Finance

Financecan also be defined as the science of money

management.

Finance is a field that deals with the study

of investments.

Itincludes the dynamics of assets and liabilities over

time under conditions of different degrees of
uncertainty and risk.
Corporate Finance
 How a corporation acquires its financial
resources and how it uses them, over time and
under uncertainty, with a view to maximize its
net worth.

Investment Analysis
 Investment analysis is a broad term
 It can include analyzing past returns,
 evaluating securities such as stocks and bonds
for valuation and investor specificity
Corporate Finance
Ownership, control and
compensation
 Ownership, control and compensation

◦ It has become clear that a country’s legal, culture,

and historical environment dramatically impacts
how that nation’s companies organize their
financial affairs

◦ Financial systems in Germany, Japan and USA are

fundamentally different from each other
◦ Common factors among top economies
 (All are capitalist economies)
 (All three represent 40% of worlds output)
 (All three economies are successful with dissimilar system)
 Ownership, control and compensation

◦ What are the common factors among these three

economies?
◦ What are the successful economic model around
the world (Both developed and developing)

This chapter will answer these questions

To be successful, any economic system must have?
First

◦ It must promote keen competition between

individuals and between companies

◦ Also ensure that recourses are used effectively

and that new ideas are processes are rapidly
incorporated

◦ Maintain a sense of common purpose and

preventing healthy competition from degenerating
into economic conflicts
To be successful, any economic system must have?
second

◦ Society must develop a powerful government

system, stable legal and regulatory environment

◦ That system not allows government to become so

intrusive and bureaucratic that initiative and
entrepreneurship are stifled
To be successful, any economic system must have?
Finally

◦ It must provide a method for individuals to pool

their talents and recourses into companies

◦ But the system must then develop an effective

means to monitor and control these companies
and the professional managers hired to run them
Legal forms of Business organizations in
USA

◦ The sole proprietorship

◦ The Partnership
◦ The Corporation
◦ The Limited partnership
◦ The S or C Corporation
Forms of Business organizations used by
non US companies

◦ Worldwide patterns
 In Britain public limited companies (plc)
 In Germany for public limited Aktiengesellschaft (AG) and
for private limited Gesellschaft mit beschrankten Haftung
(GmbH)
 In France for public limited Societe Generale for private
limited Societe a Responsibilite Limitee (SARL)
 In Spain, Mexico and Latin America Sociedad Anonima
 State owned Enterprises and
Privatization

◦ In USA total absence of state owned

enterprises
◦ In European countries
 Telephone, television, airline, electric utilities
and railroads
 National oil companies
 Steel, aluminum, aerospace, chemical and heavy
engineering
 State owned Enterprises and
Privatization

◦ First major privatization program of the

modern era was initiated by west Germany
in 1960’s
◦ First phase
 Aerospace, telecommunication, automobile, airline,
steel, Gas, electric and water Utilities
 Ownership structures and
corporate policy

Three ownership structure models observed in

non-cummunist world

◦ Open corporate model

◦ Closed or entrepreneurial corporate model
◦ Large industrial groupings
 Ownership structures and
corporate policy

◦ Open corporate model

 They rely on public capital markets for external
financing
 Their shares are diffusely held
 This model is most apparent in these countries where
formal
◦ legal contracting,
◦ government regulations and
◦ private litigation for controlling corporate behavior and
resolving business conflicts than is true in other countries
 Open corporate model conti…..
Characteristics of capital market based corporate system

◦ Many large shareholder, own 1-5% companies shares

◦ Public markets based on external financing. Commercial

banks role is limited

◦ Very large and liquid and informationally efficient stock and

bond market

◦ Small stock holders are the focus of the corporate

governance and regulation

◦ Almost all companies are controlled by professionals

◦ Very active markets for corporate control.

 Open corporate model conti…..
Strengths of capital market based corporate system

◦ Able to raise enormous sums to finance corporate

investments
◦ Transparency of accounting information
◦ Allocation efficiency
◦ Allows for specialization of labor
◦ Liquid capital markets
◦ Risk tolerant equity markets (help in nurturing
entrepreneurial growth firms)
◦ Technology seems to favor capital markets
(information acquisition, monitoring and trading
costs)
 Open corporate model conti…..
Weaknesses of capital market based corporate system

◦ Separation of ownership and control

◦ Entrenchment incentives (Mangers can be

dismissed by shareholders, so they spent time to
save their tenure in office rather value creation)

◦ Lack of powerful and informed monitors (Negative

NPV project are taken)

◦ Excessive, mandated information disclosure

 Closed corporate model conti…..
Characteristics of Financial intermediary based corporate
system

◦ Relatively few large, independent publically traded companies

◦ A small number of very strong banks

◦ Commercial banks have investment banking powers as well

(Universal banking)

◦ Capital markets play small, but growing roles in corporate

finance
 (equity markets are rare for private companies, but commonly used
for privatization of state owned enterprises)
 (Bond markets very small and illiquid)

◦ Very little mandated information

◦ Far less professional managers
◦ Relatively inactive market for corporate control
 Closed corporate model conti…..
Strengths of Financial intermediary based corporate system

◦ Intermediaries are natural corporate monitors

◦ Commercial banks enjoy natural comparative
advantage

◦ Intermediaries are especially capable of building

long term relationships

◦ Intermediary based systems appear better able to

handle borrowers financial distress

◦ Intermediaries seems able to fund multi year

investments
 Closed corporate model conti…..
Weaknesses of Financial intermediary based corporate system

◦ Inherent conflict of interest for bankers

◦ Very little transparency

◦ Channeling even large scale financing increase

costs

◦ Information processing technology is weakening

 Large industrial groupings conti…..
The key features of Large industrial groupings
◦ A close alliance of large, manufacturing,
marketing and banking companies

◦ The group is held with large cross listing

shareholdings

◦ There is typically a commercial bank at the

center
 Large industrial groupings conti…..
Characteristics of Large industrial groupings

◦ National economies are dominated by small number of

powerful industrial groups

◦ The industrial groups numerous large manufacturing,

distribution and assembly companies (lead by a company
usually a commercial bank)

◦ Dominant in home market as well as leading exporter. (Most

enjoy close relationship with national governments)

◦ Some of the industrial groups control by founding families but

in Japan case are run by professional managers

◦ Capital markets play very little role

◦ Rare takeover’s or corporate controls and rare share owned by

managers
 [
Large industrial groupings conti…..
Strengths of Large industrial groupings

◦ Industrial groupings is an effective way for economic

development, without reliance on foreign investment

◦ Competition between groups and non exclusive intra group

purchasing allow the groups to build networks. And
discourage entry of foreign investor

◦ Group system is particularly effective at managing financial

distress

◦ Centralized managerial control allows rapid dissemination of

market information, manufacturing expertise and
technological innovations.
Large industrial groupings conti…..
Weaknesses of Large industrial groupings

◦ Unless all group members grow at similar rates,

the group will inherently unstable

◦ Groups must fight a natural tendency to purchase

inputs exclusively from group members even if
competitors offer lower cost or higher quality

◦ National reliance on industrial groups impose

immense costs on consumers

◦ There is little evidence that industrial groupings

can be effective outside Japan and Korea
 KEEP CALM
END OF THE LECTURE