INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS

CONFLICTS CONFLICTS

Chapter 1

An Overview of Financial
Management

Forms of Business Organization

Creating Value for Investors
Stockholder-Manager Conflicts
Stockholder-Debtholder Conflicts
Balancing Shareholder Interests and Society Interests
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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Finance Within the Organization

Board of Directors

Chief Executive Officer (CEO)

Chief Operating Officer (COO) Chief Financial Officer (CFO)

Marketing, Production, Human Accounting, Treasury, Credit,

Resources, and Other Operating Legal, Capital Budgeting, and
Departments Investor Relations

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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Forms of Business Organization

• Proprietorship
• Partnership
• Corporation

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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Proprietorships and Partnerships

• Advantages
 Ease of formation
 Subject to few regulations
 No corporate income taxes
• Disadvantages
 Difficult to raise capital
 Unlimited liability
 Limited life
• Often set up through LLCs/LLPs.
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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Corporation

• Advantages
 Unlimited life
 Easy transfer of ownership
 Limited liability
 Ease of raising capital
• Disadvantages
 Double taxation
 Cost of setup and report filing

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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Stock Prices and Intrinsic Value

• In equilibrium, a stock’s price should equal its

“true” or intrinsic value.
• Intrinsic value is a long-run concept.
• To the extent that investor perceptions are
incorrect, a stock’s price in the short run may
deviate from its intrinsic value.
• Ideally, managers should avoid actions that
reduce intrinsic value, even if those decisions
increase the stock price in the short run.

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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Determinants of Intrinsic Values and Stock

Prices
Managerial Actions, the Economic
Environment, Taxes, and the Political Climate

“True” Investor “True” “Perceived” Investor “Perceived”

Cash Flows Risk Cash Flows Risk

Stock’s Stock’s
Intrinsic Value Market Price

Market Equilibrium:
Intrinsic Value = Stock Price
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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Stockholder-Manager Conflicts

• Managers are naturally inclined to act in their

own best interests (which are not always the
same as the interest of stockholders).
• But the following factors affect managerial
behavior:
 Managerial compensation packages
 Direct intervention by shareholders
 The threat of firing
 The threat of takeover

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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Stockholder-Debtholder Conflicts

• Stockholders are more likely to prefer riskier

projects, because they receive more of the
upside if the project succeeds. By contrast,
bondholders receive fixed payments and are
more interested in limiting risk.
• Bondholders are particularly concerned about
the use of additional debt.
• Bondholders attempt to protect themselves by
including covenants in bond agreements that
limit the use of additional debt and constrain
managers’ actions.
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 INTRO ORGANIZATION CREATING VALUE STK-MGR STK-DBT BAL INTERESTS
CONFLICTS CONFLICTS

Balancing Shareholder Interests and Society

Interests

• The primary financial goal of management is

shareholder wealth maximization, which
translates to maximizing stock price.
 Value of any asset is present value of cash flow
stream to owners.
 Most significant decisions are evaluated in terms
of their financial consequences.
 Stock prices change over time as conditions
change and as investors obtain new information
about a company’s prospects.
• Managers recognize that being socially
responsible is not inconsistent with maximizing
shareholder value.
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© 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.