Corporate Finance

Corporate Finance

[TOC]

Corporate Government

shareholder theory: maximize the market value of the firm's common equity

stakeholder theory: considers the interest of other stakeholders

Stakeholders

1. shareholders
2. creditors
3. managers and employees
4. board of directors
5. customers
6. suppliers
7. governments/regulators

Principle-Agent Relationship

1. shareholder and manger/director relationships
2. controlling and minority shareholder relationships
3. manager and board relationships
4. shareholder v.s. creditor interests
5. conflict between customers and shareholders
6. conflict between customers and suppliers
7. conflict between shareholders and governments/regulators

Stakeholder Management

1. legal infrastructure
   • employee laws
2. governmental organizational
   • comprise the regulation to which companies are subject
3. contractual infrastructure
   • contractual agreement with creditors
   • contractual agreement with customers and suppliers
   • employee contract
4. organizational infrastructure--a company's corporate governance procedures
   • annual meeting
   • board of directors
   • the audit function
   • reporting and transparency
   • policies on related-party transactions
   • remuneration policies
   • say on pay--enables shareholders to vote on executive renumeration matters

annual meeting

• straight voting--vote for each candidate separately
• cumulative voting--can accumulate all his shares for a single candidate
• proxy voting
• extraordinary general meeting--special resolution require a vote

board of directors

board structure

• one-tire board--include both internal and external directors
• two-tire board
  1. executive board directors--led by the CEO
  2. non-executive board directors

board responsibilities

• Selecting senior management, setting their compensation and bonus structure, evaluating their performance, and replacing them as needed.
• Setting the strategic direction for the company and making sure that management implements the strategy approved by the board.
• Approving capital structure changes, significant acquisitions, and large investment expenditures.
• Reviewing company performance and implementing any necessary corrective steps.
• Planning for continuity of management and the succession of the CEO and other senior managers.
• Establishing, monitoring, and overseeing the firm's internal controls and risk management system.
• Ensuring the quality of the firm's financial reporting and internal audit, as well as oversight of the external auditors.

board committees

• audit committees
• governance committees
• nominations committees
• compensation committees/remuneration committees
• risk committees
• investment committees

Factors Affecting Stakeholder Relationships and Corporate Governance

Market Factors

• shareholder engagement
• shareholder activism--shareholders' attempt to compel a company to act in a desired manner
• competition and takeovers--shareholders are persuaded to vote for a group seeking a controlling position

Non-Market Factors

• legal environment
  • common law system v.s. civil law system, in common law system shareholders and creditors can appeal to rule against management decisions that are not expressly forbidden by statute or code
• the media
  • negative media attention can affect the reputation of a company
  • social media are used to protect stakeholders' interests
• the corporate governance industry
  • SEC

Considerations in Corporate Governance

1. company ownership and voting structure
   • have dual class structure
2. composition of a company's board
   • directors are involved in related-party transactions with company
   • have served for many years and may have become too close to the company抯
     management
3. management incentives and remuneration
   • offer greater incentives, paid in cash, to achieve short-term goals
   • performance-based incentive pay is stable over time
   • management remuneration is high compared with the industry
4. composition of shareholders
5. relative strength of shareholders' rights
6. management of long-term risks

Environmental, Social, and Governance (ESG)

ESG investing:

1. positive screening
2. negative screening
3. impact investing
4. thematic investing

Capital Budgeting

The Capital Budgeting Process

1. Idea generation
2. Analyzing project proposals
3. Create the firm-wide capital budget
4. Monitoring decisions and conducting a post-audit

Categories of Capital Budgeting Projects

1. replacement projects to maintain the business
2. replacement projects for cost reduction
3. expansion projects
4. new products or market development
5. mandatory projects
6. other projects

Principles of Capital Budgeting

1. Decisions are based on cash flows, not accounting income
   • incremental cash flows--the changes in cash flows that will occur if the project is undertaken
   • sunk costs should not be included in the analysis
   • externalities
     • cannibalization--a new project takes sales from an existing product
2. Cash flows are based on opportunity costs
3. The timing of cash flows is important
4. Cash flows are analyzed on an after-tax basis
5. Financing costs are reflected in the project's required rate of return

project interaction

• independent v.s. mutually exclusive projects
• project sequencing--projects must be undertaken in a certain order
• unlimited funds v.s. capital rationing

Investment Decision Criteria

1. Net Present Value

   NPV profile

   

2. Internal Interest Rate

   • multiple IRR or No IRR problem

3. Payback Period--the number of years to recover the original investment

   • a measure of payback but not a measure of profitability
   • it does not take into account the time value of money

4. Discounted Payback Period--uses the present values of the project's estimated cash flows

5. Profitability Index

$$
PI=\frac{PV\ of\ future\ cash\ flows}{CF_0}=1+\frac{NPV}{CF_0}
$$

Cost of Capital