Corporate Issuers

22.1 Features of Corporate Issuers / LO 22a iii

- A corporation (or limited company) is a legal entity away from its owners and managers. All of the corporation's shareholders have limited liability. An owner can lose entire investment if the company goes bankrupt or shares fall to 0 value. Beyond initial investment, they are not responsible for claims against the corporation. Can distribute profits to owners if want to. Most large firms are corporations because that structure gives them the greatest capital access to capital --> both debt (borrowed capital) and equity (ownership capital) - Corporation separates owners and managers. Owners appoint BoD that is reponsible for hiring senior managers to run the company (BoD/SMs should act in the interest of shareholders). - Public corporation (or public limited company) is one that has shares that can be sold to the public and traded in an organised market/stock exchange. - A private limited company has a limited number of shareholders and restrictions on transfer of shares. - Depending on the country, a corporation's profits may be subject to double taxation if a govt taxes companies on earnings and taxes dividends (distribution of earnings to owners) as personal income.

22.1 Features of Corporate Issuers / LO 22b

- A corporation's legal identity is separate from owners and formed by filing an articles of incorporation with a regulatory body. As a legal entity, a corporation has many of the rights and responsibilities of an individual (right to hire employees, enter contracts, borrow/lend money) - Shares issued to raise capital, giving voting rights to shareholders to allow them to elect BoD. Shares are easily transferable if traded on an exchange. BoD may distribute a portion of company earnings to shareholders as dividends. - The disadvantage of double taxation of corporate income is less for investors in low-payout companies (effective tax rate lower).

23.1 Investors and other stakeholders / LO 23b ii

- BoD is responsible for protecting the interests of shareholders, hiring/compensating senior managers, strategic direction, monitoring financial performance - Board members have inside directors (senior execs, founders) and independent directors who have no material relationship with company and hence should better protect shareholder interests w/o CoIs. - In a one-tier board structure, inside and INEDs serve on single board. Major stock exchanges require e.g. most of the board to be INEDs. Could also require diversity of backgrounds and competencies. - In a two-tier board structure, INEDs serve on supervisory board that oversees a management board comprising inside directors. - Board members elected for specified term. In a staggered board, only a fraction of board elected each year, decreasing shareholder ability to overhaul board if ineffective, but providing continuity and allowing for LT view of strategy. - Senior managers' remuneration = salary + bonus on company perf + perks (expense accounts, company planes, retirement benefits). Their interests would be continued employment and maximising their comp. Executive bonuses are tied to some measure of firm performance usually, to give senior managers interest in firm success.

23.1 Investors and other stakeholders / LO 23a

- Debtholders have a legal, contractual claim to the interest and principal payments the company has promised to make. Higher priority of claims, - Equityholders have a residual claim to the company's net assets (after all other claims paid). - Debt is less costly a form of capital than equity (to the company) because it is less risky than equity. - Both debt and equityholders can lose entire investments if the company fails, but losses cannot exceed the amount invested. - Upside potential: debtholders can receive principal payments + interest, while equityholders have theoretically unlimited upside - Value of a company = debt value + equity value - Assuming company value > value of debt, as company value increases, Ve increases while Vd is constant. If value of debt > company value then Ve = 0 and Vd = value of company. -Increasing leverage (and therefore risk) can increase the return on equity as long as the expected rate of return on assets exceeds the cost of debt. If return on assets = or > cost of debt, then equity investors benefit from taking the risk. Debt investors only receive their promised interest and then principal when debt matures. -A debt investor may not receive interest payments if net income < interest expense. Hence debt investors have no upside, only downside. - Interests of D/Eholders may conflict. Debtholders concerned with repayments and not growth. Eholders may favour actions that increase potential growth and increase its risk level, such as adding financial leverage by issuing new debt. Issuing additional debt as opposed to equity also prevents dilution of shareholders' proportional ownership. -Existing dholders faced increased P(default) of company without an increase in E(return), + can limit borrowers' actions via contractual provisions such as max leverage/min ICR (covenants).

