Notes Session 1 PDF

about H.IE 1 Session 1 a question I Introduction to corporate f...

about H.IE 1 Session 1 a question I Introduction to corporate finance Goal of financial management What should be the goal of a corporation? Maximize profit? Monimize costs? Maximize market share? The best choice should be: maximize the current valueof the company's stock Does this mean we should do anything and everything to maximize owner wealth? No Primary goal of financial management (MxP) maximize shareholder wealth Number of stocks X price P maximize share price Maximize firm value NxP Principle-agent relation The problems begins when each part try to maximize their own interest The agency problems: Agency relationship Principal hires an agent to represent their interests Stockholders (principals) hire managers (agents) to run the company Agency problems Problems due to conflicts of interests can exists between the principal and the agent Agency costs The cost’s associated with agency problems Managing managers: Board of directors Managerial compensation Incentives can be used to align management and stockholders interests The incentives need to be structured carefully to make sure that they achieve their goal Corporate control The threat of a takeover may result in better management Conflicts with other stakeholders Principles of corporate governance make clear that that the board of directors has ultimate responsibility for governance  Board Independence (cont'd) Monitoring by the board of directors and others Captured In principle, the board of directors hires the executive team, –Describes a board of directors whose sets its compensation, approves major investments and monitoring duties have been acquisitions, and dismisses executives if necessary. compromised by connections, perceived loyalties to management or Responsibilities of Board compensation/incentive structure Board’s written mandate must include board’s satisfaction with integrity of CEO and other executives and that they are creating a culture of integrity. Board size and performance Board must apply high ethical standards and take into Researchers have found the surprisingly account the interests of stakeholders robust result that smaller boards are associated with greater firm value and Types of Directors performance. Inside Directors –The likely explanation for this –Members of a board of directors who are employees, former phenomenon comes employees, or family members of employees from the psychology and sociology research, which finds that smaller groups Grey Directors make better decisions than larger –Members of a board of directors who are not as directly groups. connected to the firm as insiders are, but who have existing or potential business relationships with the firm Managing managers Board of Directors Outside (Independent) Directors Managerial compensation –Any member of a board of directors other than an inside or –Incentives can be used to align gray director management and stockholder interests Board Independence –The incentives need to be structured On a board composed of insider, gray, and independent carefully to make sure that they achieve directors, the role of the independent director is really that of their goal a watchdog. Corporate control –However, because independent directors’personal wealth is –The threat of a takeover may result in likely to be less sensitive to performance than that of insider better management and gray directors, they have less incentive to closely monitor the firm. Conflicts with other stakeholders –There has been a trend toward more equity-based pay for outside directors. It is now standard for outside directors to be granted shares of stock and/or options to more closely align their interests with the shareholders they serve.  Is CEO's being payed too much? Executive compensation serves 3 main purposes 1) It must attract executives with the skills, experiences, and There is a market for CEOs behavioral profile necessary to succeed in the position. The question isn't whether CEOs are paid too much but whether or 2) It must be sufficient to retain these individuals, so they do not they are paid above their not leave for alternative employment. market value. 3) It must motivate them to perform in a manner consistent with Companies have to offer huge the strategy and risk-profile of the organization and discourage salaries to attract candidates self-interested behavior. already earning millions of dollars elsewhere. Structure if CEO pay Whether it's fair that a CEO's Executive compensation usually includes: salary is so much higher than that –Cash Compensation of an average worker is not a Salary and Bonuses relevant question for the board of Other cash directors... –Long-term incentives The relevant question is whether Stock options the board is paying the CEO the Restricted stock awards market wage. If the board is paying the CEO above a market –Other Long-Term Compensation wage, that is a problem. Retirement contributions Tax reimbursement CEO Turnover Life insurance premiums etc. Different types of turnover: –Voluntary turnover Due to poor health/death Compensation Policies Retirement Stock and Options Resignation with succession in place –Managers’ pay can be linked to the performance of a firm in many CEO stays as chairman after ways. resignation Many companies have adopted compensation policies that include –Involuntary turnover grants of stock or stock options to executives. Resignation due to poor performance Scandal –These grants give managers a direct incentive to increase Merger (takeover) the stock price which ties managerial wealth to the wealth of shareholders.  What is the role of financial markets in corporate finance? Stakeholders Cash flows to and from the firm Money vs. capital markets Primary vs. secondary markets Cash flows to and from the form The stakeholder theory Financial Institutions Financial institutions act as intermediaries between suppliers and users of funds Institutions earn income on services provided: –Indirect finance – Earn interest on the spread between loans and deposits Social Responsibility and Ethical Investing –Direct finance – Service fees (i.e. bankers acceptance and stamping fees) Investors are increasingly demanding that corporations behave responsibly Trends in Financial Markets and Management Issues include how a corporation treats the Financial Engineering community in which it operates, their customers, Derivative Securities corporate governance, their employees, the Advances in Technology – i.e. E-business, environment and human rights Fintech Deregulation Controversial business activities include alcohol, Corporate Governance Reform gaming, genetic engineering, nuclear power, Hedge Funds pornography, tobacco and weapons Shareholder Activisms