FINANCE CHPT 1 – Flashcards
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In most corporations, the CFO ranks under the CEO.
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TRUE
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The Chairman of the Board must also be the CEO.
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FALSE
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The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.
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TRUE
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Partnerships and proprietorships generally have a tax advantage over corporations.
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TRUE
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A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership.
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FALSE
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An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships.
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FALSE
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Some partners in a partnership may have different rights, privileges, and responsibilities than other partners.
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TRUE
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One advantage of the corporate form of organization is that it avoids double taxation.
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FALSE
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It is generally harder to transfer one's ownership interest in a partnership than in a corporation.
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TRUE
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One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
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TRUE
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If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income.
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TRUE
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If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses.
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FALSE
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It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required.
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FALSE
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The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation.
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TRUE
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One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm's investors to transfer their ownership interests.
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FALSE
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Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations' stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests.
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TRUE
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In order to maximize its shareholders' value, a firm's management must attempt to maximize the expected EPS.
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FALSE
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In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price on a specific target date.
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FALSE
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In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price in the long run, or the stock's "intrinsic value."
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TRUE
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If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year.
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FALSE
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Globalization of business has been facilitated by improvements in information technology.
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TRUE
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As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics.
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TRUE
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There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders.
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FALSE
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A stock's market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock's market price would equal its intrinsic value.
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TRUE
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If a stock's market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy.
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FALSE
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If a stock's intrinsic value is greater than its market price, then the stock is overvalued and should be sold
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FALSE
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For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value.
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FALSE
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The term "marginal investor" means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the "marginal investor" who determines the actual stock price.
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TRUE
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If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby increase profits above the correct profits because he or she was told to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted.
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FALSE
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If someone deliberately understates costs and thereby increases profits, this can cause the price of the stock to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized.
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TRUE
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Managers always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible. However, there can be conflicts between stockholders and bondholders.
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FALSE
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A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake.
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TRUE
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If a firm's board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose goal is to maximize the stock's intrinsic value rather than the stock's current market price.
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TRUE
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Which of the following statements is CORRECT? a. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in the event of bankruptcy. b. Proprietorships are subject to more regulations than corporations. c. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner. d. Corporations of all types are subject to the corporate income tax. e. Proprietorships and partnerships generally have a tax advantage over corporations
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A
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Which of the following statements is CORRECT? a. One of the advantages of the corporate form of organization is that it avoids double taxation. b. It is easier to transfer one's ownership interest in a partnership than in a corporation. c. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability. d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., "one person, one vote." e. Corporations of all types are subject to the corporate income tax.
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C
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Which of the following statements is CORRECT? a. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership. b. Corporations face fewer regulations than proprietorships. c. One disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.
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A
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Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a. Relaxant's shareholders (the ex-partners) will now be exposed to less liability. b. The company will probably be subject to fewer regulations and required disclosures. c. Assuming the firm is profitable, none of its income will be subject to federal income taxes. d. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. e. The firm will find it more difficult to raise additional capital to support its growth.
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A
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Which of the following statements is CORRECT? a. Corporations generally face fewer regulations than proprietorships. b. Corporate shareholders are exposed to unlimited liability. c. It is usually easier to transfer ownership in a corporation than in a partnership. d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. e. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small.
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C
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Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership? a. Corporations generally face fewer regulations. b. Less of a corporation's income is generally subject to federal taxes. c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. d. Corporate investors are exposed to unlimited liability. e. Corporations generally find it easier to raise large amounts of capital.
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E
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The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected total corporate income. b. Maximize its expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share over the long run, which is the stock's intrinsic value. e. Maximize the stock price on a specific target date.
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D
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Which of the following statements is CORRECT? a. In most corporations, the CFO ranks above the CEO. b. By law in most states, the chairman of the board must also be the CEO. c. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person. d. The CFO generally reports to the firm's chief accounting officer, who is normally the controller. e. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility.
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C
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Which of the following statements is CORRECT? a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations. b. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities. c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. d. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. e. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to transfer their ownership interests.
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A
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Which of the following statements is CORRECT? a. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. b. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation. c. It is generally easier to transfer one's ownership interest in a partnership than in a corporation. d. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. e. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.
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D
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Which of the following statements is CORRECT? a. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations. b. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships. c. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment. d. Large corporations are taxed more favorably than proprietorships. e. Corporate stockholders are exposed to unlimited liability.
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C
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Which of the following statements is CORRECT? a. A hostile takeover is the main method of transferring ownership interest in a corporation. b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers. c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization. d. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization. e. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm's managers in the same way, i.e., bondholders can sue the firm's managers if the firm defaults on its debt.
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B
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Which of the following statements is CORRECT? a. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. b. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. c. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. d. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. e. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself.
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D
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The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to a. Maximize managers' own interests, which are by definition consistent with maximizing shareholders' wealth. b. Maximize the firm's expected EPS, which must also maximize the firm's price per share. c. Minimize the firm's risks because most stockholders dislike risk. In turn, this will maximize the firm's stock price. d. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers. e. Since it is impossible to measure a stock's intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value.