23.1 Investors and other stakeholders / LO 23c i

- Investors could be interested in ESG factors bc 1) Govt stakeholders increasingly prioritise climate change/social policies through regulation 2) ESG factors can have a material impact on companies' results through loss of customer goodwill and financial losses due to fines/judgements. Poor CG may lead to senior managers exploiting shareholders to advance personal interests. 3) Younger investors manage wealth with ESG considerations in mind Negative externalities arise when a company does not bear full cost of actions - govt regs or stakeholder awareness necessitate companies to recognise these costs explicitly in FSs or implicitly.

22.1 Features of Corporate Issuers / LO 22c i

- Most public companies are listed companies (stock exchange, shares traded). - Stock exchange is a rules-based open market, providing price and volume transparency. - Shareholders can be indivs, corps, non-profits, govt. - Shares that are actively traded (not held by insiders, strategic investors or sponsors) are called the company's free float. (% of total outstanding shares). - Public companies are subject to compliance and reporting requirements; financial reports to regulatory bodies and disclosure of material changes in business or ownership. - Shares in private limited companies do not trade on an exchange and so their value is not readily available/transfer is difficult. Investors usually wait until company goes public or is sold to exit their investment. Fewer regulatory reqts and less disclosures + longer-term view of the business. - Sometimes there is a benefit to taking an u/p public company private to restructure it (lower regulatory burden and associated cost savings) and unlock potential value. In such a case, an acquirer purchases all outstanding shares and the company is delisted.

23.1 Investors and other stakeholders / LO 23b iii

- Other employees are the human capital of the company, who provide labour and skills. They may have an interest in the sustainability + success of firm, their rate of pay, opportunities for career advancement, training and working conditions. They may hold equity in the company via stock participation plans, aligning their interests with shareholders. In some countries, employees join unions to negotiate the terms of their employment. -Suppliers to the firm have an interest in preserving an ongoing relationship with the firm, in the profitability of trade, and in the growth/stability of the firm. Because they are usually short-term creditors of firms, they are interested in the firm's solvency and ongoing financial strength. -Customers rely on firm to provide services (HQ, good price), and are interested in preserving a relationship for post-sale support and service. Maintaining goodwill of customers is critical for long-term prospect of any company (inc. ESG). -Govts rely on corporations for tax revenue, economic growth, social welfare, employment creation. Regulators have an interest in ensuring compliance with variance laws.

22.1 Features of Corporate Issuers / LO 22a ii

- Sole proprietorship: a business owned and operated by an individual. Legally the business is an extension of the owner, who is personally responsible for claims against the business (i.e. unlimited liability) and receives all profits and losses. Profits then taxed as personal income of the owner. Sole proprietorship tend to be small as they can only expand within the limits of the person's ability to secure financing. - General Partnership: Two or more individuals. The partnership agreement specifies each business partner's responsibilities for business operations/shares of profits and losses. The agreement may be written/verbal/incidental through the actions of partners. Partners have unlimited liability for claims against the business and profits allocated to each partner are taxed as personal income. May expand financing capabilities from just one individual. - Limited Partnership: involves 2 levels of partners - one or more general partners operate the business and have unlimited liability, but also there are limited partners who are liable only for the amount they invest in the partnership (limited liability) and have claims to profits proportional to their investments. Limited partners are not usually involved in appointing or removing GPs. LP/GP profit division is specified in the Partnership Agreement. Because they manage the business, the GPs usually receive a larger portion of profits than the LPs. Profits allocated to each partner are taxed as personal income to each partner. - Some jurisdictions allow a limited liability partnership: GP not required and all partners are LPs. In the US, LLPs allowed only for providers of professional services and so there are restrictions on partner numbers/the amount of equity investment.

