Chapter 1

Introduction to Corporate Finance

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Key Concepts and Skills
 Know the basic types of financial management
decisions and the role of the Financial Manager
 Know the financial implications of the various
forms of business organization
 Know the goal of financial management
 Understand the conflicts of interest that can arise
between owners and managers
 Understand the various regulations that firms face

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What Is Corporate Finance?
Corporate Finance addresses the following
three questions:
1. What long-term investments should the firm
choose?
2. How should the firm raise funds for the selected
investments?
3. How should short-term assets be managed and
financed?

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Balance Sheet Model of the Firm
Total Value of Assets: Total Firm Value to Investors:
Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity

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The Capital Budgeting Decision
Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets
What long-term
1 Tangible investments
Shareholders’
should the firm
2 Intangible choose? Equity

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The Capital Structure Decision
Current
Liabilities
Current
Assets Long-Term
How should the Debt
firm raise funds
for the selected
Fixed Assets
investments?
1 Tangible Shareholders’
2 Intangible Equity

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Short-Term Asset Management
Current
Liabilities
Current
Net
Assets Working Long-Term
Capital Debt

How should
Fixed Assets
short-term assets
1 Tangible be managed and
financed? Shareholders’
2 Intangible Equity

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The Financial Manager
The Financial Manager’s primary goal is to
increase the value of the firm by:
1. Selecting value creating projects

2. Making smart financing decisions

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Hypothetical Organization Chart
Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

President and Chief

Operating Officer (COO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

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 TSMC organizational structure
Audit Committee
Board of Directors

Compensation Internal Audit

Committee
CEO

Business Material Management and

Development Risk Management
Finance

Legal

Corporate Strategy Treasurer Controller

Office
Information
Technology
Human Resources

https://www.tsmc.com/schinese/aboutTSMC/organization
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The Corporate Firm
 The corporate form of business is the standard
method for solving the problems encountered
in raising large amounts of cash.
 However, businesses can take other forms.

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Forms of Business Organization
 The Sole Proprietorship
 The Partnership
 General Partnership
 Limited Partnership
 The Corporation
 Limited Liability
Company (LLC)

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A Comparison
Corporation Partnership
Liquidity Shares can be easily Subject to substantial
exchanged restrictions

Voting Rights Usually each share gets one General Partner is in charge;
vote limited partners may have
some voting rights

Taxation Double Partners pay taxes on

distributions
Reinvestment and dividend Broad latitude All net cash flow is
payout distributed to partners

Liability Limited liability General partners may have

unlimited liability; limited
partners enjoy limited
liability
Continuity Perpetual life Limited life

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The Importance of Cash Flow
Firm Firm issues securities (A) Financial
markets
Invests
Invest in Retained ST debts
in assets
assets cash flows (F)
(B) LT debts
Short-term
Equity debt
Current assets Cash flow Dividends and Long-term debt
Fixed assets from firm (C) debt payments (E)
Equity shares

Taxes (D)

Ultimately, the firm The cash flows from

must be a cash the firm must exceed
Government
generating activity. the cash flows from
the financial markets.
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The Goal of Financial Management
 What is the correct goal?
 Maximize profit?
 Minimize costs?
 Maximize market share?
 Maximize shareholder wealth
 Maximize the value of stock (owner’s equity)

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On whose behalf should a company be run?
2010: U.S. mean = 31,
meaning 31/69
stakeholder/shareholder focus.

2022: U.S. mean = 41

41/59 stakeholder/shareholder

0=Shareholders’ 50=Balanced 100=Other stakeholders’ interest only

interest only
(not shareholders)

Source: Graham (2022)

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 Which Stakeholders/constituents Matter? (Other Than Common Stockholders)

This figure displays the 2022 CFO responses to the following question: Which (if any) constituents or stakeholders do you
think should be ranked above shareholders? The results are conditional on answering a score greater than or equal to 40
to the question in Figure 22: In whose interests do you think a company should be run? {0 = Shareholders Only, 100 =
Other Stakeholders Only}.

Source: Graham (2022)

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The Agency Problem
 Agency relationship
 Principal hires an agent to represent his/her interest
 Stockholders (principals) hire managers (agents) to
run the company
 Agency problem
 Conflict of interest between principal and agent

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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
equivalent to increased shareholder wealth

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Managing Managers
 Managerial compensation
 Incentives can be used to align management and
stockholder interests
 The incentives need to be structured carefully to make
sure that they achieve their intended goal
 Corporate control
 The
threat of a takeover may result in better
management
 Other stakeholders
 Customers, suppliers, employees, government, etc.
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Regulation
 The Securities Act of 1933 and the Securities
Exchange Act of 1934
 Issuance of Securities (1933): initial public
offerings (IPOs)
 Creation of SEC and reporting requirements
(1934): secondary market securities transactions
 Sarbanes-Oxley (“Sarbox”) 2002
 Increased reporting requirements and responsibility
of corporate directors
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