Summary
Summary Summarry classes Corporate Finance
- Course
- Institution
A summary of the Corporate Finance lessons taught by Roman Goncharenko.
[Show more]
1 review
By: seppehorions • 6 months ago
Seller
Follow
Ellendv
Reviews received
Content preview
CHAPTER 11. CORPORATIONS
1.1. TYPES OF FIRMS
SOLE PROPRIETORSHIP = Business is owned and run by one person. Typically has few, if any, employees
- Advantages
o Easy to create
- Disadvantages
o No separation between the firm and the owner: any capital comes from the owner itself. Even external
capital is not liable to the firm, but the person.
o Unlimited personal liability
o Limited life
PARTNERSHIP = Similar to a sole proprietorship, but with more than one owner. All partners are personally liable for
all of the firm’s debts. A lender can require any partner to repay all of the firm’s outstanding debts. The partnership
ends with the death or withdrawal of any single partner. Limited Partnerships have two types of owners:
- general partners (“regular” partners)
- Limited Partners (have no management authority / decision making, supplies capital but Have limited liability,
so does not have to pay back debt)
LIMITED LIABILITY COMPANIES (LLC) = All owners have limited liability, but they can also run the business. If the
company fails to repay the debt to the bank, then the owners do not have to pay back the debt, only the assets of the
company itself can be seized, not personal assets of the owners. Relatively new business form in the USA but a
common one in Europe (GmbH, SARL, SRL, SL)
Most firms are sole proprietorships, they are the most common. Only 18% are corporations. But when we look at the
revenue, corporations make up 4/5 of all the revenue while sole proprietorships only make 4% of total revenue.
CORPORATION = A legal entity separate from its owners. A corporation is like a person, it lives by itself and has its
own identity. Difference with limited liability companies is that the separation goes further in corporations. Has many
of the legal powers individuals have such as the ability to enter into contracts, own assets, and borrow money. The
corporation is solely responsible for its own obligations. Its owners are not liable for any obligation the corporation
enters into. Corporations must be legally formed. Some regions/countries offer more attractive legal environment for
corporations
,1.2. SEPARATION OF OWNERSHIP AND CONTROL IN A CORPORATION
Ownership in a corporation is r epresented by shares of stock.
Owner of stock is called:
- Shareholder
- Stockholder
- Equity Holder
Sum of all ownership value is called equity
There is no limit to the number of shareholders and, thus, the amount of funds a company can raise by selling stock
Owner is entitled to dividend payments. People own shares because they want to earn some profits. Two things can
happen with profits:
- Keep it in the firm, retain it inside and invest it in something within the firm.
- The company can pay the profit out in dividends to the shareholders. So it is the choice of the company itself
if they want to pay out dividends.
Different types of owners within the corporation: owners who can vote and can decide on things within the company
and non-voting owners that have no say in the corporation.
Control in a corporation: Who makes decisions on a day to day basis? Because anyone who holds a share is an “owner”.
In a corporation, ownership and direct control are typically separated. Think of a corporation as a democracy with
shareholders being its citizens, the board of directors being its parliament, and the CEO being its prime minister. The
board of directors are elected by shareholders and have the ultimate decision-making authority. The CEO is appointed
by the board of directors and the board delegates day-to-day decision making to CEO.
Responsibility of Financial Manager:
- Investment Decisions: Which projects to undertake and when. We need to rank the projects on liability.
- Financing Decisions: How to finance investment projects (debt vs equity)
- Cash Management: How to manage liquidity needs. How easy it is to transform the asset into cash (cash is the
most liquid, a house for example is less liquid).
What is the objective of a corporation?
, - Shareholders will agree that they are better off if management makes decisions that maximizes the value of
their shares. If share prices go up, it is a prospect of the corporation performing well in the future.
- The firm and society often,but far not always,a corporation’s decisions that increase the value of the firm’s
equity benefit society as a whole; it becomes a problem when increasing the value of the firm’s equity comes
at the expense of others (think of pollution, privacy issues etc.). For corporations the only “right” thing to do
objectively is to maximize the profit so they won’t really take society issues into account, unless there are
made some rules about it.
Double taxation = Important tax-implication for corporations is the problem of “double-taxation”. Since a corporation
is essentially a “citizen” from the law’s point of view its income is taxed at a corporate tax rate. But since dividends is
the source of shareholders’ income, thus, it is also taxed. Thus, profits are effectively taxed twice (at the level of
corporation and at the level of personal income)
EXAMPLE 1.1.