23.1 Investors and other stakeholders / LO 23b i

- Under shareholder theory, primary focus of CG is the interest of the shareholders, to maximise the MV of the firm's common equity. CG primarily concerned with the conflict of interest between the firm's managers and its owners (shareholders). - Under stakeholder theory, CG focus is broader, considering conflicts amongst groups. Stakeholders: - Shareholders: residual interest, claim to net assets after all liabilities settled. Have voting rights for BoD and other matters, controlling firm+mgmt. Interested in ongoing profitability/growth of the firm to increase ownership share value. - Lenders: Public dholders (bondholders) supply debt capital to firm via outstanding bonds, while private dholders such as banks extend loans, credit facilities and leases to the firm. Private dholders may have access to NPI, decreasing information asymmetry. This is why they are key for financing SMEs. Sometimes private debtholders hold equity in the firm, allowing them to take a more equity-like approach and make them more amenable to changes in terms of the loans (covenants). By contrast, bondholders rely on public info and do not influence operations. The interest of both types of lenders are protected to varying degrees by covenants in their debt agreements.

24.1 Corporate Governance / LO 24a ii

-controlling shareholders could act against minority shareholders....a controlling shareholder may have concentrated ownership in that a large % of wealth might be shares in this company. Then a controlling shareholder may want the company to diversify into different businesses to mitigate risk. Minority s.hs may already hold diversified portfolios and do not want company to squander resources by investing in less desirable business just to diversify. -dual class structure: different classes of common stock, some more voting power than others. Can give a group of shareholders (founders) effective control even with claims of less than 50% of its earnings and assets. -CFA advocates against dual class voting structures because they allow one group of shareholders to further their interest at the result of others. -s.hs may prefer more business risk than creditors do bc creditors have a limited upside from good results compared to s.hs. Mgmt actions that favour the interests of equity owners over creditors include issuing new debt (increases default risk of existing shareholders) or increasing dics at the cost of decreasing company assets as collateral and increasing the risk of default. Potential for conflict is a greater risk for long term debtholders.

26.1 Capital Investments and Project Measures iv

1) idea generation - wide sources such as snr management, functional divisions, employment, or sources outside company 2) analysing project proposals - decision to accept or reject CF based on project's future CFs so a cash flow forecast must be made to gauge profitability 3) create the firm - wide capital budget, firms must prioritise projects according to the timing of the project's cash flows, available company resources and the overall strategic plan - projects attractive individually may not make sense strategically 4) monitoring decisions and conducting a post - audit, compare actual results to projected results and why didn't it match. Bc capital allocation process only as food as estimated inputs, post-audit can identify systematic errors in the forecasting process and improve company operations.

26.1 Capital Investments and Project Measures ii

3) Expansion projects grow the business and require complex decision,aging process that includes forecasting future demand. Expansion projects can involve entering new markets or introducing new projects within the same market. A detailed analysis including forecasting revenues and expenses is required. Other projects such as new investments outside lines of business also entail a complex decision making process with detailed analysis due to uncertainty involved. Could be similar to startup and explore new idea, can also involve buying out an existing company in a new industry - risks involve overpaying.

26.1 Capital Investments and Project Measures

4 types of capital investments 1) going concern projects - may be needed to maintain the business or reduce costs. Projects that maintain the business do not require detailed analysis. Only issue is whether existing operations should continue and if so whether existing procedures and processes should be maintained. Projects to improve efficiency may involve determining if equipment that is obsolete, but still usable, should be replaced. To reduce financing risk, companies often use a match funding approach, financing projects with capital sources that are consistent with project life. Annual depreciation expense can be used as an estimate of the capital investment it needs for going concern projects. 2) Regulatory/Compliance projects - may be required by a govt agency or insurance company and often involve safety - related or environmental concerns. These projects typically generate little to no revenue and require the company to evaluate alternative ways of carrying out the projects

25.1 Working capital and liquidity 25c Qs

A company with shorter CCC would have lower DOH (lower amount of cash in inventory) lower DSO (lower amount of cash tied in accounts receivables) or higher DSO (increased use of supplier credit) Liquidity can be reduced by reducing inventory. Extending repayment times would increase DSO, reducing liquidity, paying suppliers earlier decreases DPO, thus reducing liquidity. Financing an increase in CA with long term borrowing is an example of conservative WC mgmt.