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D
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Which of the following statements is CORRECT? a. If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. b. There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm. c. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the price of the stock to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted. d. Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business.
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C
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With which of the following statements would most people in business agree? a. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. b. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. c. "Whistle blowers," because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees. d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.
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E
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Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders? a. Compensating managers with stock options. b. Financing risky projects with additional debt. c. The threat of hostile takeovers. d. The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions. e. Abolishing the Security and Exchange Commission.
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D
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Which of the following actions would be most likely to reduce potential conflicts between stockholders and bondholders? a. Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). b. Compensating managers with more stock options and less cash income. c. The passage of laws that make it harder for hostile takeovers to succeed. d. A government regulation that banned the use of convertible bonds. e. The firm begins to use only long-term debt, e.g., debt that matures in 30 years or more, rather than debt that matures in less than one year.
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A
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Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Pay managers large cash salaries and give them no stock options. b. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. c. Beef up the restrictive covenants in the firm's debt agreements. d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold.
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B
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Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers? a. Congress passes a law that severely restricts hostile takeovers. b. A firm's compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock. c. The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period. d. The company's outside auditing firm is given a lucrative year-by-year consulting contract with the company. e. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.
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E
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Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.
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D
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Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders? a. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced. b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. c. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%. d. The firm's founder, who is also president and chairman of the board, sells 90% of her shares. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think best without obtaining board approval.
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C
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Which of the following statements is CORRECT? a. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure. b. The threat of takeover generally increases potential conflicts between stockholders and managers. c. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers. d. The threat of takeovers tends to reduce potential conflicts between stockholders and managers. e. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders.
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D
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Which of the following statements is CORRECT? a. Corporations are taxed more favorably than proprietorships. b. Corporations have unlimited liability. c. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships. d. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders' interests. e. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders.
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E
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Which of the following statements is CORRECT? a. A good goal for a firm's management is the maximization of expected EPS. b. Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers. d. Corporations and partnerships have an advantage over proprietorships because a proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. e. For a stock to be in equilibrium, its intrinsic value must be greater than the actual market price.
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C
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Which of the following statements is CORRECT? a. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability. b. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. c. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started. d. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers. e. The managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers.
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D
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Which of the following statements is CORRECT? a. Well designed bond covenants are useful for reducing potential conflicts between stockholders and managers. b. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced, because otherwise there would be no incentive for the stockholders to sell to the hostile bidder and the takeover attempt would probably fail. c. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value. d. Takeovers are most likely to be attempted if the target firm's stock price is above its intrinsic value. e. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.
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B
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Which of the following statements is CORRECT? a. Hostile takeovers are most likely to occur when a firm's stock is selling below its intrinsic value as a result of poor management. b. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. c. Hostile takeovers are most likely to occur when a firm's stock sells at a price above its intrinsic value because its management has been issuing overly optimistic statements about its likely future performance. d. In general, it is more in bondholders' interests than stockholders' interests for a firm to shift its investment focus away from safe, stable investments and into risky investments, especially those that primarily involve research and development. e. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm's stock to sell at a price below its intrinsic value.
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A
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Which of the following statements is CORRECT? a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners. b. Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital. c. There is no good reason to expect a firm's stockholders and bondholders to react differently to the types of assets in which it invests. d. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. e. Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.
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D
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Which of the following statements is CORRECT? a. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. b. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects. c. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. d. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor
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B
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Which of the following statements is CORRECT? a. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships. b. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. c. Bond covenants are an effective way to resolve conflicts between shareholders and managers. d. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. e. One advantage to forming a corporation is that the owners of the firm have limited liability.
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E
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what is finance
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the system that includes the circulation of money, the granitic of credit, the making of investments, and the provision of baking facilities. 4
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finance is divided into what three areas?
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1. financial management 2. capital markets 3. investments pg 4
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financial management
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called corporate finance, focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value. pg 4
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capital markets
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relate to the markets where interest rates, along with stock and bond prices, are determined. pg 4
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investments
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relate to decisions concerning stocks and bonds and include a number of activities: 1. security analysis 2. portfolio theory 3. market analysis. pg 4
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CFO COO CEO
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pg 5
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Sarbanes-Oxley Act
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law passed by congress that requires the CEO and CFO to certify that their firm's financial statements are accurate. pg 5
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finance versus economics and accounting
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pg 6
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defined contribution pension plans
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where each year the company puts a specified amount of money into an account that belongs to the employee. pg 6
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The basics of financial management are the same for all businesses, large or small, regardless of how they are organized. pg 6
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still a firms legal structure affects its operations and thus should be recognized
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four main forms of business organizations
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1. proprietorships 2. partnerships 3. corporations 4. limited liability companies (LLCs) and limited liability partnerships (LLPs) pg. 6
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in terms of numbers, most businesses are proprietorships. however, based on the dollar value of sales, more than 80% of all business is done by corporations.
