Corporate Finance

By
Abdul Moueed
PhD (Finance)
Academic Background

Title Specialization Year

M.Com Finance 2009

M.Phil Finance 2015

PhD Finance 2020

(Behavioral Finance)
Teaching and Research Experience
More than 10 years of teaching experience
Major Subjects are
 Corporate Finance
 Corporate Governance
 Islamic Banking
 Investments and Portfolio Management
 Financial Accounting
 Cost and Management Accounting
Teaching and Research Experience

 Supervision of Research projects and Thesis of Graduate

and Master’s level students (BBA, MBA and MSc)
 National college of business administration and economics,
Lahore
 DHA Campus
 Chenab college of advanced studies, Faisalabad
 Ripha international university (Informatics College,
Faisalabad)
Research Publications
 I have published 8 Research Papers and 2 items are in
publishing process

 Google Scholar/ Research Gate

 Research Items = 8 & Citations = 21

Chapter 1:
Introduction
to corporate
finance
CORPORATE FINANCE
ROSS, WESTERFIELD & JAFFE
Outline

1.1 What is corporate finance

1.2 Forms of business organization
1.3 The goal of financial management
1.4 The agency problem and control of the corporation
1.5 Ethics and corporate governance
1.6 Financial markets
What is corporate finance?
 Suppose you decide to start a business to manufacture tennis balls
 What you need to do next?

 You have to answer three questions…………..

1. What long term investments should you take on?

2. Where will get the long term financing to pay for your investment?
3. How will you manage everyday financial activities?
So, corporate finance, broadly speaking, is the study of ways to answer the
questions about investments decisions, financing decisions and financial
activities management decisions.
Main tasks of corporate finance
• Capital budgeting: The process of planning and
managing a firm’s long-term investments  fixed
assets.
• Example: deciding whether or not to open a new
restaurant.
• Capital structure: The mixture of debt and
equity maintained by the firm  S-T and L-T debt
and equity.
• Working capital management: A firm’s short-
term assets and liabilities  current assets and
current liabilities. Collection from customers,
payment to suppliers
The Capital Budgeting Decision

Current
Liabilities
Current
Assets Long-Term
Debt

Fixed Assets What long-term

1 Tangible
investments
should the firm Shareholders
2 Intangible choose? ’ Equity
1.2 Forms of business organizations

1. Sole proprietorship
2. Partnership
3. Corporation
4. Limited liability company
Sole Proprietorship

 A business owned by a single individual

Advantages
 Easy to start
 Least regulated
 Low taxes
Disadvantages
 Unlimited liability
 Uncertain/limited life
 Insufficient capital to expand
Partnership

 A business forms by two or more individuals or entities.

Advantages
 Tax on personal incomes
 Flexible to operate
 Joint skills and capital
Disadvantages
 Unlimited liability
 Uncertain/limited life
 Transfer of ownership
 Insufficient capital to expand
corporation
 A business created as a distinct legal entity owned by large number of
individuals or entities.
 Starting a corporation is more complicated
 It requires articles of incorporation
 Enjoys limited liability
 Unlimited life
 Huge amount of debts
Disadvantages
 Double taxes
 Agency problem
Limited liability company (LLC)

 Hybrid form of partnership and corporation

 Limited liability
 Single taxation
Who make the decisions?

 Owners (typically in small businesses).

 Professional managers

 CFO (Chief Financial Officer)

 Financial managers
Financial managers

 Frequently, financial managers try to address these tasks.

 The top financial manager within a firm is usually the
Chief Financial Officer (CFO).
 Treasurer – oversees cash management, credit management,
capital expenditures and financial planning.
 Controller – oversees taxes, cost accounting, financial
accounting and data processing.
1.3 The goals of financial management

 Survive
 Avoid financial distress and bankruptcy
 Beat the competition
 Maximize sales
 Maximize net income
 Maximize market share
 Minimize costs
 Maintain steady earnings growth
 Maximize the value of (stock) shares
The “appropriate” goal of financial
management

 Maximize the (fundamental or economic) value of

(stock) shares is the right goal.
 Why? Shareholders own shares. Managers, as agents,
ought to act in a way to benefit shareholders; i.e., to
enhance the value of the shares.
 A limitation of this goal is that value is not directly
observable.
Value vs. price

