Scope of Corporate Finance

The Scope Of Corporate Finance Professor Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics Finance Career Opportunities Corporate Finance • Budgeting, financial forecasting, cash management, credit administration, investment analysis, fund procurement Commercial Banking Investment Banking Money Management 2 • Consumer banking • Corporate banking • High income potential • Very competitive industry • Opportunities in investment advisory firms, mutual fund companies, pension funds, investment arms of financial departments • Advise on business practices and strategies of corporate clients Prof.Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics Consulting Raising Capital: Key Facts Most financing comes from internal rather than external sources (“pecking order”). Most external financing issued as debt Primary vs. secondary market transactions or offerings Traditional financial intermediaries (banks) declining as a source of capital for large firms 3 Securities markets growing in importance Prof.

Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics Growth in Global Security Issues, 1990-2003 $ Bn 6000 5000 4000 Global debt & equity 000 2000 U. S. Issuers worldwide 1000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Prof. Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics 4 Role of The Financial Manager (2) (1) Firm's operations (3) Financial manager (4a) Financial markets (4b) (1) Cash raised from investors (2) Cash invested in firm (3) Cash generated by operations (4a) Cash reinvested (4b) Cash returned to investors 5 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics Corporate Finance Functions External Financing Capital BudgetingCorporate Finance Functions Financial Management Risk Management Corporate Governance 6 Prof. Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics Dimensions of the External Financing Function Equity vs. debt Funding via capital market vs. via financial intermediary Public vs. private capital markets Going public 7 Prof.

Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics The Capital Budgeting Function Capital Budgeting – the process firms use to choose the set of investments that generate the most wealth for shareholdersSelect investments for which the marginal benefits exceed the marginal costs. 8 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics 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 9 Prof. Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics The Risk Management Function Managing the firm’s exposure to significant risks: Interest rate risk Exchange rate risk Commodity price risk 10 Prof.Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics The Corporate Governance Function Ensuring that managers pursue shareholders’ objectives • • • • • Dimensions of corporate governance Boards of directors Ownership structures Capital structures Compensation plans Country’s legal environment - in U. S. Sarbanes-Oxley Act of 2002 11 Takeover market disciplines firms that don’t govern themselves. Prof.

Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics 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. Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics 12 Separation of Ownership and Control Principal – Agent Relations Fringe – Benefit Consumption Information Asymmetry Controlling Procedures (Agency Costs) Fringe – Benefit Consumption 3 Moral Hazard Management Compensation Schemes Prof. Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics Goals of The Corporation • Shareholders desire wealth maximization • Do managers maximize shareholder wealth? • Managers have many constituencies “stakeholders” • “Agency Problems” represent the conflict of interest between management and owners 14 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics 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. 15 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics 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. 6 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics Example: Moral Hazard in Financial Relations Moral Hazard can destroy business opportunities: Loan Option A Option B 100 100 p 1,0 0,5 0,5 Cash Flow 120 200 0 100 Creditor/Bank 110 110 0 55 Debtor/Corp.

10 90 0 45 ?? Option B Increase the interest rate to 20% does not lead to a solution Loan Option A Option B 100 100 p 1,0 0,5 0,5 Cash Flow 120 200 0 100 Creditor/Bank 120 120 0 60 Debtor 0 80 0 40 Prof. Dr. Rainer Stachuletz Corporate Finance Berlin School of Economics ?? Option B 17Solution 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 Expected Value Option A Expected Value Option B ?120 ? x ? 1,10? ? 1 ? ?200 ? x ? 1,10 ? ? 0 ,5 120 ? 1,1x ? 100 ? 0 ,55 x 0 ,55 x ? 20 x ? 36 ,36 = Equity Option A Option B 63,64 63,64 Loan 36,36 36,36 p 1,0 0,5 0,5 Cash Flow 120 200 0 100 Creditor 40 40 0 20 Debtor 80 160 0 80 ?? Option B 18 Prof. Dr.

Rainer Stachuletz Corporate Finance Berlin School of Economics