AGENCY PROBLEMS IN A CORPORATION
Ex. : you want to sell your house, you go hire a real estate agent to sell your house. You pay the agent a commission
for selling the house at the highest price. Preference of the client = sell my house at the highest price. Agent = has a
portfolio, has different houses to sell and also has more valuable houses so they will put in more effort in the more
expensive houses because they get more commission on that. So you can say: you put in less effort so you get a lower
commission but this is not possible because the effort is not observable. You do not know if the agent is putting in
100% effort.
Managers vs shareholders: Managers may act in their own interest (moral hazard) rather than in the best interest of
the shareholders (private benefits, entrenchment problem, etc.). Ex.: as a CEO you do not want to lose your job, so
you try to minimize the chances to lose your job. A lot of CEO’s loses their job in mergers and acquisitions, the manager
can put in a lot of effort that his corporation will not fall target for a takeover, one way to avoid this, is to grow a lot ,
the manager can acquire small corporations so that the corporation is big enough to not fall victim to a hostile
takeover. These decisions of acquiring small corporations are very unlikely to maximize the value of shareholders.
→ A solution to fix this incentive problem is to design compensation schemes that would incentivize the CEO to put
more weight on the shareholders value rather than an personal objectives. Ex.: give managers some equity options.
, Equity holders vs Debtholders (bank, companies that give out loans): Equity pays dividends and debt pays interestrates
and is not discussable, you have to pay back the interest. But paying out dividends is more “flexible”. Priority lies with
paying back the debt. As an equity holder you only get what is left after the debt is paid off, the worst payment you
can get is 0, liability is limited. High profits are thus important for equityholders because this means that the dividends
will be higher. For debtholders it is different, high profits does not matter for the debtholders because it does not
mean you are going to get more money than contracted as a debtholder. Equity holders prefer more riskier projects
than debtholders.
Inside vs Outside investors: Private benefit extraction by insiders; debt contract for outsiders
1.3. PRIVATE VS PUBLIC CORPORATIONS
Public corporations have their shares traded publicly at a stock exchange, while the stock of private corporations is
not traded publicly. Public corporations are more transparent, the price of the stock tells you something about how
good a company is doing. You can go private if things are going not very well, then you are going to restructure within
the company and eventually go public again in the future. If a firm is successful and big enough, then it is time for the
firm to become public, it is a step in the lifecycle of the company.
Private firms can go public via Initial Public Offering (IPO), by selling its stock publicly to all subscribed investors; after
the IPO the firm’s stock is traded at a stock exchange
Main reasons to go public include: raising external capital, reducing the cost of capital via improved transparency
(higher reporting standards + market monitoring), allowing the insiders to cash out, and other strategic reasons
Public firms can go private: for example by consolidating all of the shares of a private firm investor can delist the firms
from a stock exchange or a public company can be acquired by a private company
Main reasons to go private: To restructure with the hopes of eventually going public once again in the future.
1.4. CORPORATE BANKRUPTCY
You cannot skip paying debt. If you cannot pay the debt, then you go in bankruptcy.
Bankruptcy is a legal process through firms that cannot repay debts to creditors (i.e., defaulted firms) may seek relief
from some or all of their debts. In most jurisdictions, bankruptcy is imposed by a court order, often initiated by the
debtor. Two prominent types of bankruptcy:
- Reorganization: is an attempt to extend the life of a company facing bankruptcy through special arrangements
and restructuring to minimize the possibility of past situations reoccurring
- Liquidation: all the company’s assets are sold by an appointed trustee to bring in cash to pay back as much of
debt as possible to those that the company owes
CHAPTER 2: INTRODUCTION TO FINANCIAL STATEMENT
ANALYSIS
2. INFORMATION DISCLOSURE BY CORPORATIONS
A great advantage of corporate organizational form is that it places no restriction on who can own shares in the
corporation— anyone with money to invest is a potential investor. This greatly facilitates the firm's access to
investment capital and corporations are often widely held
With the separation of ownership and control (management) and with often highly dispersed shareholders how do
shareholders actually know what is happening in their firm?
Likewise,how do prospective investors learn enough about a company to know whether or not to they should invest
in it?
How can small investors(minority shareholders)be guaranteed equal information access with larger investor (large
blockholders)?
→ The answer to all those questions is: Public Disclosure Requirements for Corporations = In this course, we are
concerned with financial information disclosure, which takes the form of financial statements such as balance sheet,
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller Ellendv. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $10.72. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
52510 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now