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Summary Corporate Finance, Global Edition, ISBN: 9781292304151 Finance 1
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Summary Corporate Finance, Global Edition, ISBN: 9781292304151 Finance 1 For Business. Chapters 1-13 + 26.27.
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End Term FinanceCh 1: The corporation
Topics:
1.1 The four types of firms
1.2 Ownership versus control of corporations
1.3The stock market
1.4 Fintech: finance and technology
The four types of firms
There are four major types of firms; Sole proprietorships, partnerships, limited liability
companies, corporations.
Sole proprietorships = is a business owned and run by one person. They have the
following key characteristics:
1. Sole proprietorships are straightforward to set up. Consequently, many new
businesses use this organizational form
2. The principal Limitation of a sole proprietorship is that there is no separation between
the firm and the owner- the firm can have only one owner. If there are other
investors, they cannot hold an ownership stake in the firm.
3. The owner has unlimited personal liability for any of the firm’s debts.
4. The life of a sole proprietorship is limited to the life of the owner. It is difficult to
transfer ownership of a sole proprietorship.
Partnerships = is identical to a sole proprietorship except it has more than one owner. The
key features are:
1. All partners are liable for the firm’s debt. That is, 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, although
partners can avoid liquidation if the partnership agreement provides for alternatives
such as a buyout of a deceased or withdrawn partner.
A Limited partnership = is a partnership with two kinds of owners, general partners and
limited partners. General partners gave the same rights and privileges as partners in a
partnership - they are personally liable for the firm's debt obligations.
Limited partners, however, have limited liability = that is, their liability is limited to their
investingment. Their private property cannot be seized to pay off the firm’s outstanding
debts.
A Limited liability company (LLC) = is a limited partnership without a general partner. That
is, all the owners have limited liability, but unlike limited partners, they can also run the
business.
,A Corporation = is a legally defined artificial being, separate from its owners. It is not liable
for any personal obligations of its owners.
Formation of a corporation must be legally formed, which means that the state in which it is
incorporated must formally give its consent to the incorporation by chartering it.
There is no limit on the number of owners a corporation can have. The entire ownership
stake of a corporation is divided into shares known as Stock. The collection of all the
outstanding shares is known as equity. An owner of a share is known as a shareholder,
stockholder or equity holder. And is entitled to receive dividend payments.
Tax implications:
First the corporation pays tax on its profits and then when the remaining profits are
distributed to the shareholders, the shareholders pay their own personal income tax on this
income. So double taxation.
Effective tax rate = total amount paid in taxes/ total earnings * 100%
S corporations = are corporations that elect subchapter S tax treatment. Unders these tax
regulations, the firm's profits and losses are not subject to corporate taxes, but instead are
allocated directly to shareholders based on their ownership share. The shareholders must
include profits as income on their individual tax returns.
Most large companies are C corporations = which are corporations subject to corporate
taxes.
1.2 Ownership versus control of corporations
The owners, board of directors and chief executive officer possess direct control of the
corporation.
The corporate management team
The shareholders of a corporation exercise their control by electing a board of directors = a
group of people who have the ultimate decision making authority in the corporation.
The CEO chief executive officer = is charged with running the corporation by instituting the
rules and policies set by the board of directors.
The most senior financial manager is the chief financial officer (CFO).
The financial manager
Financial managers are responsible for three main tasks: Investment decisions, financing
decisions and managing the firm’s cash flows. Investments are the most important.
The goal of the firm
The objective of a firm is to maximize shareholder value.
,The firm and society
Ethics and incentives within corporations
Agency problem = When managers despite being hired as the agents of shareholders, put
their own self interest ahead of the interests of shareholders.
To solve:
Compensation contracts) This way shareholders interest are tied to the compensation of a
manager or to the stock price
Threat of firing) When stakeholders notice that a manager is not acting in their interest they
may have the possibility to re-elect a new board of directors that will function better.
The CEO’s performance
In a Hostile takeover = an individual or organization can purchase a large fraction of the
stock and acquire enough votes to replace the board of directors and the CEO.
Corporate bankruptcy
Liquidation = shutting down the business and selling off its assets.
A corporate bankruptcy is best thought of as a change in ownership of the corporation and
not necessarily as a failure of the underlying business.
1.3 The stock market
Private companies = have a limited set of shareholders and their shares are not regularly
traded.
Public companies = whose shares trade on organized markets called a stock market.
An investment is said to be liquid = if it is possible to sell it quickly and easily for a price very
close to the price at which you could contemporaneously buy it.
Primary and secondary stock markets
When a corporation itself issues new shares of stock and sells them to investors, it does so
on the primary market. After this initial transaction between the corporation and investors,
the shares continue to trade in a secondary market between investors without the
involvement of the corporation.
Traditional trading venues
Market makers = matched buyers and sellers. They posted two prices for every stock in
which they made a market: The price at which they were willing to buy the stock, The bid
price, and the price at which they were willing to sell the stock, the ask price.
, Market makers make money on the difference between ask prices and bid prices also known
as the bid ask spread.
The bid ask spread is a transaction cost investors pay in order to trade.
New competition and market changes
Limit order = an order to buy or sell a set amount at a fixed price.
The collection of all limits orders the limit order book.
Market order = orders that trade immediately at the best outstanding limit order.
High frequency traders = are a class of traders who with the aid of computers will place,
update, cancel, and execute trades many times per second in response to new information
as well as other orders, profiting both by providing liquidity and by taking advantage of stale
limit orders.
Dark pools
Dark pools = dark pools offer investors the ability to trade at a better price, with the tradeoff
being that the order might not be filled if an excess of either buy or sell orders is received.
1.4 Fintech: finance and technology
Fintech is the relation between financial innovation and technical innovation.
Telecommunications
Security and verification
Blockchain = technology allows a transaction to be recorded in a publicly verifiable way
without the need for a trusted third party to certify the authenticity of the transaction.
Cryptocurrency = a currency whose creation and ownership is determined via a public
blockchain.
Automation of banking services
Robo advisors = computer programs that are intended to replace the work of financial
advisors by providing detailed and customized investment recommendations.
Big data and Machine learning
Competition
Technological advances and the internet in particular opened the way for non-finance
organizations to provide financial services.
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