25.1 Working capital and liquidity 25c ii

A conservative approach to working capital mgmt is for the company to hold higher amounts of short term assets rel to long term, and finance the working capital using longer term sources, such as long term debt and equity. Benefits of a conservative approach include using more permanent capital with less need for rolling over, greater flexibility during market disruption, and a high probability of meeting short term obligations. The conservative approach results in higher costs and lower profitability. Additionally, long term lenders may impose operational constraints such as a min interest coverage ratio. Aggressive approach - hold rel lower levels of short term assets and finance WC using short term debt. The benefit of an aggressive approach is to lower costs, but it's risks are failing to meet business obligations and vulnerable to market disruption. Middle ground - permanent current assets funded using long term sources of capital while variable current assets via short term.

26.1 Capital Investments and Project Measures vi

A key advantage of NPV is that it is a direct measure of the expected increase in the value of the firm. Positive NPV project should cause a proportionate increase in a stock company's price. Advantage of IRR - it measures profitability as a %, showing the return on each dollar invested. The IRR provides info on the margin of safety that the NPV does not. From the IRR we can tell how much below the IRR (estimated return) the actual project return could fall, in percentage terms, before the project becomes uneconomic - negative NPV. Disadvantages of IRR - assumes cash flows reinvested at IRR while NPV assumes those cash flows reinvested at the project rate of return (second more realistic). For sign changes, a project may have multiple IRRs, difficult to interpret.

24.1 Corporate Governance / LO 24b iii

Activist shareholders pressure companies in which they hold signif shares for changes they believe will increase shareholder value. May initiate shareholder lawsuits or seek representation on BoD. Other activist tactics include proposing shareholder resolutions for a vote and raising their issues to all shareholders or the public to gain support. HFS involved increasingly in shareholder activism. Activists may initiate a proxy context in which they seek the proxies of shareholders to vote in favour of their proposals or may make a tender offer for enough shares if a company to gain control. Senior movers and BoD can be replaced by shareholders if they think performance is bad. Threat of hostile takeover, not supported by mgmt, can act as incentive for leadership to act in line with shareholder interest. It might also cause the current management or board to adopt takeover defences such as staggered board elections or poison pill provisions (low price additional share offerings)

25.1 Working capital and liquidity 25biii

An increase in CCC reduces a issuer's liquidity. The CCC can increase due to drags or pulls on liquidity. A drag on liquidity occurs when cash inflows lag. This can occur when excess inventory builds up or inventory becomes obsolete (DOH increases), or when collections are slow or receivables become collectible (DSO increases). A pull on liquidity occurs when cash outflows accelerate. This can occur when suppliers reduce credit lines or demand faster payments (DPO decreases).

26.2 Capital allocation principals and real options iii

Behavioural bias - Pet projects of senior management : may contain more overly optimistic projections that realistic and not be subjected to scrutiny Inertia in setting entire capital budget : may be similar YoY, indicates anchoring of capital budgets to the year prior. Should be returning excess funds to shareholders when there is a lack of positive NPV projects and make a case for expanding the budget when there are multiple positive NPV opportunities. Analysts should watch for companies with static or rising capital budgets coupled with declining returns as a sign of bias Basing investment decision on EPS or ROE: managers whose incentive comp is tied to increasing EPS or ROE may avoid positive long term NPV investments that are expected to reduce EPS or ROE in long run. Failure to generate alternative investment ideas: once an acceptably good one found

24.1 Corporate Governance / LO 24b v

BoD has committees : Audit committee: oversight of financial reporting function and implementation of accounting policies, effectiveness of firm's internal controls and internal audit function, recommending an independent external auditor and its comp, proposing remedies based on their review of internal and external audits. Nominating/governance committee: oversight of the CH code including board elections, setting policies for nomination of candidates for board membership, implementing the company's code of ethics and policies regarding conflicts of interest, monitoring changes in relevant laws and regs, ensuring company in compliance with laws and regs and internal governance policies. Compensation or remuneration commuted recommends to board amounts and types of comp to be paid to directors and senior managers. May also be responsible for oversight of employee benefit plans and evaluation of senior managers. Should and sometimes req to be all independent directors only.