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because corporations conduct the most business and because most successful businesses eventually convert to corporations. pg 7
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proprietorship
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an incorporated business owned by one individual. pg 7 businesses are frequently started as proprietorships and then converted to corporations when their growth results in the disadvantages outweighing the advantages
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advantages of proprietorship
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1. they are easy and inexpensive to form 2. they are subject to few government regulations 3. they are subject to lower income taxes than are corporations
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limitation to proprietors
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1. proprietors have unlimited personal liability for the business' debts, so you can lose more than the amount of money you put into the company 2. the life of the business is limited to the life of the individual who created it, and to bring in new equity, investors require a change in the structure of the business 3. because of the first two points, proprietorships have difficulty obtaining large sums of capital; hence, proprietorships are used primarily for small businesses. pg 7
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partnership
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an incorporated business owned by two or more persons. pg 7
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advantages and disadvantages to partnership
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pg 7
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corporation
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is a legal entity created by a state, and it is separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability. pg 7 look to grow shareholders wealth
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advantages of corporation
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-unlimited life -easy transfer or ownership -limited liability -ease of raising capital
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disadvantages of corporations
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-double taxation -cost of setup and report filing
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two types of investors
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those who look at short run (1 yr) or long term (growth investor, warren buffet)
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a major drawback to corporations is taxes.
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most corporations' earnings are subject to double taxation.
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S corporations
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a special designation that allows small businesses that meet qualifications to be taxed as if they were a proprietorship or a partnership rather than a corporation. pg 8
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limited liability company
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a popular type of organization that is a hybrid between a partnership and a corporation pg 8
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limited liability partnership
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similar to an LLC but used for professional firms in the files of accounting, law, and architecture. It provides personal asset protection from business debts and liabilities but is taxed as a partnership. pg 8`
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LLCs/LLPs were created by lawyers and are structured in different ways by state
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when deciding on its form organization, a firm must trade off the advantages of incorporation agains possibly higher tax burden,.
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advantages of corporations pg 8
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-limited liability reduces the risks borne by investors; and other things held constant, the lower the firm's risk, the higher its value -a firm's value is dependent on its growth opportunities, which are dependent on its ability to attract capital. because corporations can attract capital more easily than other types of businesses, they are better able to take advantage of growth opportunities. -the value of an asset also depends on its liquidity, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential buyer than is an interest in a proprietorship or partnership, and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is relatively liquid. This too enhances the value of a corporation.
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The main goal for a corporation
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create value for investors. 9
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investors like higher expected cash flows, but they dislike risk:
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so the larger the expected cash flows and the lower the perceived risk, the higher the stock's price. 9
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intrinsic value
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an estimate of a stock's "true" value based on accurate risk and return data. the intrinsic value can be estimated but not measured precisely. 10
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market price
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the stock value based on perceived but possibly incorrect information as seen by the marginal investor. 10
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marginal investor
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an investor whose views determine the actual stock price. 10
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equilibrium
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the situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying and selling a stock. 10
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intrinsic values are estimates; and different analysts with different data and different views about the future form different estimates of stock's intrinsic value
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estimating intrinsic values is what security analysis is all about and is what distinguishes successful from unsuccessful investors. 10
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management's goal should be to take actions designed to maximize the firm's intrinsic value, not its current market price.
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that maximizing the intrinsic value will maximize the average price over the long run, but not necessarily the current price at each point in time. 11
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consequences of having a short-run focus 11
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huge bonuses for engaging in risky transactions that generated short-term profits. 12
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stockholder manager conflicts 12managers' personal goals may compete with shareholder wealth maximization. in particular, managers might be more interested in maximizing their own wealth than their stockholders' wealth
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effective executive compensatiomn plans motivate managers to act in their stockholders' best interests. useful motivational tools inclue 1. reasonable compensation packages. 2. firing managers who don't perform well. and threat of hostile takeovers. pg13
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compensation packages
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should be sufficient to attract and retain able managers, but they should not go beyond what is needed. 13
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direct stockholder intervention 13
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the majority of stock is owned by institutional investors such as insurance companies, pension funds, hedge funds,a nd mutual funds, and private equity groups are ready and able to step in and take over underperforming firms. 13`
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corporate raiders
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individuals who target corporations for takeover because they are undervalued. 15
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hostile takeover
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the acquisition of a company over the opposition of its management. 15
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managers should try to maximize their stock's intrinsic value and then communicate effectively with stockholders. that will cause the intrinsic value to be high and the actual stock price to remain close to the intrinsic value over time 15
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stockholder debtholder conflicts 15
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shareholder wealth maximization
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the primary goal for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm's common stock.17
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most managers understand that maximizing shareholder value does not mean that they are free to ignore the larger interests of society. 17
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business ethics pg 19. most firms today have strong written codes of ethical behavior; companies also conduct training programs to ensure that employees understand proper behavior in different situations.
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consequences of unethical behavior. 20
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how should employees deal with unethical behavior. 21
