The Scope Of Corporate Finance

The Scope Of Corporate Finance

Professor Dr. Rainer Stachuletz

Corporate Finance

Berlin School of Economics

Prof. Dr. Rainer StachuletzCorporate FinanceBerlin School of Economics

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Finance Career Opportunities

Corporate Finance

• Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement

Commercial Banking

• Consumer banking• Corporate banking

Investment Banking

• High income potential• Very competitive industry

Money Manageme

nt

• Opportunities in investment advisory firms, mutual fund companies, pension funds, investment arms of financial departments

Consulting • Advise on business practices and strategies of corporate clients


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Raising Capital: Key Facts

Primary vs. secondary market transactions or offerings

Most financing comes from internal rather than external sources (“pecking

order”).Most external financing issued as debt

Traditional financial intermediaries (banks) declining as a source of capital

for large firmsSecurities markets growing in

importance


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Role of The Financial Manager

(3) Cash generated by operations

(3)

(4a) Cash reinvested

(4a)

(4b) Cash returned to investors

(4b)

Financial

managerFirm's

operationsFinancial

markets

(1) Cash raised from investors

(1)

(2) Cash invested in firm

(2)


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Corporate Finance Functions

Financial Management

External Financing

Capital Budgeting

Risk Management

Corporate Governance

Corporate Finance

Functions


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Dimensions of the External Financing Function

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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

Capital Budgeting – the process firms use to choose the set of investments that generate the most wealth for

shareholders

Select investments for which the marginal benefits exceed the marginal costs.


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The Financial Management Function

Managing daily cash inflows and outflows

Forecasting cash balances

Building long-term financial plans

Choosing the right mix of debt and equity


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The Risk Management Function

Managing the firm’s exposure to significant risks:

Interest rate risk

Exchange rate risk

Commodity price risk


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The Corporate Governance FunctionEnsuring that managers pursue shareholders’

objectives

Dimensions of

corporate governanc

e

• Boards of directors• Ownership structures• Capital structures• Compensation plans• Country’s legal environment - in

U.S., Sarbanes-Oxley Act of 2002

Takeover market disciplines firms that don’t govern themselves.


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What Should Managers Maximize?• Profit maximization as goal:

– Does not account for timing of returns– Profits - not necessarily cash flows– Ignores risk

Maximize shareholder wealth

• Maximize stock price, not profits• Accounts for risk• As “residual claimants,” shareholders have

better incentives to force management to maximize firm value than do other stakeholders.


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Separation of Ownership and Control

Principal – Agent Relations

MoralHazard

Fringe – BenefitConsumption

Management Compensation

Schemes

Information Asymmetry

Controlling Procedures

(Agency Costs)

Fringe – BenefitConsumption


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Goals of The Corporation

• Shareholders desire wealth maximization

• Do managers maximize shareholder wealth?

• Managers have many constituencies or “stakeholders”

• “Agency Problems” represent the conflict of interest between management and owners


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Managerial Goals

• Managerial goals may be different from shareholder goals

– Expensive perquisites– Survival– Independence

• Increased growth and size are not necessarily the same thing as increased shareholder wealth.


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Do Shareholders Control Management ?

• Shareholders vote for the board of directors, who in turn hire the management team.

• Compensation Schemes can be carefully constructed to be incentive compatible.

• There is a market for managerial talent—this may provide market discipline to the managers—they can be replaced.

• If the managers fail to maximize share price, they may be replaced in a hostile takeover.


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Loan p Cash Flow Creditor/Bank Debtor

Option A 100 1,0 120 120 0

Option B 100 0,5 200 120 80

0,5 0 0 0

Option B 100 60 40

Example: Moral Hazard in Financial Relations

Loan p Cash Flow Creditor/Bank Debtor/Corp.

Option A 100 1,0 120 110 10

Option B 100 0,5 200 110 90

0,5 0 0 0

Option B 100 55 45

Increase the interest rate to 20% does not lead to a solution

Moral Hazard can destroy business opportunities:


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Equity Loan p Cash Flow Creditor Debtor

Option A 63,64 36,36 1,0 120 40 80

Option B 63,64 36,36 0,5 200 40 160

0,5 0 0 0

Option B 100 20 80

36,36x

20x55,0

x55,0100x1,1120

5,010,1x200110,1x120

Expected

Value Option A

Expected Value

Option B

Solution of Moral Hazard Problems By Credit Limits

A solution should provide no incentives to the management to follow the risky option B, i.e. the expected values of each option should at least equal

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The Scope Of Corporate Finance