particularly focusing on corporations. This quiz highlights benefits like limited liability and ownership transferability, as well as drawbacks including lack of privacy and potential decision-making delays.
