Tutorial 1

Questions

1. What is corporate finance? What are some of the key questions that need to be answered in
corporate finance?

Corporate finance refers to the subset of finance that addresses how companies manage
capital structuring, funding, and investment decisions to increase a firm’s value. The main
questions in corporate finance are capital budgeting, capital structure, and working capital
management.

Capital budgeting: What investments should a firm make?

Capital structure: What is the best source of financing for that investment?
Working capital management: What is the role of the management team in managing the
financial activities of the firm?

2. What is the role of the finance manager? What are some of the key issues finance managers
face in performing their role?

Role of financial manager:

The financial manager acts as an intermediary, standing between the firm’s operation and
capital market, where the firm’s securities are traded. The financial manager must have a
deep understanding of how the capital market works. For example, a firm chooses to finance
a major expansion programme by issuing bonds. The financial manager must have
considered the terms of the issue and concluded that it was fairly priced.

Financial managers find ways to reduce or maintain a company’s costs and analyze market
trends and competitors to discover business opportunities and maximize profits. They also
liaise with auditors to make sure that the appropriate monitoring of company finances is
maintained.

The corporate finance manager is responsible for financial planning and execution of a
company's short- and long-term business goals. This includes developing financial plans,
issuing and selling securities, and managing investments. The corporate finance manager
typically reports to the chief financial officer (CFO).
https://www.causal.app/finance/corporate-finance-manager-finance-roles-explained

3. What are agency problems? Explain (with examples) the 3 parties to the agency problem
and how each party is related to the other.

In corporate finance, an agency problem refers to a conflict of interest between

management and shareholders.

Example – real example

In 2001, the energy giant Enron filed for bankruptcy. Accounting reports had been fabricated
to make the company appear to have more money than what was actually earned. The
company's executives used fraudulent accounting methods to hide debt in Enron's
 subsidiaries and overstate revenue. These falsifications allowed the company’s stock price to
increase during a time when executives were selling portions of their stock holdings.

In the four years leading up to Enron's bankruptcy filing, shareholders lost an estimated $74
billion in value. Enron became the largest U.S. bankruptcy at that time with its $63 billion in
assets. Although Enron's management had the responsibility to care for the shareholder’s
best interests, the agency problem resulted in management acting in their own best interest.

4. Explain some of the measures that can be taken to reduce agency problems in a firm.

1. Practice transparency
- Agency problems are most prevalent when there’s a disparity in knowledge between
the agent and the principal. It’s too easy and too tempting for the agent to exploit the
knowledge gap for personal gain. When agent-principal relationships arise in your
business, practicing full transparency can help close the knowledge gap and prevent the
agency problem from emerging. The agent should educate you, the principal, on
everything that’s going on, rather than leaving you in the dark while the agent makes
decisions on your behalf.

2. Restrictions on the Agent’s Capabilities

- Giving the agent too much power to act on your behalf opens the door for future
challenges and can lead the financial advisor to perhaps make poor choices. Most
successful governments practice checks and balances because it tempers the power of
any one individual or entity, keeping corruption to a minimum. You can practice the
same principles in your business by limiting the power of the agent.

3. Commission and Bonus Structures

- Perhaps the simplest method for eliminating the agency problem is to remove financial
incentives that encourage conflicts of interest. Returning to the financial advisor’s
example, the agency problem exists in that scenario because the advisor’s compensation
is tied to the specific financial products, he offers you.

The products that pay the highest commissions aren’t always the best choices for you,
the client. Often the advisor is forced to choose between doing right by his client and
maximizing his paycheque. If the advisor receives a set salary or earns commission based
on total assets under management rather than specific product sales, the agency
problem disappears.

-Appoint more independent directors

-impose internal control – segregation of duty (reduce concentration power)
-adhere to corporate governance
-practice transparency

5. Are zero agency problems/costs possible? Why/why not? How about in a sole
proprietorship?

Agency conflicts typically arise when there is a separation of ownership and management of
a business. In a sole proprietorship and a small partnership, such separation is not likely to
 exist to the degree it does in a corporation. However, there is still potential for agency
conflicts. For example, as employees are hired to represent the firm, there is once again a
separation of ownership and management.
-human factors (greed)
-introduce ethnics (business judgement)

6. What is Fintech? How will it affect the role of the finance manager?

The term “fintech company” describes any business that uses technology to modify,
enhance, or automate financial services for businesses or consumers.

The rise of financial technology has brought pressure to the financial manager as they might
be replaced by more professional bodies who specialize in financial technology.

Problems

Problem 1

Brealy, Myers, Allen Chapter 1, Q5

In most large corporations, ownership and management are separated. Why is this separation
necessary? What are the main implications of this separation?

Separation of ownership and management typically leads to agency problems, where managers
prefer to consume private perks or make other decisions for their private benefits – rather than
maximize the value of shareholder wealth.

Problem 2

Brealy, Myers, Allen Chapter 1, Q12

Why might one expect managers to act in the shareholders’ interest? Give some reasons.

Managers would act in shareholders' interests because they have a legal duty to act in their
interests. Managers may also receive compensation, either bonuses or stock and option payouts
whose value is tied (roughly) to firm performance.
Discussion

1. Corporate finance is a branch of finance that focuses on the key decision made by CFO:

Key decisions made by the CFO:

（i） Investment decisions
（ii） Financing decision, e.g, retained earnings, equity financing, debt financing or a mix
of both
（iii） How do the 1’ two decisions affect the capital structure of the firm (affects the cost
of financing)

Goal

-maximize shareholders (s/h) wealth / value (e.g max value of the firm better performance >
better earnings > capital appreciation > better dividends