The Scope Of Corporate

Finance

Professor Dr. Rainer Stachuletz

Corporate Finance

Berlin School of Economics

 Finance Career Opportunities
Corporate Budgeting, financial forecasting, cash
management, credit administration,
Finance investment analysis, fund procurement

Commercial Consumer banking

Banking Corporate banking

Investment High income potential

Banking Very competitive industry

Opportunities in investment advisory firms,

Money mutual fund companies, pension funds,
Management investment arms of financial departments

Advise on business practices and strategies

2 Consulting of corporate clients Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Raising Capital: Key Facts
Most financing comes from internal rather
than external sources (pecking order).
Most external financing issued as debt
Primary vs. secondary market transactions or
offerings
Traditional financial intermediaries (banks)
declining as a source of capital for large firms

3
Securities markets growing in importance Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Role of The Financial Manager

(2) (1)

Firm's Financial Financial

(4a)
operations manager markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
4 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Corporate Finance Functions

External Financing

Capital Budgeting

Corporate
Finance Financial Management

Functions
Risk Management

Corporate Governance
5 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Dimensions of the External Financing
Function

Equity vs. debt

Funding via capital market vs. via financial

intermediary

Public vs. private capital markets

Going public
6 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 The Capital Budgeting Function

Capital Budgeting the

process firms use to
choose the set of
investments that
generate the most
wealth for shareholders

Select investments for which the marginal benefits

exceed the marginal costs.
7 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 The Financial Management Function

Managing daily cash inflows and outflows

Forecasting cash balances

Building long-term financial plans

Choosing the right mix of debt and equity

8 Prof. Dr. Rainer Stachuletz

Corporate Finance
Berlin School of Economics
 The Risk Management Function

Managing the firms exposure to significant risks:

Interest rate risk

Exchange rate risk

Commodity price risk

9 Prof. Dr. Rainer Stachuletz

Corporate Finance
Berlin School of Economics
 The Corporate Governance
Function
Ensuring that managers pursue shareholders
objectives

Boards of directors
Ownership structures
Dimensions
Capital structures
of corporate
Compensation plans
governance Countrys legal environment - in U.S.
Sarbanes-Oxley Act of 2002

Takeover market disciplines firms that dont

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govern themselves.
Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 What Should Managers Maximize?
Profit maximization as goal:
Does not account for timing of returns
Profits - not necessarily cash flows
Ignores risk

Maximize shareholder wealth

Maximize stock price, not profits
Accounts for risk
As residual claimants, shareholders have better
incentives to force management to maximize firm
value than do other stakeholders.
11 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Separation of Ownership and Control

Principal Agent
Relations

Fringe Benefit Controlling

Consumption
Information Procedures
Asymmetry (Agency Costs)

Management
Fringe Benefit Moral Compensation
Consumption Hazard Schemes
12 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Goals of The Corporation

Shareholders desire wealth

maximization
Do managers maximize shareholder
wealth?
Managers have many constituencies or
stakeholders
Agency Problems represent the
conflict of interest between
management and owners
13 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Managerial Goals

Managerial goals may be different from

shareholder goals

Expensive perquisites
Survival
Independence

Increased growth and size are not necessarily

the same thing as increased shareholder
wealth.

14 Prof. Dr. Rainer Stachuletz

Corporate Finance
Berlin School of Economics
 Do Shareholders Control Management ?

Shareholders vote for the board of directors,

who in turn hire the management team.
Compensation Schemes can be carefully
constructed to be incentive compatible.
There is a market for managerial talentthis
may provide market discipline to the
managersthey can be replaced.
If the managers fail to maximize share price,
they may be replaced in a hostile takeover.

15 Prof. Dr. Rainer Stachuletz

Corporate Finance
Berlin School of Economics
 Example: Moral Hazard in Financial Relations
Moral Hazard can destroy business opportunities:
Loan p Cash Flow Creditor/Bank Debtor/Corp.

Option A 100 1,0 120 110 10

Option B 100 0,5 200 110 90

0,5 0 0 0

Option B 100 55 45

Increase the interest rate to 20% does not lead to a solution

Loan p Cash Flow Creditor/Bank Debtor

Option A 100 1,0 120 120 0

Option B 100 0,5 200 120 80

0,5 0 0 0

Option B 100 60 40
16 Prof. Dr. Rainer Stachuletz
Corporate Finance
Berlin School of Economics
 Solution of Moral Hazard Problems By Credit Limits

A solution should provide no incentives to the management to

follow the risky option B, i.e. the expected values of each option
should at least equal

Expected Expected 120 x 1,10 1 200 x 1,10 0 ,5

Value Value 120 1,1x 100 0 ,55x
=
Option A Option B 0 ,55x 20
x 36 ,36

Equity Loan p Cash Flow Creditor Debtor

Option A 63,64 36,36 1,0 120 40 80

Option B 63,64 36,36 0,5 200 40 160

0,5 0 0 0

Option B 100 20 80

17 Prof. Dr. Rainer Stachuletz

Corporate Finance
Berlin School of Economics