LECTURE 2 FORMS OF BUSINESS ORGANIZATION AGENCY RELATIONSHIPS.
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Transcript of LECTURE 2 FORMS OF BUSINESS ORGANIZATION AGENCY RELATIONSHIPS.
1-2
Alternative Forms of Business Organization
Sole proprietorship An unincorporated business owned by
one individual Partnership
An unincorporated business owned by two or more persons
1-3
Sole proprietorships & Partnerships Advantages
Ease of formation—just start! Subject to few regulations No corporate income taxes
Disadvantages Unlimited liability Difficult to raise capital Limited life Difficult to transfer ownership
1-4
Corporation A legal entity, separate & distinct from its
owners and managers, having unlimited life, easy transferability of ownership & limited liability
Advantages Unlimited life Easy transfer of ownership Limited liability Ease of raising capital
Disadvantages Double taxation Cost of set-up and report filing
1-5
Value Maximization If organized as a corporation, the
business value will most likely be maximized
Reasons: Limited liability means lower risk and
therefore, higher value Easy access to funds results in growth
opportunities Easy transfer of ownership means
investors are willing to pay more Some tax differences are beneficial for
corporations
1-6
Agency relationships An agency relationship exists
whenever a principal hires an agent to act on their behalf
Within a corporation, agency relationships exist between: Shareholders and managers
Shareholders and creditors
1-7
Shareholders versus Managers Managers are naturally inclined to
act in their own best interests. They may want more perks whilst
shareholders want an increase in the stock price
1-8
How to motivate Managers?
The threat of firing The threat of takeover
Hostile takeover: instances in which management does not want the firm to be taken over
How to prevent takeovers? Poison pill: an action the firm takes
that can practically kill it and makes it unattractive, e.g. giving huge retirement bonuses if the management changed
1-9
Motivating managers… Greenmail: like blackmail. The target
company offers to buy the stock from the potential buyer at a price above the market
Managerial compensation plans Allows managers to purchase stock at
some future time at a given price
1-10
Shareholders versus Creditors Shareholders (through managers) could take
actions to maximize stock price that are detrimental to creditors.
E.g., stockholders might push management to take up a project that has high returns but also high risk
If the venture is successful, all the benefits accrue to shareholders; creditors just get a fixed return
If things go bad the creditors will have to share the losses
CHAPTER 2The Financial Environment: Markets, Institutions, and Interest Rates and Taxes
Financial markets Types of financial
institutions Determinants of interest
rates Yield curves
1-13
What is a market? A market is a venue where goods
and services are exchanged. A financial market is a place where
individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds.
1-14
Types of financial markets Physical assets vs. Financial assets Money vs. Capital Primary vs. Secondary Spot vs. Futures Mortgage vs. Consumer credit
1-15
Physical assets vs. Financial assets Physical assets: wheat, autos, real
estate, machinery Financial assets: Stocks, bonds
1-16
Money vs. Capital Money mkt: for debt securities with
maturity of less than 1 year Capital mkt: for long-term debt
AND common stock
1-17
Primary vs. Secondary Primary mkts: in which
corporations & governments raise new capital
Secondary mkts: in which existing, previously issued (already OUTSTANDING) securities are traded
1-18
Spot vs. Futures Spot markets: where assets are
bought or sold for “on the spot” delivery (immediately or within a few days)
Futures markets: where assets are bought or sold for delivery at a later date (e.g. six months or a year into the future)
1-19
Mortgage vs. Consumer credit Mortgage mkts: loans on
commercial, residential, industrial real estate & farmland
Consumer credit markets: loans for autos, appliances, education etc.
1-20
How is capital transferred between savers and borrowers?
Direct transfers Investment
banking house Financial
intermediaries
1-21
Capital formation process
Business sells stocks or bonds to savers w/o going through any financial institution
1-22
Capital formation process
Intermediary obtains funds from investors, issuing its own securities
The intermediary might lend to business
Intermediaries create new forms of capital (e.g. certificates of deposit)
Efficiency of financial mkts increases
1-23
Capital formation process
Investment bank buys & holds securities for a period of time—so it is taking a chance
Investment bank deals with the issuance of securities not loans and deposits
1-24
Types of financial intermediaries
Commercial banks Savings and loan associations Mutual savings banks Credit unions Pension funds Life insurance companies Mutual funds
1-26
NYSE (New York Stock Exchange) All trades occur in a physical place, on the
trading floor of the NYSE An auction market, wherein individuals are
typically buying and selling between one another and there is an auction occurring
Highest buying (bidding) price will be matched with the lowest selling (asking) price
Stocks of well established (Blue chip) companies
1-27
NASDAQ (National Association of Securities Dealers’ Automated Quotations)
Located on a telecommunications network. Dealer's market, wherein market
participants are not buying from and selling to one another but to and from a dealer
He is the market maker Stocks of firms dealing with the Internet or
electronics. Stocks are more volatile
1-28
Differences have narrowed NASDAQ exchange was listed as a
publicly-traded corporation, while the NYSE was private corporation.
In March 2006 the NYSE went public after being a not-for-profit exchange for nearly 214 years.
The shares of these exchanges, like those of any public company, can be bought and sold by investors on an exchange.
1-29
Organized exchange vs. OTC market
Organized exchange: Physical place
Over-the-Counter market: Brokers and Dealers connected over an electronic network
Give an example…