24.1 Corporate Governance / LO 24b iv

Bond indenture specified rights of bondholders and company obligations when issuing new bond. An indenture typically includes covenants to require company to take or not take some actions, a bond can be backed by collateral for bondholders to have a claim against should the company default on bond. Financial institution may act as trustee to mentor compliance with covenants. Creditor committees may form among bondholders to protect their interests when an issuer experiences financial distress. Some countries require this when company files for bankruptcy. A group of bond investors may form an ad hoc committee when company struggling to meet its obligations. Does not represent all of bondholders but interests are generally aligned.

25.1 Working capital and liquidity 25ai

CCC measures efficiency of the company's cash flow management, representing the time it takes for a company to convert its investments to inventory and other resources into cash inflows from sales. Measures how quickly a company can convert its investments into cash and use that cash to invest in new opportunities. A lower CCC is better as it indicates a company can generate cash quickly and efficiently, meaning less of a company's capital is devoted to working capital. A high CCC indicates taking longer to convert its investments into cash, which could lead to cash flow problems and potentially limit the company's ability to invest in growth opportunities. Can decrease CCC by decreasing its inventories and receivables or by extending its payables. -reducing inventories of raw materials may create production bottlenecks due to supply chain disruptions, reduced inventories may mean inability to meet spikes in demand. -reducing credit to customers may result in lost sales

24.1 Corporate Governance / LO 24b

CG: internal controls and procedures by which indiv companies are managed. Includes framework that defines the rights, roles and responsibilities of various groups within an organisation. Objective is to manage and minimise conflicts of interest between stakeholders of the company. Stakeholder management: mgmt of company relations with stakeholders and having good understanding of stakeholder interests and maintaining effective communication with stakeholders. There are standard practices that are required by corporate laws and similar in many jurisdictions. Stakeholders gather information about company from public reports filed, annual reports, proxy statements, public notices on financial performance and standing, related party transactions, executive remuneration and governance structure. Private companies usually give info to investors directly, transparency in reporting reduces info asymmetry and allows stakeholders to evaluate whether company actions align with their interests

26.1 Capital Investments and Project Measures vii

Can examine whether a company is creating shareholder value by comparing the return on investment in assets to its cost of capital. ROIC can be increased by improving operating margin, or by increasing capital turnover. Analysts compare ROIC to investor's required rate of return, which could be debt and equity blended rate. If ROIC > required rate, then firm adding value over time. ROIC uses accounting data which is available for outside investors. While NPV and IRR are project specific, ROIC is for the firm as a whole. ROIC more relevant for outside investors because they typically cannot invest in a firm's indiv projects.

26.2 Capital allocation principals and real options

Capital allocation process involves the following key principles: 1) decisions are based on after tax cash flows, not accounting income. Accounting income is based on accruals and doesn't consider timing of CFs, impact of taxes must be considered when analysing CA projects. Firm value is based on cash flows firms get to keep, not those they send to govt. ! ! Any tax savings from non cash tax deductions, such as D&A should also be included in the analysis 2) incremental cash flows only (those that change if the project is undertaken). Sunk costs are costs that cannot be avoided even if the project is not undertaken. Bc these costs are not affected by the accept or reject decision, they should not be included in analysis. 'Cannibalisation' occurs when a new project replaces sales from an existing project, and a positive externality occurs when doing the project would have positive effect on sales of a firm's other product lines. 3) timing of CFs - CA accounts for time value of money

26.1 Capital Investments and Project Measures iii

Capital allocation process is identifying and evaluating capital projects (where cash flows received over a period longer than a year). Any corporate decisions with an impact on future earnings can be examined like this. May be most important responsibility of financial manager bc 1) Capital allocation decision can involve purchase of costly long term assets with lives of many years, and decisions can underly future success of firm 2) Principles underlying the capital allocation process also apply to other corporate decisions, such as working capital management and making strategic M&A. Making good capital allocation decisions is consistent with mgmt primary goal of maximising shareholder value.

