What does a firm start from?
OUR VIEW OF THE FIRM
|
What does a firm start from? |
o
An
idea for making money
o
Very
first decision the firm faces: evaluate project (INVESTMENT DECISION)
o
If
project pans out, raise capital (FINANCING DECISION)
o
Once
firm is running, how use cashflows (DIVIDEND
DECISION)
|
What a firm does: raise capital to acquire assets to generate
cashflows |
|
real assets versus financial assets |
o Financial assets = securities. The assets a firm issues in the course of raising capital
o Real assets = the assets a firm uses to generate cashflows.
§ includes tangible assets, like a manufacturing plant
§ also includes intangible assets, like a patent or a trademark (e.g. Burger King)
| Investment decision |
o Value
versus cost
o The cost of the assets to be acquired is the same for any firm
o The value of the assets is the value of the cashflows generated by the assets
§
value is use-dependent: depends
§ NPV of a project is simply value - cost
§
this is why the same project can have different NPV for
different firms; the more efficiently you can use the assets, the higher is the
project's NPV for you
=> Our stylized view of the firm: all firms are in the same business: use real assets to generate cashflows whose value is more than the cost of the assets
|
Firm as 2-way money pump |
OBJECTIVE OF THE CORPORATE FINANCIAL MANAGER
|
Who should the corporate financial manager work for? |
o
S/h,
since they own the firm and hire and fire the manager (through board of
directors)
|
What should the objective of manager be?
What should he maximize? |
o
Work
for s/h => maximize s/h wealth
o
Usually
translates into maximize stock price
|
Agency problems |
o
S/h
hire manager and tell him to maximize their wealth
o
Will
manager always do this?
o
agency
problem: when a principal (s/h) hires an agent (manager), there is intrinsically
a conflict of interest
§
Agent will have own agenda, own objectives
§
What manager wants to do will sometimes differ from what s/h
want done
§
e.g. project that increases s/h wealth but also increases
risk of bankruptcy
|
Managers must be given incentives to align their interests
with s/h |
o
There’s
both a carrot (incentives) and a stick (threat of dismissal)
o
Between
them, they substantially mitigate the agency problem
o
Standard
assumption: even though the carrot and stick will not make managers work
perfectly in s/h’s interests, the remaining agency problems are negligible,
and can be ignored
=>
managers actually maximize s/h wealth
o
Whenever
this assumption seems inappropriate (e.g. when agency problems are likely to be
large) we’ll relax this assumption, and consider the impact of agency problems