The Scope of Corporate Finance

sole proprietorship

A business with a single owner.

public company

A corporation, the shares of which can be freely traded among investors without obtaining the permission of other investors and whose shares are listed for trading in a public securities market.

limited liability company (LLC)

A form of business organization that combines the tax advantages of a partnership with the limited liability protection of a corporation.

joint and several liability

A legal concept that makes each partner in a partnership legally liable for all the debts of the partnership.

corporation

A legal entity, owned by the shareholders who hold its common stock, with many of the economic rights and responsibilities enjoyed by individuals.

limited partnership (LP)

A partnership in which most of the participants (the limited partners) have the limited liability of corporate shareholders, but their share of the profits from the business is taxed as partnership income.

fiduciary

A person who invests and manages money on another's behalf.

partnership

A proprietorship with two or more owners who have joined their skills and personal wealth.

Sarbanes-Oxley Act of 2002 (SOX)

Act of Congress that established new corporate governance standards for U.S. public companies.

financial intermediary (FI)

An institution, such as a bank, that raises capital by issuing liabilities against itself, and then uses the capital raised to make either loans to corporations and individuals or to buy various types of investments.

S corporations

An ordinary corporation in which the stockholders have elected to allow shareholders to be taxed as partners while still retaining their limited-liability status as corporate stockholders.

equity capital

An ownership interest purchased by an investor, usually in the form of common or preferred stock, that is expected to remain permanently invested.

primary-market transactions

Cash sales of securities to investors by a corporation to raise capital.

agency costs

Costs that arise from conflicts of interest between shareholders and managers.

stakeholders

Customers, employees, suppliers, and creditors of a corporation.

executive compensation plans

Incentives offered to a manager to encourage her to act in the best interests of the owners.

residual claimants

Investors (typically common stockholders) who have the right to receive the cash that remains after a firm pays all of its bills and makes necessary new investments in the business.

debt capital

Long-term borrowed money.

general partners

One or more participants in a limited partnership who operate the business and have unlimited personal liability.

limited partners

One or more totally passive participants in a limited partnership, who do not take any active role in the operation of the business and who do not face personal liability for the debts of the business.

stock options

Outright grants of stock to top managers, or, more commonly, giving them the right to purchase stock at a fixed price.

shareholder

Owner of common or preferred stock in a corporation.

equity claimants

Owners of a corporation's equity securities.

venture capitalists

Professional investors who specialize in making high-risk/high-return investments in rapidly growing entrepreneurial businesses.

financing function

Raising capital to support a company's operations and investment programs.

board of directors

Representatives elected by shareholders to be responsible for hiring, firing, and overseeing managers and for setting overall corporate policies.

double-taxation problem

Taxation of corporate income at both company and personal levels—traditionally a significant disadvantage of the corporate form.

hostile takeover

The acquisition of one firm (the target) by another (the acquirer) through an open market bid for a majority of the target's shares if the target firm's senior managers do not support (or, more likely, actively resist) the acquisition.

corporate governance function

The activities involved in developing company-wide structures and incentives that influence managers to behave ethically and make decisions that benefit shareholders

risk management function

The activities involved in identifying, measuring, and managing the firm's exposure to all types of risk to maintain an optimal risk-return trade-off and therefore maximize share value.

corporate finance

The activities involved in managing cash (money) that flows through a business.

financial management function

The activities involved in managing the firm's operating cash flows as efficiently as possible.

capital budgeting function

The activities involved in selecting the best projects in which to invest the firm's funds based on their expected risk and return. Also called the investment function.

agency problems

The conflict of interest between the goals of a firm's owners and its managers.

Securities and Exchange Commission (SEC)

The federal agency, established in 1934, charged with oversight of the fair reporting of financial information to investors in public companies (those whose shares are listed for trading in a public securities market).

initial public offering (IPO)

The first public sale of a company's common stock, offered through the sale of shares to outside investors and listed for trade on a stock exchange.

president or chief executive officer (CEO)

The top company manager with overall responsibility and authority for managing daily company affairs and carrying out policies established by the board.

hedge

To use complex financial instruments to offset market risks such as interest-rate and currency fluctuations.

chief financial officer (CFO)

Top management position charged with developing financial policies and strategies covering all aspects of a firm's financial management and accounting activities.

secondary-market transactions

Trades between investors that generate no new cash flow for the firm.

collective action problem

When individual stockholders bear all the costs of monitoring management, but the benefit of such monitoring accrues to all shareholders.

corporate charter

When individual stockholders bear all the costs of monitoring management, but the benefit of such monitoring accrues to all shareholders.