 The value of shares are not observable. In contrast, the

price of shares can be observable.
 If one believes that share price is an accurate/good
estimate of share value, the appropriate goal would be
to maximize the price of shares.
 This belief/assumption is, however, questionable.
 Nevertheless, it is showed that investors care about stock
price, and that stock price performance is very
important to the tenure of managers.
 Value maximization and
sustainability
 Business sustainability: often viewed as managing the triple bottom
line - a process by which companies manage their
economic/financial, ecological, and social opportunities and risks.
 Sustainability and value maximization are somewhat different.
3 aspects of sustainability

 Economic/financial – here is more about

economic viability and profitability, and not
directly about value maximization.
 Ecological – reaching your financial goals should
not impose burden on the current natural
environment.
 Social – reaching your financial goals should not
damage the well-being of the society
(employees, etc.).
Shareholders and other
stakeholders
 Shareholders and other
stakeholders
 Customers
 Suppliers
 Employees (human capital and assets)
 Creditors (bondholders, banks, debtholders)
 Government: tax and regulations
 Community (local / global)
 Owner/shareholder
1.4 The Agency Problem

 Agency relationship:
 Principals (citizens) hire an agent (the president) to represent
their interest.
 Principles (stockholders) hire agents (managers) to run the
company.
 Agency problem:
 Conflict of interest between principals and agents.
 This occurs in a corporate setting whenever the agents do not
hold 100% of the firm’s shares.
 The source of agency problems is the separation of (owners’)
control and management.
 Agency costs
 Direct costs: (1) unnecessary expenses, such as a
corporate jet, and (2) monitoring costs.
 Indirect costs. For example, a manager may choose
not to take on the optimal investment. She/he may
prefer a less risky project so that she/he has a higher
probability keeping her/his tenure.
Managerial incentives

 Managerial goals are frequently different from shareholders’ goals.

 Expensive perks (Advantages).
 Survival.
 Independence.
 Growth and size (related to compensation) may not relate to
shareholders’ wealth.
Corporate governance
 Set of rules and regulations to run and control corporations
 Compensation:
 Incentives ($$$, options, threat of dismissal, etc.) used to align
management and stockholder interests.
 Corporate control:
 Managers may take the threat of a takeover seriously and run the
business in the interest of shareholders.
 Pressure from other stakeholders
Corporate Regulations

Sarbanes-Oxley Act (2002)

 In response to corporate scandals at companies such as Enron and
WorldCom, Congress enacted “Sarbox”.
 Companies must have an assessment of the firm’s internal control
structure and financial reporting.
 The officers must explicitly declare that annual reports does not contain
any false statements or material omissions.
 The officers are responsible for all internal controls.
Ethics

 Managers are expected to behave in an ethical

manner.
 The province of ethics is to sort out what is good and
bad.
 But, what is the criterion or guideline for doing so?
 Philosophers came up with some criteria, but none of
them makes sorting out what is good and bad an easy
task.
 Here, we introduce two of these criteria.
Ethics….

 Golden rule: Do unto others as you would have others do onto you.
 Do not do to others what you do not want done to yourself.
 This is a rather robust (but passive) criterion.
 But its limitation is that it says nothing about what you should do.
Dilemma

 Ethical decisions often yield a dilemma.

 Suppose that you were the CEO of investment bank XYZ
in 2005. The debt/equity ratio of the bank was 20. All of
your competitors raised their debt/equity ratios to 30 to
please the stock market so that their stock prices could
be higher than otherwise would be. You knew that
raising the debt/equity ratio to 30 was rather risky and
could destroy the bank if business went wrong. But you
knew the investors would be disappointed by the
otherwise lower share price if you did not raise the
debt/equity ratio.
So, what is the answer?

 I do not have an answer for this kind of ethical question because it is

a dilemma; otherwise, I would not use the word “dilemma.”
 All I know is that you, as professional managers, are expected to
behave ethically.
 One thing I know for sure is that never do anything that will put you
in a prison cell; you are too cute for a prison cell.
Financial markets
 Cash flows (i.e., financing and payoffs/dividends/interests)
between firms and financial markets.
 Primary markets: the corporation is the seller and
transaction raises money for the corporation.
 Listing: stocks that trade on organized stock exchange
 Secondary markets: where one owner selling to another
- Pakistan stock exchange (PSX)
Summary and Conclusion
 Corporate finance has three main area of concern
1. Capital budgeting
2. Capital structure
3. Working capital management
 The corporate form of organization is superior to other forms
 The goal of financial manager/ financial management to increase the
market value of equity
 There is possibility of conflict of interest between shareholders and
managers of a company
 Existence of financial markets increases the advantages of
corporations
End-of-chapter

 Concept questions: 1-10. (Students’ Activity)

Thank You