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Chap ter 1

The Role of FinancialManagement

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The Role o f

Financ ial Management

What is Financial Management?

The Goal of the Firm

Corporate Governance

Organization of the FinancialManagement Function

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What is Financ ial

Management?

Concerns the acquisition,

financing, andmanagement of assets

with some overall goal inmind.

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Investment Decis ions

What is the optimal firm size?

What specific assets should be

acquired?

What assets (if any) should be

reduced or eliminated?

Most

important of the three

decisions.

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Financing Decis ions

What is the best type of financing?

What is the best financing mix?

What is the best dividend policy (e.g.,dividend-payout ratio)?

How will the funds be physically

acquired?

Determine how the assets (LHS of

balance sheet) will be financed (RHS

of balance sheet).

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Asset Management

Decis ions

How do we manage existing assets

eff icient ly?

Financial Manager has varying degrees

of operating responsibility over assets.

Greater emphasis on current assetmanagement than fixed asset

management.

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What is the Goal

o f the Firm?

Maxim izat ion o f

Shareho lder Wealth!

Value creat ion occurs whenwe maxim ize the share pr ice

for cu rrent shareho lders.

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Sho r tcom ings of

A lternat ive Perspec t ives

Could increase current profits while

harming firm (e.g., defer maintenance,issue common stock to buy T-bills, etc.).

Ignores changes in the risk level of the

firm.

Profit Maximization

Maximizing a firms earnings after taxes.

Problems

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Sho r tcom ings of

A lternat ive Perspec t ives

Does not specify timing or duration of

expected returns.

Ignores changes in the risk level of the firm.

Calls for a zero payout dividend policy.

Earnings per Share Maximization

Maximizing earnings after taxes divided

by shares outstanding.Problems

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Streng ths o f Shareho lder

Wealth Max im izat ion

Takes account of: current and future

profits and EPS; the timing,

duration, and risk of profits and EPS;dividend policy; and all other

relevant factors.

Thus, share price serves as a

barometer for business performance.

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The Modern Corporat ion

There exists a SEPARATION

between owners and managers.

Modern Corporation

Shareholders Management

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Role o f Management

An agentis an individual

authorized by another person,called the principal, to act in

the latters behalf.

Management acts as an agent

for the owners (shareholders)

of the firm.

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Agency Theory

Agency Theory is a branch of

economics relating to thebehavior of principals and their

agents.

Jensen and Meckling developed

a theory of the firm based onagency theory.

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Agency Theory

Incentives include, stock options,perquisites, and bonuses.

Principals must provide incent ives

so that management acts in the

principals best interests and then

moni tor results.

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Social Responsib i li ty

Wealth maximization does no t

preclude the firm from being socially

responsible.

Assume we view the firm as producing

bothprivate and social goods.

Then shareholder wealth maximization

remains the appropriate goal in

governing the firm.

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Corporate Governance

Corpo rate governance: represents the

sys tem by wh ich co rporat ions are

managed and con tro l led.

Includes shareholders, board of

directors, and senior management.

Then shareholder wealth maximization

remains the appropriate goal in

governing the firm.

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Board o f Directo rs

Typical responsibilities:

Set company-wide policy;

Advise the CEO and other senior executives;Hire, fire, and set the compensation of the CEO;

Review and approve strategy, significant investments, and

acquisitions; and

Oversee operating plans, capital budgets, and financial

reports to common shareholders.

CEO/Chairman roles commonly same person in US,

but separate in Britain (US moving this direction).

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Organ izat ion o f the Financ ial

Management Funct ion

Board of Directors

President

(Chief Executive Officer)

Vice President

Operations

Vice President

Marketing

VP of

Finance

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TreasurerCapital Budgeting

Cash Management

Credit Management

Dividend DisbursementFin Analysis/Planning

Pension Management

Insurance/Risk Mngmt

Tax Analysis/Planning

Organ izat ion o f the Financ ial

Management Funct ion

VP of Finance

ControllerCost Accounting

Cost Management

Data Processing

General LedgerGovernment Reporting

Internal Control

Preparing Fin Stmts

Preparing Budgets

Preparing Forecasts