26.2 Capital allocation principals and real options ii

Common mistakes of managers make when evaluating projects have 2 categories, cognitive errors (calculation errors) and behavioural biases (errors of judgement) Cognitive errors - poor forecasting, not considering cost of internal funds. Often the cost of internally generated funds is not accounting for (it should be the cost of equity as these funds would have been paid as dividends if not for project). Companies that have an aversion to paying dividends are potentially using the RE to fund poor projects - incorrectly accounting for inflation, any analysis on real CFs must also use a real discount rate

25.1 Working capital and liquidity 25bii

Companies generally rely on primary sources of liquidity. If needed p, company can rely on secondary liquidity sources: -cash saved by suspending dividends to shareholders -delaying or reducing capital investments -selling assets -issuing additional equity -restructuring debt to extend maturity -bankruptcy protection filing, which suspends the need to service the liabilities Using secondary liquidity sends negative signals to market, and are most costly than primary. CCC may change w seasonality and as business conditions change e.g. dip in demand. Cash and marketable securities serve as a buffer to meet obligations when there is a deviation from normal CCC. Excess cash has a cost bc not invested in the business, but inadequate liquidity can result in having to rely on higher cost secondary sources.

26.1 Capital Investments and Project Measures viii

Concerns with ROIC - bc accounting treatments differ, ROIC may not be comparable - ROIC is backward looking and can be volatile from year to year - because ROIC is for the whole company, it may let profitable projects and good decisions mask unprofitable projects and poor decisions

24.1 Corporate Governance / LO 24b

Corporations hold AGM at end of fiscal year, provide shareholders with unaudited statements for the year, addresses company performance and actions and answers shareholder qs. Corporate laws dictate when this must occur and how to be communicated to shareholders, any one owning shares can typically attend, speak and ask qs and to vote their their shares. Shareholder who doesn't attend can vote by proxy, assign vote to another person who will attend the meeting, proxy may specify the shareholder's vote on specific issues or leave discretion to proxy. Ordinary resolutions like auditor approval and director elections require majority vote. Others are discussed at extraordinary general meetings, which can be called anytime shareholder vote needed, examples include amendment to company bylaws, merger or takeover, special board election proposed by shareholders or liquidation of firm.

23.1 Investors and other stakeholders / LO 23c ii

Environmental: material factors can impact operations/business models. Can be indirect or direct environmental impact. Companies may face physical risk of adverse effects of climate change on assets/operations, as well as transition risk as govt regs or consumer choice means they have to switch from high to low-carbon activities. Stranded assets are those that become unviable due to such changes. Poor safety policies or inadequate governance systems increase the risks of adverse events (oil spills, contamination). The costs of penalties+litigation+ reputation loss etc can be significant risks for investors. Social: Protection of data privacy, customer satisfaction, employee engagement, D&I, labour relations and community relations. Taking measures to reduce social risk (company image etc) can reduce costs through higher employee productivity, lower turnover, increased customer loyalty, less litigation risk. Governance: Board composition, IA, exec comp, bribery/corruption/political contributions and lobbying. CG systems should have adequate checks to ensure managers act lawfully/ethically/in shareholder interests. - Analysts should identify and measure ESG risks a company is exposed to and how this will affect CFs. Equity investors bear the brunt of risk of adverse outcomes. Debt investors have less exposure unless they result in default. Because some risks may be delayed, longer-maturity debtholders may be more exposed to ESG risk than short-term debtholders.

