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Finance SummaryChapter 1: The Corporation and financial markets
- A key factor in the success of corporations is the ability to easily trade ownership
shares.
- The four types of firms=
1) Sole Proprietorships: is a business owned and run by one person. Most common
type of firm. Few or zero employees.
Key characteristics:
Advantage;
1. Straightforward to set up. Many new businesses use this form.
Disadvantages;
2. The principal limitation of sole proprietorship is that there is no separation
between firm and the owner. Firm can only have one owner. So no investors.
3. The owner has unlimited personal liability for any of the firm’s debts.
(aansprakelijk voor alle persoonlijke schulden)
4. Life of sole proprietorship is limited to the life of the owner. Difficult to
transfer ownership.
Example: small shops, freelancers and self-employed.
2) Partnerships: business with more than one owner.
Key features:
1. All partners are liable for the firm’s debt. A lender can require any partner to
repay all the firm’s outstanding debts.
2. The partnership ends on the death or withdrawal of any single partner.
Partners can avoid liquidation if the partnership agreement provides for
alternatives like buyout of a deceased or withdrawn partner.
Example: Professional practices, Doctors, Lawyers, Consultants.
- Limited partnership: two types of owners, General and limited partners.
General partners=
-Have the same rights and liability as partners in a ‘regular’ partnership. They are
liable for the firm’s debts.
-Typically run the firm on a day-to-day basis. (managing responsibility’s)
Limited Partners=
-Have limited liability and cannot lose more than their initial investment.
-Have no management authority and cannot legally be involved in the managerial
decision making for the business.
-Their interest/ownership can be transferred to someone else.
Example: Venture Capital Funds (and Private Equity Funds)
-Passive investors > limited partners (owners of the capital, bank, financial
institutions or healthy family. Ones with money)
-Active investment managers > general partners ( experienced investor managers)
, 3) Limited Liability Companies (LLL): All owners have limited liability (business is
responsible for the debts), but they can also run the business. Relatively new
business form in the US. Usually, partnership tax rules apply. LLL is between
partnership and corporation.
Corporation can survive forever but LLL has limited life like a partnership.
4) Corporation: a Legal entity separate from its owners. (managers and owners not
the same)
-Has many of the legal powers individuals have such as the ability to enter into
contracts, own assets, and borrow money. (under own name)
-The corporation is solely responsible for its own obligations. Its owners are not
liable for any obligation the corporation enters into.
When the business goes bankrupt your personal assets are safe. Bank can’t ask
you to sell your personal belongings to pay back the debt.
Example: industrial companies or start-ups.
Formation:
-Corporations must be legally formed. The corporation files a charter (licence)
with the state it wishes to incorporate in. The state then “charters” the
corporation, Formally giving its consent to the incorporation. ( need to be
registered)
-Due to its attractive legal environment for corporations, Delaware is a popular
choice for incorporation.
Ownership:
-Represented by shares of stock. Owner of stock is called share/stockholder or
equity holder. Sum of all ownership value is called equity.
-No limit to the number of shareholders. Amount of funds can raise by selling
stock.
-Owner is entitled to dividend payments. (distribution of the profit to the
owners).
Tax implications:
-Double taxation:
on the profit (net income) paid by the corporation.
On the dividend paid by the individual owner.
Ownership vs. Control in Corporations
- Corporate Management Team:
In a corporation, ownership and direct control are typically separate.
Board of Directors: elected by shareholders, have ultimate decision-making authority.
Chief Executive Officer (CEO): Board typically delegates day-to-day decision making to
CEO. Making best decisions for shareholders
Treasurer decides about investments, risk in business and credit and bank loans.
Financial Manager: Responsible for investment, financing decisions and cash management.
Goal of the Firm:
- Shareholders will agree that they are better off if management makes decisions that
maximizes the value of their shares.
, The Firm and society:
-Often, a corporation’s decisions to increase the value of the firm’s equity benefit society as
a whole (with the right regulatory oversight).
-As long as nobody else is made worse off by a corporation’s decisions, increasing the value
of the firm’s equity is good for society.
-It becomes a problem when increasing the value of the firm’s equity comes at the expense
of others.
Regulations about pollution made by companies, how to treat employees, customers’ right.
Ethics and incentives within corporations:
-Agency problems: managers may act in their own interest rather than in the best interest of
the shareholders. Like private loans, corporate jet, expensive parties, hiring family.
-One potential solution is to tie management’s compensation to the firm’s performance.
Company’s success > manager’s success. If share price increases, manager profit from it as
well.
Corporate Bankruptcy: When a business cannot pay back their debts. But you have also
personal bankruptcy, not only for businesses.
- Reorganization (change in business, owners are the former lenders still same
business) if the business is still profitable bc owner has temporarily (issue) no money
then this is a good option.
- Liquidation (sell properties/assets > company disappears) > permanent issue
The stock market: provides liquidity to shareholders. Buy or sell shares.
Liquidity: sell an asset quickly for a price close to the price at which you can currently buy it.
-public company: stock is traded by the public on a stock exchange, easy to find a buyer for a
share.
- Private company: Stock may be traded privately, difficult to find a buyer for a share.
-Primary markets: when a corporation itself issues new shares of stock and sells them to
investors, they do so on the primary market.
- Secondary markets: After the initial transaction in the primary market, the shares continue
to trade in a secondary market between investors.
-Trading venues:
New York Stock Exchange: market makers/specialists.
NASDAQ: Does not meet in a physical location
Euronext Amsterdam: Merger of Amsterdam, Brussels and Paris Stock Exchanges, about 140
listings.
EPS= net income/ selled shares= x
Diluted EPS= net income/ total amount of shares= x
Chapter 2: Firms’ Disclosure of financial Information
Financial statements:
- Firm-issued accounting reports with past performance info.
- Filed with regulatory authorities for public firms. SEC (us) and AFM (NL), Quarterly,
semi-annually (halfjaarlijks), or annual (jaarlijks)
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