The objective of the firm

Corporate Finance is about decisions made by corporations. Not all businesses are organized as corporations.
Corporations have three distinct characteristics: 1. Corporations are legal entities, i.e. legally distinct from it owners and pay their own taxes 2. Corporations have limited liability, which means that shareholders can only loose their initial investment in case of bankruptcy 3. Corporations have separated ownership and control as owners are rarely managing the firm The objective of the firm is to maximize shareholder value by increasing the value of the company's stock. Although other potential objectives (survive, maximize market share, maximize profits, etc.) exist these are consistent with maximizing shareholder value. Most large corporations are characterized by separation of ownership and control. Separation of ownership and control occurs when shareholders not actively are involved in the management. The separation of ownership and control has the advantage that it allows share ownership to change without influencing with the day-to-day business. The disadvantage of separation of ownership and control is the agency problem, which incurs agency costs. Agency costs are incurred when: 1. Managers do not maximize shareholder value 2. Shareholders monitor the management In firms without separation of ownership and control (i.e. when shareholders are managers) no agency costs are incurred. In a corporation the financial manager is responsible for two basic decisions: 1. The investment decision 2. The financing decision The investment decision is what real assets to invest in, whereas the financing decision deals with how these investments should be financed. The job of the financial manager is therefore to decide on both such that shareholder value is maximized.

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