25.1 Working capital and liquidity 25c iii

Firms should maintain a variety of alternative sources and evaluate the costs of each source, while securing sources ahead of time to meet spikes in liquidity needs. Factors that affect a firm's approach to short term funding : - company size (smaller firms have limited options) - creditworthiness (which affects the interest rate on loans as well as operational restrictions imposed) - legal systems (developed economies with well defined protections for lenders offer more funding alternatives) - regulatory concerns (firms in regulated industries, such as banks and utilities, have restrictions on funding sources as well as amounts raised) - underlying assets that serve as collateral on loans

25.1 Working capital and liquidity 25bi

For an asset, liquidity refers to its nearness to cash. For a liab, liquidity refers to its nearness to settlement. Assets that can be quickly converted to cash (marketable securities) are considered liquid. Inventory is less liquid than accounts receivable. Inventory may need processing before a sale and once sold, inventory might be converted to AR, which needs to be collected to be converted into cash. For a corporate issuer, liquidity = availability of cash and other liquid assets to meet short term obligations. Primary liquidity sources include cash and MSs on hand, bank borrowings, cash generated from business. Long term solvency of a co meant depends on its ability to generate sufficient cash from its business to service its liabs. Analysts evaluate a company's liquidity mgmt primarily by reviewing its statement of cash flows.

24.1 Corporate Governance / LO 24b and c

Govts often enact and enforce regs that govern company actions, often by establishing agencies to regulate sectors or monitoring specific issues like health and safety and environmental protection. In some countries, regulators develop corporate governance codes that companies must either adopt or explain why they haven't. In some counties, CG regs are in stock exchanges' listing requirements. When CH weak, control functions of audits and board oversight may be weak as well. Risk is that some stakeholders gain advantage to the disadvantage of other stakeholders. Accounting fraud, or poor record keeping will have negative implications for company performance and value. When governance weak and managers not monitored, they may serve their own interests with less than optimal risk, reducing company value. Without proper monitoring and oversight, mgmt may have skewed incentives and engage in related party transactions that benefit friends and family to the detriment of shareholders.

22.1 Features of Corporate Issuers / LO 22a i

Organisational forms = how businesses are set up from a legal and organisational POV. Features include: - Whether the business is a separate legal entity from owners - Whether owners also operate the business, and if not, the nature of relationship b/w owners and operators - Whether owners' liability for the actions and debts of the business is limited or unlimited - The tax treatment of profits or losses from the business - Access to additional capital to fund expansion and distribute risk

24.1 Corporate Governance / LO 24b vi

Other committees industry specific. Risk committee (financial services) informs the board about appropriate risk policy and risk tolerance of org and enterprise-wide risk management and investment committee (insurance) reviews and reports to the board prudent investment and capital mgmt policies. Regs often require firms have ACs, and composition of a board committee is often based on its function, with ACs, CCs and GCs often made up of non executive or independent directors. Labour laws, employment contracts and the right to form unions are the primary mechanism for employees to manage relationships with employers. Some countries have laws that require boards of large companies to include employee representatives. Employee stock ownership plans (ESOPs) may help align employee and company interests. For customers and suppliers, contracts tend to be mechanism though which they manage their relationships with companies. Stakeholders recently have been using social media.

24.1 Corporate Governance / LO 24c ii

Poor compliance can lead to legal and reputational risk - violating stakeholder rights can lead to lawsuits, and failure to comply with govt regs can damage reputation while failure to manage creditor rights can lead to debt default and bankruptcy. Effective CG can improve operational efficiency by ensuring that mgmt and board member incentives align with shareholders'. Effective governance implies effective control and monitoring and avoidance of legal and reg risk. Formal policies on conflicts of interest and RPTs can also lead to better operating results. Proper governance wrt interests of credits can reduce the risk of debt defaulting or bankruptcy, thereby reducing the cost of debt financing. Aligning of mgmt interests with those of shareholders leads to better financial performance and greater company value.

26.1 Capital Investments and Project Measures v

Positive NPV project is expected to increase shareholder wealth, a negative NPV project is expected to decrease it, zero NPV project has no expected effect on shareholder wealth. For independent projects, the NPV decision rule is simply to accept any project w positive npv. Usually required rate of return for a given project is the firm's cost of capital. A project analyst may adjust the rate of return higher or lower than this to account for differences between the project risk and the average risk of all the firm's projects (which is what the cost of capital shows) Minimum IRR above which a project will be accepted is called the hurdle rate. A project has conventional cash flow pattern if one or more cash outflows followed by one or more cash inflows. Unconventional if more than one sign change, or the time intervals between cash flows differ. Need spreadsheet software for this.

24.1 Corporate Governance / LO 24a i

Principal-agent relationship can arise because agent hired to act in interests of principal but agent's interest may not coincide exactly with principal's. Underwriting standards used to mitigate this and also continuing to work only with agents who act in company's best interest. Agency costs are costs of principal-agent conflict. Can be direct (hiring monitors) or indirect (opp cost of lost business). -shareholders are principals and management are agents. Managers may choose lower level of business risk than ideal as they may lose their income if firm fails. Shareholders can however diversify portfs cheaply. -conflicts arise if mgmt favour one group of shareholders at expense of another. Information asymmetry b/w A and P, decreasing monitoring ability to see if A is acting in P's best interest. More acute w big companies, complex products and lower levels of institutional ownership and free float. Common P-A conflicts: -insufficient effort from managers, poor evaluation of investment opportunities and risks taken -managers getting option grants may increase risk as options have no downside while managers compensated with cash may be inadequately motivated to take risk. -incentive building through poor acquisitions if comp tied to company size -self-dealing, exploiting firm resources for personal benefit -managers may seek to entrench themselves by taking inadequate risk, mimicking competitor's actions rather than original ideas or engaging in unprofitable projects that require their knowledge. Directors may entrench themselves by going along with decisions instead of questioning them

26.2 Capital allocation principals and real options iv

Real options are future actions that a firm can take, given that the invest in a project today. Give the holder the right but not the obligation to take a future action. The value of real options could enhance a project's NPV. Options never have negative values because if in the future the specified action will have a negative value, the option holder will not take the action. Types of real options - 1) timing options: Can delay making an investment bc expects to have better info in future 2) abandonment options: allow mgmt to abandon a project if present value of incremental cash flows from existing a project exceeds the PV of the incremental cash flows from continuing 3) expansion or growth options: allow a company to make additional investments in future projects if company decides they will create value

25.1 Working capital and liquidity 25aii

We can think of accounts payable as implicit source of credit from suppliers, as opposed to explicit sources such as bank loans. Suppliers offer payment terms in the form a/b net c, which means a % discount of a if the invoice is paid within b days, otherwise full payment due within c days. A company can find a lower EAR by borrowing from their lenders as opposed to foregoing the discount. CCCs vary by industry; pharma have long CCCs bc they maintain inventories of high margin drugs to meet surges in demand, airlines have low CCCs bc most of their sales are prepaid and do not keep significant inventories. Analysts should use the CCC to compare companies within the same industry or to track performance over time. In addition to CCC, overall levels of working capital can indicate how efficiently a company manages its liquidity. To compare companies of different sizes, analysts calculate WC as a proportion of sales. Compare in similar lines of business.

25.1 Working capital and liquidity 25c

Working capital mgmt seeks to maximise profits while ensuring that sufficient liquidity is available to maintain the firm's operations and meet its obligations. Firms may choose to hold more short term assets (which offer lower rates of return) to ensure that sufficient cash is available to service its obligations. The firm can also choose to finance its WC using short term loans, which are cheaper than sources such as long term debt and equity. However, the firm must consider the risk of being able to roll over short term debt at a reasonable cost. Important to control for size differences between companies. We do this by calculating companies' relative amounts of long term vs short term assets as a proportion of sales.